Tuesday, March 31, 2009

Ideas for the Hurriyet Daily News Column

I always tend to get really good ideas for my columns in the most unusual times: When I am driving, at Inonu or even erging. Anyway, I usually do not jot down these and when I do, it is invariably always illegible. So I decided to keep a weekly tab of interesting ideas for my columns. I plan to start the laundry list on Monday or Tuesday and then add in as new ideas emerge.

Of course any comments and/or suggestions are always welcome:

Let's see how it goes:
  1. The take from past week's data (especially growth and inflation).
  2. Revisiting my outlook for bonds and FX.
  3. A Hithchiker's guide to the Turkish economy (some common misconceptions like: retail investors will continue to support the lira, Turkey is eligible for the new IMF facility, CBT quantitative easing, tourism and exports will benefit from the weak lira, credit guarantee fund will not work- it's the leverage & confidence, stupid)
  4. Banking sector outlook (Banking on rate cuts while it lasts).
  5. Economist's take on the local elections (is it really the economy, stupid).
Right now, I am leaning towards 2, 3 or 4...

Special article for Hurriyet Daily News: Buck Rogers and the 25 Sentries

Below is the unedited version of a special column I wrote for Hurriyet Daily News. It was designed as part of an excellent series on the global meltdown and what to do about it. I wrote the article Thursday evening at Elmadag Starbucks; it appeared in today's paper. You can see the final (edited) version at the Hurriyet website: Although I do not agree with all the editors' edits all the time, I have to give them credit for the title. Their title is much better than my original one, which was a bit cheesy. BTW, the hard copy has really nice graphs, for which the credit goes to my editors as well. Well done guys, I couldn't have chosen better myself...

God created the world in six days. The leaders of the Group of Twenty countries have just one to save it (there are actually 25 of them at this meeting and hence the title). But the cure to any illness comes from the right diagnosis. In a similar vein, to discuss what the G-20 should do and will do on April 2, one first needs to be clear on what is behind the crisis and why the crisis is taking so long to resolve.

First of all, while I am not a big fan of the maestro myself, easy US monetary policy during the last years of the Greenspan era did not cause the current mess, although it provided the necessary nice & warm cultivation environment in the form of a liquidity flush. Similarly, financial innovation was not the culprit, lax financial supervision & regulation coupled with distorted incentives were. But if this was it, we would not have been dealing with a global crisis, just a bigger version of the numerous crises of the past two decades such as the time when genius failed (LTCM fallout and the Asian crisis), savings & loans fiasco and the dotcom crash. At a more fundamental level were the global current account imbalances that have been eloquently brought to light by Financial Times Economics editor Martin Wolf in his weekly columns for the past couple of years and his most recent book. These balances were to be corrected sooner or later; the catalysts above contributed to a rapid and therefore damaging unraveling rather than a slow and steady adjustment.

Given the nature of the crisis, the first priority of the G-20 should be to agree on a global response so that these global current account imbalances will shrink rather than get amplified. After all, everyone needs to chip in wood to light a strong fire, as a proverb from China, which has started the largest stimulus package along with the United States, aptly puts. However, imposing strict guidelines, such as the IMF proposal of a fiscal stimulus of 2% of GDP, should be avoided on many grounds. First, a one-size-fits-all jacket ignores each country’s unique economic structure. For example, while the German stimulus seems to pale in comparison to the American one when the actual numbers are compared, adjusting for automatic stabilizers brings it to the same level. Similarly, as Tolstoy noted in the opening sentence of Anna Karenina, all happy families are alike, but every unhappy family is unhappy in its own way. Each country has different room for fiscal policy, based on their balances at the onset of the crisis and their monetary policy stance, among other things. For example, contrary to the conventional wisdom, the consequences of attempting a stimulus of Chinese proportions would be devastating for the Turkish economy. So, the G-20 should be agreeing on general guidelines rather than specific targets and emphasizing the willingness to act together, not only now but also in the future.

