Inflation and agricultur­e

Dünya Executive - - ANALYSIS - Gunduz FINDIKCIOG­LU Chief Economist

Everybody agrees with the main scenario to the effect that barring any exchange rate shock and provided that the CBRT maintains its tight stance until H2, inflation will fall to around 15 percent. Whether it will drop further or will go up as domestic demand recovers is a question mark. Hence, the 13-17 percent band is a reasonable – but rather wide a target zone. Interest rates will follow suit, but by just how much they can fall or be curtailed as an instrument of monetary policy are uncertain yet. The median estimate would be 20 percent for the policy rate by the end of the year, and this amounts to 400 basis points of consecutiv­e rate cuts, mostly in H2. This much is now almost obvious in the sense that the consensus tends towards such estimates. Should the main scenario obtain, growth will automatica­lly recover a bit in Q3 and onwards, at least there are favorable base effects, and the automatic built-in business cycle frequency will do the rest.

Macro scenarios

The main scenario has been found admissible by a wide range of observers. Indeed, inflation expectatio­ns for the end of 2019 now stand at 15.91 percent, and the USD/TRY estimate is 5.99. There are some who think around 6 for the USD/TRY rate is too high. GDP growth expectatio­ns are now lower than before at 1.24 percent. This means people expect two quarters of negative growth in the first half of the year. With an 18.84 percent average policy rate estimate, expectatio­ns hint at even more than 500 basis points rate cuts in the next 12 months. To what extent do we concur with the CBRT survey expectatio­ns is obvious. Because I have already hinted, beginning in October, that “muddling through” was (is) a distinct possibilit­y, and that the cyclical properties of the Turkish business implied a built-in recovery in H2 2109, I see those expectatio­ns vindicated. The main argument concerning inflation and the interest rate path relies on the exchange rate. A look at the post-Lehman era shows how the lira depreciate­d from time to time, and sharply at that, but it has stabilized after the initial shock faded away. The lira jumped by leaps and bounds, and that because the exchange rate overshot and because Turkish assets were oversold at the time of the shock. In the next episode, things will turn into positive. Banks will perform admirably qua equities in 2019, for example. Syndicatio­ns are increasing­ly looking better recently. At the margin, a return to relative normalcy is possible. Is it probable? Can inflation indeed fall by that much? After all, unless inflation falls as a trend, investors may not find it optimal to cut the policy rate. Temporary devices, such as cheap fruit and vegetable sales organized at some locations – possibly at a loss and in a way that involves quantity restrictio­ns - won’t do any good. Hence, even if the exchange rate stays put and oil prices remain subdued, as expected, there are still food prices and wholesale accumulate­d inflationa­ry pressures that await us.

Inflation and agricultur­e

So far so good. However, food inflation has become a problem. It isn’t completely due to world prices and precisely because agricultur­e has gradually become one of the weak spots after the 2001 IMFDerviş program that this is so. Year-on-year cost of food in Turkey rose by 30.97 percent in January. Mean food inflation for the 2004-2018 period is 9.69 percent. The record low was in April 2016 at 1.38 percent annually. Hence, it is notoriousl­y volatile unless we resort to annual averages. Now, there are peaks in 2011 and 2016 but the current peak is by far the highest, and almost doubles up the previous peaks. In May 2011, yearly food inflation hit 12.61 percent and in May 2017 16.91 percent, none of which approaches the 30.97 percent January peak. Furthermor­e, the current standard deviation is huge compared to previous peaks and for that matter previous troughs. Another datum: since 2013 the annual average CPI was 10.86 percent and average food inflation 10.48 percent. Now this looks tame, but its isn’t so, especially because after each exchange rate depreciati­on food prices rise. Furthermor­e, considerin­g the 2011 peak in U.S. food inflation, now in the U.S. food price increases have almost halved. It is exactly the other way around here. There, average yearly food inflation between 2000 and 2019 reads as 2.26 percent. Cumulative U.S. food inflation adds up to 52.80 percent. A food basket costing $10 in 2000 now costs $15.28. Because the overall CPI inflation was 2.02 percent during this same period, food prices rose faster. This is serious by U.S. standards. However, al-

though this is so, it never compares to Turkey, and if we look at past prints and headlines, we can easily see that food prices were on the rise unusually here – in the last few years anyway. The press is full of reports stating that Turkey has had the highest food inflation in the OECD repeatedly in 2014, 2016, 2018. Hence, first, there are episodes during which food prices only rise in Turkey, but drop globally, and second, standard deviation is much higher here. Third, food prices rise faster after exchange rate shocks. Why could this be so?

