1 monetary policy framework central bank of the republic of turkey september 2002

1

MONETARY POLICY FRAMEWORK

CENTRAL BANK OF THE

REPUBLIC OF TURKEY

September 2002

2

Outline of the Presentation

Macroeconomic Prospects Key Indicators of Financial Stability Inflation External Sector Growth

Recent Monetary Policy Actions A Brief Overview of the FX Policy Inflation Targeting: The Eventual Monetary

Policy Framework

3

50

53

56

59

62

65

68

71

74

7/2

7/17 8/

1

8/16

8/31

9/15

9/30

10/1

5

10/3

0

11/1

4

11/2

9

12/1

4

12/2

9

1/13

1/28

2/12

2/27

3/14

3/29

4/13

4/28

5/13

5/28

6/12

6/27

7/12

7/27

8/11

8/26

45

55

65

75

85

95

105

Overnight Repo, Simple, Left ISE Bonds and Bills Market, Compound, Right

500

600

700

800

900

1000

1100

08-0

1

09-0

1

10-0

1

11-0

1

12-0

1

01-0

2

02-0

2

03-0

2

04-0

2

05-0

2

06-0

2

07-0

2

08-0

2

09-0

2

Signs of Stability are Emerging

Following its upward trend caused mainly by increased political uncertainty in July, interest rates have been declining since August.

The CBT continues to strictly limit its discretionary FX interventions. Pre-announced auctions have been suspended in June.

Volatility of Exchange Rate(TL/USD, Coefficient of Variation)

Interest RatesTurkish Eurobond Spreads (bps)

Spread =The difference between Turkish Eurobonds and US Treasury bills.

Source: JP Morgan

* (+) indicates FX sales to the market.

FX Auctions

Volatility of the exchange rate has diminished compared to its peak in June.

-200

0

200

400

600

800

1000

5/4

5/18 6/

16/

156/

297/

137/

278/

108/

24 9/7

9/21

10/5

10/1

911

/211

/16

11/3

012

/14

12/2

81/

111/

28 2/8

2/21 3/

83/

22 4/5

4/19 5/

35/

175/

316/

146/

287/

127/

26 8/9

8/23 9/

6

1000000

1100000

1200000

1300000

1400000

1500000

1600000

1700000

Sales Amount (Weekly , Millions of USD) TL / USD (Weekly Average,Selling Price)

0%

1%

2%

3%

4%

5%

03/0

1

04/0

1

05/0

1

06/0

1

07/0

1

08/0

1

09/0

1

10/0

1

11/0

1

12/0

1

01/0

2

02/0

2

03/0

2

04/0

2

05/0

2

06/0

2

07/0

2

08/0

2

09/0

2

The upward trend in spreads between May and July was reversed in August in light of the improved political outlook.

4

Inflation displayed a declining pattern during this period owing to: The increase in the credibility of the program which, in turn, had a favorable

impact on expectations; The absence of demand pressures; The relative stability of the exchange rate and the marked decline in the pass-

through from the exchange rate. The significant slowdown in food and agricultural prices.

Price Developments between January-August 2002

20.0

40.0

60.0

80.0

01

-99

03

-99

05

-99

07

-99

09

-99

11

-99

01

-00

03

-00

05

-00

07

-00

09

-00

11

-00

01

-01

03

-01

05

-01

07

-01

09

-01

11

-01

01

-02

03

-02

05

-02

07

-02

Annual change

CPI (y-o-y percent change)

5


0

2

4

6

8

10

12

Jan-

00

Mar

-00

May

-00

Jul-0

0

Sep

-00

Nov

-00

Jan-

01

Mar

-01

May

-01

Jul-0

1

Sep

-01

Nov

-01

Jan-

02

Mar

-02

May

-02

Jul-0

2

CP I monthly % change, sa CP I excluding food, monthly % change, sa

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Jan

-00

Mar-

00

May-0

0

Jul

-00

Sep

-00

Nov-

00

Jan

-01

Mar-

01

May-0

1

Jul

-01

Sep

-01

Nov-

01

Jan

-02

Mar-

02

May-0

2

Jul

-02

Goods, monthly % change, sa Services, monthly % change, sa

Due to the increased political uncertainty between May and July, both CPI and CPI excluding food displayed an upward trend. The acceleration in prices, however, was limited in August as a result of the improved market sentiment and political outlook.

The current trend of inflation suggests that the end year target should be comfortably met.The increase in price of services has been more subdued compared to that of price of goods.