But this is barely enough, given the financing woes of many emerging markets. The Institute of International Finance, the global association of financial institutions in Washington, DC, forecasts capital flows to emerging and poor countries to retract to USD 165bn in 2009 from almost a trillion in 2007. While emerging markets like Turkey have not had much trouble in tapping domestic markets so far, the private sector has not been so lucky. Therefore, the IMF’s resources should definitely be at least doubled to USD 500bn, so that the Fund does not run out of funds soon. Other matters related to improving the IMF, such as defining a new role and drawing up new voting rights, should be put to sleep for now in favor of expediency. One exception could be extending this week’s reforms on doing business with emerging markets to low-income countries.

A third direction the G-20 should take is a clear stance against protectionism. While a global protectionist backlash similar to the aftermath of the Great Depression is unlikely, anti-dumping cases and buy-domestic clauses are surging not only in dirigiste countries such as France but also in bastions of laissez faire capitalism such as the United States. Further protectionism would cause world trade to contract much more than the optimistic 9% forecast of the World Trade Organization. I should emphasize that I am hoping for a bit more than polished words from the meeting, as talk is cheap. In fact, a recent Word Bank note reports that 17 of the very same 20 who had “underscored the critical importance of rejecting protectionism” back in November at the summit in Washington, DC have resorted to various protectionist measures since then.

The G-20 is likely to adopt measures similar to the ones above when it meets next week, even though we will have to wait and see if they will be able to walk the walk rather than just talk the talk. That much I am not worried about. What I am concerned about is that they will attempt at much more and end up achieving much less, especially as the G-20 agenda is more and more looking like a grocery list, with anything but the kitchen sink thrown in. For example, even more ambitious than an overhaul of the IMF I advised against above, the G-20 has been charged with setting up a global financial regulatory structure, creating an early warning system to prevent future crises and help the poor, who are starting to get affected from the crises.

Some of these measures are debatable. For example, the much-touted-for Spanish banking regulation model, where banks have to adapt cyclical capital provisioning, may help marginally at best. Similarly, global regulation may not be the optimal response, as Harvard-based Turkish economist Dani Rodrik has argued eloquently in a recent article in The Economist. Other measures make sense from an economic point of view, but homo sapiens is not only homo economicus, but also homo politicus. Such ambitious proposals are likely to divert the G-20 from the real problem at hand. To me, it seems downright silly that many are concentrating on preventing future fires without putting out the current one at first. Moreover, a more ambitious list also means more potential sources of discord, which is likely to lead to end-results that will not satisfy anyone.

As for the market response, despite some like George Soros are expecting miracles from the meeting, my sense is that the market is not too optimistic. Therefore, the risk of a negative reaction is quite low, unless the world leaders come out completely empty-handed. In this sense, I am crossing my fingers that the meeting will not be diluted by China’s demands for a new reserve currency or the recent Czech anger at the US fiscal profligacy- both countries will be present at the meeting, the latter because it is holding the EU presidency. Such outbursts reflect the growing worries on the decline in the dollar and at a more fundamental level who will bear the burden of the US fiscal stimulus at the end of the day, another important debate that should be postponed.

But if the G-20 does not act decisively next week, there will not be many trees left to save in the next wildfire.

Emre Deliveli is an independent consultant. His daily Economics blog is at http://emredeliveli.blogspot.com/.

I am back!

I had to stop my blog entries for a while due to a couple of unforeseen things like travel, too much work, etc (planning ahead is not one of strong points). Anyway, I am finally back.

As a first step, I plan to put in the unedited versions of my Hurriyet Daily News articles for the past month and a half here, as I also use this blog as an archive for those. Hopefully, I should be up and running in full gear tomorrow. But in the meantime, just for entertainment, here are two economist takes on the Turkish last quarter GDP figures, which were released just over an hour ago:
Q4 GDP data worse than expected

Turkey full year GDP better than expected
Sounds contradictory, but what happened is that the second and third quarter figures were revised upwards. Still, I find it interesting that the two economists have chosen to look at the data from two different views. I was expecting something worse for the last quarter and smaller revisions, so for me both the Q4 and the full year are better than expected! I guess the greater the bliss the smaller the expectations:)...

