Emre Deliveli

As the financial crisis was making its way to the real sector in the U.S., economists were using the alphabet to debate how the recession would shape out: While "U", "V" and "W" were the popular letters, Roubini’s "L" won out at the end. In Turkey, we more or less know that inflation will also be an "L", but we cannot agree on where the corner will be turned. Inflation fell sharply late last year, as the very same commodity prices that had fuelled inflation to 12 percent collapsed. Helped by stagnant demand, inflation ended the year at slightly above 10 percent and despite a higher-than-expected outturn last month, was finally back at single-digit (9.5 percent) territory. The Central Bank expects this trend to continue, seeing inflation in the range of 5.4 percent to 8.2 percent with a 70 percent probability.

While I concur with the Bank that inflation is on a downward path, I would place my bets on the upper half of its forecast range. For one thing, the limited exchange rate pass-through so far, which is one of the reasons behind the Bank’s confidence, might be illusionary: While it is true that the recessionary environment is helping, the lack of the pass-through might be partly due to the inventory depletion in certain sectors.

Moreover, with uncertainty on the IMF front and limited room for further local support for the lira, the exchange rate weakness is likely to be permanent this time around. Then, even a modest pass-through would add a few percentage points to inflation.

The Bank has been emphasizing lately that inflation could fall below its end-year target of 7.5 percent. This is in fact not too different from my own outlook; I just see inflation stabilizing at a higher rate than the Bank. In other words, my "L" is somewhat smaller than the Bank’s. It is this large "L", combined with the concern over the growth outlook, which has led the Bank to cut rates 5.25 percent since November. I agree with the Bank on its growth assessment; in fact, I have been writing on strong negative growth this year since November, when most analysts were still behind the curve. In addition, the Bank could turn out to be right on inflation, too. But regardless, I believe it has taken an unduly risk with little benefit.

First, as I anticipated two weeks ago, the impact of the last cut on benchmark rates has been limited, highlighting the limited ability of conventional monetary policy to affect longer-term rates and normalize credit markets in situations where the binding constraint is not the price of credit, as was (and to a certain extent still is) in the U.S., but the quantity. In a recessionary environment where more firms are likely to default (as evidenced in the upward trend non-performing loans), it will be the default risk not funding costs that will be in the bankers’ minds.

Moreover, loose fiscal and monetary policy could prove to be a dangerous mix. Simple sustainability calculations reveal that a primary surplus of less than 2 percent would increase the golden ratio of debt to Gross Domestic Product, which could, after a certain point, bear on the country’s risk perception and rates.

Moreover, the accompanying higher Treasury borrowing would put further strain on the monetary transmission mechanism by crowding out private lending. If all these found their way to the exchange rate, not only the Central Bank’s disinflation plans would be disrupted, but the real sector’s deteriorating foreign exchange open positions would mean that many firms would find themselves in dire straits, as would their lenders.

The Central Bank has taken monetary policy to uncharted waters, hopping on the global rate-cutting bandwagon on disinflation winds. I hope they are watching for the reefs.



Emre Deliveli is an independent consultant. His dailyeconomics blog is at http://emredeliveli.blogspot.com/.

The Treasury’s record tax levy against the Doğan Media Group, or DMG, managed to bypass even the Central Bank’s 1.5 percent rate cut as the shocker of last week. It is true that given the past surprises, the real surprise would have been if the Bank had cut the policy rate in line with expectations, but the Treasury still deserves some credit for stealing the show. It was only natural that the stock prices of DMG and other media companies of the Doğan Group dove on the news. After all, even though DMG is likely to fight the levy in a lengthy legal battle, there is a possibility of a huge cost item entering DMG’s balance sheet, which needs to be priced in, not only for DMG but also for other Doğan companies in the media sector. However, the sharp falls (more than 10 percent for each Doğan company and nearing 20 percent for DMG over the course of three days) are much more than simple accounting can account for. More interestingly, the mere fact that Petrol Ofisi, a non-media company in the Doğan group, also had a fall in excess of 10 percent hints that something deeper and more sinister might be going on.

