Turkish Central Bank between the devil and the deep blue sea

Turkish Central Bank between the devil and the deep blue sea

Turkish Central Bank between the devil and the deep blue sea

By Seyma Araz,

As Turkey experienced the coldest days of winter this week, kids in several cities enjoyed the weather building snowmen and carving out snow angels after a heavy snow storm forced a slew of schools to close. Roads were slippery, and the people, who still needed to show up to work, had to watch their steps and be cautious on the road while walking or driving. But, the country's people were patient and knew that the sun would rise eventually and make it all disappear, which is exactly how Turkish economists and businesspeople feel about their currency.

The Turkish lira hit a historic low of 3.94 against the U.S. dollar this week. It has been hard to understand what is going on with the local currency since no economic observation has been made signaling to push the lira that hard.

Borsa Istanbul, the country's major stock market, recorded new gains during the week. The BIST 100 index increased by 4.2 percent with an excessive total trading volume of TL 8.1 billion (approximately $2.15 billion) on Thursday, closing the day at 80,891.04 points. According to new data released on Monday, the Turkish industrial production index rose 2.7 percent in November compared to the same month in 2015.

So what happened to make the lira lose more than 2 percent in a single day? And what is the Central Bank of the Republic of Turkey (CBRT) doing to ease the exchange rate pressure on the economy?

Turkey's Central Bank will meet on Jan. 24 to make a hard decision on interest rates. The upward trend of the U.S. dollar against the Turkish lira forces the bank to take new measures to control the depreciation of the local currency. Some believe that raising interest rates is the only solution to ease the pressure, while some believe that it would be the least logical solution and moreover, it would cause more problems.

The lira has lost over 18 percent of its value against the dollar since Donald Trump won the U.S. presidential election on Nov. 9. However, the global trend of the rising dollar has mostly ended, yet the lira alone continues to depreciate.

Turkey's gross domestic product (GDP) shrank by 1.8 percent in the third quarter of 2016 compared with the same period in 2015, after recording positive growth for 27 quarters. In a narrowing economy, interest rates are expected to be cut normally like Brazil did this week. The Bank of Brazil sped up its interest rate cuts on Wednesday and cut its benchmark interest rate by 75 basis points to spur growth and enable the country to escape its worst recession in a century. Experts predict Turkey's fourth quarter will follow the third one and experience more shrinkage.

The CBRT is now between a rock and hard place. The bank needs to support the lira, but also needs to ensure that the economy does not enter a recession. Moreover, U.S.-based credit rating agency Fitch is expected to revise Turkey's credit outlook on Jan. 27. After two other U.S.-based credit rating agencies, Standard & Poor's and Moody's put Turkey in the junk basket; Fitch's investable outlook for Turkey seems to be in danger.

The CBRT took some steps in this period to protect the local currency.

To contain the depreciation of the Turkish lira against the U.S. dollar, the CBRT raised its benchmark one-week repo rate by 50 basis points from 7.5 percent to 8 percent during the Monetary Policy Committee's meeting in November. In the meantime, the upper band of the interest rate corridor (marginal funding rate) was also increased by 25 basis points to 8.50 percent. The U.S. dollar fell to 3.37 against the Turkish lira after the bank's decision, which saw another historic high of 3.42 earlier in the day. However, after the European Parliament's decision to temporarily suspend Turkey's EU accession talks, the rate again jumped over the 3.44 mark, reaching a new historic high.

The euro also hit a new record high of 3.63. In its December meeting, the CBRT left all interest rate levels unchanged. The lira was around 3.51 at that time and stayed around that level for the following days.

The CBRT took new measures on Tuesday to control the rising trend of the euro and dollar against the lira. The bank announced that foreign exchange reserve requirement ratios were decreased by 50 basis points for all maturity brackets to provide $1.5 billion for financial markets. Thanks to the bank's announcement, the lira started to recover after reaching 3.78 earlier in the day. However, the lira hit 3.8950 against the dollar on Wednesday as the currency slumped to a further record low despite the Central Bank's move to support the currency.

The bank, which funds the market with an 8 percent interest rate in a weekly repo auction, did not go to auction this week due to continuing tensions in foreign exchange. A quick drop in the dollar attracted notice following the decision. The CBRT did not open the weekly repo auction on Thursday, and according to CBRT sources, the fact that this week's repo auction was not opened means a stricter stance in liquidity policy. U.S. dollar-TL parity fell from the 3.93 level to the 3.78 level after the central bank skipped the one-week repo auction. Probably, that was the most effective step the CBRT has taken so far.

"You cannot see in any country where the stock market continues to gain, but the local currency loses," said Hikmet Baydar, a financial analyst at 3.Göz Consultancy. And Baydar called it like many economists do these days. "It is all about politics."

"We observe a politically-motivated exchange rate policy these days," he added, mentioning the constitutional change, which is open to vote in Parliament these days as the government seeks to get approval for a presidential system change. Adding the Syrian crisis, operations in Iraq and terrorist attacks in the country, Turkey's agenda is full of political concerns. "I bet if we were not experiencing these political developments, the lira would be just around 2.50-2.70 against the dollar now," said Baydar. "Once this debate is over, whether the system changes or not, the lira will ease," he added. Baydar believes that if the CBRT raises interest rates it would cost more. The bank should use other measures like not going to repo auction, according to Baydar.

"It is manipulation," said Prof. Kerem Alkin from Istanbul Medipol University. "If the economy was in trouble, then not only foreign exchange rates but also the Credit Default Swap rates, the risk premiums of Turkey's treasury stocks, should rise very rapidly," he added. "It would be the biggest mistake right now to raise interest rates," Alkin suggested. "We just need to be patient, and use other measures," he added.

Speaking to Anadolu Agency, Professor Necat Co?kun from Gazi University said: "Although there is improvement, the country's current account deficit is still an important factor. The open position of the private sector puts serious pressure on foreign exchange rates because short-term debt, up to a year, is worth $87 billion." Co?kun noted Turkey became separated from other emerging economies during this period. "The instruments of the central bank are limited. The smartest solution is to increase interest rates plus fund the economy by increasing public investments," he said. And for some this increase should be at least 300 basis points to be effective.

However, interestingly, Turkish private sector's short-term foreign debt, debt that must be paid in the next 12 months, decreased by $4.1 billion in November to $16.4 billion from the end of December 2015, the central bank announced Friday. With a depreciated local currency, the private sector is still able to decrease debt.

Eyes now turn to the central bank.

Source: Daily Sabah



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