PULSE of TURKEY No.14.................. THURSDAY, JUNE 11th, 1998
YILMAZ GOVERNMENT’S FIRST YEAR IN THE ECONOMY
Taner boasts of reducing inflation in 10 months to the level he took over. Structural changes in the fundamentals with the help of luck – falling oil prices. Monetary policy under careful quarterly review. Interest rates fall sharply but will it yield expected results? Tansu Çiller surpises economists. The Central Bank decides to stop foreign exchange purchases, but cannot stick to it. The key to success in inflation fight: sustainability. The Government’s trump card for the success is $12 bn privatization income (For figures see Issue No.9)
In June 1997 when PM Mesut Yýlmaz took over the government reins the inflation rate was 75.7% for wholesale prices and 77.8% for consumer prices. With overall changes made in economic policies, especially after the Yýlmaz Government received the vote of confidence on July 12th, 1997, prices began to rise and reached their peak in January 1998 with 92.5% for wholesale prices and 101.6% for consumer prices.
As usual and to some justification, the government blamed the previous government’s populist economic policies for this rise, stressing that a speeding bus could not come to a standstill immediately even if you applied the brakes. It promised to reduce the inflation to one digit within a three-year economic stability program – to 50% at the end of 1998, 20% a year later and 3% or so at the end of 2000. The government pledged that this would be done with structural reforms foreseen in the stability program and not with the artificial and populist methods used before. But still it took recourse to one such measure and froze the public sector prices for six months, but for a different purpose explained below than the populist economy.
This program has been received with great suspicion at home and abroad and it is still considered over-ambitious by most economists. Yet the promise has so far been kept and wholesale prices fell to 89.6% in February, 86% in March, 83.3% in April and 79.9% in May. Consumer prices were 99.3%, 97.2%, 93.6% and 91.4% respectively in the same period.
Minister of State for the Economy Güneþ Taner boasts of having reduced prices to the level when they took over 10 months ago and expects that the inflation rate will be 51.25% for wholesale prices and 56.14% for consumer prices at the end of the year. If the Wholesale Fruit and Vegetable Markets Bill is legislated in June he expects zero or minus inflation rates in July and August and better results at the end of the year.
World oil prices help Turkey’s heterodox economy
The months ahead will show how realistic Güneþ Taner’s expectations and promises are. It is certain, however, that the present Government’s anti-inflationary policy is based on structural changes in the economy, though freezing public sector prices for six months evoked great suspicion about it
at home and abroad. It is because such populist policies have been tried before, especially in election times and yielded no durable results. Practice shows that even though such steps artificially lower the inflation rate for a while, prices soar again as soon as the ban is lifted after the elections. This practice is called “election economy” in Turkish and “populist applications” in English.
The Yýlmaz Government’s ban, however, was somewhat different. Above all, it was not a total ban on price increases. Certain prices, among them electricity, sugar, monopoly goods and even fuel prices recently, were increased by SEEs (State Economic Enterprises) in the first five months, but very carefully and sparingly. The monthly increases in fuel prices discontinued because while the Government was putting up fuel prices by 4-5% every month on a par with the devaluation of the Turkish Lira, transporters and middlemen were putting up their fares and prices by 15-20% each time, taking advantage of the public sector’s initial small increase.
In other words, there was a “stadium effect” on the economy by these fuel prices and it had to be stopped. When the first row stands up to applaud a goal at a football match the entire stadium also has to stand up because otherwise they can see nothing. By discontinuing these regular price increases, they would remove this psychological effect on the inflation. They called it “heterodox economy” and announced it to the public so that they could obtain the required psychological impact. It was another difference from the previous “election economy” practices, because previous governments used to do it silently for the election period only.
The ban on monthly increases on fuel prices was really very timely because this 5-6-month period coincided with the fall in world oil prices from some $20 a barrel to $13-14. This stroke of luck may well provide the Government’s economic stability program with a golden opportunity.
