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ANALYSIS: Gates of lower rates now open; buckle up for a bumpier ride

25 July 2019

The central bank of Turkey with its freshly appointed governor has beaten the market expectations of a rate cut in July which were already revised up following the sacking of the former governor by President Erdogan.  Now the results show how Turkey’s new central bank governor Uysal serves the purpose.

From 24%, the central bank of Turkey cut its policy rate by a strong 425 basis points to 19.75% versus the expectations of 300 basis points on average.  The wording of the press release was profoundly altered with more emphasis on growth rather than inflation which currently stands at 15.7%.

The hefty rate cut is based on two pillars:

  • The slowing global economic activity and the expected continuation of easy global monetary policy,
  • Along with still shrinking domestic demand in Turkey.

No need to say based on such reasoning the central bank was already expected to deliver a rate cut in June as it had signaled one back at its March meeting.  The outgoing governor was to deliver a much muted rate cut to a tune of 150-200 basis points and continue in a more cautious manner; while the new governor began with a bold rate cut step endangering credibility that is also likely to continue; though at a narrower scale at its upcoming meetings.     

Here are the highlights from the press release:

  1. The central bank points at the moderate recovery in the economic activity; led by the upward trend in goods and services exports despite the weakening in the global economic outlook. The bank believes that such a trend is the by-product of improved competitiveness. The central bank appears happy with a strong tourism season which supports economic activity through direct and indirect channels. Looking forward, the central bank believes net exports are expected to contribute to the economic growth while the gradual recovery is likely to continue with the help of the disinflation trend and the partial improvement in financial conditions.
  2. On a rather interesting note, the bank believes the composition of growth is having a positive impact on the external balance as it stresses that the current account balance is expected to maintain its “improving” trend.

It should be noted however that the shrinkage in the current account deficit is far from an “improvement” and it is not balanced given the contracting domestic demand.

  1. Turkey’s central bank seems to be betting on weaker global economic activity and as it stresses the rising possibility of advanced economy central banks taking expansionary monetary policy steps. Thus, the bank believes downside risks to inflation have strengthened. The bank also expects increased demand for emerging market assets.
  2. On inflation outlook, the bank is perfectly dovish as it singles out a deceleration in unprocessed food and energy prices for the fall on the inflation front during 2Q19. The strong contraction in domestic demand and the tight monetary policy also continue to support disinflation according to the central bank. It thus takes position based on expectations that inflation is to materialize slightly below the projections of the April Inflation Report by the end of the year.
  3. Making no further promises for a tight monetary policy, the central bank switches focus to the “extent of monetary tightness” in keeping the disinflation process in track with the targeted path and promises a “cautious monetary stance”.

What to understand; what to expect…

  1. More rate cuts are coming: By the end of the year, the central bank will have three more monetary policy council meetings scheduled for September, October and December.  From today’s 425 basis points, the bank is surely to deliver more rate cuts adding the total figure to 800-900 basis points; as long as the global conditions stay supportive.
  2. Higher risk premium not permitting low real rates: Rising early election risks in Turkey along with the expected split from the AKP ranks urges the government to safeguard economic growth. Yet, looming further economic sanctions from the US government along with the CAATSA and developments on the Syria front mean that Turkey’s risk premium is not likely to reduce to levels desired by the government.
  3. Lira will weaken and turn more volatile: Moreover, limitations on the disinflation story will become tangible by the end of 4Q19, and Turkish citizens will still be piling up hard currency reserves at a speedier manner with real rates coming down fast. Thus, with the high real rate shelter down, lira will be more prone to economic and political tensions and uncertainties; it will weaken gradually and turn more volatile.
  4. Growth impact will be limited: As the interest rate spikes are the results of increasing inflation; lowering the risk premium will only make the mistakes more visible. Turkey’s real sector debt problem stands out as USD 175 billion payments due for the next 12 months, bad debt in Turkey’s banks roughly add to USD 50 billion, Turkish citizens are struggling hard with debt payments and the central government whole year budget deficit target already achieved as of 1H19; rate cuts delivered beyond a point is not likely to have a huge impact on growth.  Such huge debt payments and the limitations on public spending in fact, it could just backfire if the current central bank leadership “guided” by President Erdogan, does not slowdown in delivering strong rate cuts.

Long story short, investors should buckle up for a bumpier ride in the coming quarters.


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