Economic Update
Market observers have been scrutinising Turkey’s rate of inflation of late, and with good reason. They are partially right in concluding the country was wide off its target as inflation reached 8.4% last month: almost 4.5% over the annual target for 2007. But close inspection shows the gap between Turkey’s current position and its target is not as unbridgeable as it might appear.

That said, the spike in inflation between October and November was significant. Last month the central bank’s monetary policy committee revealed that consumer prices increased by 1.8% during October, pushing annual inflation up to 7.7%. A further 0.7% increase was added in November.

A number of factors have been responsible for the rise. The drought this summer pushed agricultural commodity and processed food prices up, with consumers having to pay for a shortfall in domestic food supplies. Figures from the central bank (TCMB) showed that the prices for non-alcoholic beverages and food spiked by 14.7% year-on-year.

Increased household expenses have also been a factor, with new municipal water tariffs in Istanbul accounting for a 14% increase in costs in November compared to the previous month, according to the local investment firm and brokerage house AK Securities.

In November the government announced tax hikes on tobacco and petroleum products. While the special consumption tax on tobacco was increased from 1.40YTL to 1.55 YTL ($1.19 to $1.31), the tax for gasoline increased by 5% on average. The central bank predicted these would account for a 0.8% rise in inflation.

Meanwhile, consumers are bracing themselves for anticipated electricity and natural gas price increases.

The rise in the price of global crude oil hardly helped, particularly for a country that, according to energy experts, imports 92% of its oil supplies. Consumers have had to bear the brunt of the higher logistical costs of transporting goods and produce. The central bank nonetheless points out that the strength of the Turkish lira has limited the internal impact of the global rise in crude prices.

This is not to say that the causes of Turkey’s higher-than-desired inflation can be explained solely through recent events.

“The turmoil in the market that we experienced in June of last year was one of the reasons why inflation has deviated from the target,” Durmus Yilmaz, governor of the TCMB, told OBG. “There was a huge, almost a 3.5%, pass-through effect until the end of the year due to the negative currency development.”

The run on emerging markets in mid-2006 saw the Turkish lira lose almost 20% of its value and saw the Istanbul Stock Exchange (ISE) index fall by 32.3% in US dollar terms by the end of June that year.

While the divergence between reality and Turkey’s inflation target may appear significant, a number of considerations help neutralise initial fears. “Positively, by reducing the purchasing power of consumers, high food and energy prices restrict demand on other items of the consumer price index basket and help service sector disinflation,” said Hakan Aklar, chief economist at AK Securities.

The TCMB also underlined positive inflationary developments in the CPI basket – a reference to the breakdown of inflation as applied to individual commodities, goods or activities in the economy.

“Excluding food and energy prices, inflation for goods is around 5% and therefore in that respect the disinflation process is continuing,” said Yilmaz. “When you look at the services sectors as well, inflation in this area stayed around 11% for some time in a very sticky way. But it also began to come down starting in the second quarter of this year. As of today, inflation for services stands at around 8%.”

Despite the setbacks, the TCMB maintains that the disinflation process resulting from its tight monetary policy is in fact working. In support of this, Aklar said that annual core inflation, which excludes such inflationary commodities as energy, unprocessed food, alcoholic beverages, tobacco products and gold, remains flat at 6.4%.

As a result, most economists have expressed optimism that the current inflationary pressures will fade. Through cutting interest rates in a measured fashion to encourage economic growth, the central bank is confident the fruits of its disinflation efforts will become far more apparent in the medium term. In this respect, it is telling that the inflation target for 2008 and 2009 remains at 4%.