Monday, November 2, 2009

Weekly Hurriyet Column: My Minority Report’s collateral damage

Below is the unedited version of my column for this week. You can read the final version at the Daily News website. And not one but two cheesy movie references squeezed into the title this time around. And I managed to make a reference to the word collateral, which I use in the second part of the column. As for the column itself, here are a few extra notes:

First, a small game: Replace the word capital with IMF in the article (hint: there are two) and you'll see why I favor an IMF deal. As for the CBT's need for collateral, as I was doing my weekend reading of favorite Econ. columnists Sunday afternoon, I found a really good article by Ugur Gurses explaining in painful detail why the CBT did not need bonds as collateral or any collateral at all. Most of the points he is making were already relayed to me by my friends from the CBT, but since I am no CBT expert, I definitely could not have written them that clear myself. Finally, I am now realizing I have once again been too harsh. Governor Yilmaz noted that the full details of the bond-buying deal will be given out at the press briefing for the 2010 monetary policy strategy on December. I will therefore be waiting for this annual strategy document on monetary policy and be on the lookout for any developments before then. Maybe, I will be pleasantly surprised at that time, but the fact remains that the Bank has taken a really awkward first step in a very delicate matter. Anyway, on to the column:

The Central Bank, or CBT, released its latest Inflation Report on Tuesday. With analyst reports having gone into all the nitty-gritty details, I will only briefly summarize the Report’s salient features before jumping to my own minority report.

First, the Central Bank’s inflation outlook is, if anything, slightly more optimistic than before: Despite higher commodity prices, the Bank has only marginally revised its end-2010 forecast. The CBT also notes that inflation will creep up during the remainder of the year and the first half of next year due to base-year effects, unwinding of tax cuts and administrative price hikes, but sees inflation continuing with its downward move afterwards.

This trajectory is fully in line with your humble neighborhood economist’s own projections as well, although I see inflation edging up higher than the Bank envisages and being more resistant on the way down. While this is partly due to my higher oil price expectations, I guess I am also penciling in a higher exchange rate pass-through. In any case, even if my well-above-consensus October forecast of 2.3 percent is realized, yearly inflation will still be below 5 percent, a level we are unlikely to see again at least for a year.

While its inflation outlook may be more dovish, the Bank’s assessment of risks to this outlook is actually less so, as the Bank has taken a more balanced approach than before, highlighting upward risks to global inflation such as growing developed country budget deficits and exit strategies. However, domestic risks barely get any mention in the Report. It seems that the CBT has opted to take as given the government’s fiscal outlook as outlined in the budget and the Medium-term Program, which are, lo and behold, consistent with each other, but totally inconsistent with reality.

Without a weaker-than-expected global recovery and appreciation pressures on the lira driven by capital flows, the CBT is set to pause after limited cuts in the near-term, and the seemingly contradictory views of the report are simply efforts by the Bank to position itself against tail risks in both directions. All in all, I would have said the Bank did a pretty god job with communication this time around, only if this bond-buying business had not come up.

At first sight, it looks innocent enough: Governor Yilmaz highlighted that all the Bank will be doing is to replace the maturing Treasury debt in its balance sheets from the 2001 crisis bank bailout, as the CBT needs collateral for its operations in the Istanbul Stock Exchange and the reverse repo market.

Now, this raises question marks. After all, as I confirmed with conversations with ex-Central Bankers, not only the Bank has many other means to obtain collateral, it could also conduct its operations without collateral as well. Moreover, someone has yet to explain to me why the CBT would need to coordinate this with the Treasury, unless of course it would like markets to perceive this as fiscal accommodation or debt monetization.

A better explanation would be the need to respond to the financial market liquidity squeeze, which the Treasury’s high borrowing requirements have finally managed to make permanent. Unless the CBT increases FX purchases, which it is unlikely to do without significant capital inflows, all the onus of funding the markets would be on open markets operations, which is only a temporary fix. In this environment, the 9 billion the Treasury would have to pay to the CBT would be a major drain from the market if it were to borrow this amount from the markets.

I wonder why the CBT has not put it this way rather than resort to the collateral argument, risking serious collateral damage.


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