Even if the 6.5 percent year-end target is achieved, Turkey’s CPI will be relatively higher than those in Turkey’s rivals in international markets.

Inflation figures for July came as no surprise: annual consumer price inflation increased to 9.1 percent from 8.9 percent in June. This matches with the estimations of both the Central Bank and the majority of economists. An unpleasant, if not worrisome, development is that the headline inflation index (l) started to demonstrate rigidity. Average value of the indicator was 7.9 percent for the last ten months, 7.7 percent for the last five and 7.4 percent and 7.5 percent respectively in June and July. 

CPI higher than rivals

The chief point that raises concerns about inflation is: the rate currently at 9.1 percent is considered positively as, despite the slight rise, it is still in harmony with the Central Bank’s scenario for year-end inflation around 6.5 percent. Nevertheless, even if the year-end target is achieved, Turkey’s CPI will be relatively higher than those for Turkey’s rivals in international markets. What is more, this has been the case throughout the last year and a half. In short, Turkey already suffers from a cumulative cost disadvantage. 6.5 percent year-end inflation will perpetuate this disadvantage; yet we are content with it.

The current developments in Europe affect the exchange rate significantly and the outlook in the continent will probably remain intact. Therefore, what goes on in Europe will affect Turkey also through the inflation channel. Recent remarks by the European Central Bank (ECB) President Draghi are on top of the agenda for some time now. I tried to interpret what his statements imply in the last two commentaries. On Thursday, the ECB held a meeting after which Draghi held a press conference and answered questions. He said that the ECB may step up if countries in trouble apply to the temporary bailout fund and the European Stability Mechanism (ESM) and if they comply with the fund rules. Of course, provided that Germany’s Constitutional Court announces it does not violate the country’s constitution on September 12 and thus the Fund becomes active.

When you see the glass half full, if the troubled countries apply to the fund and sign deals, they guarantee that they will comply with the rules of fiscal discipline and other conditions defined. Therefore, the funds will purchase government securities in the primary market while the ECB will purchase short term bonds in the secondary market until markets are relieved. As a result, falls in the interest on bonds will be possible. Moreover, Draghi announced that they were working on some technical issues to facilitate the purchase of bonds by the private sector. These all were awaited for a long time and if actually taken, will evidently stir markets. 

The fund alone is not enough

On the negative side; first it is not certain if Italy and Spain will apply to the stability funds. Furthermore, the temporary fund (EFSF) only has €148 billion, which is clearly insufficient. The capital of the ESM, which can become active only if the Germany Constitutional Court judges in favor, is €500 billion. Some argue that the amount will prove insufficient if the ESM is not given a banking license. Germany is against this option to begin with. More importantly, we don’t know what the Constitutional Court will decide. Finally, the ECB declared that they “may” step up, not “will definitely” step up. Also, during the press meeting, Draghi stated that the President of Bundesbank opposed to this plan, and we all know Germany’s influence. Another positive development that was rather overlooked was that Draghi, after mentioning the oppositions of the Bundesbank President, said that the ECB was an independent agency and could take decisions not necessarily unanimously but also with the majority of the votes.

So, here is the moral of the story: Thursday’s commentary concluded, “Under these circumstances, it is too soon to say that the worst part has ended.”Draghi’s latest statements did not change my opinion. And concerning inflation, I believe that Turkey mustn’t be completely sure that year-end inflation will be 6.5 percent.

This commentary was published in Radikal daily on 04.08.2012