Turkey raises rates, but leaves some economists asking for more

By bne IntelliNews July 23, 2013

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Having hinted a week before that it would hike interest rates at its next meeting on July 23, it came as little surprise when Turkey's central bank raised the overnight lending rate by 75 basis points (bp). Whether that will prove enough to help the wobbling economy is another question.

Economists had been predicting a rise of between 50bp and 100bp on the overnight rate, so the rise was in the middle of that range. The benchmark one-week repo was left unchanged at 4.5%, although this is of little import right now because the Central Bank of the Republic of Turkey (CBRT) allows market rates to move in a corridor between that lower rate and the higher overnight rate (now 7.25%). Market rates have already moved to the upper ceiling of the corridor over the past month.

The accompanying statement from the central bank made clear that monetary policy would be tightened further "if needed". However, for those that worry about the imbalances in the economy, this wasn't enough.

"Disappointing... and I think an opportunity missed," says Timothy Ash of Standard Bank. "The reality is that the current account [deficit] and external financing requirements are way too large and the one message from the [US Federal Reserve] tapering scare for [emerging markets] over the past month is that the CBRT needed to work harder to force rebalancing and close the external financing equation sooner rather than later."

Turkey's high current account deficit is the economy's chronic Achilles' heel, leaving it reliant on hot-money flows to fund a large part it. In April, the 12-month trailing current account deficit widened to $51.3bn, which is equivalent to about 6.0% of GDP, and it's expected to come in at around $59bn for 2013.

"If you take the $59bn current account deficit forecast from the latest CBRT survey, and then add in the $163bn in short-term debt falling due over the next 12 months, this is the total external financing requirement which needs to be covered," Ash notes. "At $222bn, this is a huge number relative to the size of the economy (about 28% of GDP). Indeed, this external financing requirement is probably equal to that of the rest of Emerging Europe combined, plus some change. "

At times of market turbulence, when money flows out of riskier economies and brings down the exchange rate, such countries like Turkey need high interest rates to attract and keep the capital required to fund a large current account deficit. The lira has lost about 8% of its value against the dollar since May, when anti-government protests - and Prime Minister Recep Tayyip Erdogan's heavy-handed response - together with a deterioration in the economy, began unnerving investors.

Following today's announcement, the lira strengthened to 1.9081 against the dollar from 1.9153, while the 10-year benchmark bond yield fell to 8.49% from 8.69%, according to Reuters. However, Turkey faces a long, hot summer of protests and a year of crucial elections, so few think the hike from the central bank will be enough.

"Turkey's current account deficit leaves it vulnerable to a fresh deterioration in investor sentiment," says Neil Shearing, chief emerging markets economist for Capital Economics. "We think the currency is likely to weaken further over the next six months, meaning further rate hikes are likely. We've pencilled in another 50bp increase in the by the end of the year. But another sharp sell-off in EM assets could still result in a much sharper rise in rates."

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