That something may be the value of political links. The notion that firms with political ties might be affected from the fate of their party would be a no-brainer to almost any Turk. But actually measuring political connections is no easy task. The trick is to find unexpected political events that have no obvious financial bearing on the firm so that any abnormal return (the difference between the expected and actual return) could solely be attributed to the political event and thus to the value of the political tie. The Doğan levy unfortunately does not pass this litmus test, but Turkey has seen its share of political events in the past two years, providing fertile testing ground.

In an exercise borne out of curiosity a few months ago, I tried to measure the value of political connections by following up on the fate of companies perceived to be close to AKP by the finance community (from a small survey I conducted) during the major political events since 2007: The e-warning at the end of April 2007, Tarhan Erdem’s July 19 survey showing AKP further ahead than thought, the AKP election victory, the filing of charges with the Constitutional Court against AKP in March 2008 and the Court’s decision at the end of July.

In AKP-positive events, the average cumulative abnormal return (CAR) turned out to be around 3 percent, with the effect almost doubling in AKP-negative events.

Destruction of market value
While the results above show the value of political connections, they do not demonstrate the destruction in value of being labeled by the AKP. Therefore, urged by the events of last week, I repeated the same exercise for Doğan companies. There does appear to be an AKP effect in the reverse direction, but only for the Constitutional Court events, and much smaller in magnitude- less than 1 percent CAR. But then again, the hatchet has just been unburied, so we might have to wait for the next political shock.

I should say that this small exercise is by no means original: The first academic paper to demonstrate such effects showed that firms close to Indonesia’s Suharto were affected disproportionately by changes in the dictator’s health. Another looked at the Nazi seizure of power after the Reichstag fire, snap election and constitutional change by March 1933, when the Nazis decided to get off the democracy tram (no pun intended), and found that stock prices of firms that had tied their fortunes to the Nazis in the process surged.

It is comforting to know that AKP finds itself in such good company.



Emre Deliveli is an independent consultant and part-time lecturer at Izmir Economics University. His daily economics blog is at http://emredeliveli.blogspot.com/

Last week, the economics agenda was rather lively. While the policymaking community was doing its best to lighten up the mood with humorous words and deeds, it was also possible to detect some important signals pertaining to government bonds, most of which got almost lost in all the clatter. The Turkish Statistical Institute’s (TÜİK) industrial production data blunder was highly entertaining and managed, albeit unintentionally, to turn the attention away from the dismal figures, which have ascertained that the economy almost came to a halt in 2008. That a 40 percent growth in textiles could go undetected would itself warrant a separate column, but having spent some time at TÜİK thanks to various World Bank projects, I somehow wasn’t surprised at all. Quoting Forrest Gump, stupid is as stupid does, and that's all I have to say about that.

Equally entertaining were Economy Minister Mehmet Şimşek’s remarks that if the government had acted early on the crisis and secured a deal with the International Monetary Fund, the recession would have been deeper. Never mind the contradiction with another claim made moments earlier that inflation and interest rates were falling thanks to the government’s measures, I find it hard to choose which part of the statement is more virtual: The implication that the government is acting now or that an IMF deal would have fuelled the recession.

While the former is simply out of sync with reality, the latter is based on the idea that the Fund would have called for tighter fiscal policy instead of the loosening necessary to get the economy out of recession. In fact, the January budget figures of last week have been justified in some circles on exactly these grounds. To me, the figures reek of election spending rather than a boost to the economy. Moreover, even in developed countries, where textbook expansionary policy works best, the effectiveness of fiscal stimulus is uncertain. In Turkey, where there is arguably much less scope for fiscal policy, it is remarkable that expansionary policy is taken as a panacea without question by many.

The demand and supply picture for bonds

Election spending or not, the rise in expenditures, along with the decrease in tax revenues on the back of a slowing economy, is causing a rapid deterioration in the budget. If not reversed, this trend is likely to lead to an increase in the debt rollover ratio, putting upward pressure on bond rates and crowding out private lending. In this sense, although the Treasury does not face a heavy financing burden for the next couple of months, the fiscal outlook does not paint a supportive supply picture for bonds.

