Turkey central bank vows fully-fledged inflation targeting strategy

Turkey’s central bank pledged a full-frontal battle against double-digit inflation, saying a borrowing boom last year continued to hurt the inflation outlook and the current account.  

Central bank governor Naci Ağbal, appointed by President Recep Tayyip Erdoğan in early November, signalled that he was committed to bolstering the central bank’s independence, severely undercut in recent years, and to slowing inflation towards an elusive medium-term target of 5 percent.

“In 2021, the central bank will implement a full-fledged inflation targeting strategy and make monetary policy decisions in pursuit of the primary objective of price stability,” Ağbal, 53, said in an online presentation of the bank’s quarterly inflation report on Thursday.

“All factors affecting inflation will be taken into account, and the tightness of monetary policy will be decisively sustained until there are strong indicators that point to price stability and a permanent fall in inflation,” he said.

Turkey’s central bank has raised interest rates to 17 percent from 10.25 percent since the arrival of Ağbal, a former finance minister. But inflation has continued to pick up, accelerating to an annual 14.6 percent in December from 14 percent the previous month.

Ağbal said that the central bank has retained a goal of slowing inflation to 9.4 percent by the end of the year even after the inflation rate climbed. That target compares with an average expectation of 11.2 percent in the bank’s monthly survey of finance industry professionals and business leaders.

Increased domestic demand, caused by high credit growth, “continues to have an adverse effect on the current account balance and inflation”, Ağbal said.

“The strong credit impulse boosted imports through the channels of both domestic demand and inflation expectations and dollarisation and became an important driver of the deterioration in the current account in 2020,” he said.

Investors are looking to Ağbal to drive down inflation this year even if Erdoğan’s government pressures him to ease monetary policy. Ağbal’s predecessor, Murat Uysal, helped the government fuel last year’s borrowing boom by keeping interest rates at below annual inflation. He was then forced to spend tens of billions of dollars of the bank’s foreign currency reserves defending the lira, leaving them severely depleted.

Erdoğan has sacked two central bank governors in two years and has reiterated his opposition to high interest rates twice this month. Erdoğan claims that higher borrowing costs stoke inflation, a view that contradicts with conventional economic theory.

The lira hit a record low of 8.58 per dollar on Nov. 6, the day before Ağbal’s arrival. It was trading up 0.5 percent at 7.35 per dollar after the governor spoke.

Ağbal said that loan growth in Turkey has been slowing significantly due to tighter monetary policy.

“It is essential that loans and domestic demand move towards a moderate path,” he said.

A “considerable high rise in the minimum wage” was also impacting inflation, he said. The government, labour unions and employers agreed to hike the minimum monthly salary for 2021 by 22 percent at a meeting last month.

The wage increase “will affect inflation adversely through the channels of services prices in particular and increasing inflation rigidity,” Ağbal said.

A rise in global commodity and food prices was also hurting the central bank’s efforts to tame inflation and “the tendency to raise prices has become widespread across sectors”, he said.

“The decisive implementation of the tight monetary policy in line with the 5 percent medium-term inflation target will cause the inflation expectations to become compatible with the target, exchange rate pass-through to decline to reasonable levels, and inflation rigidity to go down,” he said.

Ağbal said demand in Turkey for foreign currency and gold, spurred on by high inflation and lira weakness last year “keeps the risks that may lead to a delay in disinflation process alive”.