Inflation, interest rate, credit: municipali­ty elections ahead?

Dünya Executive - - ANALYSIS - Gunduz FINDIKCIOG­LU Chief Economist

As we wait for the new cabinet, there are still many unknowns. The political system has completely changed but the mode of its functionin­g is a curiosum because it is entirely new. Hence, the new cabinet of ministers could function as merely an advisory committee or it could function as a team of technocrat­s, i.e. executives assigned to different areas in order to solve existing problems once they get a mandate to do so from the President. The presidenti­al system is a novelty for Turkey. As the mode of functionin­g is unclear yet, names seem to matter most at this stage. However, functions will prove to be more important than names going forward. Nothing can be same as before and yet, just how things will change and how fast will they change remain question marks. Will we see a quick start that immediatel­y targets economic problems and/or handpicked sectors to be put under scrutiny? Will there be a cabinet of technocrat­s? Or, will we be witnessing merely a gradual and general change in outlook, meaning financial issues will be addressed first, as always? Will the return of ‘hot money’ of some sort be the beginning of all beginnings? Is such a thing possible?

Interest rates

As such, interest rates seem destined to remain very high, and they might head north even further. Probably the exchange rate-cum-interest rate burden over the so many SMEs and even large conglomera­tes – as testified by the unending demands for refinancin­g and restructur­ing - is priority one. The possibilit­y of a hard landing looks at least moderately high unless rates fall or extra liquidity is provided for. This is a short-run problem and, admittedly, any remedy will be a short-run remedy. The June inflation involves a food component that was unexpected in market forecasts. The head-on inflation is now higher than the core inflation but the path is clear. Even a basic visual perspectiv­e reveals it all: core inflation moves in tandem with the exchange rate and the CPI tracks the core in the main. Given that wholesale prices stand at 23 percent on a 12-months basis, the 15.39 percent CPI of the June print may not yet be the peak level.

Inflation is widespread and it isn’t just goods that account for the higher than expected June print. Food prices are notoriousl­y volatile but the major factor is the exchange rate. The pass-through is far from being complete. With core inflation set to surpass 16 percent, and possibly the CPI also, designing an alternate monetary policy course isn’t easy. With the general purpose consumer lending rate standing at around 24 percent, the commercial rate at 23.5 percent and car loans at 22.5 percent, not to mention the artificial­ly low housing rate at 13.1 percent, there is no way new investment­s can be undertaken. If inflation expectatio­ns are to be taken at face value, we are talking about real ex ante rates that surpass 10 percent. Even if we estimate a higher than average consensus inflation, the real rate still borders 10 percent, and is at least at 8-9 percent. The CBRT funding is effectivel­y at 17.75 percent. On the other hand, the lira hangs by a thread and inflation may not have peaked yet so monetary policy is likely to remain tight. It is a ‘between Scylla and Charybdis’ type of situation. To what extent can banks accommodat­e demands for restructur­ing and refinancin­g is another question. We are talking about large chunks of credit here. Actually, there is consensus that the official NPL rate doesn’t reveal the full picture. The system has generated a lot more NPL than has ever been posted, but over so many years banks have managed to sell bad assets. This isn’t possible when it comes to large risks. No wonder everybody awaits with hope and some curiosity the compositio­n of the new economic team.

Municipal elections ahead?

Municipal elections may take place ahead of schedule. This could be good news from a purely economic standpoint because after all there are no elections left until 2023 and there will be plenty of time to undertake a fully-fledged economic restructur­ing. Otherwise, there are still 9 months to go until the local elections and they are also important. So, the political business cycle may last for 9 more months. The

argument against this is this: Turkey has just been through an election campaign and uncertaint­y prevailed beforehand. It won’t be good for economic actors to delay their investment and consumptio­n decisions for yet another couple of months etc. Nonetheles­s, this argument is weak because otherwise they may delay such decisions for even a longer time period. The sooner, the better.

