WHAT HAPPENED IN MARCH?

In our previous report, we shared that three factors will determine the course of the economy in March: the Russia-Ukraine conflict, the FED’s interest rate decision, and the interest rate decision domestically.

The war between Russia and Ukraine has had widespread sectoral impact from foreign trade to tourism, from energy to food. This month, we will briefly analyze these effects.

The Fed made its first interest rate hike, as expected. The 25-basis point increase implemented was in line with expectations. Statements following the hike did not change the general environment. Therefore, there is less uncertainty in this sense. Internally, the Monetary Price Committee (MPC) did not change the interest rates, as expected. However, we cannot say that there has been a decline in domestic economic uncertainties.

A month has passed since the beginning of the Russia-Ukrainian War. More than 3 million people have left Ukraine. In addition to the weight of the humanitarian and political dimensions of the war, its economic cost is also growing.

Agricultural, metal, and energy prices have increased worldwide. This shock has added to already-high prices before the war and historical highs are now seen in the prices of some products. Although there was a short-term pullback in oil prices in March, the direction is still upward.

Russia and Ukraine are extremely important in terms of both our exports and imports of goods and services. In 2021, Turkey exported USD 5.9bn to Russia and USD 2.9bn to Ukraine. However, the main importance of these two countries is in our tourism revenues. Four out of ten tourists coming to Turkey are Russians and Ukrainians. The largest contributions to the tourism industry in 2020 and 2021 came from these two countries. The prolongation or expansion of the war may cause a serious decrease in tourism revenues in 2022.

Turkey is an important holiday destination for Ukrainians. In 2021, the number of Ukrainian tourists exceeded 2 million for the first time. The number of arrivals from Russia also reached 4.7 million. If the war does not end in the summer months, it will not be possible for Ukrainians to visit Turkey for tourism purposes. There will also be a significant decline in the number of Russian guests.

The second important point is commodity trading. The prolongation of the war means a decline in trade. Our total monthly exports to the two countries are around USD 700m (USD 500m to Russia, USD 200m to Ukraine). Sales to Ukraine have practically halted, and reports indicate that there is a decrease in the Russian market by half. Therefore, we will see a decrease of around USD 400-450m on a monthly basis. This is not a big enough effect to turn the country ’s overall export growth into a decrease. However, we will enter a more moderate period in terms of export growth.

The prolonged tension between these two countries, from which Turkey imports many agricultural products, may also cause problems in a range of sectors, especially in grain supply. Agricultural commodity prices rose by 23% in February. This is the sharpest monthly increase since 2015. We should keep in mind that Russia and Ukraine account for one-third of world wheat exports, one-fifth of corn exports, and four-fifth of sunflower oil exports.

Another risk in terms of agricultural products is the possibility of no new planting in Ukraine, where agricultural production has come to a standstill. In such a case, there may be a shortage in product supply in 2023, even if the war ends.

THE ECONOMIC PRICE OF WAR IS CLEARER

Russia and Ukraine are also important suppliers of coal and metals for Turkey. There has been a serious jump in the prices of these products as well. Many companies stopped importing from the region. Coal and metal importers are looking for alternative markets. A long duration of the war, therefore, carries a great risk.

Turkey is following a very correct and proactive policy in the current tension. However, both countries are partners with whom we have good political relations and strong economic and commercial ties and therefore the war has direct and indirect damage to both our foreign trade and production. There are signs, however, that companies in different sectors are considering moving their management units and some production facilities to Turkey. Additionally, some retail brands - from ready-to-wear to shoes, from furniture to cosmetics - are trying to transfer their stores in these two countries to Turkish investors at affordable prices.

INFLATION: THE BIGGEST PROBLEM

The Consumer Production Index (CPI) rose to 54.4% and the Producer Price Index (PPI) to 105.1% in March. We are at the highest CPI level CPI since March 2002 and PPI since March 1995. These are rates that most of us had forgotten and that the young generation in Turkey has never seen before.

The inflation data seen in Turkey is many times higher than in other countries. For this reason, the view that “inflation is a big problem not only in Turkey but also around the world” do not fully reflect the truth. The reason why inflation is so high in Turkey is the negative real interest rate that emerged when the policy rate, which was lowered from September 2021 onwards, fell below the inflation rate.

As the difference between the policy rate, which was lowered more than once, and inflation widened, TL savers started to turn to foreign currency, which in turn jumped the exchange rates. As the exchange rates jumped so did the TL costs of imported goods, then there were great increases in product prices. When the increase in global commodity prices is added to that, we can understand why we are seeing historic prices.

