Turkey’s official annual consumer price index (CPI) inflation rate stayed on the downward path in February, falling to 19.67% y/y from 20.35% y/y in January, the Turkish Statistical Institute (TUIK) announced on March 4.

A Bloomberg poll had predicted the headline figure would fall to 19.9% y/y. The current market consensus is that Turkey will see its annual CPI figure hover around 20% across the first half of this year, prior to a decline caused by base effects. Last month, the market consensus was suggesting a slightly worse first half with inflation staying above 20%.

The Turkish government’s current inflation story suggests that although the TUIK does not include the prices offered at the government’s newly-introduced discount vegetable stalls in its calculations, inflation fell partly because supermarket chains had to cut their prices countrywide to deal with the public sector competition. As Turkish President Recep Tayyip Erdogan issued warnings to what he claimed were price gougers exploiting the country’s inflation difficulties by massively overcharging in the private sector, the government launched 50 pop-up stalls in Istanbul, home to more than 15mn people, and 30 more in Ankara, home to more than 5.5mn. The scheme has not, however, gone nationwide, as officials had suggested it might.

State of disbelief
Foreign media and analysts seem to be buying into the official inflation story given by Ankara but many Turkish social media users appear to be in a state of disbelief—some are struggling hard to communicate their reactions to what they see as mass propaganda.

“Turkish Inflation Slows as Government Intervention Bears Fruit,” Bloomberg headlined a story. “The government’s effort to bring down prices of fruit and vegetables succeeded in tempering inflation. Even so, the chance of any rate cuts by the central bank on [March 6] is slim—April or June remain the most likely dates for the start of monetary easing,” Ziad Daoud of Bloomberg Economics commented in a separate story.

“The effect of cheap vegetable sales by municipalities seen in official figures. Here is a chart of tomato and dry onion prices, falling compared to January,” Fercan Yalinkilic of Bloomberg said on Twitter, adding in another tweet: “Little clarification is needed. The discount sales by municipalities doesn't directly go into the inflation basket. However cheap sales by groceries to compete in fact is considered.”

“I really like your tweets, but is this a joke you are sharing?” one Turkish Twitter user responded to Yalinkilic. “All these charts are fiction, everybody knows but can’t talk,” another Turkish Twitter user wrote.

“Turkey—inflation came in slightly below expectations which is encouraging… Guess concern will be over impact of price controls longer term on supply response… Don’t think there is enough downward movement here to allow the MPC to cut rates on March 6. That would be big risk especially given lira’s slight weakening bias again of late,” Tim Ash of BlueBay Asset Management said on Twitter.

“Is this figure monthly inflation? I am very confused all goods and utilities have doubled in price. People's wages are the same, their buying power has halved. Can someone explain please,” a foreign Twitter user responded to Ash, while one other Turkish Twitter user was attacked by a government troll after asking in reply to Ash’s tweet: “Who assesses the inflation rate in Turkey? Turkish government or independent institutions?”

Rates hold “widely expected”
Ercan Erguzel of Morgan Stanley said on February 26 in a research note: “The main takeaways from our recent marketing trip on February 18-20 in London, where we met fixed income and security investors… It is widely expected that CBT [Central Bank of Turkey] will remain on hold this week… The first medium-term uncertainty is about the pace of easing in the baseline/positive scenario.

“Some investors thought that the CBT would not deliver high ex-post real policy rates on a consistent basis as economic growth is very weak… [Required Reserve Ratios] cuts are not signalling a change in monetary policy stance, in our view… We expect a reversal in unprocessed food prices due to the indirect impact of regulated food sales by some municipalities… Our discussions suggest that investors are more comfortable with the outlook for the banking system as banking system rollovers have not been a major issue recently.

“Yet, some investors argue that it would take much longer than expected for lending growth to reach its potential without a structure to clean distressed assets from banks’ balance sheets… Investors mostly agree with our view that local elections should not deliver big surprises, with the distribution of municipalities in big cities likely to remain unchanged, while Ankara is a close call.”

All in all, it seems that the government will not struggle to find buyers for its inflation or election stories as long as real interest rates remain incredibly high. Meanwhile, the Turkish real sector must survive by its own means.

Trade deficit contracts 73%
Turkey’s foreign trade deficit contracted by 73% y/y to $4.1bn in January-February, according to preliminary data provided by the Ministry of Trade and Customs on March 4.

Isbank Research said on February 28 in a note on TUIK’s final data release for January foreign trade. “Foreign trade deficit has fallen for the eighth consecutive month in January 2019… Due to the weakness in TRY [Turkish lira], the decline in gold imports and the loss of momentum in domestic demand, the contraction in foreign trade deficit continued in the first month of 2019. It is understood that the course of the foreign trade deficit will depend on the recovery in economic activity in the coming period. In terms of export performance, the recent slowdown signals from the EU countries will be crucial in the forthcoming period.”

