Turkey’s soaring inflation, exacerbated by a fresh spike in August, is stoking apprehension over the country’s economic future and appears to strengthen the prospect of an intervention by the International Monetary Fund (IMF). The August figures, released Sept. 3, brought year-on-year inflation to 18% in consumer prices and 32% in producer prices. Barring Argentina, such rates are unseen among Turkey’s emerging-economy peers, in many of which inflation is not even in double digits.
The price hikes are unlikely to abate in the coming months, with consumer inflation expected to hit at least 20% at the year-end. The ballooning problem owes much to structural reasons, which highlights the need for sounder diagnoses and long-term remedies.
Two key factors are pushing inflation to the creeping 20% level: the rising prices of agricultural products and food, and the dramatic depreciation of the Turkish lira.
Turkey used to have a self-sufficient agricultural sector, but ill-advised policies and neglect of the sector have resulted in annual imports of $9 billion to cover the food gap at home. The deficit in the food supply is a key reason for the surge in inflation. In fresh vegetables and fruits, for instance, year-on-year inflation stands at a staggering 38%.
Price increases in another crucial rubric — energy products — have exceeded 21%. Turkey is heavily reliant on foreign energy supplies, and atop the increase in global energy prices, it has seen its currency depreciate 55% this year. With the price of the dollar rising 78% since the beginning of the year, the prices of energy products have shot up despite certain subsidies.
In durable consumer goods such as cars, domestic appliances and furniture, prices rose between 5% and 6% in August, bringing year-on-year inflation to 30%. The domestic production of durable goods relies heavily on imported inputs; hence, production costs have soared due to the extraordinary increase in foreign-exchange prices. In other words, the price increases in this category stem directly from the slump of the lira. In its latest inflation report, the Central Bank itself notes that “widespread price hikes in durable and other basic goods have continued as a result of foreign-exchange rate effects.”
In another important point, the bank notes, “Producer-driven cost pressures on consumer prices increased considerably in August.” Producers hiked their prices 6.6% in August, bringing the year-on-year rate to 32%. Obviously, this stems also from the increased prices of foreign exchange, as Turkey’s industry relies heavily on imported energy and inputs. With their costs on the rise, producers are hiking prices, forcing retailers to follow suit. This trend is expected to continue in the coming months, given that the gap between producer and consumer inflations is no less than 14 percentage points, signaling an avalanche of prospective price hikes should consumers sustain demand.
The Central Bank appears equally pessimistic, noting that the rise in energy prices is expected to continue in September. Though the bank speaks specifically of energy prices, its projection could be taken as a general one given that foreign exchange rates show no sign of letting up. The dollar, which traded for about 6.6 liras Sept. 3 as the inflation figures were released, hit up to 6.75 liras the following day.
No doubt, the mounting inflation is further upsetting income distribution. For some 19 million Turks who are either wage earners in the private sector or public employees, inflation means a drastic decrease in real income as they stand no chance of pay hikes matching the inflation rate. More than 10 million pensioners face the same prospect of relative impoverishment.
Yields on the Turkish lira, meanwhile, remain below the inflation rate, which not surprisingly has led Turks to keep their savings mostly in foreign exchange rather than in lira deposits. Ankara may pretend to not understand this, but the slumping lira and the rising inflation continue to make foreign exchange a refuge for savings. To boost the attractiveness of the local currency, yields on the lira should increase, but Ankara remains reluctant to hike interest rates, making futile efforts to curb the rise of foreign exchange through verbal interventions only.
After the release of the August inflation data, which sparked concerns of a new currency shock, the Central Bank pledged to “take the necessary actions to support price stability,” adding that “monetary stance will be adjusted at the September Monetary Policy Committee meeting in view of the latest developments.”
The regular meeting is scheduled for Sept. 13. If the statement is to be taken as a signal of a rate hike, one cannot help but wonder why the bank opts to wait 10 days instead of acting immediately. Hence, many have come to see such statements as a transient wave breaker against the rise of foreign exchange that serves nothing but to erode the credibility of the bank.
So, how to stop the hemorrhage of the lira? Are Ankara’s diagnoses and treatments correct? Hiking interest rates is the way to prop up the lira, but President Recep Tayyip Erdogan has a well-known aversion to rate hikes, which, he believes, will plunge the economy into stagnation. And ahead of local elections in March 2019, he needs a growing and not a stagnating economy.
Yet the prevailing conditions are already bringing about stagnation and even contraction. Domestic consumption is shrinking, investment projects are being shelved, company equities are melting against the rising foreign exchange prices, loan repayment capacities are weakening and banks are piling pressure on indebted companies. This means a decline in production capacities and company closures that will eventually lead to contraction.
On Sept. 4, international credit rating agency Fitch cut its 2019 growth forecast for Turkey to 1.2%. Pointing to “considerable uncertainty” for the Turkish economy, the agency cited risks that include “policy missteps, heightened financial stress in the private sector, geopolitical tensions and potential capital flight.”
Turkey needs to secure $230 billion — or roughly $20 million per month — in external funds to roll over its economy in the next 12 months. Such gloomy assessments by Fitch and similar agencies indicate that securing those funds is becoming more difficult and costlier for Turkey. The tightening circle is pushing the country in the direction of the IMF, but whether or when the Erdogan regime will acquiesce to this option remains a big question mark.
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