Turkey's Inflation

This in Bloomberg today:

Turkey Needs Budget Rule to Cap Spending, Yilmaz Says


Turkish central bank Governor Durmus Yilmaz said the country risks a return to accelerating inflation, squandering the achievements of its International Monetary Fund accord, unless the next government imposes limits on spending.

The fight with inflation is at a ``very, very critical threshold,'' Yilmaz, 60, said in an interview in Istanbul on June 28. There has been a ``slippage'' in government spending ahead of July 22 parliamentary elections, he said.

The $10 billion IMF agreement expires in May next year and European Union candidate Turkey needs ``a fiscal rule'' to replace it, Yilmaz said. In the last five years of the arrangement, the economy has grown about 7 percent a year and inflation tumbled to 9.2 percent from more than 70 percent.

``If a society has the internal dynamics to put its own house in order, then there is no need for external impetus,'' Yilmaz said. ``When the present program runs out, either we have a cap, for example, on government spending or on the budget deficit or something in place.''

Yilmaz raised the benchmark interest rate shortly after he was appointed governor in April 2006, boosting it in several stages by 4.25 percentage points to 17.5 percent, the highest in the 30- member Organization for Economic Cooperation and Development.

Yields on lira-denominated government bonds fell 11 basis points to 17.99 percent at 10:00 a.m. in Istanbul. The lira gained 0.3 percent to 1.2928 against the dollar.

Higher rates helped slow consumer price inflation to 9.2 percent in May from 10.7 percent in April, though it remains more than double the 4 percent target. The country can't afford to ``hesitate'' and must push inflation lower, Yilmaz said.

`Paid a Cost'

``Either we have to go to price stability of 2 percent or 3 percent or in the long run we will go back to seeing two-digit numbers,'' he said. ``So far this society has paid a cost. And this cost should not be wasted.''

The government has cut public spending and increased tax collection under the IMF program, which obliges Turkey to produce a budget surplus before interest payments of 6.5 percent of gross domestic product.

The government's main opponent, the Republican People's Party, has criticized the measures, arguing they have slowed job creation, bankrupted farmers, starved social services of investment and left the economy dependent on foreign capital.

Yilmaz, who has worked at the bank since 1980, had ``a baptism of fire,'' said Tim Ash, London-based emerging markets analyst at Bear Stearns & Co. Inc. ``He proved himself to be a person who has very high standards and who, perhaps because of the start he got, is determined to prove his independence.''

`Uncertainties'

Yilmaz said he won't lower rates until there's a sustained fall in inflation and ``uncertainties'' surrounding the elections are resolved.

He was named governor after President Ahmet Necdet Sezer rejected the Islamist-rooted government's first two candidates. Between May 1 and June 23, the lira tumbled 23 percent against the dollar, leading Yilmaz to raise interest rates.

Turkey ended last year with inflation at double the target of 5 percent, the first time since 2001 that it has failed to beat inflation goals agreed with the IMF.

The ruling Justice and Development Party is sticking to the ``basic framework of fiscal discipline,'' Yilmaz said. Still, the bank needs to be ``careful'' that pre-election spending doesn't accelerate inflation.

Justice called early elections to break a deadlock with the secularist military, which forced four governments from power since 1960 and opposed the party's candidate for president.

Higher Spending

Non-interest budgetary spending jumped an annual 23.4 percent in the first five months of the year as the government accelerated building of new roads and water pipes for small towns and villages.

Economy Minister Ali Babacan said yesterday the spending wouldn't breach full-year limits and the government is committed to fiscal discipline under the IMF accord.

Justice, which leads in all opinion polls ahead of the elections, hasn't yet resolved what to do when the IMF agreement ends, Babacan said in a June 28 Bloomberg interview.

``The time to decide is May 2008,'' he said.

Justice is campaigning in part on an economic performance that produced a budget deficit of 0.7 percent of gross domestic product last year, narrower than that of France or Germany. The target is a deficit of 2.7 percent of GDP this year.

Falling Inflation

The economy will probably grow at ``around 5 percent this year,'' the governor said. While higher borrowing costs are causing ``a slowdown in domestic demand, this is compensated for by external demand.''

GDP grew an annual 6.8 percent in the first three months of the year as record exports and increased government spending drove the 21st consecutive quarter of expansion.

Yilmaz said he expected inflation ``by the summer to come down to 8 percent and even somewhere below that.'' Year-end inflation between the bank's forecast range of 4.5 percent to 7.1 percent ``could be achievable,'' he said.

Food prices pose a major risk to inflation, Yilmaz said, as a drought in central Turkey may reduce the size of the harvest and drive up prices. Central bankers discussed the issue at a recent meeting of the Bank for International Settlement, he said.

``Governor after governor all complained about food prices due to climate change,'' Yilmaz said, adding the problem was outside the control of central banks. ``We cannot redirect climate changes by interest rates and foreign exchange policy.''