Monday, March 30, 2009

Weekly Hurriyet Column: Busy Week, quite a few surprises

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. I guess this is my most precise column to date, but you didn't need to be a genius what would come (or not come) from the G-20.

There is a busy domestic and international agenda next week, which could spit out quite a bit of surprises.

Inflation could go for another upward surprise on Friday, as my own analysis points to a turnout of around 1%, somewhat higher than market expectations of 0.8%. While they are rather crude preliminary indicators of the official figures, a nasty April Fool’s day joke from the Istanbul Chamber of Commerce indices would increase the likelihood of a higher-than-expected turnout on Friday. In any case, a 1% reading would leave yearly inflation roughly unchanged, whereas the I index, the Central Bank’s favorite measure of core inflation, could continue with its crawl downwards. But this month’s figure will not change my somewhat unconventional conviction that the Bank (as well as most analysts) is taking many inflationary risks for granted. In fact, I would not be surprised if inflation edges up to the upper portion of the Bank’s forecast range of 5.4-7.2% after hitting 6% by the end of the summer.

At the end of the day, however, even a higher-than-expected March inflation is unlikely to move markets or change anyone’s outlook. The burden of providing the weekly shocker will instead fall on growth and to a lesser extent the trade balance, both of which will be released on Tuesday. With growth, it is not a question of whether the economy has contracted in the last quarter of 2008, the issue is by how much. Here, I again find the market expectation of 5.8% (year on year) a tad bit of too optimistic and would not be surprised if the yearly contraction approach double-digit territory.

Another surprise could come from the trade balance, but here the problem is one of measurement. The well-known link between oil prices and Turkey’s net energy imports has recently broken, making a good forecast of the trade balance rather difficult. In any case, at this point, I would pay more attention to the Turkish Exporters Association’s monthly export figures for March rather than the official statistics for February. I am keeping my fingers crossed that we will not fall to yet another April Fool’s day joke there.

But even a real blow from growth will pale in comparison to a shock bomb from the international front. Here, while the international agenda is quite busy, with such heavyweight items as the European Central Bank rate decision, purchasing manager indices on both sides of the Atlantic, and last but not the least, US non-farm payrolls, the real bliss or heartbreak could be the G-20 summit on April 2. I have written a comprehensive analysis of what the G-20 should and will do for this paper, which will appear tomorrow. But to give out a few spoilers, a global fiscal response to the crisis without too many strict guidelines, at least doubling of the IMF’s resources and concrete steps towards preventing protectionism would make me more than happy. While we are likely to get these measures, though some in word rather than in deed, the G-20 agenda is in danger of being diluted with a pointless grocery list. In any case, though the mood could definitely change until Thursday, the markets are not hoping for too much from the meeting at the moment. This is in fact good news, as it means that a positive reaction is more likely than a negative one.

But market-reaction or not, Thursday’s gathering could be the last chance to avert disaster. If the summit does not lead to concrete steps, we could soon find out that the recent signs of recovery were just part of a false spring, a couple of days of sunshine in a long and dark winter.

Thursday, March 26, 2009

Some Weird Pricing

Below is the price menu from the Kentucky Fried Chicken (KFC) in Turkey (thanks to KorayYurekli for the photo).

What I find really puzzling is the pricing for chicken pieces (upper left side): They have set up their pricing scheme so that you do not actually save more my buying more; unless you are buying bulk, say a dozen pieces or more, the best way to go is to buy in sets of two: For example, it is actually cheaper to buy 2+1 rather than 3 pieces (8TL vs 8.25TL). Or let's say you want 5 pieces: You can either go for 5 at 13.50TL, or do a 3+2 for 8.25+5=13.25TL or even better, you can go for 2+2+1 at 5+5+3=13TL.

