Government rejoins pressure on the financial system
"Government rejoins pressure on the financial system” by Mindy Crawford
History only repeats, when one doesn’t learn from past mistakes. This maxim fully applies to the Turkish government which just can’t seem to shake off the bad habit of meddling with the Central Bank (CBRT) or the credit mechanism. The hostility of AKP at large, led by President Erdogan, towards CBRT and the banks moderated miraculously in 2017, when the Credit Guarantee Fund scheme lowered loan rates and separated monetary policy from credit flow. However, as loan growth came to a halt in August, while the lira appreciated against the Currency Basket (consisting of 0.5 Euro and 0.5 Dollar), led by Erdogan, attacks on the financial system were renewed. As if this is not enough, all-powerful presidential advisors began arguing in public, adding to the confusion of foreign financial investors (FFI), whose positions in TL denominated assets are crucial for the stability of the lira.
Rising by 12% between January and July, credit growth came to a halt in August, expanding by only 0.8%. Moreover, loan rates in mortgages to autos rose by 150- to 300 basis points over the last three months, as higher inflation and political uncertainty drove savers from TL to F/X deposits. Erdogan and the Cabinet are acutely aware that Turkey’s construction and consumption driven economy can’t replicate the 5% plus growth rates of the first half of the year without ample and cheap credit.
The first salvo to mind their manners to banks came from president’s economic advisor Mr. Bulent Gedikli, who said the economy can’t be sacrificed to expensive credit and overvalued lira. On his way back from Kazakhstan trip, president Erdogan told journalists that loan rates ranging from 15 to 18% were unacceptable and conversations will be held with banks to lower them. “Let them make profit from volume” he added, making a historic contribution to the banking literature. Immediately, Economy Minister Mr. Nihat Zeybekci confirmed that conversations with banks will indeed be held to see if loan rates can be cut.
This is one aspect of the meddling with financial system. In the sub-plot, presidential advisors Cemil Ertem and Gedikli disagreed on exchange rate policy. Gedikli is an ardent advocate of a cheap TL, while Ertem—at this point—defends letting the flexible exchange rate find its own market equilibrium. In the past he has defended opposite positions, but as deceased President Suleiman Demirel once quipped, in Turkish politics “Yesterday is yesterday, and today is today”. Consistency is not a job requirement. When asked to comment on Mr. Ertem’s view, Mr. Gedikli essentially called him a rookie, driven to overexcitement by too much media exposure.
Can loan rates be reduced? Can CBRT cut interest rates to help banks? How about the TL? To reduce loan rates, banks need cheaper TL funding, which is simply not available. The chart below shows the steady dollarization of the financial system.
Residents are tired of CPI inflation refusing to retreat to single digits and ever-changing economic policy, finding solace in the security of hard currency savings. Reducing TL deposit rates would drive them deeper into F/X, escalating the TL funding shortage of the banking industry. CBRT can trim required reserves and fine-tune the ROM, but these free only small amounts of TL to the system, which now manages close TL2,000 billion of loans.
Essentially, short of reducing inflation, it is difficult to trim loan rates. However if the monthly survey of CBRT is to be believed, inflation is here to stay. The chart below is in Turkish, but it graphs 12 and 24 month forward inflation forecast by participants in CBRT survey. They are respectively above 8% and just around 8% compare to CBRT target of 5%–and rising.
Clearly, if CBRT were to ease monetary policy now, inflation expectations could shoot up further, driving the demand for F/X deposits.
The jaw boning on the financial system came at the worst possible time. The Dollar Index had just begun a climb from 91 to 93, with Turkey’s only financial news channel BloombergHT reporting that London traders were exiting the overcrowded TL long positions.
Indeed, as the chart above indicates, along with the rest of EM, hot money flows into TL denominated assets have been buoyant. Flows to the secondary market have reached $10 billion YTD. The quarrel on interest rates and currency, as well as the bounce in the Dollar Index has pushed dollar/TL to a 2-week high by Thursday morning. Is this a turning point for the currency, which has been appreciating against the dollar steadily for 7 months?
It is up to Erdogan and Trump. If Erdogan forces CBRT and Turkish banks to cut rates, while Trump manages to legislate a tax reform bill, YES, the salad days of TL are definitely over.
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