Resurgence of inflation in Türkiye: Turn to rationality or a red light

On August 3, Turkish Statistical Institute (TurkStat) announced a consumer price index increase of 9.5 percent for July, which is a one-month increase. Unfortunately, the annual consumer inflation is 47.8 percent.

Moreover, regarding what has been happening in Türkiye since 2021, there is nothing strange about the 9.5 percent monthly uprise in the consumer price index. In the last month of 2021, and January 2022, the price increase was 13.6 and 11.1 percent, respectively. Hence, July’s monthly inflation is not the highest but the third highest in the last twenty months.

However, having worked as an executive at the Central Bank of the Republic of Türkiye (CBRT) and played an active role in designing the monetary policy after the 2001 crisis, when annual inflation dropped from 73 percent (January 2002) to 7.9 percent in twenty-eight months (April 2004) and the average inflation for the following year was 7.7 percent, I cannot make sense of what has happened since the last months of 2021.

As the Ministry of Treasury and Finance revealed, there would be a return to rationality. Is it the case?

It all started with an interest rate cut

Out of the blue, the CBRT lowered the policy rate in September 2021, although the inflation target was 5 percent and inflation was 19 percent. Apparently, the CBRT was not independent. It is unlikely that the CBRT executives did not apprehend that declining interest rates one after the other would cause the exchange rate and inflation to burst; if there had been an insistence on lowering interest rates, the CBRT managers of that period should not have continued to sit in those seats because the task assigned to them by law was not to explode inflation but to fight inflation.

In this country, annual inflation, which had fallen to single digits in March 2004 after years, averaged 8.4 percent from 2004 to 2017. It oscillated up and down in a narrow range around this average, not performing a downward or upward trend. At the time, I criticized this level, asking why we could not bring inflation down.

Laborers lose ground to inflation

One might say that the motive for my criticism is due to my professional experience; nonetheless, who can explain this high inflation to laborers living on minimum or fixed wages?

Figure 1 exhibits the movements of the net minimum wage and the ‘food’ sub-item of the Istanbul Chamber of Commerce’s (ITO’s) Istanbul Wage Earners’ Livelihood Index since January 2021. Both series have been adjusted to 100 in January 2021 for easy comparison. The red line as a step is the net minimum wage. The area between the blue and the red line displays the loss of a minimum wage worker due to inflation.

Moreover, I have taken the August 2023 – December 2023 ITO inflation in line with the CBRT’s forecast of 58 percent (20.5 percent price increase for the rest of the year). My and some economists’ forecasts suggest that inflation may approach 70 percent by the end of the year. So, the area between blue and red will get even more significant.

Notice that this calculation does not even include the share that minimum wage earners should get from the increase in GDP, which is the sum of all our incomes. If I had added GDP growth on top of inflation, the blue line would be even higher than the red, demonstrating both the inflation loss and the (relative) welfare loss of the minimum wage earner.

I should note that more than half of all workers in Türkiye earn minimum wage, and it is below the July hunger threshold, which is 11.658 liras. Nonetheless, some employers complain that “the minimum wage is high” and that they cannot compete and their exports will decrease.

Why ITO and not TurkStat?

I used ITO’s food inflation instead of TurkStat’s consumer inflation for the minimum wage/inflation comparison for two reasons: First, what matters for minimum wage earners is how food prices evolve.

Nevertheless, TurkStat also includes food inflation in their calculation, one might also ask, which brings us to the second reason: In the context of what we have experienced since September 2021, definitions such as ‘inflation according to TurkStat’ or ‘official inflation’ have become a part of our lexicon.

Let us compare the ITO and TURKSTAT inflation to give an idea. Both inflation rates are, of course, expected to be different from each other. First, one is for Istanbul, while the other is for Türkiye. Second, the baskets of goods are diverse. Regardless, this difference should remain within a certain range. More notably, in any period longer than a few months, the unlikeness between the two inflation rates should not deviate significantly from the disparity in previous periods.

Why is this diversion of inflation?

TurkStat has been publishing the consumer index since January 2003. Therefore, it is likely to calculate annual inflation since January 2004. Between January 2004 and December 2017, the average monthly dissimilarity between the annual inflation measured by both indices was 0.69 percent. However, this difference then widened and reached high levels (Figure 2). The monthly average of the disparity since April 2022 is precisely 19.5 percent. Consider the distinction between 0.69 percent and 19.5 percent!

After the good news that we would return to rational policies, two inflation data were announced: June and July. Regarding the monthly inflation figures, TurkStat is higher in the first and ITO in the second. Although there is still a significant difference between the annual inflation figures, this difference decreased slightly in July and became ‘only’ 15.9 percent.

