Turkey’s annual consumer price inflation rate stayed on the decline in December, falling to 20.3% y/y from 21.61% y/y in November, the Turkish Statistical Institute (TUIK) announced on January 3.

The further reduction in inflation was anticipated given the impact of tax cuts on consumer goods, voluntary private sector discounts “encouraged” by the government targeting certain items in TUIK’s inflation basket, the partial recovery of the Turkish lira (TRY) and falling oil prices. A Reuters poll had predicted the annual headline figure for the last month of the year would be 20.52%.

Gaps between figures and prices
However, with the official food inflation figure still standing at 25.11% y/y at end-2018 and annual inflation on alcoholic beverages and tobacco observed at only 2.39% by TUIK, many Turks are finding the gaps seen between official figures and prices at supermarkets hard to fathom. Uncertainty in Turkey over how bad the economic turmoil has become and how much light there is at the end of the tunnel is aggravated by the desperate situation faced by fact-checkers in the country—“The truth is having a hard time in Turkey these days,” Zia Weise wrote on December 21 in a news analysis for Politico on the plight of the fact-checkers in the new presidential republic launched last year under the Erdogan administration .

Finance minister Berat Albayrak said on December 3 in an interview with state broadcaster TRT that complaints had been received as regards supermarket and food prices, Bloomberg reported.

Official food inflation slowed to 25.7% in November from 29.3% the previous month, with the end-year figure significantly lower than the central bank’s end-2018 estimate of 29.5%.

Meanwhile, domestic producer price inflation (PPI) in December remained more than 1.5 times higher than the headline CPI figure despite falling for a third consecutive month. It was recorded at 33.64% y/y, compared to its 2018 peak of 46.15% y/y seen in September.

One month after PPI inflation peaked, CPI inflation saw a 15-year high of, hitting 25.24% in October. That prompted the Turkish government to introduce policies to curb skyrocketing prices. Moves included the dismissal of the deputy TUIK director with responsibility for the inflation data , an “all-out-war against inflation” that involved pushing the private sector to “voluntarily” cut prices of items included in TUIK’s inflation basket by 10% for two months, tax cuts, raids on onion warehouses following an onion price “crisis”, price controls and encouraging local lenders to “voluntarily” cut interest rates.

PPI has now stood at more than 1.5 times CPI for nine consecutive months since April, but the Turkish private sector has not kicked up a fuss about cutting prices despite the cost pressures.

“Rate cuts on the way”
“The further fall in Turkish inflation in December, combined with the weakness of the latest activity and the recovery in the lira, means that the central bank is likely to press ahead with a rate cut at this month’s MPC meeting [to be held on January 16]. We have pencilled in a 50bp reduction in the one-week repo rate to 23.50%,” Jason Tuvey of Capital Economics said on December 3 in a research note entitled “Fall in inflation to reinforce CBRT’s dovishness, rate cuts on the way”.

Isbank Research expects annual CPI inflation to hover around 20% in the first half of 2019 while BBVA Research said in a note that the maintenance of tax incentives till the end of March, reductions in utility prices and relatively weaker oil prices will likely lead consumer inflation to increase slightly less than expected, by only around 1-2pp in Q1.

Tax incentives extension
“The extension of the tax incentives will also change the forecast path for inflation, bringing this year’s peak to April. The higher-than-expected minimum wage hike and the increasing volatility in the currency could be the upside risks on inflation,” BBVA Research also said.

Seker Invest expected that CPI inflation might continue to decline on a year on year basis over the next few months to below 20%, considering the government’s extension of the duration of the previously enacted tax cuts, as well as the introduction of 10% cuts in electricity and natural gas prices, Serkan Gonencler of the Istanbul-based brokerage house said in a research note.

“We expect that CPI inflation may fall to 12.5%-13.0% by end-2019, well below the 15.0-17.0% consensus, but with an important conditionality of avoiding stress on the Turkish lira (i.e., USD/TRY averaging between 5.5-6.0 levels throughout 2019). Our below consensus estimate basically depends on our expectation of a greater GDP slowdown/contraction for 2019 (at -2.0-2.5%). Despite our below consensus CPI inflation estimate for end-2019, we continue to believe that the CBT [central bank] should not risk improvement in the TRY’s trend with a premature 1Q rate cut. If all remains well on the currency front, a rate cut cycle may be on the cards from late 2Q/early 3Q,” Gonencler cautioned.

“For January, the electricity and natural gas price decreases as well as lower global oil prices and rather stable TRY will stir further energy price decreases. The electricity and natural gas price decrease at 10% will cut inflation by 0.4pp. In addition, the government extended the SCT and VAT cuts on automotive, white goods and furniture sectors for another 3-months, which will keep the price change of core goods under control… We do not expect a policy rate change at [the next MPC meeting to be held on January 16]. However, given a more benign than expected course of inflation, the MPC might lower its tightening biased tone in January, keeping the March MPC on sight for a rate cut. However, we maintain our base scenario for a rate cut cycle to kick off in June given that inflation will portray a significant drop in 2H19. Apart from the MPC meeting, the CBT will release its Quarterly Inflation Report on January 30, as the investors try to collect further clues in respect to the path ahead of monetary policy,” Ozlem Bayraktar Goksen of Tacirler Investment said in a research note.

