Q Turkey has been able to achieve a record reduction in inflation over the past year or more. How do you view this process and can the prospect of single-digit inflation be maintained?
A First of all, we need to focus on the new macroeconomic framework and structural transformation of the Turkish economy in the last three years to have a better understanding of the changing dynamics of the inflation process.
The stabilisation programme, implemented in 2001, has set the concrete and specific goals of the macroeconomic policy framework. These policies have not only enabled structural transformation in the economy but also eliminated the underlying reasons behind high rates of inflation.
The institutional change that has taken place through the amendment to the Central Bank Law in May 2001 signals the beginning of a new era in terms of the structural transformation of the economy. The Central Bank of Turkey (CBT) became independent and clearly specified its primary objective as achieving and maintaining price stability. Furthermore, there is an enhanced emphasis on transparency and accountability, which are the main components of independence as the CBT puts effective communication policy at the centre of its monetary policy. An effective communication policy has become more essential together with the recognition that managing expectations improves the effectiveness of monetary policy. To achieve a better communication policy, information regarding monetary policy objectives and implementation of policy decisions are transparently announced through press releases, weekly press bulletins, periodic reports, speeches by top executives and other publications of the CBT.
As another indicator of the major change in the dynamics of the economy, the CBT no longer extends credit to the public institutions, breaking the inflationary episode led by monetisation of public debt.
Moreover, there were some other factors that contributed to the change in the inflationary dynamics, such as the change in the price-setting behaviour of economic agents and weakening pass-through effect of exchange rates to inflation with the adoption of a floating exchange rate regime.
Additionally, as inflation targets were achieved in 2002 and 2003, people believe in the decisiveness of the policy makers to fight against inflation. As a result, policies have gained credibility and inflation targets set by the CBT and government jointly have become a more credible nominal anchor for the economic agents. This has strengthened the policies of disinflation and guaranteed its continuity.
Therefore, all of these changes in the economy strongly suggest that the disinflation process of Turkey is a lasting one and single-digit inflation will be maintained with more progress in our policies and structural change of the Turkish economy.
Q What are the inflation goals for 2004 and 2005, and what are the prospects of these targets being achieved?
A The consumer price index inflation target for 2004 is 12%, which was set jointly by the CBT and the government. When we look at the inflation figures for the first seven months of this year, we see that the downward trend in inflation has further accelerated, as both consumer and wholesale prices registered a single-digit inflation rate of 9.6% and 9.4% respectively. Although there are some risks in front of us in achieving the target of 2004, such as the aggressive climb of oil prices and fluctuations in foreign exchange markets, so far it seems quite within reach.
As far as the inflation outlook for 2005 is concerned, I should emphasise that our final goal is to maintain price stability at single-digit inflation. Hence, our policies are directed to pursue this goal. We undoubtedly know that as long as we continue on tight fiscal and monetary policies and fulfil our structural reforms with determination, we will achieve our goals.
Q The Central Bank intervened in the foreign exchange market six times in 2003. How do you see developments in the floating exchange rate system this year and into the future?
A As you know, we drew the main lines of our exchange rate policy when we began to implement a floating exchange rate regime. Now we have a history of a floating exchange rate regime for more than three years. We have been very clear about interventions and the reasons are announced every time that we have intervened in the foreign exchange market. As there is no exchange rate target, the CBT intervenes in the foreign exchange market in a very transparent manner only in order to prevent excessive volatility on either side.
Furthermore, the CBT conducted daily foreign exchange buying auctions from time to time to sterilise the excess supply of foreign exchange which is mainly driven by the change in the portfolio preferences of the economic units towards Turkish lira-denominated assets. Daily foreign exchange buying auctions are held on a transparent and rule-based mechanism. Accordingly, the CBT strengthened its reserve position in a way that does not contradict with the floating exchange rate regime.
The floating exchange rate regime has played a crucial role as a shock-absorber and in reducing the fragility of the Turkish economy, as justified with some experiences during the last three years. We will continue on a floating exchange rate regime along the same lines. Moreover, economic agents have gained lots of experience during this three-year period.
In the context of the floating exchange rate regime, the CBT also encourages economic agents to participate in forward markets to hedge themselves against foreign exchange risk under the floating exchange rate regime. Therefore, the CBT gives utmost importance to the development of forward markets.
Q As an autonomous Central Bank, how do you view the country’s economic reforms, particularly those in the banking sector, and what particular measures do you favour to maintain monetary stability?
A In order to have a well-functioning market economy, distortions that impede proper functioning have to be removed. Structural reforms have a major role in establishing sound macroeconomic fundamentals and allowing proper functioning of the market economy. The banking sector is at the centre of these reforms and closely related to our main goal of price stability and the auxiliary goal of financial stability.
Under the current monetary policy framework, a strong banking system is vital for the transmission mechanism of interest rate and credit channels to work properly. Moreover, banking sector reform is essential in order to establish the relationship between banking sector and real sector and supply funds to the private sector by way of stimulating investment and growth.
Furthermore, banking sector reform is also essential to reduce any fragility in the financial system and to bring more competitiveness to the economy. So far, major progress has been achieved in this area, but for further improvement, there remain some steps to be taken.
Surely, development of the financial sector is a key element for price stability but not enough to maintain it. All other reforms, which aim to eliminate distortions in the economy and promote a market-based economy, will also help to achieve price stability. In this context, tax, social security and labour-market reforms as well as policies aimed at reducing the share of unregistered economy have priority among others. In all these areas, further improvement is required despite some efforts and progress registered until now.
Q Earlier in the year, it was suggested that Turkey may need additional IMF financing, how do you see the country’s financing needs and support from the IMF and the EU?
A We believe that the EU and the IMF should be treated separately. Although politics is more influential on the accession process to the EU, recent economic progress of the Turkish economy complements Turkey’s accession preparations. Progress on the way to EU membership will definitely support Turkey’s economic outlook, increase international credibility and serve as an anchor in the long run, but accession to the EU is not a sine qua non for the Turkish economy. More importantly, all the major improvements realised so far in economic terms – and further steps planned to be taken in the future – are, in fact, the necessities on the way to make Turkey converge to developed countries, rather than just progressing towards EU membership.
On the other side, our relationship with the IMF has only an economic dimension. After the deep crisis in 2001, IMF played a crucial role in providing financial support and enhancing credibility of the new economic programme during the recovery of the Turkish economy. During the last three years, the Turkish economy has gained strength. As the new stand-by agreement with the IMF is likely to be signed in the beginning of 2005, the IMF will serve as an anchor in terms of demonstrating decisiveness of policy makers to continue on long-term economic policies and structural reforms as well as increasing credibility.
Both the IMF and the EU will have a role in shaping the investment environment and growth prospects of Turkey. Turkey is a large and dynamic country with ambitious and young entrepreneurs. As long as the convergence of the Turkish economy to advanced economies keeps evolving, together with the favourable environment for investment, relations with the EU and the IMF will contribute to attract more foreign direct investment, which will help the goal of having sustainable economic growth.
