VZCZCXRO1967
RR RUEHDA
DE RUEHAK #1045/01 1571141
ZNR UUUUU ZZH
R 051141Z JUN 08
FM AMEMBASSY ANKARA
TO RUEHC/SECSTATE WASHDC 6474
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHIT/AMCONSUL ISTANBUL 4301
RUEHDA/AMCONSUL ADANA 2977

UNCLAS SECTION 01 OF 02 ANKARA 001045 
 
DEPT FOR EEB AND EUR/SE 
TREASURY FOR INTERNATIONAL AFFAIRS - JROSE 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV PREL TU
SUBJECT:  INFLATION TROUBLE IN TURKEY 
 
Ref:  Ankara 1026 
 
¶1.  Summary:   Following May CPI inflation data that signaled the 
return of double-digit inflation for the first time since 2004, the 
Central Bank of Turkey (CBRT) significantly revised upward its 
official inflation target for 2009, 2010, and 2011 to 7.5%, 6.5%, 
and 5.5%, respectively.  Inflation management has been on track 
since 2002, but was hit hard by high energy and food prices and 
loose GOT fiscal policy.  The May announcement took annual rates 
(May 2007-May 2008) of CPI and PPI inflation to 10.7% and 16.5%, 
respectively.  In an exchange of public letters, both the CBRT 
Governor Durmus Yilmaz and Treasury Minister Mehmet Simsek suggested 
the target revisions were timely and were made in compliance with 
current market conditions and the Medium-Term Economic Program that 
will be made public later in June.  Immediate markets reaction to 
the May inflation data and new targets was negative.  End Summary. 
 
 
Inflation Data 
-------------- 
 
¶2.  On June 3, the Turkish Statistics Agency (TUIK) announced May 
inflation data, moving Turkey back to double digits.  In May, CPI 
increased 1.5% month on month, above the consensus estimate of 1.1%, 
while the PPI increased 2.1% month on month.  These monthly rates 
took the annual rates of CPI and PPI inflation to 10.7% and 16.5%, 
respectively.  Year to date (January-May 2008) inflation became 
6.38% for CPI and 13.39% for PPI.  In May, clothing prices increased 
by a whopping 12%. 
 
Background on Inflation Targeting 
--------------------------------- 
 
¶3.  To put these numbers in perspective, it is interesting to note 
that inflation in Turkey was 84.6% in 1998, 25.3% in 2004, and has 
been under 10% since 2005.  The CBRT adopted the inflation targeting 
regime under the 19th IMF stand-by arrangement in 2005.  Despite 
setting inflation targets of 4% for 2006 and 2007, Turkey was only 
able to reach year-end levels of 9.6% and 8.4%, respectively.  Since 
2007, the CBRT has been struggling with GOT overspending on 
elections.  Since the end of 2007, global increases in oil and food 
prices have hit Turkey hard, and the previous targets were no longer 
sustainable. 
 
New Inflation Targets 
---------------------- 
 
¶4.  After the TUIK announcement, the CBRT revised its inflation 
targets for 2009, 2010, and 2011 to 7.5%, 6.5%, and 5.5%, 
respectively, up from 4% across the board, noting that current 
inflation targets no longer served as a short-term nominal anchor. 
The CBRT said persistent supply shocks and global economic 
uncertainties have increased risks on the inflation outlook, and it 
will take until at least 2012 to reach 4%.  The CBRT had already 
signalled a possible amendment in its inflation target and these 
revisions were expected.  They justified making the announcement now 
to meet the GOT's need for accurate inflation guidelines for its 
Medium-Term Economic Program, which is expected to be announced in 
June, and which will be used to formulate the 2009 budget. 
 
¶5.  Under Article 4 of the Central Bank Law, inflation targets are 
determined jointly by the Central Bank and the Government.  This is 
done transparently by an exchange of public letters.  In its June 4 
letter, the CBRT said "our assessments suggest that, even under the 
maintenance of a cautious policy stance, reaching the four percent 
target is likely to take an extended period.  Food and energy prices 
continue to pose risks to the medium term inflation outlook, and 
there is no clear evidence that this trend will reverse in the short 
term".  Treasury Minister Simsek wrote back to the CBRT that the GOT 
considered the proposed targets "appropriate" and vowed to support 
the independent institution in its fight against inflation.  Despite 
on-going tensions between the GOT and the CBRT over looser fiscal 
policy, Simsek agrees the CBRT is doing the right thing on inflation 
now. 
 
Reactions 
--------- 
 
¶6.  Higher inflation and the revision announcement caused Turkish 
markets to react negatively on June 4.  The Turkish lira (TRY) 
depreciated 1.6% against the USD to 1.24, and government bond rates 
increased to their highest level since March 16, reaching 20.28%. 
Equities lost about 1%.  Although it was expected, economists and 
analysts regarded the Central Bank's change in the inflation target 
as a credibility loss and claimed that monetary policy management is 
now weaker than in earlier years.  Ferhat Emil, former CBRT vice 
governor and now an Ankara University professor, said he did not 
 
ANKARA 00001045  002 OF 002 
 
 
expect monetary tightening to succeed sufficiently to down inflation 
without the application of tight fiscal discipline, especially in a 
world of rising food and energy prices.  Central Bank Markets 
Department Manager Cigdem Kose told us there is not much room for a 
CBRT price stability program under current global conditions as long 
as there is increased government spending.  The CBRT must have 
support and tight fiscal policies from the GOT to succeed with its 
inflation management goals. 
 
¶7.  EFG Economist Baturalp Candemir pointed out that double-digit 
inflation will also lead to an inflation compensation payment to 
civil servants.  He expects an across-the-board 1.4%-4.8% civil 
servant wage increase.  By his calculations, each percentage point 
of inflation compensation will cost the GOT a budget-busting TRY 250 
million (USD 201.6 million).  (Note:  News sources report that 
Simsek said the GOT will provide inflation compensation for civil 
servants.  End note.) 
 
Expected Outcomes 
----------------- 
 
¶8.  On the market side, Murat Gulkan from Deutsche Securities said 
he saw carry investors focusing more on short-term bonds.  Rising 
inflation, a Central Bank frustrated by loose GOT fiscal policy, and 
political uncertainty will make it challenging to roll over GOT debt 
totaling TRY 25 billion (USD 20.2 billion) in July.  As a result, he 
expects to see a further rise in government bond rates to a range of 
21-23%.  Gulkan also points out that rising rates are bad news for 
equities and current circumstances will make investors reluctant to 
buy long-term government bonds. 
 
¶9.  Comment:  Revising inflation targets, although needed, have 
caused a credibility loss for the CBRT and the GOT.  With the 
inflation targets of the past two years missed and the 2008 target 
clearly out of reach, economists have been arguing that the 4% 
target was no longer perceived as an anchor by the markets, business 
circles, or even the GOT.  Market players expect further rate hikes 
when the Central Bank's Monetary Policy Committee meets on June 16. 
The GOT's loose fiscal policy might promote growth, but it plays 
havoc with inflation management.  End Comment.