Turkey’s passenger car and light commercial vehicle (LCV) total market contracted by 52% y/y to 39,248 units in January-February, automotive distributors association (ODD) said on March 4.

Vladimir Bespalov of VTB Capital said on March 1 in a research note entitled “Turkish Autos- Buy exporters amid weak domestic outlook”: “Tofas (Buy; 12-month target price up 13% to TRY 34) is our top pick, as it offers an attractive valuation and lower risk, with its exports protected by take-or-pay contracts.

“Ford Otosan (Buy, 12-mo TP of TRY 70) will keep benefitting from being the key producer of Ford commercial vehicles in Europe, in our view, although dispelling Brexit-related concerns might take some time. Meanwhile, the bleak domestic market outlook will likely backload the deleveraging of Dogus Otomotiv (Hold; 12-mo TP up 9% to TRY 6; ETR 12%), which remains the key to value creation, we believe,” 

Turkey’s sole major petrochemicals producer Petkim, 51%-owned by Azerbaijan’s state-owned energy company Socar, said on March 1 in a bourse filing that its net income declined by 38% y/y to TRY872mn in 2018 despite revenue growth of 27% y/y to TRY9.32bn.

“Petkim reported a net loss of TRY 44mn in 4Q18 (3Q18 net income: TRY 413mn; 4Q17: TRY 365mn), versus a market average expectation of a net income of TRY 77mn (Seker Invest.: TRY 167mn), due to a much lower than expected operating performance in 4Q. The results are likely to reflect negatively on the short-term share performance,” Fulin Onder of Seker Invest said on March 4 in a research note.

“More bearish” on banks’ earnings
“We model an 8% YoY decline in [our coverage of banks’] earnings for FY19E. This is more bearish than the Bloomberg consensus estimates due to our more conservative expectations on asset quality and volume growth. This scenario assumes 7% [net interest income] growth and 15% fee growth combined with 8% lending and deposit growth YoY. [Net interest margin] tightens by 40bps YoY due to lower CPI linker revenues and narrowing core spreads, especially in 1H19. Fees are expected to grow 15% YoY in 2019 through bank-wide initiatives, which should support sustainable returns for 2019, while LLPs and trading loss should remain at elevated levels. Our top picks are Akbank (AKBNK.TI; OP), Garanti (GARAN.TI; OP) and Yapi Kredi Bank (YKBNK.TI; OP),” Sevgi Onur of Seker Invest said on March 1 in a research note on the Turkish banking industry’s January data entitled “Margin pressure in 1Q19”.

“As we expect domestic demand weakness to persist throughout 1H19, [12-month cumulative] C/A deficit is likely to continue shrinking over the next few months, dipping at USD2-3bn (or possibly reaching a small surplus) by July 2019. The downward trend is likely to reverse in 2H19, but it would only bring end-2019 C/A deficit to about USD11-12bn (1.8% of GDP) or probably slightly higher. This downward trend in the C/A deficit might also support the case for stabilization in TRY, and indirectly help inflation… we expect the budget deficit to reach about 3.0% of GDP in 2019, vs. the new economy program’s (NEP’s) 1.8% guidance,” Seker Invest said on March 3 in its macro outlook for the month.

“There will be a significant fall in inflation from this summer due to structural measures on food prices, and the goal of single-digit annual inflation will be reached sooner than expected… February state sales of cheap vegetables were successful in holding food prices down,” Turkish finance minister Berat Albayrak said in comments on the February inflation release in a tweet.

Official inflation figures pointed to a 0.9% m/m rise in food prices, which has the biggest weight, at 23.29%, in the inflation basket, in February. Consequently, the official food inflation figure declined from 30.97% y/y in January to 29.25% y/y in February.

Official annual inflation in the prices of alcoholic beverages and tobacco during February, which has a limited 4.23% weight in the headline figure, was observed at only 2.71% by TUIK, up from 2.63% in January.

Serkan Gonencler of Seker Invest said in a research note on February inflation: “We expect CPI inflation to remain close to 20% until June as cigarette prices are likely to be hiked by 15-20% (possibly more) shortly following the recent tax hike (in fact, they may edge up above 20% in April).”

End-year CPI seen at 13%
He added: “That said, assuming no large-scale TRY depreciation in 2019, the downward trend in CPI inflation will accelerate in 2H19 with the base effect. We expect CPI inflation to fall to 13.0%-13.5% by end-2019, well below both the 16.0- 17.0% consensus and the CBT’s 14.6% expectation. Our below-consensus estimate basically depends on our expectation of a greater GDP slowdown/contraction for 2019 (we expect -2.0% GDP growth for 2019) and assume stabilization of the TRY.

