beyondbrics

Will Turkey’s central bank raise interest rates at its policy meeting on Thursday? Not likely. But analysts reckon that, before long, Ankara will be forced to re-examine its peculiar brand of monetary policy.

The bank has promised to intervene heavily in foreign exchange markets to prop up the ailing lira. That could be enough to see it through the dying days of the year – but not much longer.

The central bank said it would spend up to US$1.7bn on Wednesday and Thursday to support the lira, which fell to within a whisker of TL1.90 to the US dollar this week having lost about a fifth of its value this year.

But the bank remains reluctant to raise interest rates as this would hamper growth. It would also rob it of what it says is the valuable flexibility of its peculiar interest rate structure: it has a “policy” repo rate of 5.75 per cent a year and an overnight rate of 12.5 per cent and effectively fine tunes the market rate by limiting access to the former.

“The central bank calls it flexibility but for banks it is unpredictability. They hate that,” says Christian Keller, head of emerging Europe research at Barclays Capital. “They go into the week not knowing if their funding rate will be 6 per cent or 12 per cent.”

But sticking to its unorthodox ways leaves the bank in a bind. “Turkey has one of the highest exchange-rate pass-throughs [to inflation] of all emerging markets,” says Imran Ahmad, emerging markets foreign exchange strategist at RBS. “Any further depreciation would mean even more inflation.”

With prices already rising by more than 9 per cent a year, that is something Ankara can ill afford – which is why it has turned to foreign exchange intervention. “This is a step change in the bank’s intervention efforts,” Ahmad says. “They are a lot more worried about the currency than they have been.”

The signal from Ankara is that it is ready to use some $20bn to keep the lira above LT1.90 to the dollar. But that would be a serious drain on foreign exchange reserves of about $94bn. With external financing needs in 2012 of close to $200bn, the bank has very little room for manoeuvre.

Keller at BarCap says the bank is gambling that the European Central Bank’s offer of liquidity will encourage European banks to roll over loans to Turkish banks and corporations and supply a big chunck of their financing needs.

But if the ECB’s action is less effective and the eurozone banking crisis worsens, European banks will shrink their exposure further.

“Our view is that we will continue to see pressure and the lira will cross the 1.90 mark,” Keller says.

What matters most to the bank and Turkey’s corporates right now is holding the line in the sand until the end of the year as it is the year-end exchange rate that is used for adjusting balance sheets.

Next year it will face a new set of problems.

Keller says monetary policy is hurting banks and that lending will fall more rapidly than the central bank wants – while it is keen to see a contraction of credit to avoid further deterioration in the current account deficit, it does not want a sudden stop. This means it could reverse some of the increases in reserve requirements brought in this year. “But that leaves them in a tough spot because if they provide more tier 1 capital, they potentially weaken the lira again.”

So, is current policy sustainable?

Ahmad at RBS thinks not. “We see the lira going to LT2.10,” he says. “That could finally force Turkey to give up its unorthodox approach.”

Keller is less sure. “It’s very hard to say if it is sustainable. But the bank is in a situation where it is becoming clear that its multiple goals are not consistent. It will have to decide, do we want a strong lira, or a weaker lira with more growth and higher inflation. My hunch is it will go for the latter.”

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