The Turkish Republic Central Bank (TCMB) has decided to raise interest rates and revise its inflation targets for the coming three years. While some local businesses bemoan the fact that interest rates remain stubbornly high and that economic growth may be affected as a result, the decision is a clear indication of the bank's efforts to curb inflation as a priority and to persevere with an inflation targeting policy that has come under criticism in recent weeks.
On June 4, Minister of State for economy Mehmet Simsek announced that the government and the TCMB had agreed to raise the inflation target for 2009 to 7.5% from 4%. The targets for 2010 and 2011 were also revised to 6.5% and 5.5% respectively. On May 15, the TCMB raised interest rates for the first time in two years pushing the lending rate up 50 base points to 15.75% and increasing the lending rate by the same margin to 19.75%.
The moves come on the back of an inflation rate that has reached a 14 month high. In May Turkey's consumer price index (CPI) inflation reached 10.7%, up from 9.7% in April. The rise can be mainly attributed to the global spike in food and fuel prices that has affected the economies of developed and emerging markets alike and driven the average world inflation rate to 5.5%, the highest level since 1999.
In an open letter to the government that accompanied the rate rise in May the TCMB blamed "exceptionally persistent supply shocks" for its failure to meet inflation targets. As an oil importing country Turkey has been particularly hard hit by rising oil prices that peaked at $135 a barrel in May. While Minister Þimþek said at the time that 'the risk of a persisting inflation shock in Turkey is very low', the revision of the targets suggests that the government has acknowledged that the effect of high food and oil prices will continue in the coming years.
The inflation targeting process, which was adopted by Turkey on an implicit basis in 2001 under a letter of intent submitted to the IMF and on an explicit basis since 2006, had been at risk of losing all relevance. The TCMB has missed its targets for each of the past three years and the 4% target for 2009 appeared totally out of touch with the realities of the global economic situation.
The targeting process has the merit of improving the transparency and accountability of the central bank's policy, and is worthwhile maintaining therefore, as long as the goals are achievable and reflect local and global economic conditions. The inflation targets for the coming years are all higher than the TCMB's forecast inflation rates of 6.7% (2009) 4.9% (2010) and 4% (2011). This should give the government additional leeway in meeting these targets should price shocks continue.
There is widespread expectation in the local banking community that the TCMB will raise interest rates by a further 50 basis points when it meets on June 17 in order to further ease inflationary pressure.
Not everyone is convinced that this is the correct strategy to pursue, however. Christian Keller an economist from Barclays Capital in London, told investors in an email note that the decision to raise the inflation targets was 'premature' and indicated 'limited ambition in terms of achieving disinflation'.
Representatives from business associations including the Independent Industrialists and Businessmen's Association and the Ankara Chamber of Commerce have said that the May increase in rates will impair business expansion and employment and only benefit currency speculators.
The government have already revised its growth projections in the wake of the global liquidity crunch. Finance Minister Kemal Unakitan told the local press that "Turkey will grow 4% in 2008 and 4.5% in the following years. But growth rates of 7, 8 or 9% will not be seen in Turkey for a few years." Further rate increases in June could exacerbate the slowdown.
The TCMB's decision to raise interest rates and maintain inflation targeting is a necessary one. Given the country's history of high inflation (in the 1990's it frequently exceeded 100%) it is crucial to maintain fiscal discipline and increasing interest rates are of central importance to this end. At the same time, however, if inflation targeting is to have any use at all, it needs to provide tough but achievable goals. The upwards revision of the inflation target was the only feasible way to reflect the inescapable effect of escalating food and oil prices.
Nevertheless, the central bank may well find that domestic issues are fanning the inflation fires. Following the expiration in May of the IMF's standby agreement with Turkey there is a risk that the fiscal discipline imposed by the Fund will be eased. In late May the Turkish Industrialists and Businessmen Association (TUSIAD) accused the government of introducing 'populist' policies. The decrease in the rate of primary surplus from 6.5% to 3.5% and a YTL 4bn increase in the allocation of funds towards local authorities were given as examples of this trend. The criticism serves a reminder that while global commodity prices may be beyond the control of Turkey's central bank in its enduring battle against inflation, domestic policies still matter.