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Prospects for the Turkish economy in 2014 (1)
If you are not implementing an economic policy measure that will radically alter the inflationary outlook, changing inflation depends on luck.
A change in inflation = A change in economic policy + luck’. ‘A major change in inflation = A little more change in economic policy + a lot of luck’. This was how I adapted Nobel economy prize winner psychologist Daniel Kahneman’s favorite equations (Success = Talent + Luck and Great success = a little more talent + a lot of luck) to inflation. These two equations might guide our estimations for inflation outlook in 2014. Here it goes:
Average CPI in the first eleven months of 2013 was 7.5 percent, same as the CPI average since 2009. Inflation in Turkey tends to regress to the mean; it floats around the mean value. It temporarily exceeds or falls below the average; but neither of these movements proves permanent. Contrary to our expectations, inflation rate moves back to the mean soon.
If you are not implementing an economic policy measure that will radically alter the inflation outlook, changing inflation (having a rate above or below the average) depends on luck. Here, external conditions as I quoted in the baseline scenario for 2014 can be considered the luck factor. For instance, it is bad luck if the Federal Reserve (FED) launches a sharp tapering operation causing an exchange rate hike and a swift increase in inflation above the average for Turkey. Or, it is good luck if energy prices decrease remarkably, causing a significant decline in inflation below the average. Obviously, since you cannot be lucky forever, the changes achieved with the luck factor cannot be permanent.
Then, will Turkey implement any anti-inflationary policy which can enable a permanent change in inflation outlook in 2014? It does not seem likely. Fiscal policy is disciplined, so we cannot expect a major change in that realm. Monetary policy keeps changing its focus in between price stability, credit growth, and exchange rate. We hear that currently it is focused at inflation. In spite of this, the highest rate of the Central Bank (that is the upper limit of the exchange rate corridor) is only as high as CPI. A further interest rate raise might be expected in early 2014 depending on exchange rate movements; but still I don’t think this raise will be high enough to ease down CPI, causing a permanent decline. And there are the Banking Regulation and Supervision Agency decisions aimed to lower consumer loan growth. These, together with the Central Bank’s interest rate decisions might cause a limited decrease in inflation. But the baseline inflation (the l index) which is considered the indicator of CPI outlook has been floating significantly above its long-term average. We could expect that this will affect the CPI outlook negatively in the next couple of months.
Hence, when economic policy and headline inflation indicators are considered, there will be no factor in play other than the luck factor (external conditions) that will permanently reduce inflation down from the current 7.5 percent level. So the million-dollar question is: how will the external conditions I presumed in my baseline scenario for 2014 affect inflation outlook?
Since the FED will launch tapering and the European Central Bank will not initiate quantitative easing which could offset the effects of tapering even partially (assumptions number 1 and 2), exchange rate will tend upwards. Then, we should be prepared for a CPI above the average in 2014 unless external conditions evolve in the opposite direction. My fourth assumption was based on the IMF’s expectation that crude oil price will decrease by 3 percent compared to 2013. Such decline is not strong enough to affect Turkey’s headline inflation.
In conclusion, I don’t expect CPI to be lower than the 2013 average in 2014. I expect it to be around 7.5-8.5 percent.
This commentary was published in Radikal daily on 05.12.2013