Turkey tightens: implications of its aggressive rate rise

January 29, 2014 9:54 am

Turkey tightens: implications of its aggressive rate rise

By Daniel Dombey in Istanbul

In a moment of drama at midnight on Tuesday, Turkey’s central bank performed a volte face, increasing interest rates across the board where it had previously been reluctant to raise them. It more than doubled one key rate.

It was a striking move, given the political and financial backdrop: prime minister Recep Tayyip Erdogan has long made clear his opposition to high interest rates, while investors had become worried about Turkey and other emerging markets.

In the short term, the bank is seeking to bolster a hitherto painfully fragile currency. In the medium term, the move may help shift Turkey away from domestic demand-led growth, a high current account deficit and a low savings rate to a different kind of economic model.

Here are four things worth considering about Turkey’s rate rise.

1) It has shored up investors confidenceat home and abroad.

The bank signalled a rate rise on Monday, when it announced it was holding an emergency meeting. The lira immediately recovered from all-time lows. But the rate decision handily exceeded market expectations, with a rise in the overnight rate from 7.75 to 12 per cent.

The currency immediately rallied further and in the succeeding hours equity markets as far away as Australia and India basked in the glow of greater confidence in emerging markets. Neil Shearing at Capital Economics in London points out that sentiment towards such markets was already improving, as investors differentiated between countries’ varying levels of problems, but Turkey’s move certainly didn’t hurt. If a country whose currency had previously been close to free fall could get its act together, others could also breathe easier.

It also helped the credibility of the Turkish central bank, whose independence had increasingly been doubted. Whether Mr Erdogan continued to oppose a rate rise after all else had been tried or whether he gave his grudging acceptance may remain a matter of debate. The bank has nonetheless shown it can in fact increase interest rates, which is generally considered a useful capability for a central bank to have.

2) The impact on the real economy may not be pretty. Whether the Turkish economy is more sensitive to a weak currency (corporates hold more than $160bn in foreign currency debt) or high interest rates is a contentious question. But now the Turkish economy is saddled with both, in spite of the lira’s rally from T2.39 to the dollar on Monday to T2.22 (it rose to T2.19 earlier on Wednesday).

With higher interest rates hitting both their balance sheets and income statements, banks will be warier about lending. That spells potential problems for the big infrastructure and construction projects that have been a pillar of the economy in recent years

Official forecasts of 2014 growth of 4 per cent already sounded ambitious. Now, Ozgur Altug at BGC Partners suggests, Turkey could experience a couple of quarters at 0 to 1 per cent growth. For a country that needs to grow at its long term trend of 5 per cent to absorb new entrants to the labour force, that could feel awfully like a recession.

3) The tightening of policy may not be quite what meets the eye. The most striking increase was in the weekly repo rate, which more than doubled from 4.5 to 10 per cent. But, in a sign of how complex Turkish monetary policy had previously become, the central bank had not previously been lending at this rate. Instead, it was left at well below an inflation rate of 7.4 per cent, allowing Mr Erdogan to claim that interest rates were at an all-time low.

The central bank says that it will now provide most of its lending through the one week rate rather than the overnight rate. To put this in perspective, analysts say that before Tuesday’s rise, the average cost of weekly funds was a bit more than 7 per cent. Now, it will be around 10 per cent. That’s considerably less than the headline increase.

Nevertheless, the new rate regime is much simpler than before. Whether through its own technocratic inclinations or out or fear of Mr Erdogan, the bank controlled lending costs by rationing the money it lent at different rates. Now it is returning to more orthodox ways – increasing interest rates by, well, increasing interest rates.

4) Politics still matters in monetary policy. This is an extroardinarily sensitive time in Turkey. Mr Erdogan is in a bitter fight with the followers of Fethullah Gulen, a preacher and former ally, over a corruption probe into figures close to and within his government. There are local elections in March and the country’s first presidential elections take place this summer.

With voters in mind, how will the government respond to the bank’s move? This is not just a question of whether Mr Erdogan steps up or softens his attacks on the so-called interest rate lobby he says sucks growth and profits out of Turkey. It is also whether the government will make its own moves to rein in the current account deficit, increase savings and encourage a shift to exports.


Turkey More Than Doubles Main Interest Rate to Halt Lira Slump

Turkey’s central bank more than doubled its main interest rate at an emergency meeting, reversing years of policy after the lira slid to a record low.

The bank in Ankara raised the benchmark repo rate to 10 percent from 4.5 percent, according to a statement posted on its website at midnight. It also raised the overnight lending rate to 12 percent from 7.75 percent, and the overnight borrowing rate to 8 percent from 3.5 percent.

The lira extended gains after the announcement, adding more than 3 percent at 12:12 a.m. in Istanbul.

The bank’s governor, Erdem Basci, is fighting to arrest a currency run that has gained speed as domestic political tensions overlap with global market shifts. A corruption scandal that broke last month has ensnared several cabinet members. It coincided with a flow of money out of emerging economies, weakening currencies from Brazil to South Africa, as the U.S. reduces monetary stimulus.

A rate increase of at least 250 basis points may be needed to stop the lira’s slide, Royal Bank of Scotland Plc said in a report yesterday before the emergency meeting. “Turkey has exhausted all its other options,” it said.

Basci’s efforts to cushion the external and internal blows have been constrained by political opposition to raising borrowing costs as growth slows. While most investors advocate higher rates to bolster the lira, Prime Minister Recep Tayyip Erdogan has repeatedly railed against an “interest-rate lobby,” blaming it for a series of blows to his government, including last year’s wave of protests and the graft probe implicating his ministers.

Lira Crisis

It was a lira crisis that laid the foundations for Erdogan’s 11-year rule. The collapse of an International Monetary Fund program in 2001 led to a devaluation of more than 50 percent. In elections a year later, the parties that presided over the crisis were swept away, clearing a route for Erdogan’s Islamist-rooted movement to win a majority.

Erdogan says growth of 5 percent a year under his government has left Turkey’s economy less vulnerable to such shocks. The premier reiterated yesterday that he’s always been opposed to rate increases. Speaking in Ankara before leaving for Iran, he said he hoped the bank would make the right decision and usher in a “new era” for the Turkish currency.

Basci has accommodated the political pressures by developing a framework that allows him to tighten policy without raising headline rates, and vary monetary conditions day-to-day within an interest-rate corridor.

Currency Slide

At the last regular policy meeting on Jan. 21, he left the three main interest rates unchanged, even after the lira had declined 8 percent in a month. He opted instead to introduce a fourth rate of 9 percent, to be used only days when the bank decides extra tightening is needed.

As the currency’s slide picked up pace last week, Basci intervened directly in markets for the first time in more than two years, selling about $3 billion. That only accelerated the slump, leading the bank to reassemble last night.

The announcement on Jan. 27 of the emergency meeting helped the lira pare losses in the past two days, though stocks and bonds continued to drop.

The benchmark equity index reached an 18-month low yesterday, and has dropped 24 percent in dollar terms since news of the corruption inquiry broke on Dec. 17, the most among global benchmarks. Yields on two-year lira bonds closed above 11 percent yesterday for the first time since January 2012.

Turkey isn’t the only emerging nation to raise borrowing costs this month in response to plunging markets. India unexpectedly increased rates yesterday, and Brazil has pushed its benchmark higher for six straight meetings.

“Central banks in emerging markets are moving to stop the sell-off,” RBS said. “We think they will struggle to do so.”

To contact the reporter on this story: Onur Ant in Ankara at oant@bloomberg.net


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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