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Cablegate: Killing Off Inflation - Move to Formal Inflation

This record is a partial extract of the original cable. The full text of the original cable is not available.

081504Z Dec 05





E.O. 12958: N/A
SUBJECT: Killing Off Inflation - Move to Formal Inflation

1. (SBU) Summary: The Turkish Central Bank announced that it
will begin formal inflation targeting in 2006, and announced
a targeted inflation rate of 5% in 2006, and 4% each in 2007
and 2008. This marks another milestone in Turkey's quest
for economic normalcy. Although not without risk, the move
to formal inflation targeting represents another important
nail in the coffin of Turkey's history of high inflation.
End Summary.

Serdengecti Announces Formal IT

2. (SBU) In a December 5 press conference, Central Bank
Governor Sureyya Serdengecti announced details of the Bank's
monetary policy for 2006, including the long-expected change
to formal inflation targeting (IT), also called explicit
inflation targeting. Although the Turkish Central Bank
(CBRT) has been informally targeting an inflation rate as
its primary indicator, until now the Bank has had some
flexibility to consider other factors in setting monetary

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3. (SBU) The new system locks in explicit targeting of
inflation as measured by change in the Consumer Price Index
(CPI), changes the monetary policy committee from an
advisory to a policy-setting role and lays out a more
formalized and transparent policy-setting mechanism. The
Central Bank has long been preparing for the move to formal
IT, because of its successful track record in a growing
number of countries and in keeping with IMF recommendations.

--------------------------------------------- ----------
Move to IT Key Step on Turkey's Road to Price Stability
--------------------------------------------- ----------

4. (SBU) The CBRT's announcement is a powerful manifestation
of the progress it has made, under Serdengecti's skillful
leadership, in bringing down inflation. 2004 was the first
year since the early 1970's in which Turkey's inflation rate
was in single digits, with rates sometimes over 100% during
the worst years of the 1990's. In four short years since
the 2001 crisis, the CBRT's tight monetary policy, helped
along by the GOT's tight fiscal policy, favorable global
conditions, a strong lira and increased political stability,
has enabled a gradual disinflation. For 2005, Turkey is on
track to register CPI inflation slightly below the 8% target
for the year.

5. (SBU) Serdengecti has long told us privately that he
could only move to formal IT once he was confident the
disinflation process was well-entrenched: if inflation
spiked under formal IT the CBRT could lose credibility and
have few good policy options. Clearly, Serdengecti now
feels sufficient confident to move to formal IT. The
lowering of inflation expectations, the Government's track
record of fiscal austerity-including tightening fiscal
policy in 2006-and the gradual build up in the Bank's
inflation-fighting credibility have enabled the Governor to
take the plunge into formal IT.

Wiggle Room from the "Uncertainty Band"?

6. (SBU) Indeed, perhaps because he fears being locked into
a rigid target with no room for maneuver, Serdengecti
accompanied the announcement of inflation targets (5% in
2006 and 4% each for 2007 and 2008) and an "uncertainty
band" of 2% in below and above the target in 2006, with
subsequent years' bands to be announced later. Serdengecti
denied the band means the Bank is targeting a range, and
said the Bank would be accountable to explain deviations
from the target. At the same time, he explained that
setting a band recognizes the large number of factors
outside the Bank's control, such as a spike in oil prices or
other external shock. Perhaps to counter accusations that
the Bank was targeting a path, Serdengecti also charted a
quaterly "path" for inflation: 7.4% as of March, 2006, 6.5%
in June, 5.8% in September and 5% by yearend 2006.

Reserve Build-up to Continue

7. (SBU) Serdengecti also announced that the Central Bank's
program of Foreign Exchange purchase auctions would
continue, with an increase in the daily purchases from $15
million to $20 million, with optional additional purchases
of $40 million instead of $30 million. These increases
reflect the Bank's agreement with the IMF on the
desirability of continuing to take advantage of favorable
market conditions to build foreign exchange reserves.
Although, the Bank keeps increasing its reserves, the ratio
of reserves to short-term debt remains low by international

The Challenge in Meeting the 2006 Target

8. (SBU) Despite the Bank's impressive track record in
recent years, many analysts believe the 5% 2006 inflation
target may be difficult to achieve. Risks abound: higher
oil prices, the potential for erosion of GOT fiscal
discipline as elections draw near, ongoing price rigidity in
the services sector--all could threaten achievement of the
target. CSFB for example, is forecasting 2006 inflation of

Who Comes After Serdengecti?
9. (SBU) One risk cited by analysts which is increasingly
discussed in the local press is what will happen after
Serdengecti's term expires in March, 2006. Though the GOT
could reappoint him-and this would be the lowest-risk option
vis--vis potential market volatility-the betting is that
the GOT will replace Serdengecti. If the AKP Government's
track record holds true, they will select someone with
closer ties to the Government, but will most likely choose
amongst figures who would not upset the market. Serdengecti
himself has told us he just privately he just wishes the
Prime Minister would make a decision, well before the end of
his term, so as to allow him to prepare for the transition
if he is not reappointed.


10. (SBU) The announcement of formal IT is an important
stepping stone to price stability in Turkey, a key nail in
the coffin of Turkey's bad old days of high inflation.
Serdengecti deserves tremendous credit for what he has
accomplished. Risks associated with the end of his term and
other pressures will mean an extra challenging year ahead
for meeting the target.


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