DenizBank Economic Update

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1 Economy Financial Markets Banking Sector Focus The Central Bank is Still Dovish Economic Research and Strategy Saruhan Özel, Ph.D. Ercan Ergüzel Berke Gümüş Doğukan Ulusoy 1

2 External Sector Growth Economy (I) 25% 15% 5% -5% -15% Industrial Production Growth Month on Month Annualized 11.% 6.7% Leading Growth Indicators Industrial Production (SA) Capacity Utilization (SA) 85% 8% 75% 7% 65% 6% -25% Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 55% Industrial production (IP) is still losing momentum. Although, it went up by 6.7% YoY in May, the seasonally and working day adjusted (SWA) IP outturn has dropped by.9% MoM, fifth consecutive drop in a row since January 211. Capacity utilization rate (CUR), the leading indicator for the production growth in Turkey, is depicting a similar picture for July. Seasonally adjusted CUR has decelerated to 73.2% in June 211, compared unfavorably with January 211 CUR of 77%. Following the recent developments, all analysts seem to agree with the Central Bank of Turkey (CBRT) that domestic economic activity is slowing down. Just a couple of months ago some were stating that there is an overheating in the domestic economy. (Bn $) 2 Non-Energy CAD 7 Foreign Capital Inflows Into Turkey ($ bn) 6 5 Total Cap. Inflows FDI CAD -4 Non Energy CAD -6 Energy CAD Jun-211 Current account deficit (CAD) has risen to $7.5 bn in June from $3.4 bn deficit a year ago. The outturn was almost in line with the consensus estimate, carrying 12M trailing deficit to $72.5 bn, corresponding to ~9.3% of GDP, in our calculations. Indeed, the historical high figure On the financing side, the main channels of inflows were portfolio investment, corporate and bank borrowings as expected in the first half of 211. They, amounting to TL34 bn, financed a whopping 92% of the CAD. FDI has jumped to $4.7 bn from $2.3 bn of 21, but still financing a mere 13% of the CAD. The net errors/omissions, which is unexplained inflows, reached $2 bn, carrying year to date figure to $7.5 bn. Additionally, portfolio inflows was too strong that the CBRT was able to increase its reserve accumulation by 6% in the first half of 211. The CBRT has stated in its latest minutes that owing to the measures taken so far, the CBRT expects to see a notable improvement in the forthcoming period. CAD will start to improve in the final quarter of the year. We agree that it will start to decelerate at least in the last quarter, but not necessarily because of the measures taken by the CBRT (RRR hikes from 6% to 14%) and the BRSA (raising general provisioning for retail loans). The low base effect will also start to disappear starting from November

3 Public Sector Inflation Economy (II) Annual Inflation PPI 12% CPI 4% -4% % 6.31% Headline and Core Inflation 12% 1% 8% 6% 4% 2% Headline CPI 6.31% 5.43% Core CPI Annual CPI inflation has risen slightly to 6.3% in July from 6.2% previous month. The July monthly CPI outturn of -.41% was lower than consensus estimate, mainly on the back of benign food prices, contributing to -,32% monthly rise in the headline CPI.. On the flip side, the core inflation indices are rising for the last nine months in a row, reaching 5.7% in July-211 from 2.5% in October-21. Moreover, TL has lost against a basket USD Dollar and Euro (%5, %5) since the beginning of this year and 1% in the last two months. In his recent statements, The CBRT Governor has stated that the pass-through from exchange rates to prices is around 15%. Based on this, percent depreciation in TL has likely to add around 3 pps to the CPI in the course of the time. Accordingly, the CBRT has stated that the CPI is likely to hover slightly above the levels envisaged in the July Inflation Report, and core inflation, similarly, likely to rise for the forthcoming period. However, due to slowdown in domestic economy, the second round effects of the decelerating TL might be limited Budget Balance (12M Trailing) % % -1.6% % % -5.2% -5.5% -14 % -2% -4% -6% 3% 1% Rev. vs. Non Int. Exp. Increase (12M Rolling) Non-Interest Expenditures -3-4 $ bn % GDP -8.8% Jun-11-8% -1% % Revenues -1% Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 The central government budget recorded TL3.1 bn surplus in June. Thus, the year-to-date surplus has risen to TL2.9 bn from the deficit of TL15 bn last year. The stellar performance was due to 45% surge in tax revenues. The collections from debt restructuring scheme was instrumental in rising tax revenues. Similarly, primary balance (excluding interest payments) has increased to TL25 bn from TL12 bn in 21. While total tax revenues went up by 45% in June compared to same month a year ago, the VAT levied on imports increased by only 35%, signaling that imports would signal some deceleration in June. As per the Medium Term Programme, the 211 budget deficit target is TL34 bn. It appears achievable by far given the first half year s budget figures. 3