“Our estimate also assumes that food inflation will be roughly 14-15% by year-end (CBT’s assumption is 13%)… All 20 economists participating in the Foreks survey, expect the CBT to keep the policy rate at 24.0%, while the initial rate cut is expected to come within the April-July period. According to the survey, for the first rate cut, five economists expect one in April, nine expect one in June and one expects one in July, while one has said within 2Q. We continue to argue that the CBT should not risk deterioration of the TRY 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 June onward. Even if the CBT considers an earlier rate cut (let’s say in April), this might be just a symbolic move (i.e. to the tune of a 50bps cut). We project a total 650bps rate cut for 2019 (likely to be extended into 2020 as well). The median market expectation is for a 450bps cut throughout 2019.” 

Jason Tuvey of Capital Economics said in a research note: “The weaker-than-expected Turkey inflation data for February are unlikely to be enough to persuade the central bank to lower interest rates at its monetary policy meeting later this week. We expect the one-week repo rate to be left on hold at 24.00%. An easing cycle probably isn’t too far away, though, and we expect the benchmark one-week repo rate to be lowered by 400bp to 20.00% by end-2019. The markets currently anticipate rates being lowered by 650bp, to 17.50%, over the course of this year.”

The official healthcare prices inflation figure posted the highest monthly rise, at 2.48%, in February. It has the second lowest weight, of 2.58%, in the inflation basket. Consequently, official annual healthcare prices inflation fell to 17.89% in the month from 17.99% y/y in January although Health Minister Fahrettin Koca announced on February 13 that the fixed exchange rate for pharmaceutical products that are imported was to be hiked by 26.4%.

With all the reports of pharmaceutical shortages, Turkey’s health system in reality is still a serious concern that could produce a new critical situation for the country, to add to the concerns over food security.

In February, the average prices of the 29 items in TUIK’s inflation basket, which has a total of 418 items, remained unchanged while the average prices of 235 items increased and the average prices of 154 items decreased.

“In March, we expect that clothing and footwear prices will have a slight increase due to the seasonal factors and measures taken by the government that will continue to be effective on food prices. On the other hand, we maintain our expectations that the momentum loss in annual CPI inflation will become more apparent in the second half of the year due to base effects and CBRT’s monetary policy decisions will be dependent on the course of inflation,” Isbank Research said on March 4 in a note on February inflation. Isbank Research estimated headline inflation would fall to 19.09% in March.

Impact of 1H tax adjustments
“We believe the tax adjustments in 1H will retain the annual inflation at rather high levels, while inflation will dwindle during the remainder of the year. We believe that strong inflationary pressures will likely moderate in 2H19, leading to some rate cuts by the CBT. Our 2019YE CPI estimate stands at 16.3%. We expect MPC to keep the policy rate (one-week repo rate) constant [on March 6]. We do not anticipate any significant wording change either, maintaining its tightening biased stance,” Ozlem Bayaktar Goksen of Taciler Invest said in a research note on February inflation.

Is Invest still expects headline inflation to hover around 19-20% before starting to fall at an escalating pace in the third quarter, Muammer Komurcuoglu of the Istanbul-based brokerage house said in a research note.

“[February inflation] data shows the impact of benign food prices and seasonality in clothing, despite higher energy inflation… Overall, February data pulled the annual figure below the 20% threshold given weak domestic demand, a stable currency and tight stance from the central bank. However, the risks to inflation remain tilted to the upside in the near term, given the marked deterioration in pricing behaviour and inflation expectations, as well as uncertainties surrounding cost factors. We expect a pronounced drop in the second half of this year due to supportive base effects,” Muhammet Mercan of ING Bank said in a research note.

PPI falls for fifth straight month
Meanwhile, official domestic producer price inflation (PPI) in February continued to approach the headline CPI figure, falling for a fifth consecutive month. It was recorded at 29.59% y/y, compared to its 2018 peak of 46.15% y/y seen in September, TUIK said in a separate press release.

Seker Invest said on March 3 in its strategy report for the month: “We expect the CBRT to maintain the current level of policy rates and tight stance at its March meeting as well. Investors will primarily be following US-China trade talks in March… Domestically, the local elections [on March 31] and related polls will be at the top of the market participants’ agenda in March… While the political relations with the US and the EU will maintain their importance, the developments regarding Syria will remain a risk factor.

“We expect the BIST [Istanbul stock market benchmark index], which decoupled rather negatively in February, to maintain its uptrend and decouple positively in March. With a clearer dovish tone from the Fed,… foreign investor interest is also expected to continue, though not as significantly as in January. The benchmark BIST100 index is expected to trade within a wider band of 101,000 – 111,000 in March, and possible profit takings are to be regarded as opportunities for further investment.

“Considering also past years’ performance of the BIST in the third month of the year, the BIST is expected to end the month with a significant gain. In light of these expectations, we maintain the weight of bonds in our portfolio at 60%, of FX at 20% and of equities at 20%.”