Turkey monetary policy

Investors could be forgiven for being confused by the signals coming out of Turkey’s central bank on Thursday.

Governor Erdem Başçi (pictured) suggested that rate cuts were likely to continue. Speaking at a press conference in Ankara, he said the markets were pricing in a cut in the key policy rate of about 50 basis points and that any further interest rate cuts would be “measured”. 

What is going on with Turkey’s central bank? Why, more specifically, has it just cut its benchmark interest rate by 75 basis points to 8.75 per cent when the latest figures showed inflation just shy of 10 per cent? And why did it do that in the wake of a previous 50 basis point cut in May?

According to the bank’s version of events, inflation is no longer so much of a concern, because of Turkey’s mixture of increased exports, slower domestic demand and a stabilised currency. 

Turkey’s banks are having a bad time. The sector’s 16-bank MSCI index fell by as much as 15 per cent during the past month, hitting a price-to-book ratio of less than 1 for the first time in five years.

Perhaps that isn’t surprising given that higher interest rates, slower growth and a cheaper lira are likely to persist, while credit expansion won’t sustain its rapid pace of the past decade. In 2013 alone the volume of loans rose by just shy of 30 per cent and the ratio of banks’ loans to deposits currently stands at 107.7 per cent, after breaching the 100 per cent level in 2013 for the first time in at least a decade.

So, how well prepared is the financial system for the end of a world of easy money and abundant capital inflows?

 

One of the less remarked-on pieces of news out of Turkey on Wednesday was a statement from the central bank that it has ditched its “additional monetary tightening” facility, under which its overnight interest rate used to be bumped up a bit from time to time in a not very transparent manner.

In so doing, the CBRT has removed one more out of several unorthodox aspects of its monetary policy that have so bothered investors. But how complete is the bank’s conversion to the straight and narrow? 

It’s been a difficult week for the Turkish lira, which hit multiple record lows against the US dollar. It closed on Friday down 1.39 per cent on the day at 2.3242 to the dollar. Turkey’s central bank mounted a spirited defence of the currency on Thursday but only succeeded burning through around $3bn of its $40bn reserves.

The bank does, however, have other tools. On Tuesday, it said that despite keeping its three main interest rates unchanged it would, through what it refers to as additional monetary tightening, occasionally raise the overnight rate from 7.75 per cent to 9 per cent. But what exactly is additional monetary tightening and how does it work? 

Has there just been a landmark change in how Turkey runs its economy? It depends on how much importance one gives to what the country’s central bank says rather than what it does. It also depends on how much of a free hand it has.

There’s clearly been a noteworthy shift – the bank, widely known for its unorthodox stance (read: its reluctance to raise interest rates) tightened policy this week in a way that had some analysts clamouring that the days of unorthodoxy were over. 

Too much public spending, excessive reliance on domestic demand and loose monetary policy – the International Monetary Fund has made clear its concerns about Turkey in some of its harshest criticism of the country in recent years. 

Although police and protesters are fighting running battles in Taksim Square in Istanbul on Tuesday, in what looks like a new stage in the country’s political crisis, investors seem ready to sit out the day’s events.

The lira has strengthened against the dollar, falling back from over 1.906 to around 1.892. The BIST 100 index, after an 18 per cent drop from its record May high, has also had a decent start to the day, up around 1 per cent. Why? 

Turkey’s central bank specialises in Solomonic decisions. Like the Biblical Jewish king, the bank’s approach to thorny monetary and financial questions is to give a bit to both sides in a dispute. The question, is, however, whether it cuts in equal halves. 

Fresh from receiving a gong that ranks him above his peers, Turkey’s top central banker has received a further vote of quiet confidence for his management of the country’s consumption -hungry economy.

Erdem Basci, recently chosen as Central Banker of the Year by The Banker, the FT’s sister publication, can now also point to a favourable review by Fitch Ratings for one of the complicated mechanisms with which he seeks to slow the economy down.