My first thought was that this was simply a pricing mistake. But when I looked at their delivery prices through Yemeksepeti, an online delivery service, I got slightly higher prices, but the same pricing scheme:

All the exercises I went through above work in exactly the same way, which makes me to believe that it is intentional. Moreover, the cashiers seem to be aware of it, too: I tried this quite a few times (see how demented I am), and unless the cashier is new to the job, they always give you the cheapest deal; for example, when you ask for six pieces, they will write it down as three orders of 2 pieces rather than a 5+1.

I am ashamed to say that after more than a decade of having studied and taught Economics, I could not find a reason, and neither can Koray, who is an engineer (those guys are supposed to be smarter than economists). As a a last resort, I consulted two friends who are hard core micro theorists; they have no crystal clear answer, either.

I am starting to believe that this is an issue worthy of being tackled by the Undercover Economist.

Monday, March 23, 2009

Weekly Hurriyet Column: What makes a good economist?

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. BTW, the Higher Education study I mentioned in the column can be downloaded here. The World Bank commissioned other studies on higher education, and they have a relatively short report incorporating all the studies.

We had another full economics agenda last week, with a couple of events worthy of a separate column, but each will get just one paragraph, as I have to recount my newly-found optimism in the Turkish economy.

Surprisingly, the Central Bank did not surprise this time around, delivering the expected 1 percent cut. I am not worried about a real interest rate of 4 percent driving foreigners away from lira assets. It will not, as we are way past that mysterious threshold; and in fact, we have been seeing steady portfolio outflows since August, which have picked up in the last two months. Note that as a corollary, the relative stability of the lira following the rate decision can not be taken to mean that Turkey’s risk perception has decreased, especially as the lira has been supported by locals’ foreign currency selling. But I am worried about shocks from a stronger-than-expected exchange rate pass-through the rapidly deteriorating budget.

The February budget figures illustrated that higher expenditures, along with lower tax revenues on the back of a slowing economy, are working their way fast. Even without new economic packages, the primary surplus, whether you take the IMF-defined central government or consolidated public sector version, is on a fast downward trajectory and is likely to hit negative territory before summer. The deterioration in the budget, in turn, could put pressure on not only the debt stock, taking the rollover ratio to over 100% even with an IMF program, but also on the Fund itself, who might not be lenient on such major a fiscal expansion.

So, how come I am convinced that the Turkish economy is on the road to salvation? While the new crisis package, which looked promising (but has not gone beyond the consumption boosters, as we still do not know how the government will start credit flowing) certainly lifted my spirits, now that I know there is a first-rate economist at the wheel, I am relieved. How do I know? To recount the story of John and Celine, who are lost flying in a balloon and go down to ask a passer-by where they are: “You are in a balloon”, he answers. Celine comments: “His answer is perfectly right and utterly useless. He must be an economist”.

Economy Minister Simsek’s explanation that unemployment was rising because more people were looking for work is worthy of a true economist. While this added worker effect has been well-documented and was prevalent, albeit to a somewhat lesser degree, during the 2001 crisis, correcting for seasonal effects reveals that non-farm employment has contracted 100-130 thousand in the second half of 2008. Moreover, it would not be a surprise to see a contraction three times this amount this year. And even if the economy starts growing again next year at slightly below its potential, the pick-up in employment is likely to be extremely slow, as firms are likely to respond to the recovery with overtime rather than new employees at first.

Equally remarkable was the minister’s observation that much of unemployment was structural in that it reflected lack of vocations, providing the best summary of the World Bank Labor Market & Higher Education studies of a couple of years ago (email me for those reports), akin to Woody Allen’s sum-up of War and Peace as “taking place in Russia” and yet another indicator that we have a first-rate economist at the helm. Unfortunately, the minister’s solution of more education, albeit noble, is unlikely to do all those unemployed this year any good.

