A secret letter from the Central Bank to the government

Turkish inflation turned out to be 7.4 percent last year. Central Bank Gov. Erdem Başçı will have to write a public letter to economy czar Ali Babacan to explain why the 5 percent inflation target was missed by a significant margin. One of the best-kept secrets of Turkish economic policymaking is the preceding private letter, which I was able to get hold of.



[Dear Ali;

In the public letter, I will give the volatile food inflation and currency depreciation as the main reasons for why last year’s target was missed as well as explain how this year’s will be reached, but you and I know better. If nothing else, if food and energy prices rise in line with their pattern during the last few years, core inflation would have to plunge to 2.5 percent or so for the headline to fall to 5 percent.



It has instead been oscillating around 7 percent. The recent lira depreciation, compliments of some ex-colleagues of yours, is likely to take its toll on core inflation despite the weakening demand and raise the headline figure by nearly a full percentage point – if the currency does not weaken further. I already committed to selling at least $3 billion of foreign currency this month, but my reserves arsenal is not that strong, which makes us vulnerable to a currency attack.



Besides, although new Economy Minister Nihat Zeybekçi claimed that they would not have an inflationary impact, the recent tax hikes are likely to add around 1 percentage point to inflation. By the way, if you see him around, could you ask Zeybekçi to mind his own business – and how his Colorado ski vacation went?



To make matters worse, the sticky inflation expectations as well as the rise in certain service prices are hinting that we are facing a credibility problem. The IMF had warned of the danger in the lack of a nominal anchor in their latest reports on Turkey; I wish we had listened to them. All in all, we will have to revise our end-year forecast of 5.3 percent when we release our Inflation Report at the end of the month.



At the bottom of it, a significant part of the inflation problem stems from the low interest rates, which have not only caused the lira to weaken, but also boosted consumption. Why save if you are getting no return on deposits or government bonds and loan rates are so low? Better join the real estate gold rush.



That’s why you have to convince Prime Minister Recep Tayyip Erdoğan to let me hike rates before the local elections. You did it once at the end of July, and I am grateful for that. I know it will be much more difficult this time around, as he is not listening to anyone other than his phalanx of sycophantic advisors at the moment.



But you have to try it, old friend. Tell him that if we don’t raise the policy rate soon, we may end up with a substantial emergency hike as in 2006 or 2011. I heard he has a thing for hair gel, so you may try putting on some before going to meet him. Godspeed!

Your buddy Erdem]

For those of you who thought this letter was real: It is not!