Bills to pay and no relief

As the latest inflation figures reveal, transitivity of depreciation in the Turkish lira has been rising recently and it will continue rising over the coming months. The domestic producer price index (PPI) rose by 6.60 percent in August and the annual increase reached 32.13 percent, a jaw-dropping figure. This increase is the highest over the last 17 years – since the last time Turkey was struggling with high inflation.

CPI rose at a relatively lower rate (!) – 2.30 percent – due to the delay of producer prices reflecting on consumer prices and (allegedly), as it was Eid, consumer goods basket prices for the second half of the month were not included in the calculation.

The currency basket has risen by 75 percent since the start of the year. In other words, the Turkish lira lost 43 percent of its value. A large part of this depreciation happened in August when dollar rate rose to its current levels from 4.90 lira.

This recent increase has not reflected on consumer prices yet. And the increase of 30 percent in July-led inflation reached 8 percent during this period. So we can talk about a transitivity rate of 25 percent with a rough calculation.

The Turkish lira lost about 36 percent of its value over the last 35 days. If the transitivity rate calculation I just did is correct, CPI may rise to 28 percent this year. On the other hand, with tax adjustments made for gasoline prices, this transitivity rate is somewhat decreased. Even if the rise in foreign exchange stops, we may easily consider an inflation rate ceiling of 25 percent.

Indeed, due to increasing foreign exchange rates, our imports will decrease whereas our exports will eventually accelerate. But there is the issue of “time inconsistency”, meaning while the current account balance is expected to stabilize through the price mechanism (foreign exchange rates), we may face some dire developments. We don’t have the luxury of doing nothing because we think the rates will stabilize sooner or later (let’s remember that gross foreign exchange reserves fell by 27 percent in the last six weeks and declined to $88 billion, down from $120 billion).

First of all, Turkey is extreme- ly foreign-dependent. Whatever we do, we have to pay the energy bill, and that bill is heavy (it will surpass $40 billion dollars for 2018). It keeps the current account balance in the minuses (in other words, foreign exchange inflow is kind of necessary).

If we can’t find net fresh foreign exchange, this bleeding in foreign rates will continue.

The real damage foreign exchange rates create is for private companies who owe in foreign exchange and their financial situation is being dragged down to a critical state.

While banks asset quality worsens as a result of this, their capacity to roll-over their foreign debts gets weaker. So they have to narrow down their foreign exchange credits and put pressure on companies to pay their debts. To buy foreign exchange at today’s rates to pay all their debt is kind of a death sentence for many companies.

Besides, the banks’ approach on the issue fuels the demand for foreign exchange rates and increases the pressure on foreign exchange rates (if every bank acts as a captain trying to save his ship, it will be a very dangerous development for whole financial system.)

In the short term, we can’t do nothing with the recent rise in foreign exchange rates. We can’t ignore the turbulence in foreign exchange rates because of foreign political developments.

Frankly, without calming the turbulence, more monetary and fiscal policies won’t do enough. Therefore, political issues have to be solved immediately (preferably yesterday). After that, we need a Medium Term Plan with a high credibility coefficient and budget goals associated with tangible criteria.

With the risk of 25 percent inflation, there’s no need to say that the Central Bank’s policy rate of 17.75 percent is not enough. We need a rate hike of at least 300 basis points. And lastly, the banking authority, BDDK, has important duties in this regard. Banks have to avoid self-protective acts that may hurt the system. After a stabilization in foreign exchange rates is achieved, we need a transparent reckoning of banks’ balance sheets. This is important on in terms of banks having a problem of rolling over their foreign debts.