Torrid times

IFR Emerging Europe and Turkey Special Report 2014
6 min read

After a year of hard knocks, Turkey’s central bank has been fighting back with aggressive decision-making and a willingness to stand up to the administration.

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Grin and bear it. It’s been that sort of year for the Central Bank of the Republic of Turkey, which has suffered the sort of torrid time usually reserved for panic-stricken African or Latin American markets. The US Federal Reserve’s decision to begin tapering its QE programme put the lira into a tailspin against the dollar. Branded one of the “fragile five” emerging nations due to its yawning current and fiscal deficits – both of which remain a concern – investors fled, crimping growth and driving up inflation.

Yet the central bank has fought back hard this year, impressing investors with aggressive decision-making and a willingness to stand up to Recep Tayyip Erdogan’s administration. Turkey’s prime minister reacted with barely concealed fury after the central bank, refusing to bow to political pressure, raised interest rates by a hefty 500bp on January 28, after the lira hit a record low of TL2.39 against the US dollar. A fortnight earlier, it increased the marginal funding rate to 12%, from 7.75%.

And there, barring a slight trimming of the liquidity lending rate on April 24, to 13.5% from 15%, borrowing and lending rates remained through the first four months of the year. It’s a situation that is far from ideal for anyone apart from yield-hungry global investors – barring Brazil, Turkey’s central bank oversees the tightest monetary policy rate of any major emerging market.

But after a hard year, there appears to be light at the end of the tunnel for the beleaguered institution.

“Global and domestic financial conditions have improved significantly, so the need for much tighter policy is disappearing. Improvements in risk indicators put us in a better position in regard to key interest rates going forward,” said Turalay Kenc, Deputy Central Bank Governor, in an interview with IFR.

Laying the groundwork

The former Imperial College London academic is not ready to pledge the return of looser monetary conditions just yet. Inflation, for decades the bane of Turkish political and economic leaders, remains a key concern; according to the state-run Turkish Statistical Institute, consumer prices rose by 8.39% year on year in March 2014, the fastest rate of increase in 20 months.

Yet the CBRT tips consumer and producer prices to peak in May before declining; Kenc said that while inflation “will worsen for a month or two, prices will come down in the second half of the year, and when they do, the economic picture will look much better”.

Only then will the central bank, which fears a negative reaction from investors in the event of a “premature cut in interest rates”, said William Jackson, emerging market economist at London-based Capital Economics, consider a looser policy framework. But the groundwork is clearly being prepared.

CBRT governor Erdem Basci has hinted at the possibility of cutting rates; in the medium term, the monetary policy committee he oversees is likely to pursue more modest measures, such as cuts in required reserve ratios. Deputy governor Kenc flagged up this likelihood, noting that front-loaded monetary tightening adopted in January “will ease off as the inflation outlook improves. This puts us in a better position in regard to key interest rates”.

The central bank’s second inflation report of the year, published on April 30, provided investors with a more refined outlook on Turkish consumer and producer prices.

Some critics believe the only difference, other than vastly higher interest rates, between the Turkeys of 2014 and 2013 is that investors have a better mental grasp of the speed and scale of the Fed’s tapering process. Officials in Ankara still face many of the challenges that last year so enfeebled the economy: a yawning current account deficit, running at about 7% of output; inflationary pressures; and GDP likely, said governor Basci, to come in below 4% in 2014.

That figure, below last year’s 4% but above the 2.1% growth posted in 2012, is not too bad. Turkey is benefiting from rising export figures and the slow-burn economic revival of the eurozone, though the spectre of deflation remains a concern in its chief trading partner, as does the threat of further Western sanctions against another key economic ally, Russia.

Yet such concerns are beyond Ankara’s control. All the central bank can realistically do is to focus on getting its own house in order. Aggressive monetary tightening in January, and a willingness to resist political pressure to cut rates in pursuit of higher growth, has helped. Investors, respecting the CBRT’s tough line on inflation and deficits, have piled back into Turkish stocks and bonds.

The next step is to prove to investors that the positive events of the past few months were no flash in the pan.

“Growth is returning and eurozone problems are dissipating,” said Kenc. “Right now our objective its to achieve price stability and to lower inflation to reasonable levels, allowing us to have an inflation rate of around 5% next year. Central bank credibility is vital for us to achieve – it’s something that we’ll definitely need more of in the future.”