Monday, December 13, 2010

Weekly Hurriyet Column: Burnt by the winter sun

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News media webeditor since March, you won't see much of a difference between the two. As for the title, it is again a movie reference. It seems a sequel has just been released, butt given the IMDB rating, it seems like a total flop. Pity...
I was going to say that the last paragraph means that the Central Bank will soon cut the policy rate:)- I am going through my forecasting performance for an end-year evaluation, and my worst performance has again been in guessing Central Bank policy:)...

But I would no have expected to be disproved so quickly: I just learned that in a presentation on Saturday at the Turkish Economic Association, Deputy Governor Erdem Basci, who was mentioned in last week's Turkish economy WikiLeaks cable as the strongest candidate for the governorship when current governor Yilmaz's term expires in April, is stating the Bank is seriously considering cutting the policy rate and it will be on the agenda during this week's MPC meeting.

I was already planning an extensive addendum on some of the issues I could not cover,such as the low real interest rate and the rapid money growth, as well as how the Central Bank justifies cutting the policy rate, but now it is a must. I will have it posted @ the blog later today.

As for the column, I stick to all I have said, which justify why it would be unwise to cut the policy rate. Except for the last word: Substitute "credible" with "wise" and there you have it!

As for me, this incident reminds me once again the important difference between "should" and "will" in financial markets. I can explain as much as I want what the Central Bank should be doing, but at the end, what most care about is what they will do. I was told about this by my mentors when I first started out as a market economist, and used to stick to it 100%, but it seems I am just out of practice:):):) Also, I learned that it pays to look at CBT presentations, even when on a weekend:) I am in their mail list, and so was notified when they put the presentation on their web page, but it was the weekend, and I was kind of lazy:):):)

Anyway, on to the column:

Did the cold front sweeping through Turkey hit third quarter Gross Domestic Product, or GDP, numbers first?

According to data released by the Turkish Statistical Institute Friday, GDP grew 5.5 percent year-on-year, or YoY, in the third quarter, versus expectations of 6.5 percent. But the economy still managed to grow 1.1 percent, seasonally and working-day adjusted, from the last quarter, so I think this is still quite a good reading. It seems that the cold front has actually passed tangent to the economy, to quote the Prime Minister.

Moreover, Wednesday’s strong October release brought industrial production to its pre-crisis levels. In addition, capacity utilization, usually a good harbinger of industrial production, has continued to creep up in November. Other proxies for growth, such as purchasing managers, consumer and real sector confidence indices as well as credit growth are also pointing to robust growth in the fourth quarter. My simple econometric model churns out 5 percent YoY for the last quarter, bringing the 2010 growth rate to just below 8 percent.
This would be an impressive figure, but the composition of growth is worrying. Domestic demand contributed 10.5 percent to growth in the third quarter, while foreign demand, because of imports growing much faster than exports, stole away 4.6 percent from it, with stock-depletion cropping a further 0.4 percent.
An equivalent way of saying the same thing is that Turkey’s familiar disease of depending too much on external financing for growth is resurfacing. This unbalanced growth is a cause for concern because it is unsustainable: If capital flows were to dry up, we could see a sharp adjustment either through quantities (growth slowdown) or prices (exchange rate depreciation).

Latest data suggest that the portrait is getting bleaker. Economists were surprised by the surge in imports in October, and the wedge between export and import growth rates rose further. While we will have a better picture when import taxes, which help us to project imports, are released along with the November budget figures next week, preliminary exports data for November from the Turkish Exporters Association hints that the situation hardly improved last month.
Unfortunately, unsustainable growth is not our only worry: The unbalanced growth, along with the leading indicators noted above, is also raising alarm bells that the economy is overheating. But many, including the Central Bank, are arguing otherwise, using low core inflation measures, which exclude items responsive to temporary shocks but not to monetary policy, and slack in the economy as proof to their arguments.

I think core inflation is being given way too much attention at the expense of the headline figure and food inflation. For one thing, the familiar chicken or the egg problem is not resolved for Turkish headline and core inflation yet, and food inflation could spill over to core inflation. Moreover, moderate core inflation is itself a byproduct of the unsustainable growth and a sign of overheating, as surging imports are reining in tradable goods’ prices.

I would also argue that there is not as much slack in the economy as commonly thought, as the crisis seems to have decreased Turkish potential output. I used the methodology of a recent IMF paper to check my earlier calculations, and I again found out that the output gap, a measure of how far the economy is from potential output, has almost closed down.

Overheating means that the inflationary outlook is not as benign as the Central Bank claims. No wonder I do not find the possibility of further rate cuts, as outlined in their latest Financial Stability Report, credible at all.

Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at

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