The new CBRT is more realistic, but…

After the May elections, it has been said that there would be a return to rationality. The new appointments, such as Mehmet Şimşek to the Ministry of Treasury and Finance and Gaye Erkan to the Governorship of the CBRT, have implied that return.

Furthermore, on July 27, the CBRT increased its inflation forecast to realistic levels: End-2023 inflation, estimated at 22.3 percent in the previous report, was brought to 58 percent, and end-2024 inflation, estimated at 8.8 percent, was brought to 33 percent. A forecast of 15 percent was announced for end-2025.

May the rational period come

There was another positive development for the reputation of monetary policy and the CBRT. Three deputy governors of the CBRT – Emrah Şener, Taha Çakmak, and Mustafa Duman – were dismissed from the CBRT administration, whose monetary policy had caused inflation to jump from 19 percent in September 2021, meaning that four of the five members of the Monetary Policy Committee, which took those bizarre interest rate decisions, were replaced.

Moreover, the three new Deputy Governors (Cevdet Akçay, Fatih Karahan, and Hatice Karahan) appointed to replace the dismissed Deputy Governors are competent in monetary policy and macroeconomics. Thus, Governor Gaye Erkan, an expert in finance and banking, was joined by three well-educated macroeconomists, strengthening the CBRT administration.

The reasons behind inflation

In the inflation report published by the CBRT, there is a table that provides the reasons for the revision in inflation forecasts for 2023-24 in numerical terms. There are five main factors: The first four factors are the rise in import prices due to the exchange rate upsurge, the increase in food prices, tax and wage adjustments, and the boost in domestic demand.

The fifth provoking item is ‘Forecast deviation and change in forecast approach.’ The immense contribution to the increase in the end-2023 inflation forecast comes from this item with 10.9 points. The ‘change in the forecasting approach’ can positively be interpreted as a change in the model used for forecasting. Anyway, the team that allowed those forecasts to be published, or caused them to be published, has now changed.

However…

Everything is good so far. Regardless, a few reasons lead to that ‘however.’

First, the noticeable question: If inflation is estimated at 58 percent at the end of 2023 and 33 percent at the end of 2024, why is the policy rate at 17.5 percent? How will inflation fall to 33 percent in seventeen months when the policy rate is so low? The reason for 17.5 percent is now common knowledge: It means that the interest rate is not allowed to exceed an upper limit.

Second, when there is an upper limit on interest rates, it again leads to side roads. Under the definition of ‘quantitative tightening,’ steps are taken to reduce credit supply and raise loan interest rates.

The latest regulation was made on July 25; the CBRT raised the policy rate from 15 percent to 17.5 percent. This regulation is a new example of ‘raising interest rates without raising interest rates.’ “Though this also gives favorable privileges to some sectors and some types of loans,” one might say. The result does not change; this is a bypass. It reinforces the idea that there is an upper limit, a red light that interest rates are not allowed to exceed.

The independence of the CBRT

Third, due to the detour, the deposit rate has fallen while the loan rate has risen. Moreover, Gaye Erkan stated that it is a positive development that the deposit rate has fallen and is approaching the policy rate of 17.5 percent. Nevertheless, in a country where inflation in five months’ duration is estimated at 58 percent and in seventeen months at 33 percent, it is not acceptable that the deposit rate is approaching the shallow policy rate.

It is expected that the policy rate-deposit rate-credit rate trio should not be disconnected from each other. Though at what level? At a level appropriate for inflation. Moreover, in an environment where one wants to eliminate the scourge of Currency Protected Deposits (KKM), what is the point of crushing lira-denominated savings deposits under inflation? We reach back to the same ‘red light’ issue.

And the fourth concerns the independence of the CBRT. Gaye Erkan’s answer to the question concerning the KKM indicates an issue. A central bank may not lend to its country’s Treasury. In 2001, an amendment to the CBRT law prohibited extending such loans, called short-term advances (STA). However, transferring the Treasury’s portion of the KKM to the CBRT means that the CBRT finances a budget expenditure, which is an STA practice; unfortunately, Erkan defended this arrangement.

U-Turn to rational

The moral of the story is this: for monetary policy to return to a reasonable level, the red light on the policy rate needs to be removed. It would be advantageous to announce this publicly. If there is a U-turn in interest rates, a significant step will be taken to relieve the Turkish economy.

Would that step be enough? Of course not. Nevertheless, unless the red light is removed, economic policy will not return to a reasonable level; consequently, inflation will not fall.

It has been said that there would be a return to rationality; however, it seems that this is not happening immediately despite gradually. So, it is not for nothing that we often talk about a ‘transition’ period.
What can be said? Let us get through the transition period, and hopefully, the rational period will come.