Treasury and Central Bank agree on monetary and borrowing policies
Even more important though were the steps taken for structural changes in the economy in the last 10-11 months.
The Treasury and the Central Bank reached an agreement on the monetary and foreign exchange policies and put a halt to the Government’s resorting to the Central Bank’s resources for easy money.
The Treasury Chief, Yener Dinçmen, says that under this agreement the Treasury has not used “advance payments” from the Central Bank in the first quarter, but rather repaid to the Central Bank the TL337 trillion advance payments taken over from 1997. This was done through bond sales. He pledges that in the second quarter too the Treasury would not use “advance payments” other than some transitional ones for a few days for the necessary payments by the Treasury. Furthermore, TL290 trillion accumulated in the Treasury’s account in the Central Bank was not cashed out, but used for the repayment of previous debts. All these were constructive steps leading to the success of the monetary policy in the first quarter.
An amusing episode about this practice was that, at one point, DYP Chairman Tansu Çiller threatened to sue the Government for corruption because instead of receiving “advance payments” from the Central Bank at 4% interest, it was borrowing from the market with bonds at over 100% interest. This statement, amazingly misjudged for especially a professor of economy, was later forgotten when she did not follow it up after the system was explained to her.
Also to reinforce the psychological factor in the Government’s economic stability program, it began to announce quarterly programs concerning the economic fundamentals and has successfully enforced them hitherto.
The Central Bank’s monetary policy for the first quarter is geared to the estimate that wholesale prices will fall to the level of 70 odd per cent at the end of the first half. Apparently this goal will be attained, given the fact that in May it was just under 80%.
To this end, the rate of increase in reserve money was estimated to be between 18% and 20% and the total reserve money between TL1397 trillion and 1421 trillion in the first quarter. The actualization was even better - 17.3% or TL1293 trillion as of March 31st . In the second quarter, the rate of increase in reserve money will be between 14-16%. Considering that the target for the inflation rate in the second quarter was first 7.5% and updated to 8%, the reserve money increase target of 14-16% is too high. Central Bank sources say, “The need for reserve money has gone up because the cost of keeping cash has been reduced by the appearance of a sustainable drop in inflation. That is why in the second quarter the rate of increase in reserve money will be rather higher than the inflation rate in the same period.”
The improvement of the budget balance in the first quarter, therefore, helped the Treasury to easily carry out debt servicing which had been intensified in this period. This, for its part, slowed down the rise of domestic debt stock and that of monetary expansion.
As of March 31st the domestic debt stock was TL7.3 quadrillion – a drop of 2% with January 1997 constant prices. The Treasury foresees borrowing TL10 quadrillon from the domestic market in 1998 - TL6 quadrillion for servicing previous debts and TL4 quadrillion to cover the budget deficit.
In the first quarter the net domestic borrowing was TL2607.7 trillion as against the estimate of TL2350-2650 trillion. In the same period the average term of domestic borrowings was 229 days, i.e. 7.6 months and the average interest rate119.9%.
The borrowing averages have not yet been revealed for the second quarter, but while the borrowing terms are being extended the interest rates are dropping. For example, on May 12th the Treasury sold TL217 trillion one-year bonds at TL91.5% interest and the demand for these bonds was over TL1 quadrillion. Such a high demand at such a low interest rate for these bonds was proof of the fact that the market is confident that inflation will be slashed in the next one-year period. Otherwise, who would invest TL217 trillion for one year at 91.5% interest at a time when the inflation rate was 93% in consumer prices and 83% in wholesale prices?
Since then the interest rates have continued to drop and are now sailing at 80%. The Central Bank’s reducing bond interest rates by 10 points on June 5th and the drop in deposit interest rates along with the bond rates were instrumental in this drop.
The former Treasury Chief, Mahfi Eðilmez, estimates that the impact of one point in interest rates is TL1 quadrillion up or down in debt repayments. Even though this may be a rather rough estimate, it is evident that this drop in interest rates will greatly help the budget performance in the rest of the year.
