The course of events in the direction of double-digit inflation

Mustafa Sönmez – Hürriyet Daily News, February/15/2016

While the average January increases in consumer prices is around 1 percent, the increase this January reached 1.82 percent, which was quite a surprise. When the monthly rate reached 1.82 percent, then the annual inflation, which stood at 8.81 percent in December 2015, jumped to 9.58 percent at the end of January. This situation, all of a sudden, brought up the question of whether or not the yearly inflation would reach double-digits, in other words 10 percent.

The inflation target was 6.5 initially and then it was revised to 7.5 percent. However, this course of events point to a very possible double-digit number.

Target and realization

Turkey always remains behind the inflation target that is set by the Central Bank at the beginning of the year. During the 14-year period from 2002 to 2015, the number of targets reached was three, while real inflation occurred above the targeted number in 11 of those year years. This happened also in 2015. The Central Bank’s Consumer Price Index (TÜFE) target of 5 percent did not happen, and inflation went up to 8.8 percent.

The same situation was also true for the Producer Price Index (ÜFE). In 2015, the domestic producer’s price Index (Yİ-ÜFE), which is the average increase in the prices of products produced by industrialists, was 5.7 percent according to the Turkish Statistics Institute (TÜİK). This is slightly behind the 6.4 percent increase in 2014 and almost two points below the increase in the period from 2008 to 2013, when the foreign exchange rates had not started accelerating.

Rising costs, especially with the increase in foreign exchange rates, are seen to immediately trigger product prices and, as well, significant price increases are experienced in those sectors that use imported input. This situation makes it necessary to scrutinize the increasing costs and the inflation stemming from costs.

Different increases in sub-branches

In 2015, industry firms increased the prices of industrial products they produced 5.7 percent compared to 2014. Those products categorized among industrial products as durable consumer good had an annual price increase of nearly 13 percent; in 2015 the price increases in endurable consumer goods exceeded the average by 1 point to increase almost 7 percent.

While the produced intermediate goods price increases corresponded to the average, the price increases in capital goods exceeded 10 percent. The prices of energy producing firms in 2015 fell 3 percent instead of increasing, just as in 2014. The drop in world oil and gas prices has been effective on this.

When the 2008 to 2013 period is regarded as a whole, the annual increase in the ÜFE is 7.5 percent; then in the following two years it has gone down to 6 percent. However, there are details which point to other parameters affecting this outcome.

It is noteworthy that the ÜFE, which remained at 2.6 percent in durable consumer prices in the 2008 to 2013 period, first increased to 8 percent in the first two following years and then neared 13 percent. The rapid depreciation of the Turkish Lira against the dollar has been effective in this. The same situation is true for capital or investment goods that are mostly dependent on imports.

On the other hand, the low course of world energy prices pulled down the energy producer price index. Energy prices which increased 12 percent annually during the 2008 to 2013 period decreased at an average of 5 percent annually in the past two years.

When the ÜFE is broken down as manufacturing, mining and electric-gas, it can be seen that price increases in the manufacturing industry went parallel with the ÜFE; in 2015 it followed a course 0.7 percent above. On the other hand, in 2014 and 2015, annual increases in mining and quarry products remained the same. This is also related to the rapid fall in world commodity prices. Similarly, electric producer prices experienced a parallel development to the falling trend in world markets; the annual average prices in 2014 and 2015 showed a drop of 1.5 percent.

Price for the consumer

The prices consumers pay for industry products are the significant facts on the other face of the medallion. While producer prices increase at an average of 5.7 percent in 2015, the prices consumers paid for industrial products showed an increase of 8.8 percent in 2014, and when January 2016 is taken into account, the increase in 12 months neared 9.9 percent.

In 2015, the prices in the manufacturing industry on the consumer front increased the most in durable consumer goods. In the “home appliances” group, which includes several electrical appliances and electronic goods, prices increased nearly 15 percent. In automotive products, on the other hand, price increases exceeded 14 percent. In these two branches, annual increase in the 2009 to 2014 period was near 3 percent and then 8 percent respectively. This shows that in 2015, consumer prices in these two groups increased rapidly.

It is noteworthy that the price increases in branches such as home textiles, furniture and glassware exceeded five points above the increase of the past six years to reach 11 and 12 percent.

Increasing costs

In countries such as Turkey, cost components as well as demand components have an important share in determining inflation. As a matter of fact, it seems that shocks and price increases stemming from the foreign exchange rates have been determinant on inflation dynamics.

According to research, the highest share among costs in the manufacturing industry belongs to raw material expenses with 59 percent. Personnel expenses are next with 16 percent. Other operations expenses that are general operating expenses (mostly service expenses) are next with 10 percent. While energy (electric, fuel and oil) expenses have a share of an average of 5 percent, rent (building and machine-equipment) and financial expenses have a share of 1.5 percent and 22.5 percent, respectively.

If only the 2013 to 2015 period is taken into consideration, when Turkey’s exportation reached $151 billion, imports reached $234 billion. Nearly 45 percent of exports are EU dominated, thus 45 percent of the total exportation was done with the euro rate while 47.5 was done with the dollar.

In imports, though, the dollar is dominant. The exportation of the past three years, 62 percent have been in dollars while 31 percent in euros. In imports where capital goods, intermediate goods and energy are prevalent, Russia, Iran and other Asian countries stand out. The imports from the EU with the euro remain in the background.

What will the Central Bank do?

If inflation is on a course toward double-digits, what will the Central Bank do? The policy the bank will adopt is, to a great extent, determined by whether or not there will be a change in the Central Bank administration in April. This month is important in terms of the bank, or more precisely, for all of Turkey.

In general, it is too optimistic to expect that the Central Bank will adopt a firmer stance against inflation and use rates as a weapon, even if the administration changes.

Some commentators believe that if inflation would persist above 8 percent for several months then the Central Bank would revise the target upward and succumb to two digits.

Double-digit inflation, though, is not a good showcase, especially in terms of foreign investors. It is possible that such a bad performance would also activate the international rating agencies and direct them to write dark reports, pulling the credit rating down.