TEPAV publishes Monetary Policy Assessment Note: Should be increased by 500 basis points

The Economic Policy Research Foundation of Turkey (TEPAV) has published its Monetary Policy Assessment Note. In the study by TEPAV, it was stated, "The repo rate should be increased by 500 basis points, and it should be indicated that additional tightening may be implemented depending on the data."

Furthermore, while drawing attention to the observation of certain developments that deepen fundamental problems, emphasis was placed on the fact that monthly inflation in February exceeded expectations and that inflation expectations continue to deteriorate.

On the other hand, the increase observed in the exchange rate in recent weeks and the downward trend in the CBRT's net foreign exchange reserves were also evaluated.

The report included the following statements:

"Turkey's monthly inflation of 4.53 percent in February 2024 is higher than the annual inflation of 14 G20 members in the same month. Argentina and Turkey are clearly diverging from other G20 countries in terms of both inflation and risk premium.

In our previous assessment notes, we underscored that the economic program being implemented has two fundamental problems it must solve in order to achieve its short-term goals—such as placing growth on a sustainable path and reducing inflation, interest rates, and the risk premium.

The first of these was that the financing need arising from the current account deficit was not being met through normal channels. While net financing above the current account deficit was provided in the June-December 2023 period, this picture deteriorated significantly in January, and a net capital outflow occurred."

ELECTION AND EARTHQUAKE EXPENDITURES

"The second fundamental problem was the possibility that both pre-election expenditures and earthquake expenditures would lead to the budget deficit remaining at high levels. February realizations show that spending pressures persist. Studies we have conducted within TEPAV indicate that if additional measures are not taken, the deterioration in the budget deficit and debt stock may continue.

In our previous notes, we emphasized that the fundamental problem regarding monetary policy is how inflation, which is expected to peak at around 75 percent in May 2024, will be reduced to 36 percent by the end of 2024 and how this downward trend will be maintained in the subsequent period. Today, certain developments are being observed that deepen this fundamental problem."

INFLATION IMPACT

"First, monthly inflation in February was higher than estimated, and inflation expectations continue to deteriorate. Seasonally adjusted monthly inflation was 4 percent, exceeding the Central Bank's estimate of 3 percent. Expected inflation for the end of 2024 has been rising since the beginning of the year. Current data for March indicates that the expected year-end inflation is still at a high level of 44.2 percent.

Second, there is the increase observed in the exchange rate in recent weeks and the downward trend in the CBRT's net foreign exchange reserves. This trend stems from the increased demand for foreign currency in recent weeks due to expectations of a correction in exchange rates following the local elections. The fact that the Central Bank has turned to prudential policies only and with a delay has also strengthened this trend.

Third, there are the potential inflationary effects of fiscal measures that could be taken to reduce the budget deficit, which is expected to exceed 6 percent of GDP in 2024. Indeed, the tax regulations weighted toward SCT and VAT made in 2023 are among the factors pushing inflation upward, as also stated in the Central Bank's inflation reports.

Fourth, the policy rate—the repo rate—was raised to 45 percent at the January MPC meeting. However, the increase in the policy rate has not been reflected in Turkish Lira deposit interest rates to an extent that would significantly reduce both the foreign currency demand of residents and the growth rate of consumption expenditures. Despite this, the policy rate was kept constant at the February MPC meeting, and some non-interest tightening measures were resorted to in March in response to the negative developments summarized above. One negative consequence of such decisions is that they increase the suspicion that there is an upper limit to which the policy rate can rise, negatively affecting the program's chance of success. Another negative consequence is that the imbalance in monetary tightening makes access to credit unnecessarily difficult."

"SOCIAL SEGMENTS MUST SUPPORT"

"Unless the process of returning to rationality in the economy, which began after the May 2023 elections, is transformed into a comprehensive program and this program is supported by social segments, it is not possible to eliminate the aforementioned negatives.

However, in light of current information, external conditions are trending in a positive direction in terms of reaching the end-of-2024 inflation target. Estimates regarding the average Brent crude oil price for 2024 have been updated upward in recent weeks, but the estimated level is still not significantly different from the 2023 average. Major central banks such as the Fed and the ECB are also expected to enter a process of lowering policy rates. These two factors will be beneficial in terms of realizing the current account deficit, the financing of the deficit, and exchange rate increases at reasonable levels."

WHAT CAN BE DONE?

"The increase in the discrepancy between the CBRT's inflation forecast and inflation expectations, as well as the upward pressure observed in the exchange rate, must absolutely be prevented. In this framework, a series of steps should be taken to solidify economic fundamentals, and economic units must be convinced that the movements observed recently are temporary deviations from strengthened foundations.

For this, it is imperative that measures to reduce the budget deficit and tightening in monetary policy be continued in the coming period. Additionally, the decisions taken by the government regarding administered and directed prices should be in a direction that supports the inflation target.

The new term action plan of the Investment Environment Improvement Coordination Council is highly suitable for initiating a comprehensive structural reform process. However, it is important that this plan be supported by structural regulations that will make institutions—such as the CBRT, TurkStat, and the BRSA—independent if they remain under political pressure, which leads to the deterioration of macroeconomic balances, as well as policies that ensure macroeconomic stability, increase productivity, accelerate the green transformation process, improve the quality of education, and establish a fair and fast-working legal system.

"STEPS MUST BE TAKEN"

In light of these assessments, the strengthening steps aimed at transforming the process of returning to rationality in the economy, the main headings of which are given above, into a comprehensive program must be taken as soon as possible.

The repo rate should be increased by 500 basis points, and it should be indicated that additional tightening may be implemented depending on the data.

In order to eliminate imbalances in monetary policy, regulations should be made to ensure that the increase in the policy rate is sufficiently reflected, especially in deposit interest rates, and that the credit market functions more healthily; the functioning of the transmission mechanism should be facilitated."