Against the tide
Sometimes it pays to be different. That is certainly the belief of the Turkish central bank, which hopes its unorthodox and controversial monetary policy regime is starting to reap rewards.
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Others remain to be convinced – especially among local bankers, who are feeling the pain. There are signs of progress but until it is rebalanced further the Turkish economy remains particularly vulnerable to external shocks.
The new framework adopted by the central bank (TCMB) at the end of 2010 was intended both to tackle inflation and achieve financial stability by using a range of instruments. Currency market interventions and changes in reserve requirements were added to traditional repo auctions to give policymakers a more comprehensive toolkit.
However, for many observers the numerous policy adjustments implemented over the past 16 months, with multiple rate moves and regular reserve requirement and foreign exchange interventions, have led to confusion over the TCMB’s priorities and doubts about its ability to plan ahead.
“If you look at the number of policy changes that have come from the Turkish central bank over the last couple of years it runs to many pages,” said a banker in London. “One of the great frustrations of the banking community in Turkey is that it needs to monitor what the central bank is doing almost every day.”
In the first six months of 2011 policymakers looked to reduce capital inflows and cut credit growth, which they believed had fuelled the record current account deficit of 2010. In the second half of the year, as the lira fell more than expected, they reversed that policy and encouraged the currency to appreciate to quell inflation.
However, the lira failed to respond and continued to decline through the latter part of 2011, eventually falling 18% over the year even as most emerging market currencies strengthened. The unwelcome corollary of the weaker currency was inflation stuck above 10% – well above the central bank’s 5.5% target – and negative real interest rates.
“By cutting rates and taking the other actions the central bank initially discouraged investment flows, which started to have the desired impact on the deficit, but also weakened the currency,” said Bartosz Pawlowski, head of CEEMEA strategy at BNP Paribas in London. “They trouble was they left the currency vulnerable to external shocks, and when the eurozone troubles got bad over the summer it got hit.”
Banks feel the pain
To counter shorting of the lira, new policy measures were introduced, allowing the TCMB to vary its repo rate at will. The result for banks was uncertainly over the cost of funding, which one day might be at the lower 5.75% level and the next at the overnight rate of 12.5%.
“By controlling liquidity and pushing market rates towards the upper end of its corridor between the repo rate and the overnight rate, the central bank was making it very expensive to short the lira,” said Christian Keller, head of emerging markets research, EMEA at Barclays in London. “But at the same time, living with unpredictable funding costs was not an easy situation for the banks.”
The central bank’s policies on rates and reserve requirements undermined bank earnings, and soured relations between policymakers and commercial lenders. The deterioration in that relationship was epitomised by the resignation in March last year of Ersin Özince, general manager of İşbank and chairman of the Turkish banking association.
In a resignation statement, Özince said that State Minister and Deputy Prime Minister Ali Babacan had told him the government “does not wish to take police-type measures” against banks that do not limit loan growth.
Turkish banking was set to lose nearly US$2.6bn in revenue last year as a result of the Turkish central bank’s policy of raising reserve requirements, Özince said.
However, if Turkey’s bankers hope the central bank will protect their interests at the expense of rebalancing the economy they may be wishing for too much, some analysts say.
“The banking system is sustaining short-term pain for long-term gain,” said Ala Kassay, an economist with French country risk consultancy TAC Financial. “What banks need to understand is that their fortune is tied to the central bank’s success in managing inflation, the lira, and the deficit.”
The economy meanwhile is expected to slow this year after expanding some 8.5% in 2011. The IMF forecasts growth of 2.3%, while the government expects 4%. Slower growth is likely to have a dampening effect on both inflation and the deficit.
Frustratingly for Ankara, Turkey’s deficit has remained obdurately high, narrowing less than expected in January to US$6bn, from US$6.57bn in December and US$6.02bn a year earlier. Turkey spends more than US$50bn a year to import energy supplies, up fivefold over the last decade, and to some extent the deficit is at the mercy of global to oil prices.
The worse than expected deficit in January has had a knock-on effect on the lira and put central bank policy back in the spotlight, as critics highlighted IMF calls for the central bank to abandon its monetary heterodoxy and look to raise interest rates to offset the threat of inflation.
In typical style, however, the central bank once again confounded expectations, at its February policy meeting cutting its overnight lending rate by 100bp to 11.5%, citing easing concern over a weaker lira and economic growth. The March policy meeting left the rate unchanged.
“I was bullish because I thought they were starting to tighten but now they have loosened again and are funding at lower levels,” said Murat Toprak, chief currency strategist for Europe, the Middle East and Africa at HSBC in London. “It is a little hard to understand because there is a danger that if they don’t retain a tight policy for a sustained period of time that the inflation genie will not be tamed.”
Timeline of key events
♦ November 2010: Central bank adopts new policy framework aimed at securing both price and financial stability. It sets out to tackle the short-term capital inflows that were swelling the current account by cutting interest rates and making purchases in the foreign exchange markets.
♦ Amid soaring economic and credit growth, and rising imports fuelled by higher energy prices, the Turkish current account deficit at the end of 2010 reached 6.6% of GDP, its highest level ever.
♦ December 2010 and January 2011: TCMB lowers its overnight borrowing rate, cutting the return on overnight deposits from 6.25% to 1.50%, aiming to reduce carry trade flows. At the same time, it starts a programme of aggressively increasing bank reserve requirements.
♦ July 2011: The central bank cuts reserve requirement ratios on foreign exchange deposits, providing some relief for banks, though the impression remains that commercial lenders had become pawns in a game of state interference.
♦ August 2011: The measures are initially successful in taming the deficit but, with the eurozone crisis in full flow, policymakers decide that the sell-off in the lira has been too sharp. They raise the overnight borrowing rate back to 5% while reducing the weekly repo rate to 5.75%. They also suspend foreign exchange purchases, an act aimed at weakening the lira, and later aggressively sell US dollars.
♦ October 2011: A tight squeeze on bank funding costs culminates with a radical shift in strategy for the benchmark one-week repo rate, enabling the TCMB to turn it on and off at will, while at the same time raising the overnight rate to 12.5%.
♦ November 2011: The launch of a state competition investigation into 12 top banks puts further pressure on commercial lenders.