Turkey Central Bank Statement

Author: IFLR Correspondent | Published: 24 Sep 2019
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The Turkish economy entered a rebalancing period in Q2 2018. Despite the slowdown in the second half of the year following financial market turbulence, GDP growth settled at 2.6% in 2018, down from 7.4% in the previous year, on the back of robust export performance.

In order to contain the adverse effects of elevated financial volatility and uncertainty in the real economy, Turkish authorities engineered a swift and coordinated policy response. Within the context of the New Economy Program, fiscal and financial policies were designed with the aim of steering the economy towards a sustainable growth path and ensuring financial stability. Accordingly, several measures were taken to avoid an adverse feedback loop between the real side of the economy and financial intermediation that might stem from balance sheet effects.

At the same time, the Turkish central bank (CBRT) implemented a strong monetary tightening to contain inflationary pressures. Moreover, several supplementary instruments such as currency swaps, forwards, and reserve requirements were used to smooth the excess volatility in the markets.

These efforts have been instrumental in stabilising the economy. Inflation has displayed a persistent downtrend since October 2018. Economic activity, which contracted in H2 2018, started to recover at a modest pace as of Q1 2019. Despite the signs of a global economic slowdown, competitiveness gains underpin the solid performance in exports of goods and services. At the same time, subdued domestic demand and credit growth as well as prevailing exchange rate effects continue to restrain import demand. As a result, the current account balance has improved markedly and posted a surplus by mid-year.

Going forward, while domestic demand is envisaged to recover gradually on the back of the disinflation trend and improvements in financial conditions, the composition of growth will continue to support the economic rebalancing.

One major challenge for the CBRT during this episode was to steer inflation expectations in the right direction amid a period of double-digit inflation and heightened inflation uncertainty. In order to contain the risks on pricing behaviour, the role of inflation forecasts as intermediate targets was re-emphasised. Accordingly, the CBRT made an explicit commitment to keep the underlying trend of inflation close to the published projections for the next three years. As a result, the actual inflation has mostly stayed close to, or even below, the lower boundary of the CBRT's projections since October 2018. The ongoing improvement in inflation dynamics and pricing behaviour created room to reduce the degree of monetary policy tightness as of July 2019.

The projected path aims to bring inflation down to single digits by mid-2020, gradually converging to the medium-term target of 5% in three years. Keeping the disinflation process in track with the targeted path requires the continuation of a cautious monetary stance. In this respect, the extent of monetary tightness will be determined by various indicators of the underlying inflation trend to sustain the disinflation process, which is also key to achieving lower sovereign risk, lower long-term interest rates, and stronger economic recovery. The CBRT will continue to use all available instruments in pursuit of the price stability and financial stability objectives.