The new governor’s agenda

After Süreyya Serdengeçti completed his five year term and stepped down as governor of the Central Bank on 13 March the process began to select his successor and, at the time that we went to press, had still not been finalized. But what has occurred during this process has not been very encouraging.

The time when Serdengeçti, who almost everyone agrees was successful, could have been reappointed has passed. But the decision by the government, which should have announced his successor weeks ago, to keep the identity of the new governor secret during the time that the decree facilitating his appointment was awaiting ratification by the President created considerable uncertainty on the markets. The decision to disregard accepted practices during the appointment of an acting governor (namely the appointment of the highest ranking deputy governor) while the governor was being appointed has created severe disruption inside the Turkish Central Bank.

The new governor faces a difficult task
The new governor will be faced with the task of reducing inflation to the level of European Union (EU) member states, while ensuring continued high growth in order to ease the increasingly critical problem of unemployment. But, as we wrote last month, although it was possible to reduce inflation when it was running at a very high level without damaging growth, this is not an option when the rate of inflation is relatively low. The task of trying to find some way of reconciling these two contradictory goals looks as if it will severely strain the new governor’s nerves.

In addition, the overvalued YTL and the record current account deficit will also pose a problem for the new governor. The complaints in this regard coming from both the public and the government are steadily increasing. Serdengeçti opted to close his ears to these complaints and continue with his job but it looks as if it will be difficult for a new governor, who will take up his post at a time of such intense interference from the government, to resist this pressure.

Diary for April
The new governor will be faced with an extremely busy schedule from the moment that he takes up his post. During April he will have to make some important decisions regarding monetary policy.

The first important day in the new governor’s diary for April is Monday 3 April. This time the third of the month, which is when the inflation figures are announced for the previous month, will fall on a weekday. The inflation figures for March will be announced on 3 April.

The inflation figures for March are extremely important for the Central Bank. At the beginning of 2006, when the Central Bank announced the transition to an inflation targeting system, it set targets not just for the end of the year but also for the end of each quarter. It announced that if there was a deviation one way or the other of one percentage point then it would have to explain itself in discussions with the IMF; if the deviation was two percentage points then it would have to explain itself to public opinion.

Within this framework, it set a target of 7.4 percent for annual inflation at the end of March. But over the first two months inflation began to rise and stood at 8.15 percent at the end of February. Even though the rate of inflation had been expected to remain flat over the first two months of the year, the actual rate was still higher than anticipated. If inflation continues to rise in May and exceeds 8.4 percent then, even before he has settled in his chair, the new governor will have some explaining to do to the IMF. The government was already facing problems with the IMF following its decisions last month which had imposed an extra burden on the budget (a reduction in VAT for the textile sector and additional payments to public sector employees) and the delays in passing structural reforms; and it will not be easy to have to explain away a deviation in the inflation rate as well.

Is economic growth in danger?
The second important date in the new governor’s diary for April is Monday 10 April. This is when the industrial production figures for February will be announced. In Turkey the figures for industrial production are the most important indicators of economic growth. As a result, industrial production will be followed closely by both the Central Bank and every other institution and individual who is interested in future growth.

Industrial production did not make a very good start to 2006 and fell by 4.5 percent in January. The February capacity utilization rates for manufacturing industry suggest a recovery but we cannot know whether they will be reflected in practice. If we do not see a significant recovery in industrial production in February, growth for the first quarter will be very low. This will endanger the growth target of 5 percent for 2006.

Two other important dates in the new governor’s diary for April are Thursday 27 April and Friday 28 April. The Monetary Policy Committee will meet on 27 April with an almost completely new membership. On 28 April the Central Bank, which will have just entered the new inflation target period, will announce the second of its Inflation Reports, which is its most important means of communication with the public. At the meeting of the Monetary Policy Committee the new management of the Central Bank will make its first decision about the exchange rate. Its Inflation Report will reveal how it views the economy and what it expects to happen over the next 18 months. When we bear in mind that inflation is on the rise while growth has begun to contract, then neither of these are going to be easy.

Should interest rates be raised or cut?
Economic circles are expecting the new management of the Central Bank to cut interest rates. If we only look at growth then a cut in interest rates could be the right decision. But, in addition to boosting domestic demand and fuelling growth, a cut in interest rates would also lead to an increase in prices – as would an upturn in domestic demand – and raise the possibility of a steep increase in inflation. It does not look possible for a central bank which has set price stability as its more important goal and which has adopted an inflation targeting system to ignore this possibility.
,
When we only look at inflation then perhaps what is needed is not to lower interest rates but to raise them. An increase in interest rates would suppress domestic demand and could also trim back rising inflation. But, in addition to suppressing domestic demand, an increase in interest rates would also slow the pace of economic growth and could trigger a recession. At a time when the problem of unemployment is continuing to get worse, it does not appear possible for the Central Bank to ignore this possibility either.

The First News About Growth Was Bad
It was not just inflation, 2006 also started badly in terms of growth. Industry is the most important indicator of growth in Turkey but in the first two months it did not provide us with very encouraging signs for growth this year.

Industrial production fell by 4.5 percent in January. As the result of the long religious holiday, poor winter weather conditions and energy problems related to imports of natural gas no one was expecting a very good performance from industry in January, but neither had anyone expected such a fall. Forecasts had tended to predict not that industrial production would fall by 4.5 percent in January but that it would post a similar rate of growth. Even though we were not expecting growth to be that high we had still anticipated an increase in industrial production in January.

At 6.1 percent, the decline in production in manufacturing industry in January was even higher than the fall in overall production. If it had not been for a high increase in production in the energy sector, the decline in industrial production as a whole would have been as high as the fall in manufacturing industry.

If there is no recovery in industry in February it will be difficult for economic growth in the economy as a whole to be any better than mediocre during the first quarter of the year. This would endanger the target of 5 percent growth for 2006. In order to achieve this target the economy would have to record an extremely strong performance over the rest of the year.