Price hikes as pre-election front payment to Turkish voters

Price hikes as pre-election front payment to Turkish voters

As the Turkish Lira is sharply loosing value, “verbal maneuvers” have been made to buy some time. Each visit and meeting by the Central Bank governor feeds optimism, prompting people to try to draw positive conclusions.

The Central Bank recently said “it is closely monitoring the unhealthy price formations in the markets. Necessary steps will be taken, also considering the impact of these developments on the inflation outlook.” Those “developments” in fact include the Central Bank’s own failure to take action on time. The Bank was also trying to say it would “take steps against developments that have emerged,” but in the following 24 hours nothing changed. Everybody knows that moves to “pull a rabbit out of the hat” are aimed at buying more time. The Turkish economy is effectively “Waiting for Godot.”

Ten days ago the Central Bank could have prevented the turmoil by delivering a 250 basis point rate hike, but today a 350 basis point hike may not even do much good. Was it a good move to not hike the rates? Over the past 10 days, the currency has seen an additional 5 percent decline in its value and the annual interest rate in the market has surpassed 17.25 percent.

Price hike or budget deficit

Of course there will be consequences if the monetary authority just sits and watches while exchange rates are rising. Fuel prices have come under particular pressure, but necessary price adjustments in fuel prices have been “held back.” The price adjustments that the automatic pricing mechanism necessitates have been “swept under the rug.”

This was unsustainable. According to a cabinet decision issued in the Official Gazette, the special consumption taxes (SCT) on any fuel products must be lowered in the event of any increases in these prices due to an increase in oil prices and a loss in the value of the lira. As a result, the price of fuel should be increased depending on the exchange rate and price of oil in the international markets. According to the new regulation, the SCT level will be lowered to offset any fuel price rises driven by these factors.

However, in early May, responding to news reports suggesting that the SCT on fuel would be lowered, Finance Minister Naci Ağbal said the SCT has a “significant share” in budget revenues. “We are raising from 130 billion liras and 46 percent of this amount comes from fuel. A 0.5 lira reduction in the price of fuel will cost 16 billion liras in tax revenues and this is a significant burden on the budget,” Ağbal said.

At the start of May, the difference between the price of Brent oil in the international markets in terms of the lira and the price of oil sold at the pumps in Ankara was 10 percent compared to prices at the start of the year. This difference was 27 percent as of May 16. So the gap is widening because the rises in exchange rates and the price of oil in international markets have not been passed onto fuel prices. In fact, fuel prices should have been raised by 20 percent but if this necessary price adjustment is offset by giving up on SCT revenues, annual STC revenues will decline by more than 50 percent.

Private sector will suffer

As a result, either the price of fuel will be increased after the elections or the authorities will opt for a combination of a partial price increase and a SCT revenue loss. If the SCT revenue loss is chosen, the budget deficit will be 50 percent higher than initially anticipated. This budget deficit will inevitably have to be financed through borrowing, and the entire nation will pay for the interest rate through taxes.

The public sector may postpone necessary price increases by “giving up on tax revenues,” but can private industry and trade sectors afford to postpone price increases as if costs have not risen? Can private companies afford the cost increases that result from exchange pass-through for a long time? My answer is “No.”

It is very worrying to see that the only response from Turkey’s economic administration to rising exchange rates and snowballing inflation is “price control.” The budget deficit will increase the Treasury’s risk premiums when borrowing, and economic players are facing difficulties regarding uncertainties over inflation and measuring it.

Turkey, economy, snap polls, politics, opinion, price hikes, lira, currency, value