OVERVIEW OF THE ECONOMY AND THE SECTOR IN 2012

The ongoing debt problem in Eurozone and the fiscal cliff and dispute concerning the debt ceiling in the USA have taken their toll on global markets. On the other hand, however, central banks of developed countries that have expanded their balance sheet sizes through additional bond purchases continued to apply supportive monetary policies in 2012. The FED's open-ended quantitative loosening decision, the ECB's commitment to support the European bond market and the BoJ's additional bond purchases has all supported the financial system. However, the fragility in consumer and investor trust has kept consumption and investment expenditures under pressure. Consequently, global economic activity continued to exhibit a weak performance.

Turkey's GDP is estimated to have grown by 2.5% in 2012
Turkey's growth slowed down as the CBT began to apply monetary tightening in the last quarter of 2011 and through the first half of 2012. The loose monetary policy, which has been implemented since the second half of 2012, allowed economic activity to gain momentum from the last quarter of the year. In the light of these figures, Turkey's GP is forecasted to grow by around 4.5% during 2013. Meanwhile, Fitch – an international credit rating agency – raised Turkey's credit rating to investible grade.

Inflation ended the year 2012 at 6.2%, exceeding the CBT's inflation target
As the stability of the TL and a benign trend in food prices supported the inflation outlook, the rate of CPI inflation declined from 10.4% in 2011 to 6.2% in 2012; however, this still exceeded the CBT's inflation target of 5%. Inflation is projected to inch up to around 7% in 2013.

CBT starts to lower funding costs in second half of the year amid weakening domestic demand, and lowers policy interest rate to 5.50% in December 2012
The positive outlook for inflation rates strengthened the CBT's hand. From the middle of 2012, the CBT started to increase the amount of liquidity injected into the market through daily repurchase auctions, thus allowing average funding cost to banks to fall from 10.5% to 5.5%. Accordingly, money market interest rates were low throughout the year. As banks' funding costs declined, loan interest rates of loans have gradually fallen, offering momentum to consumer loan growth in the last quarter of the year. Meanwhile, the CBT aims to prevent an overvaluation of the Turkish Lira which could come on the back of increased fund inflow in the wake of Fitch's credit rating upgrade. In this context, the CBT drew attention to the progress of the real effective exchange rate (REER) and announced that a REER index of 120 would indicate an overvaluation of the TL. The CBT also expressed that it would carry out additional interest rate cuts in the event of a REER index of 120 and adopt a new policy in the event of a REER index of 130.

A new tool as part of the required reserve practice – the CBT's reserve option mechanism
In 2012, the CBT gradually increased the amounts of FX and gold that banks could hold as a proportion of their banks' required TL reserves, and applied reserve option coefficients (ROC) to determine the amounts of foreign currency or gold required to meet each TL of the required reserves. These practices forced banks to lower their currency swap positions, while raising the CBT's gross FX reserves.

Global liquidity remains abundant
As the central banks of developed countries continued to extend increasing amounts of liquidity, capital inflows remained strong; as a result, US$ 16.2 billion worth of foreign investment entered the Turkish bond market in 2012. Turkey faced no difficulty in external financing thanks to the global liquidity conditions and the increase in the country's credit rating. Moreover, in line with the balancing of the Turkish economy, the current account deficit/GDP ratio declined from 10% in 2011 to 6.1% in 2012. However, as domestic demand began to rally in the last quarter of 2012, the current account deficit is projected to widen again, with the current account deficit/GDP ratio set to reach 7% in 2013.

The Turkish banking system maintains its strong structure
The sector's capital adequacy ratio, which had stood at 16.5% at the end of 2011, rose to 17.9% by the end of 2012. Accordingly, the banking sector succeeded in expanding its asset base by 13%, its loan volume by 16% and its deposits by 11% by the end of 2012, when compared to its 2011 levels. As the public sector's borrowing needs were reduced, the banks' securities portfolio declined by 5%.