Another aspect of the matter is that the difference between CPI and PPI has exceeded 50 points. As the difference grows, we must start to wonder to what extent the giant wavelength in PPI will be reflected on the CPI and how long this effect will last. The widening of the gap between the two indices has made it almost impossible to realize the expected fall in inflation in the spring, due to the recent rise in commodity prices and the fact that this has pushed up the domestic prices. In other words, we will not see a regression in inflation in the near future.

There are two big risks ahead. The first is the possibility that commodity prices will continue to rise. Secondly, there is the possibility of a new depreciation in TL. The worst-case scenario is that both happen at the same time. It is difficult to predict whether there will be a new rise in commodity prices. We should always remember that there is a risk for food prices. If the situation in Ukraine continues, there may be a serious decline in grain supply in late

TWO BOTTLENECKS FOR FXPROTECTED DEPOSITS

2022 and early 2023. This paves the way for prices to increase worldwide. A similar risk applies to metals. However, market and price formation in the food sector has a different dynamic than in other sectors. Even a small decrease in supply can cause big jumps in prices. Therefore, we expect the biggest risk to be in grain in the coming period.

The fact that the United States (U.S) has started to increase interest rates has not created a big enough effect to bring down commodity prices at the moment and it seems that it will happen in the near future. Therefore, it is too early to say that “interest rates have started to rise in the U.S. and this will strengthen the dollar and commodity prices will fall.”

The second risk is a new wave of depreciation in TL. The impact of exchange rates on costs has been greater than commodity price changes in the past 6-7 months. There is no doubt that we will see similar results if a wave of depreciation happens again. Is something like this likely to happen? Will TL lose value again? When we look at the statements and policy implementations of the Central Bank and the Ministry of Treasury and Finance, there does not appear to be an effective tool other than foreign exchange-protected deposit accounts to protect the Turkish lira, and this is a tool that suppresses the problem rather than solving it.

Foreign exchange-protected deposit accounts have been in high demand since they came into effect at the end of December. Those who chose this product as a savings tool have started to receive exchange rate differences as well as bank deposit interest. The application also applied to companies as well as individuals. Later, foreigners were also included in this scheme. However, there are two major structural problems with the foreign exchange-protected deposit application.

First, foreign exchange-protected deposit accounts protect the deposits of individuals and companies that choose this instrument not against inflation but against exchange rate increases. Let’s instantiate with simple figures. If we experience 70% inflation in a year, but the exchange rate rises only by 30%, you get a 30% return (interest rate and currency difference payment) on your deposit in the bank. However, the TL in hand still melts significantly against inflation.

Second, the application does not do much for foreigners included in the scheme. Namely, if the foreigner converts his USD 1,000 to TL today and puts the money in an FX-protected deposit account, and the exchange rate rises by 30% in a year, as in the example above, the depositor who converts the money he received at the end of the maturity to dollars will receive the same amount he exchanged. In other words, the USD 1,000 he has today will still be, at most ,USD 1,000 at the end of the year.

IMPORTS AT FULL SPEED

On the foreign trade side, an increase of 25.4% in exports and 45.6% in imports was announced in February data. Imports rose faster than exports in the last three months. The annualized foreign trade deficit, exceeding USD 58bn, reached its highest level since 2018.

Although our energy imports, which broke a record with USD 9bn in January, decreased to USD 8bn in February, the purchase of USD 17bn dollars in the first two months constituted 30% of the total USD 56bn imports made in this period. These are negative developments for the current account balance.

Far from decreasing, imports continue to increase. Additional customs duties were imposed on many products two years ago, but this practice did not slow down imports and caused domestic prices to rise. Taxes were then withdrawn to their previous levels. Then, the exchange rate increased the TL-based prices of imported products due to interest rate cuts that started at the end of 2021. With the simultaneous increase in commodity prices in dollar terms, we entered a period of uncontrolled price increases. However, imports continued to increase.

There are several reasons for this increase in imports. The first is global price increases. Second, is the continuation of production in the domestic market. Third, exports continued to increase. As you know, nearly 90% of our imports as a country consist of raw materials and investment goods. In other words, it is not possible to decrease the imports of these two items despite price increases. However, there may be a slowdown in imports of consumer goods.