Similarly, the onus is on the prime minister to provide incentives rather than threats to employers to keep the workers employed. And to make sure the ones who are not are supported.

Monday, March 16, 2009

Weekly Hurriyet Column: The new crisis package and the news effect

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. This has been a really ill-timed column, as a couple of hours after I sent it in, the government announced that the package would be effective immediately, killing my news effect...

Reality does indeed bite. Before the ink had dried on last week’s column where I had hinted that growth was to contract more than the one to two percent currently expected, revisions to analyst growth forecasts began to appear, some which made it to the mainstream news media with catchy titles like “shocking revision to the economy”.

I will not dare to suggest that I was the inspiration to those revisions; on the contrary, I am relieved that my back-of-the-envelope forecasting model is in line with undoubtedly more complete ones, all of them (at least the ones I trust) suggesting a contraction in the vicinity of 5%. Fortunately, the government has responded with a new crisis package, in fact its fourth if we take its word for it.

To my knowledge, the only crisis package before was the aptly named “Sack Act”, which was ratified by the President at the end of February. The consensus economist’s view was that the law, which was basically a bunch of half-measures thrown in together, would not amount to much towards alleviating the economic contraction. Therefore, I felt really relieved that there were two other crisis packages I was not aware of. But I have yet to find out what those first two were about.

Leaving the past aside, while the details are somewhat sketchy, the new package hints that more than half a year after the first signs of the slowdown appeared, the government has finally got the diagnosis right. The package concentrates on measures in getting the credit flowing and consumers consuming again, two of the three main channels that have transmitted the global crisis to Turkey -the third is the trade channel, but that is harder to deal with in a short timeframe, especially in the midst of a global recession.

Despite the right diagnosis, we are still a long way from getting cured. In fact, for the credit channel, we do not have an idea what kind of medicine the government is to offer. Other than vague statements such as “steps towards improving credit flow between finance and real sectors”, there is not much else yet.

As for the consumption boosters, there is more clarity, albeit only marginally: A three-month reduction in the special sales tax (OTV) in automobiles and white goods. We are left in the dark on the size, timing and coverage of the reduction, so while even a quick and dirty assessment is impossible at this stage, the reduction does make sense from an economist’s point of view in that it is designed to give a temporary but quick jolt to consumption.

The news effect

While I am optimistic towards this new package, its method of announcement is definitely not very commendable. For one thing, I would have preferred more clarity on the credit mechanisms. As for the consumption measures, consumers will simply choose to delay consumption until the lower taxes are in effect. This is the well-demonstrated news effect, which every student of Macroeconomics encounters at some point. Therefore, the onus is on the government to kickstart the consumption parts of the package really quickly. Otherwise, half of the fourth crisis package will not amount to much more than providing empirical macroeconomists data for academic research.

Even if my optimism proves to be well-founded when the details of the new package emerge, I will have to ask: What took you so long? For, solutions in a similar vein have been around at least since October. Earlier action by the government could have also saved the Central Bank from taking on what I see as excessive risk, or at least rendered its monetary policy more effective. Go figure…

Thursday, March 12, 2009

An Interesting Meeting

One of the advantages of writing at Hurriyet and keeping this blog is that I get to meet a different variety of people than at my previous stints at a think tank in Ankara or as a bank economist in Istanbul. There is nothing wrong with getting to know government officials/bureaucrats or hedgies, just as there is nothing wrong with lahmacun or pizza. But you do yearn for more exotic fare from time to time.

One of those exotics who have contacted me through my columns is Tim Heinemann, a native of Germany who is a PhD candidate at the Department of Geography - Queen Mary, University of London. His research on the Turkish economy and markets, is definitely very different from the usual Econ/Finance research I am used to.

