OPINION: Turkish rate hike comes, but fails to have the desired result…
The magic word here is of course “credibility”.
Here is our columnist Guldem Atabay Sanli’s latest comments on the central bank’s rate hike of 300 basis points delivered finally on Wednesday issued at her column at Ahval News.
After an emergency meeting that lasted less than an hour, Turkey’s much-maligned central bank finally delivered a rate hike to the tune of 300 basis points late on Wednesday.
The bank increased its lending rate for the late liquidity window to 16.5 percent from 13.5 percent.
The central bank’s two other interest rates remained unchanged, therefore meaning that Turkey’s confusing multiple-rates policy remains in place despite an announcement from the governor that he would simplify them. Adding in the April rate hike of 75 basis points, the central bank has now raised its policy rate by 375 basis points this year.
In a statement justifying the decision, the central bank stressed that the “current elevated levels of inflation and inflation expectations continue to pose risks on the pricing behaviour. Accordingly, the committee decided to implement a strong monetary tightening to support price stability.”
In reaction, the lira, which had hit a record low of 4.92 to the dollar during the early hours of Wednesday, strengthened to 4.57 per dollar and at first appeared to be floating around 4.55-4.65. Such a range corresponded to the TL/USD level of just a few days ago, when market participants were calling for the central bank to act with a minimum 150-200 basis points hike to stop the bleeding.
But, in the early hours of Thursday, the lira resumed its decline, dropping some 2 percent to around 4.7 per dollar. While the central bank’s decision appears a sound one from a technical perspective, why has the lira staged no meaningful recovery?
Or, to put things differently, while financial market traders, investors and commentators were all calling for a rate hike in Turkey as the lira slipped badly, why has the central bank appeared paralysed over the past two weeks and acted only when the lira’s slide reached unprecedented levels?
The magic word here is of course “credibility”.
The central bank has long lost its credibility in fighting Turkey’s high inflation rate, which now appears as if it will reach 15 percent by the year-end from today’s level of about 11 percent. Inflation in Turkey is already triple the emerging-market average and more than double the central bank’s inflation target of 5 percent.
A loss of credibility for a central bank that claims to be implementing inflation targeting is of course one of the worst things that can happen – the whole expectations’ management system that a bank devises is based on how well the information is accepted by agents of the economy.
The Turkish lira was already set to lose value because of the screaming economic imbalances in inflation, the current account deficit and budget. The private sector’s heavy dependence on external funding to the tune of 30 percent of GDP also presents grave problems.
The U.S. Federal Reserve’s march into a higher interest-rate environment, the benchmark dollar index’s consequent gains and of course U.S. 10-year Treasury yields, which have broken through a psychological level of 3 percent, are all external factors that are feeding an exodus from emerging market currencies across the globe.
So, combining domestic and external factors, the central bank of Turkey, like any other central bank in the emerging markets universe, should have already been acting pre-emptively to defend the currency.
Yet, the central bank did not. And since the start of the year, the pace of the lira’s depreciation has been remarkable, beating declines for nearly all other emerging markets, expect for the currency of Argentina, where economic troubles are already exceptionally deep.
President Recep Tayyip Erdoğan’s interview with Bloomberg TV in London last week, in which he said he would be taking a more active role in monetary policy once he gains more presidential powers at elections on June 24, revealed the true reasons for the central bank’s inaction, for those who do not follow Turkey that closely or believe that his rhetoric was real.
Erdoğan has been meddling in central bank decision-making too many times in the past six months at least, scaling up his apparent opposition to higher interest rates. His approach, coupled with Turkey’s economic fragilities, which include double-digit inflation, have all now combined to weaken the effects of this current 300 basis-point rate hike.
Just like a boomerang effect, such a hike in rates could have pulled the lira back to trade stronger than 4 per dollar, but it now has only questionable muscle to deal with the lira’s weakness.
The central bank’s dithering and Erdoğan’s blocking tactics also now appear to be such a wasted effort, just as it when the central bank and government dithered in the months after the global financial crisis in 2008.
So, in the end, the central bank’s inaction over the lira’s rapid decline in the course of the past weeks, along with Erdoğan’s harsh words on “interest rates being the mother and father of all evils in the economy” have crippled the effects of Wednesday night’s emergency hike.
Looking forward, the carry trade could help keep the lira at around the level of 4.5-4.7 per dollar. But, investors who are willing to take a risk on Turkey will now start eyeing the scheduled June 7 Monetary Policy Committee meeting for at least another 100-200 basis points rate hike, which of course would only help to stabilise the lira at around the 4.1-4.4 range, if of course such a move happens.
It is clear to everyone now that the main risk for monetary policy is not the central bank’s lack of means or ability to follow inflation targeting, but rather its unwillingness to do so due to Erdoğan’s groundless but solid belief that higher interest rates cause inflation.
Now, with the possibility of Erdoğan gaining another term as president with enhanced powers after June 24, the main risk becomes a political one rather than a technical one. That of course means that investors will demand a higher risk premium to keep their capital in Turkey, which translates into yet another round of rate hikes maybe before, or perhaps after the June 24 election. Fasten your seat belts.