Foreign exchange reserves head for American dimensions
While the Central Bank seemed in total command of the reserve money and thus prevented an excessive liquidity supply, also thanks to its protocol with the Treasury, this was not the case on the exchange rates side of the monetary policy. That is why the Central Bank has decided to further liberalize Turkey’s already very liberal foreign exchange system.
Since 1984 when the late PM Turgut Özal launched the free market economy there has been only two restrictions to absolutely free foreign exchange transactions in Turkey.
One is that exporters have to bring into Turkey within three months, 80% of their hard currency earnings from exports. The other is a rule applied since the end of 1987 about selling to the Central Bank a certain percentage of the banks’ foreign exchange deposits.
Today Turkey’s foreign exchange reserves are so comfortable that these rules are no longer needed, because in addition to the $26 bn reserves in the Central Bank, there is $10 bn in public sector banks.
The Central Bank Governor, Gazi Erçel, said on June 2nd that the Central Bank’s foreign exchange reserves were quite a match for its American counterpart, FED’s reserves. While the Central Bank had $26 bn reserves, FED had $39 bn reserves.
On June 1st the Central Bank lifted for two months, in June and July, the banks’ obligation to sell to the Central Bank a part of their foreign exchange deposits. Erçel said that if they had not done this the CB’s reserves would have risen further in summer months also thanks to tourism revenue and workers’ remittances. While high reserve levels were a good assurance for the economy they were rather costly because the TL, which had to be marketed for foreign exchange purchases, had to be sterilized. As part of their anti-inflationary policy they had to suspend this practice for two months, he said.
In practice, however, great difficulties are encountered in enforcing it. On June 5th when the CB kept away from foreign exchange markets the TL was revalued for the first time and the dollar fell by TL600 in one day. To stop the panic and over revaluation of the TL the CB again moved into the market and made big foreign exchange purchases. Also, to stop the rush away from foreign exchange into the TL, it dropped interest rates by 10 points. Not satisfied with this, banks further cut down their interest rates by five points in the following days.
Social security subsidies continue to be stumbling block, but everything is under control.
In other words, the supply and demand mechanism of the free market economy has been in full swing in Turkey in recent weeks and the developments were all in the direction of curbing inflation through structural changes in the economy. This is the biggest assurance for the sustainability of the trend, though certain other steps are needed to ensure the continuation of this success. Passing the tax and social security reforms tops the list of these steps.
The budget returns announced last week for the first four months show that unless the social security reform is carried out the budget balance cannot be struck, as the IMF has been saying all along.
The TL445 trillion subsidy given from the budget for social security in this period is 147% more than the corresponding figure a year before. The total subsidy for the year will be TL1335 trillion this year (lower than the estimated TL1.4 quadrillion) and believed to be TL3 quadrillion in 1999 unless the social security bill is passed. Mostly because of this burden, the budget expenditure rose by 154% in this 4-month period while public revenue went up by 140%, thanks to the sharp rise in tax revenue and also to the privatization income from mobile telephone licences.
The budget deficit in the first four months was TL1.3 quadrillion. Multiply it by three and you get TL3.9 quadrillion deficit for the year and it is exactly what the budget law foresees.
So all the available figures show that a promising trend to curb inflation is at work, that the Government is walking a tightrope on this successful performance and that if populist policies are repeated due to the forthcoming elections, the stability efforts may well go to dust as they did under Çiller before the December 1995 elections.
The Government swears that it will not resort to election economy during the rest of the year and thereafter, and there is reason to believe that this promise will be kept.
The Government’s trump card in the current successful budgetary performance is the $12 bn expected from privatization this year. This sum is not included in the budget bill. It stands by to be used, when necessary, to make the budget performance conform to the estimates, as was done in the first four months with the Telecom privatisation.