Turkish central bank’s policy rate cut ‘pointless’ – ex-deputy governor

The central bank’s rate cut may risk further inflation, combined with measures the government is likely to adopt to increase its popularity ahead of the 2023 elections, Fatih Özatay, former deputy governor of the Turkish central bank, wrote in an article published on the Yetkin Report.

A full reproduction of the article follows.

The Turkish central bank’s Monetary Policy Committee (PPK) convened on August 18 and lowered the policy rate by 100 basis points, to 13 percent from 14 percent. This interest rate cut was a big surprise even for those of us who are sceptical of various ongoing incredible things in our beautiful country. If there are still foreigners interested in the Turkish economy, I believe it has been a shock for them.

PPK issued a statement after the meeting that read as follows:

“Leading indicators for the third quarter point to some loss of momentum in economic activity. It is important that financial conditions remain supportive to preserve the growth momentum in industrial production and the positive trend in employment in a period of increasing uncertainties regarding global growth as well as escalating geopolitical risk. Accordingly, the Committee has decided to reduce the policy rate by 100 basis points, and has assessed that the updated level of policy rate is adequate under the current outlook.”

The central bank tells us that this 100 basis point reduction will reflect on loan rates and contribute positively to economic activity. This justification for the rate cut is much more remarkable than the rate decision itself. To argue that “the industrial production growth and the increasing trend in employment” will continue because the policy rate is cut to 13 percent from 14 percent in a country where consumer inflation announced by the Turkish Statistical Institute is 80 percent and producer inflation is 145 percent… Here I think the three dots would speak instead of my words since I do not know what else to say.

I can summarise the situation as such: Do they think that the current policy rate, which is 66 percentage points below the consumer inflation and 131 percentage points below the producer inflation, did not serve the purpose, instead changing it to 67 percentage points below the consumer inflation and 132 percentage points below the producer inflation will perform? In terms of industrial production and employment, what is the difference between 132 and 131 for God’s sake?

Will there be complaints at meetings with business people a few days later? For example, will they say, “You have lowered the policy rate by one percentage point and brought it 132 percentage points below the 145 percent price increase rate of the goods we produce; thank you, but the loan interest rates, which were approximately 105 percentage points below 145 percent (on average), did not decrease 106 percentage points below 145 percent”?

Let us say they complain as such. Will the addressee of the question answer, “Do not borrow at that high interest”?

Nothing is impossible.

After this decision was announced, the Turkish Lira further depreciated and the risk premium (CDS) jumped. In other words, the foreign borrowing costs of our banks, non-financial companies, and the Treasury increased. In the country with a foreign debt repayment of $183 billion in the next one-year period. In the country where the current account deficit increased to $32 billion in the first six months.

Turkey started demonstrating this skill in September 2021. The central bank reduced the policy rate by five percentage points one after another, and brought it to 14 percent after the PPK meeting in December. It is impossible to forget what happened during that period. There was a big jump in the exchange rate and risk premium. Official inflation then jumped from 20 percent to 80 percent in July 2022. We have not forgotten, but it seems that those who made the interest rate decision did not learn from what had happened.

It is endlessly rumoured that Turkey will have large amounts of foreign currency inflows. It is unclear what will happen, but it is said that the first signs are beginning to be seen. The central bank’s foreign exchange reserves increase in recent weeks is associated with such a “resource” inflow.

What does this have to do with the interest rate cut? The first thing that comes to mind is that the increase in the exchange rate created by the surprise interest rate cut will be prevented by selling these currencies. Well, it does not eliminate the pointlessness of interest rate cuts. We are talking about an interest rate cut that will not benefit economic activity but will adversely affect growth and employment because it increases our risk. In one way or another – which way is essential, but let us leave that aside – it is unwise that the obtained money be spent because of this pointless act.

Pre-election ammunition

However, there may be a more ‘sublime’ purpose that such a ‘source’ can serve. The elections are only 10 months away. Very soon, we will witness a substantial increase in credit growth, and the rise of the minimum wage, salaries of civil servants, and pensions at a rate above the past inflation. In the same process, we will see attempts to keep the prices of some important goods and services from going up; prices that the state determines or plays a vital role in pricing due to the tax policy. There will also be noteworthy increases in public expenditures.

Such a policy will put upward pressure on the exchange rate under the current conditions of our economy. It can be argued that the foreign currency coming from abroad (if it comes, of course) is planned to be used to reduce this pressure on the exchange rate and prevent inflation from increasing even further.

Will this interest rate cut work in terms of the election? Since I am not a political analyst, I will not go further on that subject asking if “it works” or “helps to win the election”. I am interested in the following questions: Will this policy prevent the slowdown/contraction signals of the economy and keep the economy alive? In this process, can a new inflation wave that will reduce the purchasing power of the low-income be prevented?

Let me start with the second question. It is said that the foreign currency sold to intervene in the foreign exchange market has exceeded $60 billion since last September. Was it helpful in preventing inflation from rising? Since it did not stop, the answer to the question is obvious. Moreover, we are in an environment where all pricing behaviour was extorted, and it has become challenging to do planning due to the sudden jump in inflation. Under these circumstances, it can easily be said that the kind of policy I mentioned will boost consumer inflation above 100 percent in a short time and before the election.

“Does it keep the economy alive?”

This can be easily stated: Let us assume that such a policy demonstrated a ‘success’ in preventing the GDP growth rate from falling below a certain level. It is very challenging for the majority of the public to get a share of this ‘vividness’. Especially when the consumer inflation, which may reach three digits, will dissolve the high-rate increases in salaries and wages in a few months. Moreover, if such a policy is implemented, it is clear that our risk premium, which is already very high, will increase further. Obviously this increase will not be growth-friendly.

How long can the economy be kept alive under these conditions?

The main issue that such a policy will face is this: Since it will not have an immediate stimulating effect on the economy, it must be implemented ‘sufficiently’ before the election date. The earlier the better. But in terms of inflation and the melting of purchasing power, the opposite is true: ‘The sooner, the more inflation increases, the more purchasing power melts’.

Let us see what the future brings.

(The original article can be found here. Fatih Özatay served as the deputy governor of Turkey’s central bank until 2006, and has taught in various prominent universities.)

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