In line with the expectations, the Fed continued to implement a tight monetary policy throughout 2018.
THE WORLD ECONOMY
In 2018, the Federal Reserve (Fed) announced that the recovery in the US economy was proceeding at the desired level and raised interest rates by 100 basis points. The European Central Bank (ECB) also stated that the economic strategy that had been implemented was successful and that it would wind up the quantitative easing program by the end of the year. The tight monetary policies and trade wars imposed by the central banks of developed countries adversely affected the economies of developing countries and led to a decline in the value of local currencies in these countries, and an increase in inflation and interest rates.
The year 2018 started with expectations that the US economy would continue to recover, the Fed would continue to shrink its balance sheet by increasing interest rates, the European and Japanese central banks would continue their expansionary monetary policies and growth in developing countries would gain momentum.
In line with the expectations, the Fed indeed continued to implement a tight monetary policy throughout 2018. Meanwhile, the ECB stated that its program of quantitative expansion would be would up by the end of the year, while adding that the time was not yet right to raise interest rates. Commodity prices also increased until the last quarter of the year due to the recovery in advanced economies. This was positively reflected to the economies of commodity exporters, particularly Brazil and Russia.
On the other hand, the US started to apply the protective customs tariffs against imports from China in some sectors of European countries. The US also decided to impose harsh new sanctions on Iran. The similar reaction of other developed and developing countries, especially China, in response to the protectionist policies from the US raised the risk of escalation of a potential trade war.
In 2018, although inflation in the US remained below expectations, falling unemployment on the back of tax cuts increased confidence in the applied economic policy. In this vein, the Fed raised its interest rates with four 25 basis point hikes in a bid to maintain price stability, and it reduced its balance sheet by about US$400 billion. Ten year bond yields, meanwhile, soared to their highest levels in the last five years.
Despite this strong trend in the US economy, the Fed’s tight monetary policy and the new customs duties introduced by the US have raised the perception that growth could slow slightly in the last months of the year. As a matter of fact, after the recent rate hike in December, US stock markets suffered a heavy bout of sales. While the Fed is expected to increase interest rates by a further 25 basis points in 2019, growth and inflation data are expected to have an impact on the Fed’s monetary policy.
In the first half of 2018, the recovery in the European Union’s economy continued, although some economic data releases indicated a deterioration in the second half of the year, especially in the PMI and industrial production. On the other hand, while work continued in the Brexit process, the potential costs to the EU and the UK are slowly emerging.
In 2018, the ECB continued to implement an expansionary monetary policy aimed at supporting EU countries in line with market dynamics and the ECB left interest rates on hold throughout the year. The bank maintained its policy interest rate at zero, its deposit interest rate at -0.40% and its marginal funding interest rate at 0.25%.
However, the ECB announced that it had completed the bond buying program at the end of 2018. The bank pointed out that the recovery in inflation had not met expectations and that the time had not yet come to raise interest rates.
On the other hand, high unemployment rates and debt stock in many European countries are seen as severe challenges that will take a long time to resolve in the European Union.
While the tight monetary policy and trade wars implemented by the Fed in 2018 led to bouts of sales in emerging markets, these countries suffered a loss in the values of their currencies. Meanwhile with oil demand supported by renewed growth in developed countries, oil prices tested levels of over USD 80/bbl, positively affecting the economies of oil exporters.
However, fears that the Fed’s tight monetary policy and trade wars would re-ignite the possibility of a recession in the global economy led to sharp declines in oil and commodity prices. It is expected that the Fed’s transition to a more moderate policy stance will positively affect the economies of developing countries in the coming period.
TURKISH ECONOMY
New economy program, balanced growth
The political tensions with the USA, the rapid depreciation of the TL, geopolitical risks along our borders and higher than expected inflation all took their toll on the Turkish economy in 2018. One notable development during the year was action taken by the Central Bank of the Republic of Turkey (CBRT), to rapidly increase interest rates in order to stem the fall in the value of the TL, which brought some balance to the market.
The austerity measures taken helped restrain the surge in inflation, and inflation entered a downward trend again. Furthermore, the new economic program was prepared by taking into account the current economic situation. Thus, the prospective economic program was revised. With a combination of high interest rates and undervalued TL, Turkey once again became a center of attraction for foreign investors. In addition, the fact that domestic asset prices have declined to such low levels in foreign currency terms offers serious opportunities for foreign investors. This is expected to set the stage for significant capital inflows into Turkey in the form of asset purchases in the coming period.
In 2018, the depreciation of the TL against major currencies, including the US dollar, had a positive effect on Turkey’s exports and tourism revenues. There was a noticeable improvement in the current account deficit and there has been current account surplus each month since August.
Despite the increase in oil and gas prices - Turkey’s main import items - no significant increase was seen in imports in 2018. On the other hand, exports reached their highest levels in the history of the republic with export coverage reaching 95% in 2018. The improvement in the foreign trade balance is expected to continue in 2019, being reflected to the current account deficit figures.
Inflation exceeds expectations in 2018, at 20.30%.
The rapid depreciation of the TL in the third quarter of the year stood as the main factor in the rise of inflation to beyond expectations. Moreover, the high prices of some food products also proved influential in the rise of inflation. High interest rates, a recovery in the TL and stability in the economy, as well as the contribution of the base effect are expected to lead to a decline in inflation going forward.
A disciplined monetary policy approach from the CBRT
The CBRT increased interest rates in order to stem the rapid depreciation of the TL that resulted from the political tension which flared up with the USA in the third quarter of 2018. In addition, CBRT stated that it would maintain a tight monetary policy and took a number of steps to restore confidence in the market.
In 2018, due to the incentives provided to some strategic sectors and the expenditure directed to refugees, the budget deficit increased slightly when compared to previous years, but public debt has been kept low thanks to the fiscal discipline implemented. The same commitment is expected to continue in 2019 as well.
The impact of the financial turbulence experienced in Turkey in 2018 starts to recede.
In 2019, interest rates and inflation are expected to reach the targets set out in the New Economic Program. Furthermore, the emphasis on structural reforms in the coming period will support Turkey’s growth by accelerating the transformation of its economy.