Turning to the demand side, while I plan to wait until all the fourth quarter balance sheets are released before a complete assessment of the banking sector, early releases show that banks have indeed been banking on rate cuts, with gains from the bond rally making up for the contraction in interest margins and the stall in loans. However, the latest figures also reveal an upward trend in non-performing loans (NPLs). If NPLs are to surge to twice the 2008 figure of 3.5 percent by mid-year, as forecasted by some analysts, simple scenario analysis reveals that banks’ appetite for bonds could be severely hampered. Therefore, the demand for bonds does not look that rosy, either.

Lately, I am seeing a lot of bond-optimists, dancing to the tune of Central Bank and fiscal policy. However, neither bond fundamentals, which I outlined in previous columns, nor a supply-demand framework justifies such confidence. The question is not when the music will stop, but who will be left standing when it does.



Emre Deliveli is an independent consultant and part-time lecturer at Izmir Economics University. His daily economics blog is at http://emredeliveli.blogspot.com/

One of the first things you learn living in New England is not to get deceived by the bright winter sunshine, as it usually goes in hand with temperatures in the negative Fahrenheit territory. Lately, there are increasing signs abroad that the worst of the crisis has passed, to such an extent that even the dismal U.S. non-farm payrolls data was largely ignored. While stimulus packages around the world are providing the moral motivation, the uptick in several purchasing manager indices is leading hopes that the global economy has bottomed out. In a similarly Pollyannaish manner, the recent rise in the Baltic Dry Index, an assessment of the price of moving major raw materials by sea, is being interpreted as a sign that trade credit is finally stirring.

Although I will not attempt a global economic treatise here, I find it hard to believe that the U.S. will start recovering before inventories are being worked down, household savings rise or house prices stabilize and banks get rid of their toxic assets one way (a government insurance scheme) or another (a bad bank solution). Unfortunately, none of these three necessary conditions is close to being satisfied yet.

While I hit the bull’s eye with my inflation forecast last week, this is one prediction I would have preferred to be dead wrong in. It is true that the 0.29 percent monthly rise, although above expectations, was the best January figure ever, but despite the unanimous laying of the guilt solely on food inflation, I am worryingly seeing early signs of an exchange rate passthrough. Similarly, while the muted producer inflation and decline in manufacturing prices hint to limited cost-led pressures, it seems that - as noted by the Central Bank - the fall in oil prices has equalized foreign currency movements. Inflation is likely to be a tug-of-war between domestic demand-dependent service goods and tradeables in the coming months.

No rejoicing yet
The recent rise in consumer confidence has been another confidence-booster. However, part of the increase is reflecting a correction from the sharp falls earlier. Moreover, a quick statistical analysis reveals that asset prices (especially USDTRY and the Istanbul Stock Exchange’s IMKB-100 index) and political shocks go a long way in explaining consumer confidence. Therefore, while it is definitely a positive development, the rise in the fragile consumer confidence should not lead to rejoicing yet.

As both inflation and consumer confidence seem to hinge on it, it is natural to dig deeper into the exchange rate. The lira has held remarkably well in the past few weeks despite the rout in many emerging markets, even though the government, with the delayed IMF deal, the Davos incident and another round of Ergenekon, was doing its best to have the currency move in tandem with peers. Given that Turkey has led the pack in the reduction in emerging market-dedicated funds’ net exposure, locals seem to be behind the currency’s relative strength, as foreign currency deposits have declined by around $4 billion this year. This is all fine, unless locals decide to wait out for further lira weakness, so the current situation is definitely not rock-solid.

Another interesting development is the recent uptick in parts of consumer credit, which may also be due to restructuring of credit card debt. Any short-term movements in commercial credit should similarly be taken with a grain of salt, especially as there is no change in the fundamentals restraining loan supply and demand. In this respect, the 117 percent debt-rollover in the past week’s auctions should be a reminder of the risk of crowding out.

The recent data seem to have led many to a winter jog. They might end up catching a bad cold.