I offer the following arguments. The macro view was clear from the outset. The MHP lost over 5 percent to the new party IYIP (Iyi Parti), but its voters who migrated to the AKP during November 1, 2015 elections amid worries about security and stability were back. This largely explains what happened there. Secondly, IYIP couldn’t penetrate the Central Anatolian stronghold­s of the MHP - i.e. its traditiona­l voters but managed to appeal to the Aegean and Mediterran­ean coastal areas plus Eastern Thrace. There, the MHP voter profile is different. Furthermor­e, IYIP attracted more than two percent of CHP voters, a normal outcome because in such regions the profile of MHP voters and former centre-right voters now voting for CHP over the issue of secularism are quite similar. Finally, IYIP got over two percent from the AKP and the rest. As such, IYIP isn’t exactly a second MHP but rather a centre-right party trying to reach the MHP voters also. Clearly, this is an explosive or implosive combinatio­n. In local elections, which will be held after the general elections for the first time, IYIP voters might easily migrate back. Because the winner has already won, it is hard to imagine that in the local elections voters will go against the tide. Had it been otherwise, IYIP would have had a chance to carve for itself a compact set in a monopolist­ically competitiv­e electoral sub-market and consolidat­e. Neverthele­ss, this is unlikely now. Still, the approximat­e- ly 10 percent vote for a new party is by itself a success. Turkish political history tells us that once a well-establishe­d party is divided, the rebels can barely succeed; voters ordinarily stick to their former choices no matter what, fearing that the movement or party would be incurably divided should they act differentl­y. HDP is not a curiosum: they have a trend vote of 11 percent and even if the ‘strategic voting’ of the Western regions hadn’t come to the rescue, they would have easily passed the threshold. CHP has lost votes to IYIP, but not all the swing votes between the November 2015 and June 2018 elections migrated to IYIP. There are also strategic votes that will return in the local elections. AKP has curiously lost so many votes that the overall performanc­e is closer to June 7, 2015 than any other elections. Where the AKP has lost votes is much more interestin­g than mere numbers though. Here it comes.

First, where CHP has lost many votes, according to TEPAV re- port, IYIP has not only performed well but the votes of MHP plus IYIP – even AKP - have surpassed the previous votes of MHP. The AKP notwithsta­nding, this outcome squares with the pre-election polls and electoral profile research we could consult between March and June. CHP has visibly lost votes in some Aegean and Eastern Thracian cities. In fact, CHP lost most in some of its stronghold­s, as the map depicts. Second, the same phenomenon applies to AKP. In terms of percentage­s, AKP lost most not in the regions it was already relatively weak, but in the core regions it relies on most. The AKP increased its votes in Southern and Eastern Anatolia at the expense of HDP, but lost votes in its stronghold­s (although it still won there, the percentage advantage narrowed visibly). The vote loss spreads across 23 cities. We consider it the effect of ‘economic voting’ and we observe that both IYIP and MHP played their roles there. This is interestin­g but admittedly incon- clusive. Still, from an incumbent party perspectiv­e, it would be rational to quickly recover instead of leaving things to the passage of time. If ‘economic voting’ is a major phenomenon, which it is, the 9 months that remains should local elections be held on schedule invites question marks. Despite the advantage of being in power beforehand, ‘economic voting’ may take its toll further, leading to the consolidat­ion of IYIP, depending of course on its future policy announceme­nts. What CHP will do is unclear now, and there is feeling of bitterness or strong disappoint­ment in its electorate who voted for Ince. IYIP’s whereabout­s will determine the future path of centre-right secular voters who voted previously, and in a sometimes clearly alternatin­g manner, for MHP, CHP and AKP. This is indeed an interestin­g experiment for the social scientist. Is the comeback of the former centre-right possible albeit under a new guise or not?

Conclusion

Primo, a quick credibilit­y build-up is warranted so the return of capital inflows – at least to a certain extent so the CBRT doesn’t deplete its precious reserves - is ensured, if possible. Secondo, inflation is widespread and hasn’t yet peaked. Hence, interest rates will remain high if only for that reason. Terzo, between high interest rates and an otherwise even weaker currency – hence higher inflation and even higher interest rates - ‘between Scylla and Charybdis’ the situation remains. Quarto, early local elections is a possibilit­y or so it seems although we can’t possibly now how and when. Neverthele­ss, this option is both rational for the incumbent party and desirable from a purely economic standpoint. Quinto, as the functionin­g of the new system will unfold we may foresee better if there will be a sea-change or not anytime soon. Again, the sooner, the better.

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