Another dimension is the jump in energy imports. Nearly USD 17bn in energy imports were made in the first two months of the year. This is the largest amount in recent years and almost one-third of our total imports. Therefore, it is not possible for this to decline without a decrease in energy prices or before we start to manufacture the products we need domestically. Moreover, although fuel prices have reached abnormal levels, there is no decrease in the number of vehicles in traffic.

Temporary foreign trade data for March will be announced in the coming days and we will see a high import increase again. It seems that this momentum will continue in the coming months.

CURRENT ACCOUNT DEFICIT WELL ABOVE EXPECTATIONS

The Medium-Term Program, which was announced just 6-7 months ago, predicted a current account deficit of USD 18.6bn for 2022. The Central Bank governor also announced that the government priority was to improve the current account balance, and interest rate cuts began to be implemented. A possible current account surplus for 2022 was even discussed in those days.

The policy systematic that suddenly gained popularity in the last months of 2021 was as follows: Interest rates will decrease, loans will become attractive, production will increase, exports will increase, the exchange rate will rise slightly, and this will push exports up and imports down. The current account balance will improve, growth will increase, and unemployment will decrease as a result.

While this systemic was being constructed, the assumption was that consumers would not turn to foreign exchange and would continue to keep their savings in TL after interest rate cuts turned the real interest rate negative. It will always remain a mystery on what basis this assumption was made, but it was easy even without an economics degree to know that this wouldn’t happen. As a result, we have triple-digit inflation, a staggering cost of living, and a current account deficit that continues to rise.

It seems that the annual current account deficit target will be exceeded in the first three months of the year. This has nothing to do with the war. The effects of the war will only add to this. It is too early to make an overall forecast for the year, but there is no doubt that we will see a current account deficit well above the targets of the medium-term program.

Construction costs increased by 15.2% compared to February and by 79.9% compared to last year, according to January data. The Construction Cost Index, on the other hand, rose to 464.6.

Construction costs have been rising sharply since mid-2021. There are two main reasons for the increase. First, is the jump in global commodity prices. Then, the rise in exchange rates since the autumn accelerated the increase in costs. Costs have increased by 50% since September alone. These are increases that have never been seen before.

THE CLIMB IN CONSTRUCTION COSTS CONTINUES

The Turkish Statistical Institute (TurkStat) collects construction costs under two main headings: materials and labor. The rise in material costs began some time ago. We see that the increase reached its peak at 98% in the January data. On the other hand, we see the biggest increase ever again in labor costs with 41% (due to wage hikes in January).

INCREASE IN COSTS REFLECTED IN HOUSING PRICES

The data at hand is the January data. We know from market observations that the rise continued in February and in March, which corresponded to the war in Ukraine. There have been sharp increases in commodity prices since January. Iron, glass, cement, plastic, and ceramic prices are constantly reaching their historical peaks. We have been observing an increase in the exchange rate in the last few weeks. Therefore, we will see that the rapid increase in costs continued in the February and March data. The increase in costs is reflected in the prices of newly built houses at a similar rate. The graph below shows the course of both indices.

There was a 79.9% increase in housing costs and an 85.7% increase in newly built housing prices, according to January data. We will see this increase continue in the near term.

Another big risk in terms of cost and price in the domestic market is exchange rates. If there is upward pressure in the exchange rates on top of the increase in commodity prices abroad, we can see jumps in both prices and costs. Expendable personal income growth lags behind housing price growth, and this is not expected to improve any time soon.

HOUSING SALES HAVE NEVER BEEN SO UNPREDICTABLE

In recent years, house sales across the country fluctuated in a more stable band and the ups and downs were not exaggerated. However, this changed towards the end of 2019. The bandgap has reached 60,000-220,000. We started to see rapid growth for three to four months in a row, then equal regressions.

The biggest obstacle to the revival of the housing market at the moment is the rapid increase in prices. Housing is attractive both for those who do not want to keep their savings in cash or TL and those who want to invest. However, the negative effect of the rapid increase in prices is higher than the positive effect. Low availability of new housing is another factor that drives prices up.

THE SHARE OF FOREIGNERS IN SALES HAS NEVER BEEN THIS HIGH

There has been a steady increase in house sales to foreigners recently. Beginning in the second half of 2018, the share of foreigners in total house sales started to rise rapidly. The share of foreigners in total house sales reached a then-all time high of 3.9% in 2021 and skyrocketed to 4.7% in the first two months of this year.

INDUSTRIAL PRODUCTION NORMALIZES

January industrial production increased by 7.6% compared to last year, according to calendar adjusted data. Although production continued to grow, the rate of increase fell to its lowest level since August 2020.