Emre Deliveli is an independent consultant and part-time lecturer at Izmir Economics University. His daily economics blog is at http://emredeliveli.blogspot.com

An agreement with the International Monetary Fund, one that has enough credit to cover the external financing gap, has already been priced in. The short month of February is carrying a heavy bag, with a significant part of the action coming early in the month.

With the Central Bank’s front-loaded monetary easing, inflation has returned to the spotlight. The lower-than-expected December turnout as well as the Bank’s disinflationary assessment in the latest inflation report seem to have created a positive mood with respect to inflation, with the CNBC-e expectations survey for January coming at 0.13 percent. However, my own assessment, which takes into account jumps in inflation sentiment as well, points to an outturn of around 0.3 percent. The Istanbul Chamber of Commerce’s inflation figures offer rough guidance, as a monthly fall in Istanbul prices of 0.57 percent is consistent with market expectations. In any case, a modest deviation in either direction is unlikely to move markets much.

While the ongoing positive inflation sentiment is bond-friendly, one of the factors likely to limit a bond rally even in the case of an inflation realization well below expectations is the Treasury’s domestic borrowing program. With nearly 23 billion Turkish Liras due, February is the month with the heaviest redemptions, and with more than two thirds of that due on Wednesday, the Treasury auctions in the first two days of the week will be watched closely. Just cross your fingers that there won’t be any nasty surprises on the inflation and international fronts.

Final figures for 2008

The second week of February will bring in the last statistics of 2008: December industrial production, current account and terms of trade. All three will show us how much the economy has slowed down last year before the growth figures for the last quarter are released next month. With the external indicators, I will also be looking for external financing woes and the extent the uncertain environment is leading to postponed investment decisions & durables consumption as well as the size of the damage in Turkey’s external markets and its export competitiveness.

Another major event of the month will be the release of the bank balance sheets for the last quarter of 2008. While aggregate statistics show the banking system’s response to the slowdown in terms of declining credit and liquidity management, the balance sheets will allow us to see individual differences. In this respect, I will be looking for signs of a flight to quality, which was one of the defining characteristics of the 2001 crisis. While there is not much evidence of this phenomenon so far, I would advise buckling up for some nasty surprises on that front.

A wait-and-see event this month will be the never-ending story with the Fund. While the media has reported the negotiations being deadlocked on extra fiscal measures, but I beg to disagree with the source of disagreement. The reference to the medium-term structural fiscal reform agenda in the short IMF statement last Monday hints that the discords may be more fundamental and forward-looking.

From a practical point of view, however, markets don’t care on such academic questions. In the short-run, an IMF agreement with enough credit to cover Turkey’s external financing gap has already been priced in. Moreover, at this stage, I do not think that it will matter a lot if the agreement is postponed until after the local elections, as long as the Prime Minister does not disclose that he is done with the IMF, like he declared to be done with Davos.

With such a heavy agenda, it will be an important feat to leave February behind without any significant road accidents.



Emre Deliveli is an independent consultant and part-time lecturer at Izmir Economics University. His daily economics blog is at http://emredeliveli.blogspot.com/

We have yet to see how much the Central Bank’s easing will make its way into the economy, but it has at least dispelled the myth of Sisyphus. As John Fitzgerald Kennedy once said, the great enemy of truth is often the myth. Therefore, for the noble quest for lux et veritas, I would like to devote this week’s column to deconstructing three myths of the Turkish economy.

First, the December budget figures leave no doubt that there is significant fiscal slippage. However, just as fiscal-hopefuls are well off the mark, so are those attributing the figures to expansionary policy. In fact, while the December turnout reflects the rise in primary expenditures, which have never been a strong point in Turkey’s fiscal report card, even more noteworthy is the slowdown in tax revenues. The tax system’s sensitivity to domestic demand is proving to be useful for once, as the December revenues, along with other recent leading indicators such as November industrial production and December capacity utilization, have already prepared me for the shock when the fourth quarter growth figures will be announced on the last day of March.