4 Stock Market Currency Market Depreciate Appreciate Debt Market Financial Markets EM CDS Spreads and Ratings (5 Year; Fitch, LT FX) 9 TR, BB+ Hun, BBB- Rus, BBB Bra, BBB Benchmark Bond Yield (%) Benchmark Bond Yield (Compounded) 3 Dec-8 Dec-9 Dec-1 1 Policy Rate (Compounded) 7.98% 5 O/N Equivalent: 5.92% Oct-8 Jun-9 Mar-1 Dec-1 Thanks to the CBRT s rate cut, the benchmark bond yield has eased below 8% EM Currencies (Dec 28=) Dec-8 Aug-9 Apr-1 Dec-1 Jul-11 TRY HUF CZK BRL KRW ZAR % Change Against $ (Positive Values= appreciating against $) BRL MXN CZK PLN HUF ZAR KRW TRY Monthly Change(%) JPY GBP Weekly Change(%) EURO The TL is underperforming other EM currencies, mainly on the back of global risk off mode and the CBRT s changing policy stance Stock Market Performance (Sep 28=) MSCI Turkey Index Bank's Equity Prices (Jan 28 = ) EM Banks US Banks EU Banks TR Banks MSCI EM Index Sep-8 Apr-9 Nov-9 May-1 Dec-1 Jun-11 Jan-8 Oct-8 Jun-9 Feb-1 Oct-1 Jul-11 Since the end of last year the ISE has underperformed emerging peers. 4

5 Lending Funding Capital Banking Sector (I) % Sector's Capital Strength ($ bn) 22% Owners' Equity Free Capital 21% CAR 19% 19% 18% 17% 25% 15% 6% 5% 4% Capital Adequacy Ratio by Bank Groups Private Banks' CAR State Banks' CAR Foreign Banks' CAR Q % 5% % 3% 16% 16% 1% Jan-3 Jan-5 Jan-7 Jan-9 Jan-11 Sector s capital adequacy ratio is more than two times the Basel requirement. Also, the gap between the banking groups has diminished, as state banks engage in more lending decelerating their capital adequacy ratio (CAR) to the sector average. Banking Sector's Liability Structure Other Capital Repo Wholesale Funding Deposit 1% 9% 8% 7% 7% 9% 8% 7% 7% 8% 12% 14% 15% 13% 12% 13% 12% 13% 13% 12% 3% 5% 3% 4% 5% 5% 6% 7% 6% 9% 1% 1% 11% 13% 14% 12% 13% 1% 12% 13% Total Deposits (TL bn) % 62% 62% 62% 62% 61% 62% 62% 61% 58% Jun Feb-8 Feb-9 Feb-1 Feb-11 While total deposits are rising, its share in liabilities went down by 3 pps in 211. There is switch from deposits to repo funding. Banking Sector's Asset Structure Other Retail Corporate Gov.Bonds 45% Loan and Deposit, Annual Increase (%) 36% 3% 31% 27% 26% 24% 23% 23% 21% 19% 21% 5% 9% 12% 14% 16% 16% 16% 17% 21% 24% 27% 3% 33% 34% 31% 35% 18% 36% 35% 25% 15% Loans Deposit 4% 43% 4% 35% 32% 28% 26% 32% 29% 25% 5% Jun-11-5% Feb-8 Feb-9 Feb-1 Feb-11 Some portion of the rise in total loans is coming from the TL s depreciation, such that while annualized loan growth is topping 37%, it is in fact 29% should the $/TL parity effect is eliminated. 5

