Mustafa Sönmez – Hürriyet Daily News, August /11 /2014

Inflation is a “monster” that Turkey, like many other emerging economies, sees as a threat to the wealth of the economy, appointing the Central Bank as a guardian to watch over it.

Not very long ago, in the 1980s and 1990s, Turkey witnessed two-digit or even three-digit – yes, three-digit – inflation rates. For example, during the 1994 crisis under former Prime Minister Tansu Çiller, the rate even surpassed 125 percent.

Whether with the money exodus that comes after every foreign currency restraint; devaluation that comes in practice or under the orders of the International Monetary fund (IMF); the increase in prices because of a rapid value loss in the Turkish Lira and a rapid rise in related costs or austerity policies adopted to normalize prices, Turkey has experienced economic vagrancies for dozens of years.

After this scenario played out during the 2001 financial crisis as well, the Central Bank was granted “independence” and instructed to fight inflation, or preserve “price stability” in officials-speak, as part of a series of measures adopted in cooperation with the IMF.

The Central Bank then adopted a regime to target inflation: Shaping and implementing monetary policies needed to achieve targets that are determined together with the government has become its duty.

Targets and realities

How many of these targets has it been able to realize since they were first implemented in 2002? It attempted to bring down the fever of inflation, which rose to 69 percent in 2001, to 35 percent with the austerity measures used to overcome severe economic crisis in 2001. The results were successful as the inflation declined to 30 percent.

The inflation targets were also achieved in 2003, when the Justice and Development Party (AKP) came to power, and for two more consecutive years. In 2005, for example, the inflation dropped to 7.7 percent, coming below the 8 percent target. The process was proceeding successfully.

However, the desired outcomes were unable to provide a satisfactory yield for the next three years as the inflation hovered at around 9 to 10 percent, almost doubling initial targets that were set as 5, 4 and 4 percent respectively.

When the financial crisis knocked on the door in 2009, the stagnating economy slashed the prices, and inflation came 1 percent below the targeted level. The target was reached in 2010 as well, but that was it…

The targets are increasingly being missed and inflation forecasts have been revised in the middle of year again for the next three years. But even the revised targets have not been reached, and we entered 2014 with inflation levels that were around 2 to 3 percent above the official medium-term target of 5 percent.

This year’s inflation target was 5 percent as well, but the economy was volatile. The United States Federal Reserve’s (Fed) statements indicating a change in the liquidity climate since the middle of 2013 caused a rapid loss of value for the lira. The political environment that was strained by the Dec. 17 and Dec. 25, 2013, graft operations also shook the economy.

All these caused the lira to lose 20 percent of its value against the U.S. dollar and 25 percent against the euro in a year, leading to an instability in prices.

The import input prices were reflected in costs but more importantly, the increase in food prices could not be swallowed. The drought season and frost damaged a lot of fruit, resulting in food scarcity. The cereal harvest was also lower than expected, pushing food inflation higher.

The target inflation was 5 percent but it was revised upward to 7.6 percent in light of all these developments. However, July inflation data effectively declared that this target could not be attained either. The consumer price index (CPI) was expected to increase 0.1 percent in surveys, but it rose 0.45 percent. Therefore, the overall inflation of the first seven months reached 6.3 percent while annual inflation remained above 9.3 percent.

Alcoholic beverages and tobacco prices appeared to rise 2 percent, while kitchen spending took the lead in annual inflation as food and beverages prices rose 12.6 percent over the past year. Food inflation, meanwhile, didn’t drop even in summer, especially in fruit prices.

Actually, the annual increase in restaurant and hotel prices is above the food inflation, but it should be kept in mind that food prices internationally are also affected by the rise in food and drink. Therefore, the food and drink group always takes the lead role.

Food inflation is more important than anything else as more than one-third of people’s budget consists of kitchen expenditures. Everybody is huffing and puffing about the prices at markets.

The surge in transportation fees comes second after foods with a 10.3 percent annual increase, apparently affecting the budgets of low and middle classes. It is also worth noting that clothing and shoes prices are above the inflation level that was announced as 9.3 percent, while health prices overlapped with the inflation level.

The 6.2 percent increase in consumer prices over the past seven months entail a weakening of the chances for the inflation target, which was revised to 7.6 percent, to be fulfilled by year-end because the rise in the prices should be a maximum of 1.3 percent for the rest of the year in order to be able to meet the target. In other words, a 0.3 percent monthly inflation rate is a miracle – that is, impossible.

We know there are still electricity and natural gas price hikes to come as they were postponed until after presidential elections. The increases in energy prices remained at only 2 percent while the consumer prices rose 9.3 percent on average. The postponed hikes will trigger an uproar when they are implemented.

In a nutshell, this year’s inflation is expected to be around 9 to 10 percent, meaning it will be 100 percent higher than the medium target of 5 percent and 32 percent higher than the revised year-end target of 7.6 percent. This means missing the target again. Ultimately, the targets have only be attained five times during the AKP’s 12-year rule.

Interest rate reduction?

The failure in the inflation combat has left no room for the Central Bank to make another interest rate cut. How will the Central Bank, which reduced interest rates three times upon pressure from Prime Minister Recep Tayyip Erdoğan, explain it if it cut rates further while prices also increase?

The next Monetary Policy Board meeting is on Aug. 27. What will the Bank do in an environment in which annual inflation is moving toward 10 percent? Is it going to resume “moderate” rate cuts, or is it going to reduce rates, taking a look at inflation? Everybody will take their positions, according to the new resident in the Çankaya presidential palace.

Written by Mustafa Sönmez