Investing.com – In the event of a deviation from the inflation target, the open letter sent by the CBRT to the government in accordance with the principle of accountability drew attention to the risks, the necessity of a tight stance and the support of reforms.
CBRT’s open letter:
“In order to control inflation expectations and limit the risks to the inflation outlook, tightening steps have been taken in the epidemic-specific policies since the beginning of August. The CBRT carried out a clear and strong monetary tightening by raising the policy rate from 10.25 percent to 15 percent in November in order to eliminate the risks regarding the inflation outlook, to control inflation expectations and to restore the disinflation process as soon as possible. In addition, in order to increase transparency and predictability, it was decided to adopt a simple operational framework and to make all short-term funding at the one-week repo rate, which is the main policy instrument. Funding provided by crazy traditional method repo auctions and Late Liquidity Window (GLP) facilities started to be carried out with one-week repo amount auctions, which are the main monetary policy tool, as of 20 November 2020.
In November MPC meeting, in line with the main objective of price stability, the need for a change in reserve requirement regulation in order to increase the efficiency of the monetary transmission mechanism was evaluated. In this context, it has been decided to abolish the required reserve ratios and interest / interest rates that differ according to real loan growth and to re-determine the required reserve ratios and interest / interest rates to be applied at the same rates for all banks. The simple implementation of the required reserve system has contributed to increased transparency and predictability in monetary policy. In addition to this, and the changes in the foreign currency reserve requirement ratios, the monetary stance of the CBRT and the effective functioning of the monetary transmission mechanism.
Strong communication regarding the tightening in monetary policy and price stability reflected positively on the markets, and financial indicators improved. As a result of increasing policy predictability by adopting a simple operational framework focused on price stability, risk premium, exchange rate volatility and long-term interest rates have declined and capital inflows have increased since November.
In December, a strong monetary tightening was made, taking into account the 2021 year-end forecast target. The policy rate, which is the one-week repo rate, increased from 15 percent to 17 percent. In the period following the decision of December, developments regarding international commodity prices and the supply constraints that became evident in some sectors as well as the minimum wage and administered prices had an impact on the CBRT’s assessment of the inflation outlook for 2021.
As a matter of fact, the tight monetary policy stance was strengthened in January with the verbal guidance that the tight monetary policy stance will be maintained for a “long time” until strong indicators are formed that point to a permanent decline in inflation and price stability and that “additional tightening will be made if necessary”.
It is expected that the slowing effects of the strong monetary tightening realized at the November and December MPC meetings on loans and domestic demand will become more evident, thus, demand and cost factors that have an impact on inflation will gradually weaken. In this context, inflation is estimated to be 9.4 percent at the end of 2021, to reach 7 percent at the end of 2022 and to stabilize by declining to the medium term target of 5 percent at the end of 2023. Inflation is in the range of 7.3 percent to 11.5 percent with a probability of 70 percent, with a midpoint of 9.4 percent at the end of 2021; By the end of 2022, it is expected to realize between 4.6 percent and 9.4 percent with a midpoint of 7.0 percent.
The forecasts are produced under the assumption of a monetary tightness level that will keep inflation in line with the 2021 and 2022 forecast targets. In addition, the external demand outlook for global growth and a negative shock induced epidemic will not happen again, along with the positive developments in global risk appetite taken a view are essential to continue the improvement in Turkey-specific risk perception.
In the forecast path for 2021, wages, food prices and international commodity prices affect inflation upwards, while administered prices and inflation expectations affect inflation downwards. In this interaction, the strong effect of the tight monetary stance is expected to bring 2021 year-end inflation back to 9.4 percent.
However, the upside risks on these forecasts remain significant. Therefore, it is imperative to maintain the strong tight monetary policy stance.
The basic principles of the monetary policy to be implemented by the CBRT in line with the main objective of price stability are set out in the Monetary and Exchange Rate Policy text announced on December 16:
- (i) Decisive implementation of the inflation targeting regime with all its elements in a simple operational framework
- (ii) Maintaining a tight and determined monetary policy stance with the priority and focus of price stability.
- (iii) Strengthening communication in line with the principles of transparency, predictability and accountability. (iv) Implementation of the floating exchange rate regime.
- (v) Strengthening foreign exchange reserves and using all available instruments in a transparent manner, within a plan, and under appropriate conditions when the determined strategic criteria are met. (vi) Considering financial stability as well as price stability.
In the inflation targeting regime, central banks try to control future inflation with a medium-term perspective, taking into account the duration of the monetary policy transmission. Since the effects of monetary policy decisions on aggregate demand and inflation are seen with a lag, it is a more effective practice to set the policy stance towards inflation forecasts. In this framework, the forecasts shared in the Inflation Reports are also an “forecast target” and an intermediate target by making reference to inflation expectations. In other words, in order to manage expectations more effectively while converging to the medium-term inflation target, the reference value for the economic agents in terms of the future course of inflation is the inflation forecasts in the short term and the inflation target in the medium term.
When the current levels in inflation are evaluated together with the upside risks, it is clear that it is well beyond the 5 percent target. The estimates we have presented in the January Inflation Report show that we can reach the 5 percent inflation target in 2023. For this reason, the tight and cautious stance in monetary policy should be resolutely maintained for a long time until 2023, when the 5 percent target is expected to be reached.
In order to reach the medium-term 5 percent target, the inflation targeting regime will be implemented with all its elements. In this process, the development of inflation within the projected forecast path will be monitored continuously and closely. The level between the expected inflation rate path realized and expected until the 5 percent target and the monetary policy interest rate path will be established by considering a strong disinflationary balance and this balance will be maintained continuously. In the event that any new data to be obtained besides the existing data indicates the risk of deviating from the medium-term target path in inflation expectations and pricing behavior, additional tightening will be done ahead and with determination. In this context, the underlying trend of inflation and indicators of pricing behavior, diffusion indices, demand and cost factors, and compliance of inflation expectations with targets within the forecast horizon will be closely monitored.
This tight stance in monetary policy will contribute to a decrease in the country risk premium within the target horizon, encouragement of Turkish lira savings, the start of reverse currency substitution, an increase in foreign exchange reserves and a permanent decline in financing costs. While this situation will positively affect macroeconomic and financial stability, it will also enable the tightness of monetary policy to be adjusted under these conditions.
The fiscal consolidation that will be achieved by strengthening the coordination between monetary and fiscal policy within the scope of strong policy coordination in reaching the medium-term 5 percent target will provide a very important input in reaching the inflation targets. In this framework, it remains a critical priority to maintain fiscal discipline with determination. In addition to the financial stance, managed / directed price and tax adjustments, incomes policy and public borrowing strategy in line with monetary policy targets will support our fight against inflation. In addition, reform steps to be taken in the field of law and economy will provide an important support to the disinflationary process through anticipation.
Continuing structural steps to reduce the rigidity and volatility in inflation will contribute positively to price stability and therefore to social welfare. In this context, the CBRT will continue its efforts to analyze structural elements, develop policy recommendations, and raise awareness among relevant stakeholders and the public about the importance of combating inflation. On the other hand, steps will be taken to improve confidence in monetary policy by increasing and developing transparency, predictability and accountability in the design and implementation of monetary policy.
As a result, in line with the goal of achieving price stability, the Central Bank will continue to apply all its tools in a full, timely, effective, powerful and determined manner. On the other hand, in the inflation targeting regime, it is essential that all layers of the society focus on and believe in the price stability target, and that decision-makers and policy makers take decisive steps in this direction. In this framework, an open, sincere and effective cooperation and communication policy will be implemented in order to transform the disinflation process into a process that is owned by all parties. “
Author: Necdet Erginsoy