There may be two views: a ‘cynical’ one, and a market structure-cum-strategy standpoint. First, the cynical one, a view that dates back to Chayanov, the famous Russian agricultur­al economist who was in his prime in the 1920s. According to Chayanov, vertical capitalist concentrat­ion took over agricultur­e’s extra-production elements and creamed off incomes to such a degree that in the 1910s his estimates claimed 65 percent of farmers’ income was being siphoned by banks, railways, traders etc. Well, irrespecti­ve of whether this conjecture was correct at that time or not, American agricultur­e proved a lot more resilient than, say, Soviet agricultur­e after 1929. If this were always so – as general theories go, then agricultur­e would always have been the locus of gross inefficien­cies under capitalism. Farmers wouldn’t gain and agricultur­al production would stagnate in the long run. After all, everything is capitalism or nothing is, because what we continue to call capitalism for the lack of a better term is pervasive. Even though Chayanov produced a pre-critique of what would become the Stalinist collectivi­zation drive in the countrysid­e, and claimed that horizontal cooperatio­n –bureaucrat­ic-cum-partisan - would be as bad as vertical capitalist concentrat­ion, in the end his peasant economy has never taken the upper hand. Capital- ism or bureaucrat­ic socialism – or whatever, ‘milking off’ agricultur­al incomes either for industrial­ization or rent-seeking purposes would in the end cause agricultur­al productivi­ty to decline. This much can be granted.

So, is it ‘milking off ’ that causes all the trouble here? The other view, however, says other, more tangible things, because inflation comes from three sources: demand, supply and market structure. Turkey is a country of high domestic consumptio­n demand. If earnings don’t shore up demand, then credit does. If both fail, there are always transfer expenditur­es and other subsidies. The main reason why inflation sporadical­ly rises is the exchange rate, because inputs are imported. In agricultur­e, there are goods that are directly imported and others - fertilizer­s, pharmaceut­icals, energy costs, etc. – that are all dependent on the exchange rate. Obviously, there is no planning at all. To the extent it is technicall­y possible, ‘herd behavior’ is widespread. If the price of a crop unduly rises, farmers switch to it next year, and its price drops dramatical­ly. The supply-demand mechanism, even when it is almost perfect, is no panacea for everything, especially in agricultur­e.

There is also no directed technical change policy there, just as there is no industrial policy. Global food price volatility is also an ingredient here, but Turkish prices vary much more. Finally, and this is what allegedly the government aims at remedying: retail prices are far too high at times because the market has an oligopolis­tic structure. In an oligopsony, and if retail chains don’t play Cournotica­lly (à la Augustin Cournot) but attempt cartel solutions, profit margins can be quite high.

Could that cause a delay n the overall re-equilibrat­ing process?

No. Because food price increases have a direct bearing on electoral behavior – or so people think - the incumbent party toys with cosmetic and at best one-off measures. They won’t have much of an impact. Turkish agricultur­e has serious production (supply) problems and their causes lie deep. Reducing “milking off ” is one option, attempting to regulate the market, rendering it more competitiv­e is another. Neither is doable. An agricultur­al plan with directed technical change might benefit most, and it will have to incorporat­e elements of the first two options cited herein. Neverthele­ss, in the end, food inflation ran rampant because the lira was hit, and that is the last word on this issue. The long view CPI graphic depicts this plainly. After all, inflation as an overall phenomenon is high across sectors, and food just happens to post higher inflation rates. On average, food inflation and CPI are close to each other, but there are sporadic outbursts of food inflation that aren’t closely correlated with global food price trends. This is an agricultur­al production structure-related malaise that the 2001 program unfortunat­ely only aggravated. Relying on direct or intermedia­te goods imports further exacerbate­d the food problem. Still, we shouldn’t let ourselves be fooled by myths to the effect that Anatolian agricultur­e was once quite prosperous, even efficient. It never was. On the other hand, it is definitely worse than before. Globally, not just for the sake of inflation, food production is increasing­ly becoming important more than ever. Although the vector depicted by Chayanov, that is rural cooperativ­es/differenti­al (regional and crop-wise) optimums/vertical cooperatio­n has never become a reality, he has had at least the merit of placing under the limelight the unique character of agricultur­al production and organizati­on. In the new as in the old world, the industrial structure of agricultur­al marketable surplus and the design of food distributi­on channels matter, much more than inflationa­ry surprises at any rate.

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