Relationship between growth and inflation for Turkey


Turkey maintained its 2017 growth rate in the first quarter of 2018. We knew that in the first quarter of 2018, the growth of 2017 would continue with acceleration. The annual 7.4 percent growth rate, of course, opened up the current thesis, "After a certain limit, growth creates current account deficit and inflation for the Turkish economy. For this, Turkey's priority should be financial stability not growth," to discussion.

Besides, the depreciation of the Turkish lira and the volatility in the exchange rates, which had been going on for a long time, already brought up this thesis before the last growth rate.

I think that the relationship between growth and financial stability in Turkey can be followed in the realizations after 2002 as the healthiest. Because Turkey moved on to the floating exchange rate regime, which is one of the main elements of financial stability, after the 2001 crisis.

Therefore, in earlier realizations, internal-external price equations or inequalities did not reflect positively on the exchange side, and the relationship between domestic prices (usually upwards and as inflation) and other macroeconomics was pointless. We can measure the alleged one-to-one relation between growth and inflation over the years of the floating exchange rate regime.

When we look here, we do not see an individual correlation between Turkey's growth above average (5 percent and above) and the realization of inflation. Here, the relationship between rapid growth acceleration and inflation is marginal, meaning that the growth momentum of that year leaves a load on the main body of inflation, just as much as the initial output weight.

We see this more tangibly as of the year when the Program for Transition to Strong Economy (GEGP), which started in 2002, was over and Recep Tayyip Erdoğan refused to sign a new standby agreement with the International Monetary Fund (IMF) in 2008. For example, here are two years that will be considered extremely interesting and important for Turkey; namely, 2010 and 2011. In these years Turkey grew by 8.5 and 11.1 percent, respectively.

The year 2011 is interesting even if we consider the base effect for 2010 due to the contraction of 4.5 percent in 2009. The inflation rates for these years are 6.4 and 10.45 percent. Another interesting point (as the Consumer Price Index - CPI) is that the inflation rate in the economy, which shrank by 4.5 percent in 2009 due to the 2008 global crisis, was 6.5 percent and that inflation stood at 6.4 percent, showing a downward trend despite the growth of 8.5 percent in the following year. After that, inflation fell to 6.16 percent in 2012 and went between 6.16 and 8.5 percent, catching the highest rate in 2016 until 2017.

The 11.7 percent realization in 2017 was, in our view, largely due to the volatility in energy and food prices rather than the rapid growth acceleration. Here we can also say that the pace of growth almost shouldered inflation, preventing a possible stagflation because inflation dynamics are due to structural, production-based and external pricing.

If we had not taken steps to keep up growth in 2017, the Turkish economy could not bear this inflation and would enter a permanent stagflation with a rapid collapse. This is because the inflationary dynamism, as the Producer Price Index - PPI shows, had taken action before the growth dynamics. Pushing the brakes here is equivalent to suicide.

See the Argentine story, for example. For many years Argentina has been dragged from one crisis to another with this trap. Let's continue, in 2013 and 2015, we again grew above the average with 8.5 and 6.1 percent, and inflation rates remained at 7.40 and 8.81 percent, respectively, in these years. There is an inverse correlation between inflation and growth over these years.

Let's move on to 2017. The following thesis is certainly not true: In 2017, especially with Credit Guarantee Fund (CGF) support and fiscal expansion, we grew artificially, and this raised the inflation rate, blowing up the exchange rate. As it is known that in 2016 when Gülenist Terror Group's (FETÖ) coup attempt took place, Turkey achieved quite a low growth of 2.6 percent. Estimates for 2017 were also in this direction.

In the months following the first quarter of 2017, there was a danger of recession. Credit expansions and investments expanding the capacity came to a standstill. The investor was still shocked by 2016. In this environment, CGF application and financial incentives were introduced.

Financial incentives raised the spending appetite of the final consumer. The CGF facilitated the manufacturer's credit access and breathed new life into the producers and exporters getting crashed under production costs.

However, until March 2017, the beginning of the CGF use, when we look at both producers and consumers, we see that inflation is accelerated paradoxically in a recession-driven process. Just in March 2017, we see the PPI peaking at 16 percent. The deterioration due to rapid productivity loss because of the stock and financing cost burden on industrial enterprises and the inability of companies to make investments expanding the capacity seemed clear, which led to a loss of competition outside the exchange rate in exports, and market losses were also rising.

Under these circumstances, the manufacturer could not reach the financing with traditional methods (mortgages and the like), and the general economy rapidly entered the spiral of stagnation-producer inflation. At the end of the last quarter of 2017, the PPI rose again with energy, main industrial inputs priced on a dollar basis, stocks rebounding from these prices and rising financing costs.

In fact, there will be pro-production regulations and reforms that will reduce the burden of establishing and financing businesses here, as well as permanent measures for inflation and the current account deficit. At the same time, it was also important not to lower capacity utilization of businesses by keeping consumer confidence high. Here, taking radical-orthodox measures, depending on exchange rate pressure, undoubtedly opens the doors of stagflation. For this we quickly switched on the second phase of the CGF.

We have always said that if you are stuck in the 20th century IMF orthodox policies, then pro-growth economic policies will lead to inflation and current account deficit. That is because this understanding sees inflation as a monetary phenomenon, and accordingly, monetary tightening with high interest is the only remedy of inflation.

All this 20th century practice (for developing countries) has denied this thesis to us. If you designate the country's economy as a debt and import economy away from competition as price, quality and business scale in goods subject to foreign trade with a yield ratio consisting of unfavorable exchange rates and high interest rate, of course fast growth becomes a problem. However, we think that the Turkish economy passed this threshold significantly after 2008.

After the June 24 elections, Turkey will quickly make structural reforms on the manufacturing side, eliminating both inflation and the current deficit as a problem. Years of experience have shown that monetary tightening-driven steps alone do not provide a lasting solution to inflation and current account deficit.

Likewise, as we have seen since 2008, the Quantitative Easing (QE) applications issued by the central banks of developed countries are not permanent solutions to the recession. Therefore, in countries where inflation solidifies a structural problem like Turkey, the final solution is an inclusive growth and pro-production reforms. The actual disinfection process starts from production, not from consumption.

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