With his permission, I have included below a short abstract and aims of his thesis:

Trading Turkey – Understanding the Social and Material Construction of Emerging Markets

Short abstract
This research examines the social and material construction of emerging markets through privatization, liberalization and foreign investments. The focus is on the relationship between the state, institutions such as central banks, investors and global financial institutions (e.g. IMF) in shaping the current re-construction of these countries. The research aims to understand the development of emerging markets through the concepts of risk, reward, knowledge and trust and their changes. Empirically, it seeks to comprehend the construction of Turkey through government policies and investment practices.

Aims of the project and objectives
The project aims to add to knowledge about emerging markets by focusing on the role of practitioners and policy makers and by focusing on a specific case study – Turkey. In particular, the focus is on three powerful actors; the state, the global financial industry and global financial institutions, their understanding of risk, reward, knowledge and trust and to explain their actions, motivations and relations. Investment decisions are based on the assessment of risk and reward, but in order to understand risks and rewards investors rely on knowledge to assess potential market developments and the creation of trust. Yet, markets do not operate in isolation. Rather, they heavily rely on state action and, in the case of emerging markets, on global financial institutions in turning emerging markets into an attractive place for investments. On the flip side, these policies are again constructed through forms of knowledge which are trusted to support economic growth.

The fieldwork will allow for an exploration of the understanding and practice of these concepts within the finance industry, the government and global financial institutions. It will enable an analysis of how these understandings of markets are changing under the current financial crisis; how and why investment patterns have changed in regards to emerging markets and Turkey. Thus, the research will explore the working practices of the emerging markets industry, what counts as knowledge and why, how is trust created and how these elements create a landscape of risk and reward. Additionally, what is the stake of the government in this process, how are the policies designed towards global financial markets and what is the relation to the IMF and World Bank.

Monday, March 9, 2009

Weekly Hurriyet Column: The curious case of the “resilient” lira

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive . In retrospect, we now (as of April 23) know that there was no repatriation effect at all...

Top-grossing movies, or columns for that matter, deserve sequels. As my mid-February foray into bonds got the most reader responses so far (after disqualifying the hate mails to the political connections piece of two weeks ago), it is only appropriate that I repeat a similar exercise for the lira. Of course, the fact that it is one of the most popular conversation topics of the past few days is an added bonus.

The sharp weakening in the lira last week brought all sorts of skeletons out: Even though the political agenda was quite light for Turkish standards, some put the blame on the politics. Others were quick to jump on the remarks by TUSIAD and Central Bank presidents on the dire straits of the economy. But maybe everyone was looking in the wrong cupboard after all: The secret to the lira may be not lie in last week’s weakness, but in its relative strength before that.

In fact, lira’s resiliency has been the main economic puzzle of 2009 for me so far, not only because the currency had been performing better than peers, but also I was being less and less convinced of a sound rationale for its strength. It is true that Turkey does not share many of the woes of the Eastern European countries whose currencies plunged, and the country usually ranks in the middle in standard risk rankings that take into account factors such as the size of the current account deficit, debt to reserves ratio and the financing gap. However, Turkey was also experiencing more outflows than peers for the past few weeks, as data from EPFR Global, an outfit specializing on fund flow data, have been revealing.

The strong pace of outflows, despite repeated analyst assurances on the country’s strength, is an enigma in itself and could be due to forced selling, sort of a repercussion of Turkish markets’ relative size and liquidity when regional funds could not get out of the small markets. But regardless of the reason, contrary to conventional wisdom, flows have not been supportive of the lira, not in an absolute but also a relative sense.

In the past, it would have been the locals who would come to the rescue in times of lira weakness, selling foreign currency. While still present, that cushioning effect has been rather muted so far this year. It is yet to be seen whether locals have switched from profit-taking to wait-and-see, but local support could not have been the whole story.

One “culprit” that fits in nicely with the data is the repatriation amnesty law, which expired last Monday. While government sources have put the funds drawn at USD 7.5-9bn, we do not have the currency breakdown to assess the role it played on the strength of the lira as well as its recent downfall. In that sense, the lira’s moves next week and its performance relative to peers may provide important hints on what lies ahead for the currency.

