Inflation and Risk Premium

As you know, in the economic sector, organizations such as Moody’s and S&P measure the risk premiums of various companies, institutions or countries and present them to investors by grading how safe they are for investment. I recently started coding a program that measures the risk premiums of countries with artificial intelligence. During this process, I wanted to share with you an experience I encountered, especially regarding inflation.

Does a country’s inflation affect the risk premium? Of course it does, it wouldn’t make sense to think otherwise. So, does a country’s inflation affect its risk premium more, or does it lie about its inflation figures? This is what I will talk about today.

Turkey is a country that has been experiencing small and large inflation for years. The most important reason for this is that Turkey is a developing country. There is inflation in one way or another in every developing country. However, especially after the presidential election in 2018, Turkey saw inflation at levels it had never seen before, due to a single person having absolute power in the administration of the country and the wrong decisions he made. After 2019, the country’s president ordered Turkey’s statistical institution, TURKSTAT, to announce not the real inflation figures, but the figures that were much lower than the actual inflation figures. When 2020 ended, people began to feel inflation deeply due to reasons such as the depreciation of the Turkish Lira, the departure of foreign investments from the country due to political reasons, the decrease in exports and the incredible increase in imports. During this process, professors from various universities came together and established a board called ENAG. The purpose of this board was to explain inflation in a completely transparent way by creating a basket according to the consumption habits of the consumer. By the end of 2021, the difference began to emerge. According to TURKSTAT, annual inflation was 19.08%, and according to ENAG, it was 36.08%. In 2022, the inflation gap was widening more than ever, so the president and staff of TURKSTAT informed the country president that they could not lower the inflation any further. Following this, Muhammet Cahit Şirin, who was appointed as TURKSTAT President in February 2021, was dismissed. Just 7 months later, Sait Erdal Dinçer was appointed to replace Şirin. Dinçer did not help either. Dinçer was able to stay in this position for a few months. Dinçer, who officially took office in March 2021, was dismissed in January 2022. This time, Erhan Çetinkaya was appointed to replace Dinçer. Dismissals at TURKSTAT were not limited to presidents. Cem Baş, the Head of the Price Statistics Department, who collected prices from the market and calculated inflation, was also dismissed in the same month, and was replaced by the Head of the Digital Transformation Department, Dr. Furkan Metin was brought in. No manager wanted to be a part of this lie because it was also ruining their careers.

By the end of 2022, the difference had widened tremendously. According to TURKSTAT, inflation is 64.27%; According to ENAG, it was 137.55%. No one believed the inflation figures announced by TURKSTAT anymore; everyone, from official institutions to homeowners renting their homes, was indexing wages according to ENAG inflation. But the problem was that the state was giving pensions or civil servant salaries according to the inflation rates announced by TURKSTAT. Therefore, the gap between salaries and wages widened, and the people became extraordinarily poor. In the summer months of 2023, after the country’s president won the election again and was guaranteed the next 5 years, he appointed the former finance minister from England, Mehmet Simsek, as the minister of economy again, in order to give the impression that he would put the country’s economy on a more rational basis. Mehmet Simsek made serious offers to take this position because he did not want to waste his career. The first of these proposals was that TURKSTAT should disclose inflation accurately and transparently. TURKSTAT would be transparent and accurate, so that trust in the country would increase and investment would come. The conditions were accepted and, starting from August, TUIK began to gradually bring inflation figures closer to ENAG. From here we understood that ENAG was actually making very accurate inflation determinations. However, in the last few months, TURKSTAT’s inflation correction did not have much effect on annual inflation, and again, the difference was deplorable. According to TURKSTAT, inflation in 2023 is 64%; According to ENAG, it was 127%. In order for annual inflation to improve, TURKSTAT had to provide accurate monthly inflation figures for at least 12 months, and this was a very long period. For this reason, in January 2024, TURKSTAT officials made the statement: “The inflation we offer is 64%, but what is felt is 129%.” They also attributed the reason for the difference between the official data shared with the public and the ‘felt inflation’ to consumption habits and spending patterns. But every economist knows that there is no distinction between “presented inflation” and “felt inflation” in the economic literature. Inflation is something that consumers already feel. TURKSTAT needed such a statement just to save itself.

There are a few important issues that those who manage TURKSTAT, which presents not only price and inflation data but also many other data related to price data, are biased and different from the real ones, should be aware of. TURKSTAT’s price data lost its harmony with the income level of the people, and therefore the people became poor. Economic growth rates converted into real terms by price data do not reflect reality. This disrupts revenue sharing. Although the perceived inflation rate has no place in the literature, it essentially reflects the change in the general price index in today’s Turkey. The announcement of this rate by TÜİK is literally an admission and it will have legal consequences. These data problems experienced today are a carbon copy of what was experienced in Argentina between 2006 and 2013. The unrealistic inflation data presented there also caused the people to become poor, and the economic problems in the country have continued to increase until today.

In summary; It is not a rational method for state institutions to correct their mistakes by gossiping. The damage that high inflation will cause to risk rating is much lower than incorrect disclosure of inflation and other figures. I don’t know how much credit rating agencies care about this economic falsehood, but I take these frauds into consideration in my own scoring tool that I prepared.

Lying is bad.