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    A series of oddities (2)

    Fatih Özatay, PhD05 October 2013 - Okunma Sayısı: 1141

    The average of officially declared inflation targets since 2006 averaged 5.3 percent while actual inflation over the same period had an average of 8.3 percent.

    I have new items to add to the list of oddities in Turkey. Inflation gets the first place today. The average of officially declared inflation targets since 2006 averaged 5.3 percent while actual inflation over the same period had an average of 8.3 percent. This is not because inflation rates were initially too high, pushing up the average despite the downwards trend achieved later on. Rather, inflation rates have been floating up and down around the average since 2006. For instance, the average between January 2012 and September 2013 was 8.3 percent! This could be acceptable.

    But the following is not: I am quoting from the third inflation report for 2010, page 98: “Inflation is expected to… achieve the medium-term target of 5 percent in early 2012.” The third inflation report for 2011 says (page 114): “Inflation is expected to stabilize around 5 percent in the medium term.” The report for the same period in 2012 states (page 121): “Inflation is expected to stabilize around 5 percent in the medium term.” And finally the third report for 2013 repeats in page 125: “Inflation is expected to stabilize around 5 percent in the medium term.” No, there is no typing error; and sorry for the repetition. I will not refer to previous inflation reports although they repeat similar arguments. I am just wondering how far is this medium-term that we are yet to arrive there!

    I could never ever skip the “high interest rate – low exchange rate” motto on my list. There are various forms of this mentality, which eventually come to the same thing. We have sung this song for so long that the vast majority of the audience believes that it is true, no matter what contrary evidence you suggest. This is OK.

    But even if you have a short memory, you would remember the most recent developments and ask yourself if there wasn’t something strange, wouldn’t you? For instance, for the first 20 days of May, average interest rate on the benchmark bond was 5 percent and the TL value of the Euro/Dollar basket (or the exchange rate) was 2.08. Soon they both moved up together with the benchmark rate reaching 10.2 percent and exchange rate reaching 2.40 as of the late August. How could the exchange rate increase along with the interest rate?

    Here comes the but again: Currently, the interest on Germany’s 10-year government bill is 1.8 percent, Italy’s is 4.3 percent, and Portugal’s is 6.8 percent. Greece’s is even higher. Don’t they use the same currency and are subjected to the same exchange rates? How come interest rates are such diverse while the exchange rate is the same?

    There should be straightforward answers to these questions. Here is what happens in the case with Turkey: in the event of any turbulence, some investors sell off the lira assets they hold. At the same time, new investments almost halt. Hence, the demand for lira assets decreases and the supply increases, which pushes asset prices down (and interests up). In the dearth of new foreign investment, the FX supply tightens while the FX demand increases as existing investors sell off lira assets and convert the sum to FX. Hence, both interest rate and exchange rate increase. In the case with Europe, each country has a different level of riskiness, and if riskiness is higher interest rate is higher. The essence of the matter is that high interest rate does not necessarily mean low exchange rate!

    This commentary was published in Radikal daily on 05.10.2013

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