Monthly price increases continued in September 2020…
Turkish Statistical Institute released domestic producer and consumer prices inflation figures of September. Domestic producer price index (D-PPI) increased by 2.65% compared to the previous month while consumer price index (CPI) increased by %0,97 m/m. USDTRY gained momentum by 3.51% in the same period.
In the graph above comprising the 2018-2020 period, the left axis shows monthly changes of both D-PPI and CPI while right axis the course in USDTRY.
If you pay attention to the graph above;
. The rise in the USDTRY (green line) has been increasing the costs of the producers (blue bars), and producers are able to reflect the cost burden to the output prices (red bars) to a lower extent.
. In the periods of decreasing or stable USDTRY, costs of the producers have been diminishing but output prices continue to increase.
What affects price increases?
The graph above proves that depreciation in Turkish lira (TRY) increases the input costs, and such increases are reflected to the output prices.
So, is the depreciation in TL the only reason for the increases in output prices?
Of course not. Let me explain in an example:
Why did the consumer prices continue to increase while producer prices have been decreasing in July-August 2020? The reasons are the government’s price and tax hikes following general elections on June 23rd, 2019.
What can be expected on the inflation front in the long view?
It totally depends on uncertainties: Kovid-19, US elections, the course of TRY, budget originated price changes (tax and price hikes), geopolitical developments, actions from the Central Bank, early election risk. The list can be extended. In short, everything depends on the confidence environment yet not promising.
Being a leading indicator for Central government budget data, Treasury’s cash balance gave a deficit of TRY 30.8 billion (USD 4.5 billion) in July up TRY 4 billion from June figures. Cash balance has been in a row of negative territory since February 2020.
Revenues rose by 42% m/m to TRY 87 billion in July while expenditures rose by 32% to TRY 118,2 billion.
Year-to-date aggregate cash deficit hit to top to TRY 140 billion in the first seven months of 2020 alone while total cash deficit recorded TRY 131 billion in 2019 and TRY 70 billion in 2018.
Another importance of cash balance is that it provides information about the sources of financing of cash deficit. Budget deficit of TRY 30,8 in July was financed with net borrowing of TRY 48.9 billion and the change in exchange rate of TRY 1.2 billion in the Cash/Bank item, and lastly the excess amount of TRY 18.2 billion was transferred to the deposit account of Treasury in the Central Bank of Turkey (CBT).
The main financing source of the cash deficit is the borrowing item. Let’s focus on borrowing strategy of the Treasury in July:
. The Treasury being a net payer in foreign borrowing since March 2020 did not borrow from abroad while paying its foreign debt of TRY 0.4 billion in July. For sure, this is due to the lower level of foreign debt payments. The first higher foreign debt payment of USD 4.6 billion is due on March 2021 while USD 1.3 billion of foreign debt is due on June 2021.
. The Treasury borrowed a debt of TRY 64.2 billion from domestic markets July while paying domestic debt of TRY 14.9 billion. Thus, net domestic borrowing amounted to TL 49.3 billion in July.
As it is understood, the Treasury concentrated on domestic borrowing in a current time of decreasing revenues, soaring expenditures, and depreciation of Turkish lira due to pandemic. It is quite reasonable that the Treasury concentrates on domestic borrowing to decrease the currency risk in a time of CBT melting its foreign exchange reserves so that Turkish lira not to depreciate.
What are the costs of CBT melting its foreign exchange reserves?
. Opening the credit taps mainly through public banks at lower interest rates to increase domestic demand,
. Returns on deposits and government bonds being under inflation rate (which is called as negative real rates)
. CBT financing the banks at the rates below policy rate (which makes the deposit rates being under inflation rate),
. Latest implementations jeopardizing asset quality of banking sector, and lastly
. All of the factors counted above combined with concerns on second wave of pandemic resulted in
.. interest rate of 2-year government bond increased above 14% on August 11th from the levels of 9% seen in the beginning of July,
.. USD/TRY increased above 6% and EUR/TRY increased above 5% compared to the levels at the end of July, and
.. Turkey’s 10-year CDS premium surged above 600.
CBT responded all these developments above as
. reducing liquidity limits of primary banks to half of their current limits on August 7th,
. increasing funding rate of banks to 8.25%,
. reducing liquidity limits of primary banks to zero on August 11th.
Besides, in its announcement dated August 6th, BDDK (Banking Regulation and Supervision Agency) announced that international development banks are exempted from the limitations of accessing TRY in case of fulfilling specified conditions.
CBT will convene for monetary policy meeting on August 20th. Bank’s policy rate, which is 1-week repo rate, is at 8.25%. CBT has been holding policy rate since May 2020 when CBT decreased the policy rate by 50 bps to 8.25%. Considering latest liquidity tightening measures, any rate hike seems uncertain as for now. Even if CBT decides to hold the policy rate next week, steps should be taken to restore confidence in the current environment where the budget deficit continues to increase. Otherwise, even if not in September, the pressure on bond yields may increase in October, when the Treasury’s redemptions will increase twice compared to September, as the Treasury tries to roll over its increasing domestic debt by issuing bonds. This may force the CBRT to raise interest rates drastically sooner or later. We witnessed drastic rate hikes when CBT raised policy rate from 4.5% to 10.0% in January 2014, from 8.0% to 16.5% in June 2018, from 17.75% to 24,0% in September 2018.
Turkish Statistical Institute released consumer (CPI) and domestic producer price (D-PPI) indices of May 2020. As can be seen in the graph above, monthly changes of both inflation figures have been rising continuously since December 2019.
CPI (2003=100) increased by 1.36% on monthly basis on the previous month by 1.36%, on December of the previous year by 4.57%, on same month of the previous year by 11.39% and on the twelve months moving averages basis by 12.10% in May 2020.
D-PPI (2003=100) increased by 1.54% on monthly basis, increased by 6.15% on December of the previous year basis, increased by 5.53% on same month of the previous year basis and increased by 9.14% on the twelve months moving averages basis in May 2020.
However, the year on year changes in both indices look more moderate:
If you pay attention to the graph above, I try to explain the year-on-year changes of inflation figures with the changes of USD/TRY. Why do I do that?
Because Turkey’s production mechanism depends mainly on intermediate goods imports, and payments are made in foreign currencies which are mainly in US dollars and Euro. Therefore, the price rise of imported goods in terms of Turkish lira is the most important factor affecting production costs and thus output prices.
As can be seen in the graph below, another important factor that causes price increases is the increase in taxes on goods.