6

30.0

35.0

40.0

45.0

50.0

55.0

60.0

65.0

70.0

75.0

Au

g-0

1

Sep

-01

Oct

-01

No

v-0

1

Dec

-01

Jan

-01

Feb

-01

Mar

-01

Ap

r-0

1

May

-1

Jun

-1

Jul-

1

Au

g-1

Sep

-1


End-year Inflation Expectations (Consumer Prices)

34,835,0 2002 Target

Impact of the new

economic program

Inflation expectations are rapidly converging to the target.

7

28

32

36

40

44

48

52

Au

g-0

1A

ug

-02

Sep

-01

Sep

-02

Oct

-01

Oct

-02

No

v-0

1N

ov

-02

Dec

-1D

ec-0

2Ja

n-0

1Ja

n-0

2F

eb-0

1F

eb-0

2M

ar-0

1M

ar-0

2A

pr-

1A

pr-

02

May

-01

May

-02

Jun

-1Ju

n-2

Jul-

1Ju

l-2

Au

g-1

Au

g-2

Sep

-1

Corporate sector Financial sector

The implementation of the economic program is steering the inflation expectations for 2003 towards the target.

Inflation Expectations for the Next 12 Months (Consumer Prices)

% 30,5

% 29,2


8

Price stability:

Price stability–-the primary objective of monetary policy–-is a prerequisite for rapid, balanced and sustainable growth.

Outlook for Inflation

Medium-term inflation

targets:

2002 % 35 2003 % 202004 % 122005-... Single digits

Risks:

Backward-looking indexation and price-setting behavior in the economy

Price-setting behavior of the public sector: public service prices (natural gas, electricity, water), wages, backward re-evaluation coefficient, monopoly, tobacco, wheat etc.

Price-setting behavior of the health sector

Price-setting policy of the education sector

Oil price shocks

Resumption of the political uncertainty and the spillover effect on financial markets

9

-1.5

-9.8

3.4

-14.0

-9.0

-4.0

1.0

6.0

2000 2001 2002 Forecast

-4.0

13.06.4

-20.0

-12.0

-4.0

4.0

12.0

2000 2001 2002 Forecast

Current Account (Billions of USD)

Capital Account* (Billions of USD)

The economic slowdown and the depreciation of the Turkish lira have led to a noticeable turnaround in the current account balance in 2001, giving a surplus of US$ 3.4 billion from a deficit of US$ 9.8 billion in 2000.

A current account deficit of US$ 1.5 billion is projected for 2002.

February 2001 crisis and resulting confidence loss in TL left the capital account with a deficit of US$ 4 billion in 2001 from a surplus of US$ 13 billion in 2000.

Capital inflows are projected to be US$ 6.4 billion in 2002.

External Sector: Turnaround in BoP

* Including Fund credits

10

External Sector: Evolution of the RER

Real Effective Exchange Rate

($1 + € 0.77, producer price index for foreign goods & private manufacturing index for domestic goods)

Turkish lira started to depreciate in real terms after May and...

70

75

80

85

90

95

100

105

110

115

01

/95

07

/95

01

/96

07

/96

01

/97

07

/97

01

/98

07

/98

01

/99

07

/99

01

/00

07

/00

01

/01

07

/01

01

/02

07

/02

60

80

100

120

140

94Q

194

Q2

94Q

394

Q4

95Q

195

Q2

95Q

395

Q4

96Q

196

Q2

96Q

396

Q4

97Q

197

Q2

97Q

397

Q4

98Q

198

Q2

98Q

398

Q4

99Q

199

Q2

99Q

399

Q4

00Q

100

Q2

00Q

300

Q4

01Q

101

Q2

01Q

301

Q4

02Q

1

unit labor costs ($) tradables / non-tradables

Unit Labor Costs

...the cost-based real exchange rate indices point to an increase in competitiveness.

11

A stronger-than-expected recovery to date suggests that the 3 percent GNP growth projection for 2002 should be comfortably met: GNP grew by 8.5 percent in the first half of the year.

Production A sharp recovery in business confidence since October 2001 as a result of stability in

financial markets and the implementation of the new economic program supported by the international financial institutions.

Better than envisaged performance in industrial production: Industrial production rose by 7.4 % (y-o-y) in the first six months of 2002.

Increase in agricultural production:

Agricultural production rose by 1.9 % in the first half of the year and the growth rate of agricultural value added is expected to be around 5 % in 2002.

Strong increase in inventory building and replacement investments in industrial sector: The contribution of inventory changes to GDP growth was 8.5 % in the first six months of 2002.

Growth: Signs of recovery are becoming more apparent

12

Demand

Net Exports: The contribution of net exports to GDP growth was 2.9 % in the first quarter and –5 % in the second quarter.