Monetary policy has similarly been of use in an unexpected way. While we have yet to see how much the Bank’s recent aggressive easing will make its way into the economy, it has at least hopefully dispelled the ultimate myth of Sisyphus: The high interest low exchange rate myth, i.e. the urban legend that the Bank has been targeting the level of the exchange rate. In addition, the lower policy rates and the easing bias that has come with them have earmarked the continuation of the bond rally that has been going on since the fall of last year, a rally that has happened despite the weakness in the lira in the same period.

Decoupling
While the noted decoupling between the lira and Treasuries partly reflects the global environment and is in no way exceptional to Turkey, it is curiously expected to continue, as most market economists are noting that there may still be some value left in Treasuries, while at the same time shifting their dollar/lira trajectories for 2009 upwards. Maybe, a first step towards understanding this interesting enigma is noting that both the lira and interest rates are influenced by many factors, only some of which are common to both.

To illustrate, a recent IMF paper has found disinflation credibility and the risk premium as the main determinants of real rates in Turkey. While such empirical analysis should always be handled with care, I had reached a similar conclusion around the same time (see the Oct. 8 entry in my blog). The downward trend in inflation expectations and the sharp fall in credit default swaps, or CDSs, from December to early January fit in well in this respect.

While CDSs are all-encompassing market-based measures of risk that tend to move together, there are certainly important Turkey-specific factors that could easily cause a jump in the perception of the country’s risk premium - for a case in point, just have a look at the Turkey and Ukraine CDSs for the past year. I had already discussed in previous columns the possibility of a fiscal binge, crowding out from the Treasury’s borrowing program and external financing woes in the absence or delay of an IMF program. Just add in mounting real sector troubles and rising political tensions to fully appreciate the richness of Turkey’s risks.

JFK noted that belief in myths allows the comfort of opinion without the discomfort of thought - at least before the house of cards comes tumbling down, when it is too late to think anyway. So do some thinking and worrying in advance, and Turkish Treasuries may suddenly stop being the great value they are marketed to be.



Emre Deliveli is an independent consultant and part-time lecturer at Izmir Economics University. His daily economics blog is at http://emredeliveli.blogspot.com/

It seems I was too hasty when I declared that the Central Bank had engineered the perfect surprise rate cut last month. Last week’s cut was not only more than twice the expectations, but has also brought Turkish real rates in line with peers such as investment-grade Brazil. The Bank has stated explicitly that it expects oil prices will stay low and exchange rate pass-through will be limited. However, these factors may not be enough to justify so strong an easing- unless the Bank believes the recession will be so deep that even the sticky service inflation will fall rapidly - the implicit scenario that is giving me the shivers for some time.

"Fortunately," the government has finally announced that it will disclose its "package" at the end of the month. In the meantime, it has asked for suggestions, and the Izmir Chamber of Commerce put together a diverse group from the academia, the business world and NGOs for a brainstorming session on Saturday to form its recommendations. The session and an accompanying panel discussion on Friday, organized by the Izmir Economics University have urged me, at the expense of oversimplifying, to condense the crisis propositions into two broad categories.

Disruption in financing
First, it is clear that the financing channel has been seriously disrupted, and various credit guarantee fund formulations aim to ease firms’ access to finance, differing on where the funds will come from, who they will be intended for and who will bear the risk. My own view is for a setup that will provide the least budget burden, is geared towards small- and medium-sized enterprises, or SMEs (as they are more credit constrained, and targeting SMEs is likely to have a bigger employment impact), ensures the money will flow to the real sector rather than to Treasury bills and mitigates moral hazard by sharing the risk between the banks and the government.

The next set of policies revolves around using Keynesian tools to counter the crisis. Here, the suggestions as are colorful as they come, ranging from tax breaks and tax delays to outright cash handouts, such as Finance Minister Kemal Unakıtan’s recent cash for employment announcement. I am ambivalent on the use of fiscal policy, not only because its impact is highly uncertain, but also for fear of a binge that would bring the nightmare before 2001 back. Policies that will enhance long-run growth and productivity such as infrastructure investment and human capital seem like the safest bet, even though that’s not the way to go if the government is trying to get not the best, but the quickest bang for the buck.

