The Conjuncture section in the Capital edition of December 2003 was entitled ‘Single Digit Inflation’. The subject of the article was the possibility of inflation, which was then running at over 20 percent, falling to single digits by summer 2004. As it happened, our prediction was realised and, as we had expected, inflation fell to single digits in May 2004. To tell the truth, at the time we did not imagine that two and a half years later would be giving an article the opposite title. But inflation has begun to rise so rapidly over the last few months that we are now on the threshold of double digit inflation.
According to the information we have at the moment, as of May annual consumer inflation (Consumer Price Index or TÜFE) stood at 9.86 percent. The inflation figures for June will be announced a few days after Capital is published and we believe that it is likely that they will exceed 10 percent. Both we and the markets predict that inflation will continue to rise for a few more months and will remain in double figures. The Central Bank, which is the institution responsible for combating inflation, says that inflation will continue to rise through June and July.
Where is inflation heading?
According to the calculations we have made based on the expectations for the current account and monthly inflation for next month and two months later in the Survey of Expectations conducted by the Central Bank in the second half of June, annual inflation will rise to over 12 percent in July.
These expectations suggest that annual inflation will begin to fall again from August onwards. The same survey predicts that inflation will be 9.78 percent by year-end. The expectations for inflation are 7.48 percent for 12 months later and 5.95 percent for 24 months later. That is to say, according to these expectations the rise in inflation will continue for two months and inflation will then begin to fall again.
When one looks at the statement issued after the most recent (20 June 2006) meeting of the Monetary Police Committee (MPC), the Central Bank also expects inflation to fall from August onwards. The Central Bank predicts that this fall will be faster than market expectations. Because the statement refers to inflation being close to target towards the end of 2007; and the target for year-end 2007 is an inflation rate of 4 percent. But the markets are predicting that in two years time, in mid 2008, inflation will still be close to 6 percent.
Inflation cannot fall while the exchange rate is rising
We also agree that inflation will rise over the next two months. But we believe that until the markets stabilize it is impossible to make a realistic analysis of when it will begin to fall.
While we were writing this article the turbulence on the markets was still continuing. The dollar had risen to over YTL 1.70 and, after a pause of 10 days, the Central Bank had intervened again to sell foreign exchange. The MPC was again called for an emergency meeting.
Research has shown that even if the impact of fluctuations in the exchange rate on inflation has declined since the transition to a floating exchange rate it has not entirely disappeared. Even if the exchange rate has not been the primary driving force in the recent rise in inflation it has had an acceleratory effect. The reason why inflation is expected to continue to increase over the next two months is that rise in the exchange rate is expected to have an impact on prices. If the increase in the exchange rate does not stop here but continues then of course the rise in inflation will continue after July.
Will the target for 2007 be realised?
It looks as if in all likelihood inflation will be much higher that the target of 5 percent this year. The latest expectations are that the realised figure will be twice the target. If the increase in foreign exchange continues for a little longer then it may reach double digits.
What will be important from now on is whether or not inflation will be close to target in 2007. In fact, as it usually takes six or nine months for monetary policy decisions to have an impact, any move made by the Central Bank is now focused on 2007. The shock decision to hike interest rates by 1.75 percentage points in 2007 was designed to try to ensure that inflation is close to target in 2007.
As the increase in the inflation rate will produce rises in prices and interest rates, which will in turn cut domestic demand, at some point inflation will begin to fall again. For this reason, inflation will probably fall in 2007. But it does not look as if it will be so easy for inflation to fall to the level that the Central Bank expects, which is the target of 4 percent. More to the point, a fall to such a level would require a considerable sacrifice in terms of growth.
The Increase In The Exchange Rate Has Fuelled A Growth In Debt
As happens every time there are fluctuations in the exchange rate, it has been the Treasury which has had to pay the first bill for the turbulence on the financial markets in May. The rise in the exchange rate has led to a growth in the size of the government’s debt in dollar terms and increased the burden on the Treasury.
According to date from the Treasury Undersecretariat, at the end of May the central government had a total debt stock of YTL 350.2 billion. This figure was YTL 333 billion at the end of April.
After not changing very much at all during the preceding few months, the debt stock suddenly grew by YTL 17.2 billion during the month of May as the dollar exchange rate rose from YTL 1.3155 at the end of April to YTL 1.5368 at the end of May. The increase in the dollar exchange rate has produced a sudden rise in the YTL value of the foreign loans in the debt stock. The foreign debt actually declined by US $1 billion in May but in YTL terms it rose from YTL 86.4 billion to YTL 99.4 billion. In fact, if the exchange rate had not moved, then the foreign debt would have fallen to the equivalent of YTL 85.1 billion. According to these calculations, the rise in the exchange rate resulted in an increase of an extra YTL 14.3 billion in the foreign debt in YTL terms.
The rise in the exchange rate has resulted in a fall in the central government’s debt stock in dollar terms. This is because the domestic debt part of the overall debt stock has fallen in dollar terms. But, as the Treasury’s revenues are in YTL, it is concerned not so much with the dollar value of the domestic debt as the YTL value of the foreign debt. The increase in the foreign debt in YTL terms means that the Treasury will have to use more YTL in order to repay the debt. This will add an extra burden to the budget.