1. 1 Hüseyin Zafer Executive Director May 2011 CENTRAL BANK OF THE REPUBLIC OF TURKEY 1

2. 2 Contents I.General Outlook in the Turkish Economy II.Post-Crisis Challenges III.New Policy Mix as the Response IV.Outcomes of the New Policy 2

3. 3 I. General Outlook in the Turkish Economy 3

4. 4 Strong Rebound in Economic Activity in 2010 Source: TURKSTAT, SPO GDP Growth (%) 4

5. Source: TURKSTAT Last observations: January 2011 Unemployment ratio (%, Seasonally Adjusted) Unemployment is Still High but Recovering Non-Agricultural Employment and GDP Growth 5

6. Inflation Realizations (%, red dots are the year-end inflation targets) Source: TURKSTAT 6 Disinflation Continues

7. Lending Rates (%, weighted averages for the categories) Source: CBRT 7 And so Does the Historically-Low Lending Rates..

8. Source: CBRT CDS Premia of Selected Countries (January 1, 2008 - April 22, 2011) CDS Premia of Selected Countries (January 1, 2008=0, April 22, 2011) 8 Highest Decline in CDS Spreads Despite Highest Interest Rate Cut

9. 9 II. Post-Crisis Challenges 9

10. 10 Emerging Markets Strong Growth Prospects & High Interest Rates Capital Inflows to Emerging Markets Credit Growth & Risk of Overheating Advanced Economies Low Growth rates & Very Low Interest Rates + Risk of future instability! Background

11. Source: TURKSTAT, CBT Capital Inflows (USD billion) * After controlling for the effect of change in Decree No. 32 11

12. Source: BRSA Last observation: February 2011 Loan Growth (%, year-on-year change) … Supporting the Strong Growth in Credits 12

13. Source: ECB Statistical Data Warehouse Change in Bank Credit (%, year-on-year, 2010) … which is Higher than the EU Countries 13

14. Source: IMF Latest Data Available varies btw 2009-2010 Return on Assets (%) Outstanding Outlook in the Banking Sector Capital Adequacy Ratio (%) 14

15. Source: IMF, BRSA Latest Data Available varies btw 2009-2010 NPL Ratios of Selected Countries (%) …with Comparatively Very Low NPL Ratios NPL Ratios in Turkey (%) 15

16. 16 Source: Eurostat, CBRT Last observations:Sep. 2010 2009Sep. 2010 Households FX Assets* 67,59769,338 Households FX Liabilities* 2,1721,572 FX Position* 65,42567,766 GDP* 616,753734,723 FX Position/GDP (%) +10.6+9.2 Household Liabilities to GDP Ratios (%) Household FX Positions * (USD million) 16 Strong Balance Sheet of Households

17. 17 Bank Loans to Non Financial Companies (% of GDP) September 2010 NFC FX Assets* 83,860 NFC FX Liabilities* 173,128 FX Position* -89,268 FX Position/GDP (%)** -12.7 (USD million). ** Note that the short FX position for short term liabilities are less than 1% of GDP (USD 458 mio). Banking Sector FX position is balanced. Non Financial Companies (NFC) FX Positions Source: Eurostat, CBRT Last observations:Sep.2010 17 …and Non-Financial Sector

18. 18 Source: MoF, Treasury, MTP (2011-2013) Targets, IMF WEO April 2011 … and of Public Sector Public Debt Forecast for 2011 (% of GDP) Budget Deficit Forecast for 2011 (% of GDP) Maastricht Criterium *: Turkey’s budget deficit figure is MTP (2011-2013 projection) for central govenment. IMF WEO April 2011 budget deficit forecast for Turkey is 1.7% and better than what was envisaged in Turkey’s MTP as 2.1% for general government. *: Turkey’s debt figure is MTP (2011-2013) projection. IMF WEO April 2011 public debt forecast for Turkey is 39.4%. 18

19. 19 Export and Import Quantity Indices (3-month MA) Export, Import & Foreign Trade Balance (12-month MA, USD Billion) Source: TURKSTAT Stronger Import Demand Partly Fuelled by Credit Growth... The quantity indices depict the stronger import demand growth compared to export growth. Higher growth in import demand resulted in increasing foreign trade deficit.