Repatriation effect or not, I believe that we have not seen the last of lira weakness for a number of reasons. While the familiar Big Mac index and more scientific measures of the real exchange rate do not show a significant misalignment, asset pricing and flow approaches suggest further weakening in the second quarter. Furthermore, I believe that the well-known (and much written about) vulnerabilities of the Turkish economy are not fully appreciated and have therefore yet to be entirely priced in: The economy is to contract much more than the 1-2% currently expected, monetary & fiscal policy are making a dangerous mix and to top, corporate foreign currency needs are likely to increase pressures.

If there is yet to be a trilogy, I fear I will have to call it “The Country Who Cried”. That is one column I hope I will never have to write.

Monday, March 2, 2009

Weekly Hurriyet Column: Alphabet inflation, misspelled monetary policy

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. One and a half months later, most economists still think that inflation will be an L, whereas I share the minority view with the IMF that it will be a V, albeit the uptick shorter than the downtick.

As the financial crisis was making its way to the real sector in the US, economists were using the alphabet to debate how the recession would shape out: While “U”, “V” and “W” were the popular letters, Roubini’s L won out at the end. In Turkey, we more or less know that inflation will also be an “L”, but we cannot agree on where the corner will be turned.

Inflation fell sharply late last year, as the very same commodity prices that had fuelled inflation to 12% collapsed. Helped by stagnant demand, inflation ended the year at slightly above 10% and despite a higher-than-expected outturn last month, was finally back at single-digit (9.5%) territory. The Central Bank (CBT) expects this trend to continue, seeing inflation in the range of 5.4%-8.2% with a 70% probability.

While I concur with the Bank that inflation is on a downward path, I would place my bets on the upper half of its forecast range. For one thing, the limited exchange rate pass-through so far, which is one of the reasons behind the CBT’s confidence, might be illusionary: While it is true that the recessionary environment is helping, the lack of the pass-through might be partly due to the inventory depletion in certain sectors. Moreover, with uncertainty on the IMF front and limited room for further local support for the lira, the exchange rate weakness is likely to be permanent this time around. Then, even a modest pass-through would add a few percentage points to inflation.

The CBT has been emphasizing lately that inflation could fall below its end-year target of 7.5%.
This is in fact not too different from my own outlook; I just see inflation stabilizing at a higher rate than the Bank. In other words, my “L” is somewhat smaller than the CBT’s. It is this large “L”, combined with its concern over the growth outlook, which has led the Bank to cut rates 5.25% since November. I agree with the Bank on its growth assessment; in fact, I have been writing on strong negative growth this year since November, when most analysts were still behind the curve. In addition, the CBT could turn out to be right on inflation, too. But regardless, I believe it has taken an unduly risk with little benefit.

First, as I anticipated two weeks ago, the impact of the last cut on benchmark rates has been limited, highlighting the limited ability of conventional monetary policy to affect longer-term rates and normalize credit markets in situations where the binding constraint is not the price of credit, as was (and to a certain extent still is) in the US, but the quantity. In a recessionary environment where more firms are likely to default (as evidenced in the upward trend non-performing loans), it will be the default risk not funding costs, that will be in the bankers’ minds.

Moreover, loose fiscal and monetary policy could prove to be a dangerous mix. Simple sustainability calculations reveal that a primary surplus of less than 2% would increase the golden ratio of debt to Gross Domestic Product, which could, after a certain point, bear on the country’s risk perception and therefore rates. Moreover, the accompanying higher Treasury borrowing would put further strain on the monetary transmission mechanism by crowding out private lending. If all these found their way to the exchange rate, not only the CBT’s disinflation plans would be disrupted, but the real sector’s deteriorating FX open positions would mean that many firms would find themselves in dire straits, as would their lenders.

The CBT has taken monetary policy to uncharted waters, hopping on the global rate-cutting bandwagon on disinflation winds. I hope they are watching for the reefs.