New Turkish central bank governor will struggle to retain independence

New Turkish central bank governor will struggle to retain independence
The central bank has missed its inflation targets for the last five years and it uses a confusing system of multiple interest rates.
By Kivanc Dundar in Istanbul April 13, 2016

The Turkish cabinet’s approval on April 11 of the appointment of Murat Cetinkaya as the central bank’s next head ends months of uncertainty about who would take over the helm of the monetary authority when current governor Erdem Basci’s five-year term expires on April 19.

Most analysists see Cetinkaya, deputy governor since 2012, as a compromise candidate between Prime Minister Ahmet Davutoglu and President Recep Tayyip Erdogan and welcomed the news. However, some warn that the new governor may not be able to stand up against political pressure, especially from Erdogan, to cut interest rates to boost economic growth at a time when the central bank needs to fight stubbornly high inflation and the economy faces multiple challenges.

Born in 1976, Cetinkaya graduated from Bogazici University, one of the most prestigious schools in Turkey, where he studied political sciences and international relations. Cetinkaya began his career in the banking industry at the Islamic lender Al Baraka Turk, later joining the state-owned lender Halkbank in 2003.

Cetinkaya worked at Halkbank as the head of the international banking and structured finance department and then as deputy general manager for international banking and investor relations. Cetinkaya was appointed as deputy governor of the central bank in June 2012 when Erdogan was the prime minister.

“Compromise candidate, so good that the presidency and government are working together on this - one less potential hiccup”, said Tim Ash at Nomura in an emailed comment, adding that a battle over the nomination would have been very market negative.

“I guess much less of a monetary policy guru than Basci, but I guess the market never really appreciated that anyway - Basci tended to overcomplicate things when the market wanted a much simpler policy, and the proof of the pudding I guess is in the consistent failure by the CBRT [central bank] to meet the inflation target,” said Ash.

Indeed, the central bank has missed its inflation targets for the last five years and it currently uses a system of multiple interest rates that many economists feel that it should replace with a more orthodox monetary policy.

During his term as the bank’s head Basci failed to satisfy both investors and Erdogan, who has repeatedly called for lower rates. Erdogan even argues that high interest rates cause inflation and he last year equated high rates with “treason”.

Insider relief

Given the rifts between Erdogan and Basci, analysts had feared that the president could have picked up one of his loyalists as the new head of the central bank. Thus, the appointment of Cetinkaya, a central bank insider, comes as a relief: the lira firmed 0.7% against the dollar and Turkish stocks rose more than 1% on April 12.

But some analysts still remain sceptical about Cetinkaya’s competence, how loyalty he will be to Erdogan, and above all the central bank’s independence.

“Despite being ‘an insider’, and despite him being one of the names supposedly from the Davutoglu/[deputy premier Mehmet] Simsek camp, I feel he is closer to Erdogan, especially if you look at his CV”, economist Emre Deliveli told bneIntellinews. “I believe he'd be much keener to please Erdogan than Basci. So I don't really see any conflict between him and Erdogan in the first place,”,said Deliveli.

Ozlem Derici from DenizInvest, a local brokerage firm, agrees. “He [Cetinkaya] is not as experienced as his precedents in the central bank to ward off political pressure. Hence, we should expect him to have the tendency to follow a more pro-growth monetary policy approach”, she said in an emailed commentary.

In a sign of how intense the pressure will be on Cetinkaya to cut rates, Erdogan said on April 11 that banks should lower interest rates on consumer loans. Economy Minister Mustafa Elitas also told Bloomberg in an interview on April 9 that the central bank should “radically” curb borrowing costs to boost investment and make Turkish companies more competitive in world markets. The comments caused the lira to tumble.

“Mr Cetinkaya will struggle to resist increasingly vocal demands for monetary easing – even if there’s no economic justification for doing so,” said William Jackson, an economist at Capital Economics.

“The MPC [monetary policy committee] under the leadership of Mr Basci cut interest rates in response to this pressure at various points over the past few years, with the latest coming as recently as last month. It’s unclear if Mr Cetinkaya would be able to succeed where Mr Basci failed”, stressed Jackson.

Capital squeeze

At the last MPC meeting on March 24, the central bank left its main policy rate (one-week repo) unchanged at 7.50% and it kept the overnight borrowing rate on hold at 7.25%, at a time of persistently high inflation.

As some analysts had expected, the bank reduced the overnight lending rate, the upper end of the rate corridor, by 25bps to 10.5%, for the first time in 13 months, taking the first steps towards policy simplification.

“I still expect 50 basis points cuts this month, and probably the next as well – unless the global environment turns sour”, Deliveli said.

Cetinkaya will chair his first rate-setting policy meeting as the governor of the bank on April 20.

“On the basis of his experience in the central bank in the last couple of years, we do not expect him to lead premature rate cuts in the policy rate should global market conditions reverse and a severe capital squeeze follows”, according to Derici from DenizInvest.

Rabobank also does not expect a sharp move from Cekinkaya. According to the bank, the appointment of someone who has been involved over the past few years in setting monetary policy implies that the central bank is unlikely to cut interest rates markedly.

Cetinkaya takes the helm at a time when the Turkish economy is facing strong headwinds. The main problem for the central bank is the stubbornly high inflation. The annual increase in consumer prices eased to 7.5% in March from 8.8% in February, but remained well above the 5% official target for 2016. A recent central bank survey showed that economists expect inflation to be 8.3% at the end of the year. More worryingly, core inflation is higher, hovering at nearly 10%.

Turkey’s $720bn economy grew by 4% last year, driven by domestic demand, but economists expect slower expansion this year. In the fourth quarter of 2015, GDP growth accelerated to 5.7% y/y from 3.9% y/y in the previous quarter.

Domestic demand has become the engine of economic growth and this explains Erdogan’s call for lower rates on consumer credits. Household consumption, which accounted for nearly 67% of GDP, increased by 4.7% y/y in Q4, up from 3.6% y/y in Q3. In the whole of 2015, consumer spending rose by 4.5% versus 1.4% in 2014.

The World Bank expects Turkey’s GDP expansion to slow to 3.5% in 2016 and in 2017, versus the government’s forecasts of 4.5% this year and 5% for 2017.

“Basci might have not have inspired the market in terms of his monetary policy slant, but he did protect the institutional strength of the central bank in terms of hiring/firing. Let's hope that is the case with Cetinkaya, and that key talent is retained”, said Ash. “And let's see over monetary policy - my call for 2016 is that deflation is the name of the game with growth slowing, inflation moderating, the CAD [current account deficit] continuing to ease, and the strong TRY [lira] actually leaving scope for the CBRT to cut rates - this provides Cetinkaya with something of a honeymoon.”