Improved expectations: Decline in uncertainties had a positive impact on investment and consumption decisions

Improved exchange rate stability and the downward trend in short-term rates: This development promoted consumption and created a more conducive environment for investment decisions. As a result, the contribution of private expenditures turned positive in the second quarter of 2002.


Q1 Q2 Q1 Q2Private Expenditure -5.0 -14.9 -6.4 1.9Government Expenditure -0.3 -3.1 -0.5 0.4Net Exports 9.8 16.9 2.9 -5.0Inventory Accumulation -5.3 -8.6 5.9 10.9GDP -0.8 -9.6 1.9 8.2

2001 2002

Contributions of Aggregate Demand Components to Growth

13


EXPORTS*CREDIT CARDS*

CONSUMER CREDIT*

VAT COLLECTION*

AUTOMOBİLE SALES

PRIMARY BUDGETARY

EXPENDITURE*

NON-AGRICULTURAL EMPLOYMENT

(Thousand )2001 I 8.9 - - 55.7 -61.9 22.2 12,954

II 13.4 55.30 0.9 32.8 -71.1 43.8 12,905III 13.7 32.80 -38.6 62.4 -73.3 45.2 13,199IV 12.6 12.90 -49.0 91.7 -71.2 49.7 13,310

2002 I 4.6 17.10 -45.2 74.9 -62.0 90.4 12,843II 2.3 30.70 -24.9 81.3 -16.7 65.0 13,650

IMPORTS*VELOCITY

OF EFTNEW

BUSINESSES* DURABLES

PRODUCTION*

CAPACITY UTILIZATION

RATE (%)PROTESTED

BILLS*

NON-AGRICULTURAL EMPLOYMENT

(Thousand )2001 I -4.9 3.25 18.1 -6.5 69.8 48.0 12,954

II -30.1 2.36 -19.7 -28.3 69.9 100.6 12,905III -29.6 2.41 -11.4 -19.1 71.6 80.7 13,199IV -32.9 2.47 -26.2 -3.8 73.5 80.6 13,310

2002 I -10.7 2.53 -7.3 24.4 74.0 -26.5 12,843II 19.1 2.50 17.1 68.1 75.9 -42.8 13,650

Indicators Supporting the Production Growth

Indicators Supporting the Aggregate Demand Growth

Both the production and demand side indicators, except the credit volume, confirm that a solid recovery is underway.

* Percentage change with respect to the same period of the previous year.

14


The evolution of the industrial production until July suggests that economic recovery will continue in the third quarter as well.

GNP and Total Industrial Output(Annual percentage change)

-15

-10

-5

0

5

10

15

20

25

88Q

1

89Q

1

90Q

1

91Q

1

92Q

1

93Q

1

94Q

1

95Q

1

96Q

1

97Q

1

98Q

1

99Q

1

00Q

1

01Q

1

02Q

1

Industrial P roduction GNP

15

The CBT’s Quantitative Targets are on Track

Monetary Base (TL Trillion)

Net Domestic Assets(TL Trillion)

Net International Reserves (USD Million)(1)

(1) Defined as Net International Reserves of CBT minus (i) Treasury liabilities to the IMF (ii) Treasury FX denominated borrowing with an original maturity of less than one year.

(2) Target for end-February calculated as four working day average of February 11-12 and March 11-12, 2002, to take account of the transitory impact of the Bayram (religious holiday) on currency demand. NDA targets for June onward have been lowered by TL 161 trillion compared to January 18, 2002 to reflect the drop in required reserves following the SDIF’s intervention in Pamuk Bank.

(3) Calculated by using the four working day average of Feb. 11-12 and March 11-12, to take account of the transitory impact of the Bayram (religious holiday) on currency demand.

82508900

10600 10850

9250

0

2000

4000

6000

8000

10000

12000

February(3)

April June September December

Realization

Ceiling Values (2)

26100 27700 287393313931139

0

5000

10000

15000

20000

25000

30000

35000

February April June September December

Realization

Ceiling Values (2)

-6500-7200

-8500-9700

-7800

-11000

-9000

-7000

-5000

-3000

-1000

February (3) April June September December

Realization

Floor Values

Recent Monetary Policy Actions

16

Recent Monetary Policy Actions

The favorable outlook for inflation led the CBT to lower the short term rates:

Interest Rate Cuts

Maturity

Quotations

Previous Rate

20 Feb. 2002

14March 2002

8 April 2002

30 April 2002

5 August 2002

O/N

Bid

59

57 54 51 48 46

Ask

62 62 61 58 55 53

1 Week

Bid

62 59 55 52 49 46

In view of the interruption of the improvement in market sentiment and economic outlook between May and July, coupled with increased political uncertainty, the CBT refrained from further interest rate cuts.