The question of purchasing power
Commendable as they are, the proposals outlined above adopt the producer’s perspective. A question as key as "how will they produce" is "how will they buy," especially since global demand is so weak. It was, after all, the crisis in confidence and sharp consumer pullback that pushed Turkey into a premature slowdown. But unless the consumer feels job security, the consumer will not consume, so unless the crisis in the consumer is solved, all the other measures are likely to hit a wall at some point. The optimist could hope that the crisis package will bring back consumer confidence, but I prefer to err on the side of caution.

The government has eroded confidence by claiming the crisis would pass tangent - it turned out to be the diameter - and doing nothing. Luckily, while it seems to have totally misinterpreted JFK’s famous quote, the academia, NGOs and the business world have done more than their share, with the Izmir efforts being the latest example. Now, we will see whether the government will be able to follow.


Emre Deliveli is an independent consultant and part-time lecturer at Izmir Economics University. His daily economics blog is at http://emredeliveli.blogspot.com/

To get the best bang for the buck, policies stimulating investment should be preferred, but with the goal of protecting the golden ratio of debt to gross domestic product. It is said the Irish President once asked Winston Churchill how the British war effort was faring, to which Churchill replied: "Serious but not hopeless." When Churchill threw the same question back, the President answered: "Hopeless but not serious."

While the early-year global rally, which came to a premature end, will not be the last rally of the year, it is increasingly becoming obvious that the health of the world economy is turning from grim to serious, but is still not hopeless, thanks to the huge stimulus packages most countries are throwing in. In fact, the only major country that has stayed relatively unresponsive to the dismal economic landscape is Turkey, which makes me wonder whether Turkish policymakers have adopted the Irish state of mind.

If you feel like questioning my skepticism, you have every right to: After all, the December inflation justified the Central Bank’s easing. The International Monetary Fund is in Turkey and an agreement is likely to be reached soon, filling the external financing gap. Moreover, didn’t government spending and investment contribute significantly to third quarter growth figures? All these statements are right and would normally be commendable in ordinary circumstances. But the fact is that we are not living in ordinary times, and such times require extraordinary solutions: Solutions of the type we have not seen yet.

Darkening the picture
For one thing, no efforts in mitigating the emerging financing constraints in the private sector have been announced so far, other than rumors of a credit package geared towards exporters. The high debt rollover ratio is likely to darken this bleak picture further, as public borrowing crowds out the private kind. Some early signs of this crowding out were seen in the Eurobond auction of the past week, where the two-third local subscription was curiously interpreted as a sign of liquidity of the banking system. While channeling some of the IMF funds to the Treasury could mitigate the crowding out effect, I am crossing my fingers that the high-borrowing month of February will pass without a calamity of the German kind. Otherwise, the Central Bank could find the effectiveness of the monetary transmission mechanism fading real fast.

Another concern is the nature and scope of fiscal policy. While the IMF agreement will probably not be as fiscally-restraining as before, I would like to know where the money will go to. To get the best bang for the buck, policies stimulating private investment should be preferred, but with the goal of protecting the Turkish golden ratio of debt to gross domestic product. A spiraling of debt could lead to worsening expectations and higher interest rates, not the exact place you would want to find yourself in the midst of a global recession. Maybe the government is waiting for the IMF agreement, but I find it hard to believe that policymakers have been so tight-lipped on how they will stimulate the economy.

If Turkish policymakers have an Irish frame of mind, they at least, unlike the Irish, are not impervious to psychoanalysis. How else could you explain the illusion that exchange rate pass-through has disappeared, a conclusion reached on just a couple of months of data? Maybe it is just me, but every time I look at December inflation figures, I see signs of pass-though covered up by the strong inventory depletions in textiles and autos as well as the drop in energy prices.

I do not want to be a harbinger of doom, but Turkish policymaking is looking more and more to be hopelessly unserious.



Emre Deliveli is an independent consultant and part-time lecturer at Izmir Economics University. His daily economics blog is at http://emredeliveli.blogspot.com/