MNI EM INTERVIEW: Lira Key To Inflation - ex-CBRT's Ozatay

Turkey’s government is likely to loosen its fiscal purse strings in response to losing local elections, while raising taxes and continuing to back the central bank in a bid to avoid both a bigger budget deficit and a weaker lira, ex-Central Bank of the Republic of Turkey Vice Governor Fatih Ozatay told MNI.

President Recep Tayyip Erdogan appears willing to sacrifice near-term popular support in exchange for putting the country’s economy on an even keel, tolerating high interest rates in order to beat back even higher levels of inflation, Ozatay said in an interview following local elections in which the governing Justice and Development Party suffered surprise losses in key cities.

But the president will want to regain favour ahead of 2028’s national polls, and with last year’s budget deficit coming in at just 6.4% of GDP there is room for fiscal manoeuvre even as the central bank battles inflation. (See MNI INTERVIEW: CBRT On Track, But Risks Remain - Ex-Vice Gov)

“The president has said that they will continue with the current programme, and given that there are four years until the next presidential elections, if the incumbent wants to win the next election then why make a U-turn? My guess is that they will have to increase average pensions and perhaps the minimum wage, and at the same time find some way to reduce the impact on the budget. This shouldn’t impact the current programme - they can continue with high interest rates. That’s probably the baseline scenario,” Ozatay said.

LIRA DEPRECIATION

The CBRT last month hiked its policy rate 500 basis points to 50% after inflation hit 67%, and said it would maintain a tight monetary stance. (See MNI EM CBRT WATCH: Turkey CenBank Springs 500Bps Hike Surprise) Inflation is set to peak at around 75% - roughly twice the target rate - this month or next before ending the year close to 44%. However a figure closer to 40% may be achievable if policymakers can prevent the lira’s rate of depreciation falling below the rate of inflation, Ozatay said.

“According to the Central Bank's estimates, if the monthly inflation rate stays around 3% up to July then falls to around 2.5%, that would be compatible with inflation ending the year at 36-38%. That’s under current conditions, so without any market intervention from the central bank to keep the rate of depreciation low.”

Market conditions are currently favourable, Ozatay said, with no sign of a reduction in risk appetite and financial inflows seen increasing in anticipation of Fed easing, but he added that any doubts around the future of the central bank bureaucracy and of Finance Minister Mehmet Simsek need to be removed.

“This would also help shape expectations and keep the rate of depreciation low without much in the way of market intervention. Again, it depends on how the government evaluates the local election results. Either way, it will be a strong signal.”

4% GROWTH

Another way to boost investor confidence would be to change to law to enshrine greater CBRT independence, said Ozatay, who was vice governor at the central bank from 2001-2006.

“Given that the interest rate is at an appropriate level they could take extra tax measures to further cut the budget deficit, or they may take some decisions to grant the central bank greater independence regarding basic regulatory functions - almost a return to the situation pre-2018.”

Ozatay was optimistic that Turkey’s economy can expand by up to 4% annually over the coming years without adding to price pressures, which would reduce the country’s reliance on foreign funding.

“There has to be more growth in order to decrease Turkey’s external financing needs, and given that there are more than four years to go until the next election,” he said.

“I don’t think 3-4% would be a problem for inflation. What matters is the exchange rate, market sentiment and access to foreign finance, and whether Turkey can decrease its citizens’ demand for foreign currency.”