Turkey’s central bank said on Wednesday that the battle to meet its inflation target this year had been lost and it hinted at more interest rate increases if investors continued to bail out of Turkish financial markets.
The admission came as the government issued a “don’t panic” plea to local investors, who have seen the value of the stock market plunge by 25 per cent in six weeks.
The bank’s failure to meet the target could make life difficult for the government of Recep Tayyip Erdogan, the prime minister. Facing an election within the next 18 months, he was expected to trumpet Turkey’s economic turnround. But analysts said this might become less credible if there were a sharp economic slowdown next year.
The latest developments came in a week when the European Union signalled that Turkey faced a breakdown in its membership bid unless it improved its human rights record and resolved a dispute with Cyprus.
The bank raised interest rates by 175 basis points last week to try to halt a sharp sell-off in the Turkish lira. The bank’s comments were contained in the minutes of last week’s emergency meeting of the monetary policy committee at which the dramatic rate rise was agreed.
The biggest sell-off in the Turkish markets in five years is mostly due to a wider retreat from emerging markets by investors seeking to reduce their exposure to risk. But it has hit Turkey particularly hard and might not be over yet, analysts said. “What was initially a technical correction is now turning into a bear market,” said Mahmut Kaya, head of research at Garanti Securities. Stocks recovered slightly on Wednesday and the lira was flat against the euro and the US dollar.
Turkey’s annual inflation rate, which fell into single figures in 2004 for the first time in a generation, hit 9.9 per cent last month. It would continue to rise this month and next, the bank said, and begin to fall “in the medium term” when the effects of higher import prices and slowing consumption started to be felt.
The bank’s admission that it would not meet its year-end target of 5 per cent, with a range of two percentage points on each side, is a setback for Durmus Yilmaz, who became governor in April. It is also a setback for the bank, which, in line with many of its peers around the world, moved to formal inflation-targeting only this year.
The bank hinted that more interest rate rises would be made if necessary to keep inflation in check and to reduce the volatility of the lira. “If the global appetite for risk continues to reduce and funds continue to leave emerging markets, the central bank will not hesitate to make the necessary policy response to control medium-term inflation expectations,” the minutes said.
Amid the gloom, Kemal Unakitan, the finance minister, had some good news. He said the budget surplus was TL4.3bn ($2.7bn, €2.1bn, £1.5bn) last month and the primary surplus – the budget balance before interest expenditures – was already more than half-way towards a year-end target agreed with the International Monetary Fund. He urged local investors to remain calm in the face of the market turbulence. “Don’t panic,” he said. “Turkey will not experience the crises of old, because today’s Turkey is not the old Turkey.”