6 P & L Loan Quality Loan Breakdown Banking Sector (II) Loan Breakdown (27=) SME Corporate 2 Retail C. Card Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun Retail Loans (Dec 27=) Mortgage Car General Purpose Credit Card 6 Feb-8 Aug-8 Feb-9 Aug-9 Feb-1 Aug-1 Feb-11 Retail loans have recently started to slow down, especially on the back of BRSA s new regulations. 6% 5% NPL Ratio 5.8% (TL Mn. ) 1,3 1, 9 NPL Provisions (Monthly) 21 Average: TL451 mn 29 Average: TL824 mn Avr: TL35 mn 4% 3.2% 3% Feb-8 Sep-8 May-9 Dec-9 Jul-1 Mar-11 3,% Jun-7 Jun-8 Jun-9 Jun-1 Jun-11 The NPL ratio fell significantly and provision expenses decelerated to pre-crisis levels. Accordingly, NPL provisions are falling, which is supporting the profitability in 211. (TL Mn. ) 3, 2,6 2,2 1,8 1,4 1, Net Income (Monthly) 21 Average: TL1.8 bn 29 Average: TL1.7 bn Avr: TL1.2 bn 1.5 (TL Mn. ) 4, 3,2 2,4 Net Interest Income (Monthly) 21 Average: TL3.2 bn 29 Average: TL3.5 bn Avr: TL2.5 bn Jun-7 Jun-8 Jun-9 Jun-1 1,6 Jun-7 Jun-8 Jun-9 Jun-1 Jun-11 On the back of strong base effect and new regulations, the sector s net profit went down by 15% in the first half of the year... 6

7 Focus The Central Bank is Still Dovish... The Central Bank of Turkey (CBRT) Monetary Policy Committee held an interim meeting on 4 August 211, in an aim to evaluate recently increasing concerns over the sovereign debt problems in some European countries and the global growth outlook. Surprisingly, the policy interest rate, which is one week repo rate, was decreased by 5 bps to 5.75%. Since this movement was TL negative and the domestic currency has been depreciating since the beginning of 211 by more than against a basket of currencies (%5 $ and %5 Eur), the CBRT took several precautionary measures to defend the value of the TL. 1. As might be remembered, in an aim to curb speculative short term fund inflows, the CBRT has decreased the O/N borrowing rate from 6.5% in September-21 to 1.5% in December 21. On the other hand the O/N lending rate was 9%. Now, to defend TL in the changing global financial conditions, the CBRT has decided to narrow interest rate corridor and increased O/N borrowing rate from 1.5% to The CBRT has also decided to provide foreign exchange liquidity to market through for- 6 eign exchange selling auctions on the days deemed necessary. Following the interim Agust 5 August 1 August 15 August 18 August 23 meeting held on August 4, the CBRT has completed 15 daily auctions and sold $1.3 bn to the market. Yet, the TL (against basket) has depreciated further as the details might be seen in the next graph. Since the volatility in the market has lessened and global recession fears were over, at least for some period of time, the Bank did not engage in second round of easing in its normally scheduled meeting as of 23 rd of August. The CBRT presumes that the measures taken at the interim meeting on August 4, have contained the downside risks for the economy for the time being. But the Bank has stated again that should the global economic problems intensify, all the policy instruments, mainly policy interest rate and reserve requirement rates, would be eased. Retail Loans Annualized Increase (4W MA) 8% In the Minutes, it is also stated that we would see a notable improvement in the CAD in the forthcoming period. We agree with the CBRT for the following reasons: 1. TL s recent depreciation is likely to dampen domestic demand and increase external demand 2. Oil price has plunged by 11% since April 211, contributing positively to the CAD in Turkey. Because, 55% of the yearly CAD deficit is emanating from energy deficit. Jan Feb Mar Apr May June July Aug Sep Oct Nov Dec % 3. Bank loans, especially the retail loans, are losing pace, mainly on the back of the CBRT s previous deposit reserve requirement rate hikes and BRSA s increase on general provisioning. 4. Domestic economic activity is slowing down since the beginning of this year % 4% FX Selling Auctions and TL Basket Auction Amount ($ mn) TL Basket (%5 $ and %5 )

8 Focus All in all, the CBRT might embark on further cuts in policy rate, should the domestic and/or global growth and/or financial conditions deteriorate. However, further rate cuts might also prompt TL selling, which is good to curb the rise in the CAD but may also adversely affect inflation. In his recent statements, The CBRT Governor has stated that the passthrough from exchange rates to prices is around 15%. Based on this, percent depreciation in TL is likely to add around 3 pps to the CPI in due course. True, due to the economic slowdown second round effects might be limited, but further steep drop on top of these levels is intolerable. Therefore, the CBRT would be more cautious for further rate cuts in policy rates. However, there is still much space for easing reserve requirements. Currently, the annualized rate of loan growth (based on the first 8 months outturn) is 29%. If the CBRT forecast further drops at this rate, especially below the unofficial loan growth target of 25%, the RRRs are likely to be decreased current levels, 11% for FX and 14% for TL deposits (weighted average). 8

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