The main factor keeping industrial production alive in the past months was the increase in exports. This effect will continue in the coming months. Although industrial production in Turkey’s target markets for exports has slowed in the last few months, it has taken steps towards growth again in February. Therefore, unless there is a sudden stop in domestic demand, industrial production may continue to grow in the coming months.

However, our growth rate in 2022 will be quite modest compared to last year. Growth in domestic demand slowed down. Export growth alone cannot increase industrial production to double digits. Therefore, we will see positive but more moderate increases in the coming months.

The effect of the Russia-Ukraine tension on industrial production will be limited. Our exports to the two countries approached USD 9bn (4% of total exports) last year. A significant amount of this consists of fresh fruits and vegetables.

HEADWINDS IN MONETARY POLICY

The Fed increased interest rates by 25 basis points in line with expectations. Thus, interest rates began to rise again for the first time in three years. The resolution text and the statements made after the decision indicate that five more increases will be made during the year, and the downsizing of the balance sheet will start in May.

Although a zero-interest rate and monetary expansion in the US helped the economy quickly overcome the negative economic effects of COVID -19, it is also responsible for the jump in commodity prices and inflation since the summer of 2021. For this reason, interest rate increases and monetary contraction are important for a return to normalcy.

The Monetary Policy Committee, which convened on the same day as the Fed, left the policy rate unchanged at 14%. Keeping the policy rate constant at 14% in an environment where the CPI exceeds 50% and the PPI exceeds 100%, having a higher deposit interest rate than the policy rate and having deposit and loan rates well below the inflation rate is a combination that we previously thought only existed in theories on poor economic policy.

Let’s put it more simply. There is a shift from loose monetary policy toward tight monetary policy in the world. In Turkey, on the other hand, there is an ultra-loose stance, with real interest rates of near negative 40%. Moreover, there are no signs or expectations of tightening in policies. Monetary policy, which could have been put back on track with much smaller movements months ago, now needs a complete reversal.

SLIGHT RISE IN CONSUMER CONFIDENCE, FALL IN PRODUCER CONFIDENCE

The consumer confidence index, which was 71.2 in February, rose to 72.5 in March. However, an increase in the index does not mean that consumer confidence has increased, it means that distrust has decreased. Values below 100 are interpreted as a lack of confidence and this data has hovered around its lowest-ever levels in recent months.

Four sub-indices make up consumer confidence. One of them is the index pertaining to the current economic situation of households. In March, this fell to 54.4. This is the weakest of the four sub-indices. There were slight increases in the other three sub-indices.

On the production side, all indices lost value in March.

The decline in the service sector, which covers areas such as accommodation, restaurants and cafes, education, culture, and arts and sports, is remarkable.

GLOBAL TRADE GREW BY 25% IN 2021

Global goods exports increased by nearly 25% in 2021, increasing from USD 17.2tr in 2020 to USD 21.3tr. This is the highest value ever seen for global trade.

There are nearly 80 countries that announced their trade data for the whole year. The trade of these countries accounts for 95% of world trade. The country that increased its exports the most, by far, was Norway with 89%. The country’s exports increased from USD 84bn to USD 160bn. The reason, as you can imagine, is the increase in oil and natural gas prices. Russia, Peru, South Africa, Argentina and India are also among the countries that increased their exports the most. Turkey’s increase slightly trailed this group, as a primarily commodity exporter.

Global price increases lie in the background of the increase in global trade from 2020 to 2021. Changes in oil and natural gas prices determine the prices of goods subject to global trade. As the prices of these two products increase, so do the prices of many products, from plastic to automobiles, from white goods to glass. The table below shows the 2020 and

2021 averages of key commodity prices.

The price of natural gas nearly tripled, while oil prices rose by 66% in

2021. Although there were serious increases in agricultural products, these increases were generally below the increases in other raw material prices.

UNCTAD’s commodity price index, which consists of agricultural, metal and energy products, increased by 55% throughout the year. Last year, Turkey’s exports reached USD 225bn with a 32.8% increase. This is a critical indicator as it is the highest export value ever achieved. It is also a higher rate than global export growth. Therefore, by the end of 2021, Turkey’s share in world exports reached 1.06% for the first time.

The amount of goods exported from Turkey increased by 11.5% to 174 million tons, while export unit prices increased by 18.9% to USD 1.29 in 2021. In other words, the increase in exports resulted from both the increase in quantity of goods sold and the rise in export prices. In fact, we owe most of the increase to the price increase.