March local elections
“The Turkish government appears to be turning its attention to March’s local elections, adding to the reasons to think that the central bank will start lowering interest rates at this month’s MPC meeting,” Liam Carson of Capital Economics said on January 4 in a separate research note, adding: “Turkey’s central bank (CBRT) announced this week that it will hold an extraordinary board on 18th January to discuss an advance payment of its 2018 profits. The move seems to be aimed at providing the government with additional resources to loosen fiscal policy and prop up the struggling economy ahead of March’s local elections. (The CBRT is privately-owned, albeit with the Ministry of Finance holding a majority stake. Each year, the CBRT transfers a share of its profits to the government).”

“On the basis of economic fundamentals, the MPC can probably justify a modest cut to the one-week repo rate at this month’s meeting—we expect a 50bp reduction to 23.50%. But more aggressive action would undermine the CBRT’s efforts to patch up its damaged inflation-fighting credibility, prompting a fresh sell-off in the lira,” Carson added.

“CBRT has announced an extraordinary board meeting for Jan. 18, a couple of days after the MPC meeting. Assumption is that they bring forward profit distribution to before local elections. Might be price of not cutting rates early. Independent central bank?” Timothy Ash of BlueBay Asset Management said on January 3 on Twitter.

‘No populism here’
While the government’s launch of a traditional pre-election stimulus fest has been clearly observed, Albayrak, who is also President Recep Tayyip Erdogan’s son in-law, said back on December 3 that Justice and Development Party (AKP) governments have never engaged in economic populism.

“Well…,” Ash responded in a single word emailed comment to investors in reaction to the remarks.

Albayrak also said on December 3 during the TRT broadcast that the government was working on a loan package for the real sector and with banks on a credit channel, Bloomberg reported.

The government is trying to strike a balance between tight fiscal policy and providing enough incentives to avoid a “suffocation” of the non-financial sector of the economy while it is working with banks on “costs and duration” of loans to small and medium sized enterprises, Albayrak also said.

“TRY weak today as a reflection of JPY price moves plus nervousness around early CBRT easing and Albayrak suggesting another credit support programme - suggests they are not willing to let the rebalancing story play out given local elections looming,” Ash said on January 3 in a tweet.

The Turkish private sector, loaded with heavy FX-denominated debt, continues to struggle with bottoming private consumption and a severe liquidity crunch.

Weaker lending in Q4
“Data on Turkish bank loans are now basically available through all of Q4 (they go to Dec. 21) and show a contraction in lending in Q4 that is bigger than in Q3, with the contraction driven by Lira-denominated lending,” Robin Brooks of the International Institute of Finance (IIF) said on December 29 on Twitter, adding: “This means that the credit impulse in Q3 & Q4 2018 is more negative than during the global financial crisis in 2008/9, pointing to potentially large downside risk to our 2019 growth forecast of -0.9%. The fallout from the government-led credit boom in 2017 could be quite large.”

Demonstrating the degree of the economic descent, Turkey’s Purchasing Managers’ Index (PMI) for manufacturing in December fell to 44.2 from 44.7 in November, remaining in contraction territory, at below the 50-level, for the ninth straight month since April, IHS Markit said on January 2.

As another confirmatory sign of an ongoing recession in Turkey, the country’s foreign trade shortfall contracted by 28% y/y to $55bn in 2018 from $77bn a year ago. Exports grew by 7% y/y to $168bn and imports contracted by 5% y/y to $223bn, preliminary customs ministry data showed on January 4.

Capital goods imports declined by 11.5% y/y to $29bn last year while intermediary goods imports were slightly down by 1% y/y to $170bn and consumption goods imports declined by 29% y/y to $23bn.

The Turkish Automotive Distributors’ Association (ODD) reported on January 4 that vehicle sales in Turkey shrank 35% y/y to 620,937 units in 2018 despite tax cuts.

Industrial slump
“It appears that the slump in Turkish industry, which came on the back of the currency crisis in August, will continue into 2019. After contracting by 5.7% y/y in October, the PMI suggests that industrial production will continue to fall at a similar pace over the next few months. Moreover, the latest data suggest that price pressures have continued to ease. After surging to a record high of 77.7 in September in the immediate aftermath of the lira sell-off, the output price sub-index of the PMI dropped to a nine-year low of 47.0 in December,” Carson said on January 2 in a research note on PMI figures.

“The latest activity data from Turkey provide further evidence that the economy is in recession,” Carson reiterated on December 21 in a separate research note.

“While the economy has probably entered a technical recession in Q4, there are tentative signs that the worst may have passed,” Capital Economics said on December 19 in a separate research note.

“A very hard landing and the consensus is that with the damage passed through to banks’ balance sheets, the recovery will be more L-shaped than V. It’s possible to construct a market friendly outcome for the year, with growth and inflation surprising on the downside, but key will be whether the lira remains anchored. There should be ample scope to cut policy rates later in 2019 but if the CBRT moves too early – like before local elections – then macro financial stability could be unanchored, seeing another bout of devaluation and a further death spiral for the economy… the room for policy error is now minimal. At least now Teflon Tayyip is getting a little more luck on the geopolitical side, with the [Jamal] Khashoggi [Saudi consulate murder] affair playing well for Turkey (Erdogan played a blinder), and now a warming in relations with the West. Lower oil prices are also a huge boon for Turkey,” Ash said on December 20 in an emailed comment to investors on the 2019 outlook.

“I don’t think there are any secret deals [with the IMF to be announced after the March polls]. But I think it would be the most logical option for Erdogan. It would bring a major positive confidence shock, reduce the cost of borrowing for Turkey and soften the looming hard landing for the Turkish economy,” Ash said on January 3 in a tweet.