20. 20 Source: TURKSTAT, CBRT... Leading to a Deterioration in the Current Account… Current Account Balance/GDP (%) Ratio to GDP 200720082009201 0 2011* CAB -5.3-6.8-2.2-6.6-7.7 CAB Excl. Energy -1.3-0.21.9-2.0-2.6 * As of February 2011, last 12 months. 20

21. 21 …Although “Current Account Imbalances” is a Global Issue. Source. IMF, CBRT Current Account Balance in Some Countries (2010 IMF Forecasts, ratio to GDP, percent) 21

22. 22 III. New Policy Mix as the Response 22

23. 23 The Three Phases of the Monetary Policy since the Collapse of Lehman Brothers Phase-1: Full liquidity support (after the collapse of Lehman Brothers, September 2008) Phase-2: Exit Strategy (April 2010) Phase-3: New Policy Mix (since November 2010) -A lower policy rate, -Wider interest rate corridor and -Higher reserve requirements 23

24. 24 RRR and the Policy Rate being the Main Monetary Tools 24 For Financial Stability: 1.Required Reserve Ratios 2.TRY Liquidity Management 3.Short-Term Interest Rates For Price Stability: 1.Short-Term Interest Rates 2.TRY Liquidity Management 3.Required Reserve Ratios Tools in the order of priority

25. 25 The New Policy Framework of Two Targets and Two Instruments 25

26. Policy Rate and Interest Rate Corridor (%) 26 Lower Policy Rate and Wider Corridor

27. Source: CBRT Reserve Requirements Balances (%) 27 Higher Reserve Requirements

28. Current Reserve Requirement Ratios (%) Source: Central Banks, CBRT 28 Reserve Requirements – An International Comparison

29. 29 Measures Taken by other Turkish Authorities. 1.Fiscal discipline 2.No FX loans to households 3.Domestic currency bond market 4.Loan/value restrictions 5.Tax hikes on certain consumer loans 6.Restrictions on credit card borrowing 29

30. 30 IV. Outcomes of the New Policy 30

31. Source: CBRT Reserve Requirements Balances (billion TRY) 31 1. Tightening Liquidity

32. Overnight Interest Rates (%) Swap Rates (%) Source: CBRT 32 2. Desired Level of Volatility in Money Markets

33. TRY and Other EM Currencies Against USD ( 4 Jan 2010= 1) 33 3. Impact on Currency

34. 34 Yield Curve* (%) Source: CBRT Inflation Expectations (%.) *Calculated from the compunded returns on bonds quoted in ISE by using ENS method. 34 4. Steeper Yield Curve and Inflation Expectations under Control

35. 35 Hüseyin Zafer Executive Director May 2011 CENTRAL BANK OF THE REPUBLIC OF TURKEY 35

36. 36 Reserve Slides Monetary Policy Outlook 36

37. 37  The net impact is on the tightening side.  20-25% annual credit growth is targeted at the end of 2011  Risks both on the downside and on the upside 37 Baseline Scenario – Inflation Report (April 28, 2011)

38. 38 Output Gap Forecast (%) Inflation Forecasts (%) Source: CBRT, April 2011 Inflation Report 38 Inflation and Output Gap Forecasts

39. 39 Scenario 1 In case global economic problems intensify and contribute to stronger capital flows, a policy mix of low policy rate, high RRR and wider interest rate corridor may be implemented for a long period. If this scenario leads to weaker domestic demand, it may require an easing in all instruments. Scenario 2 If the global economy faces a faster-than-expected recovery, global inflation may increase and thus trigger a tightening in the monetary policies of developed economies. Materialization of such a scenario would mean higher global interest rates and demand- driven domestic inflation, and thus necessitate a tightening by using both policy rates and reserve requirements. Scenario 3 The increases in commodity prices, if they persist, exert risks regarding general pricing behavior, given the strong pace of domestic demand. Should such a risk materialize and hamper the attainment of the medium-term inflation targets, there may be stronger tightening than envisaged in the baseline scenario. Higher commodity prices may worsen the current account balance. Therefore, the policy mix may vary depending on the developments regarding external demand, capital flows, and the outlook for credit growth. 39 Risk Scenarios