In August, however, improvements in the inflation outlook and favorable political developments led the CBT to lower its policy rate.

17

The CBT remains resolute to keep discretionary FX interventions outside the pre-announced

auctions limited. If necessary, the CBT, without interfering with exchange rates reaching their

market-determined levels over longer horizons, will smooth (temporary) excessive exchange

rate fluctuations.

A Brief Overview of the FX Policy

Contrary to “fear of floating” argument, it seems that since the adoption of the float, the volatility of the exchange rate increased while the volatility of interest rates and reserves diminished. The role of the exchange rate as an adjustment variable has clearly increased since the adoption of the floating regime, while the role of interest rates and reserve movements as shock absorbers has declined noticeably.

Gross Reserves O/N (Compound) Dollar

Jan95 – Dec99

2.75 % 15.78 % 1.59 %

Jan00 – Feb01

2.62 % 95.93 % 1.91 %

Mar01 – Oct01

4.65 % 4.18 % 3.51 %

Nov01- Aug02 2.35 % 1.18 % 2.12 %

Floating Regime

Evolution of the Volatility of Exchange rate, Interest rate, and Reserves

Has there been a “fear of floating” in Turkey?

18

The Eventual Monetary Policy Framework: Inflation Targeting

Nominal Anchor: Under the floating exchange rate regime, inflation targeting (IT) will serve as the nominal anchor of the economy.

A High Degree of Flexibility: Monetary policy will have a high degree of flexibility to respond to shocks, thanks to the absence of other objectives, i.e. an exchange rate target.

Communication: Under IT, the CBT will aim to find the clearest way to share with the public

the precise direction of monetary policy—what the target is and how the CBT is trying to achieve it—through periodic reports (Monetary Policy Report) and other means of communication with the public and markets.

Sustainable Debt: Aligning the public's inflation expectations with the CBT's inflation target

and removing the uncertainty risk premium in the interest rate will also improve debt sustainability.

Improved Policy Coordination: Inflation targets are joint targets, determined together with the Government. The joint agreement on inflation targets will enhance the coordination between fiscal and monetary policy.

Increased Public Consciousness: Evidence with the adoption of IT suggests that it fosters public awareness and acceptance of monetary policy decisions, which can help reduce the cost of disinflation and enhance credibility.

19

Monetary Policy Strategy–Inflation Targeting Significant progress has been made to satisfy the preconditions for the implementation of IT:

The Central Bank Law has been amended to ensure instrument independence, accountability and transparency; and the CBT enjoys full control over its credits.

The Law on Public Debt Management will bring about discipline and transparency in the public sector, and facilitate the adaptation of fiscal policy to inflation targeting.

Progress on establishing the technical infrastructure: Forecasting and policy analysis models

The CBT is receiving technical support from international institutions and central banks implementing IT. The CBT has been working intensively to develop:

economic databases and reporting packages

• Inflation Expectation Survey for corporate and financial sectors• Daily retail prices analysis by using sampling methods

a near-term forecasting system incorporating a wide range of available information

a core quarterly macroeconomic model

a process for putting together a medium-term projection

procedures for presenting the results to the Monetary Policy Council

20

Monetary Policy Strategy–Inflation Targeting

The CBT endeavors to enhance its credibility through:

Achieving the established objectives. Evidence to date suggests that the end year target of 35 will be achieved.

Improving communication, which is pursued with a view to communicate not only the CBT’s quantitative objectives, but also the framework of mechanisms that will be used to attain these objectives. To this end, the CBT has been issuing Monetary Policy Reports and frequent press releases in addition to presentations by the senior Central Bank officials.

21

It is important to highlight that IT is only one complementary ingredient in a broad strategy of institutional development and its success, among other things, hinges closely on: Fiscal responsibility

Financial deepening

Eliminating backward-looking indexation mechanisms in

the economy,

Flexibility in goods and factor markets to allow smooth

adjustment to relative price changes

Monetary Policy Strategy – Inflation Targeting

22

Overall, prudent fiscal and monetary policies along with deepseated structural reform measures included in Turkey’sMedium-term Economic Program will lay the foundations ofan economy that is:

well-placed on the high road of sustained low-inflationary growth

more resilient to adverse shocks

less vulnerable to crises

more equitable in income distribution

more conducive to foreign and domestic investment

as a consequence, better positioned to integrate into European Structures.

Conclusion

1 monetary policy framework central bank of the republic of turkey september 2002

Documents