Turkey's embattled prime minister, Tayyip Erdogan, suffered another blow to his tough reputation as the central bank shrugged off pressure from the government and aggressively raised interest rates at an emergency late-night meeting to stem the fall of the plummeting currency.
The government has for the past few years pushed the central bank to run a pro-growth monetary policy by keeping rates low. But as the currency has dropped about 14% over the previous two months to record lows over concerns about a corruption scandal and the US Federal Reserve's decision to start "tapering" its money-printing programme, the Central Bank of Turkey (CBRT) announced in the early hours of the morning of January 29 a series of changes that amounted to a substantial hike in interest rates.
The one-week repo rate, which forms the bottom end of the so-called "corridor" within which interest rates are allowed to fluctuate, was raised by 550 basis points (bp), from 4.50% to 10.00%. The overnight lending rate, which forms the upper end of the corridor, was raised by 425bp, from 7.75% to 12.00%. Depending on how the central bank manages the provision of funding between its various instruments, overnight interest rates are likely to rise from just below 8.00% before the meeting to between 10.00% and 12.00%. "The net result will be a sharp rise in interbank rates... In effect, this is a policy tightening of anywhere between 200bp and 400bp," says Neil Shearing of Capital Economics.
The effect was immediate: the lira jumped almost 3% to 2.1876 per dollar in the early hours. Even so, it's still the second-worst performer among major world currencies in the past two months, after Argentina's peso, which was devalued last week, according to Bloomberg.
This move is sure to frustrate the AKP government. Turkey is embarking on an election cycle, and a beleaguered administration is eager to bolster its position ahead of local elections in March, presidential elections in the summer and general elections next year. Erdogan is reckoned to prefer a weak lira to a sharp slowdown in growth that higher interest rates could bring.
As such, Erdogan made a shocking decision ahead of the CBRT emergency meeting by reiterating his opposition to higher interest rates. "I cannot quite think of any [Organisation for Economic Co-operation and Development] economy where a political leader makes such strident commentary about policy rates - kind of 'forward guidance' Turkish style!" says Tim Ash of Standard Bank.
But the CBRT's hand were tied and it desperately needed to regain some credibility after failing to raise rates at its previous regular meeting the week before. At that meeting on January 21, CBRT Governor Erdem Basci left the three main interest rates unchanged, even after the lira had declined 8% in a month. "The central bank is taking a pretty big step towards regaining some of its lost credibility," Neil Shearing of Capital Economics told Bloomberg. "It's put the emphasis squarely on preserving market stability and tackling inflation, and at the same time it's faced down the government."
Ash agrees: "CBRT credibility was on the line, after failing to adequately address a weakening lira, and by failing to do enough last week. Only today PM Erdogan had called for rates to remain on hold, and to tighten against that backdrop will enable the CBRT to win back its spurs somewhat in the market's eye. Some might argue that all this was stage managed, aimed at helping the CBRT regain credibility in the market."
The outcome of the meeting should be positive for the economy, which may mollify some of the more strident politicians in the AKP. Standard Bank predicts it could result in a little less growth (2.5% real GDP growth more likely this year), a better outlook for inflation (more likely now closer to 7% or less than 8%) and helping narrow the dangerously high current account deficit, which is the economy's Achilles heel.
"I sense AK party politicians will even accept that a little less growth this year, traded off for greater assurance/stability will be no bad thing, and especially in a difficult election year," says Ash.
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