Semih Idiz | Aug 15, 2018 | 0
What to Expect from the June 7 Central Bank Meeting
With the inflation rate announced, confirming our worst fears (above 12% compared to last month’s 10.9%), you would think that The Central Bank of Turkey has no option but to hike the interest rates once again when they meet on Thursday. You’d be equally right and wrong.
The truth is that the Turkish Lira don’t look -at all, like a currency whose printer is about to hike interest rates. Although it is the most logical (read: the only) step to take, the Lira seems to have settled into a relatively narrow trading range since its surge following the May 23 emergency meeting when the interest rates were upped by 300 basis points. Normally, you would now see the market expecting the dollar to fall since Turkey has effectively entered into a period of tighter economic policy -like what happened with the US Dollar against Euro where it rose from 1.26 to 1.15 since the beginning of the year when Fed began raising the interest rates there. The investors see little motivation in pushing the dollar below 4.5 against the Lira, given the unpredictability of the Turkish political situation with only 20 days left until the elections.
Erdogan is still the favorite to snatch the presidency that will grant him significantly more power over the economy. And that justifiably rattles the international financial community who have witnessed a central bank under complete control of Erdogan -a politician who has, with a straight face, told international hedge fund managers that interest rate is the precursor to inflation when a simple gaze at the chart below shows that the inflation in Turkey has been going up despite the more-or-less stable interest rate policy the country has chosen to pursue in the last 10 years. The gradual rise of inflation from 2011 onwards is, in fact, happened in the face of falling interest rates:
Currency markets will likely hold on to their skepticism regarding Erdogan’s ill-advised economic views. Common sense tells us that the president cannot possibly believe in such a topsy-turvy theory. It is not difficult to surmise that he wants the interest rates kept low simply to pump up the ailing housing market -the one sector of the economy from which the staggering 7.4% GDP growth in 2017 stemmed from. With the credit markets tightening, it will get increasingly harder for the citizens to borrow money for mortgages, which will further stagnate an already alarming economy. With the wages surely about to get trampled under the climbing inflation, the situation is so bad that, the government could not even promise a decent wage hike -as they are prone to do just prior to an election, but had to make do with a one-time holiday bonus for the retirees only.
All this makes the decision from the upcoming CB meeting a virtual coin toss. Announcing anti-inflationary measures just before an election would have the government shoot itself in the foot. While all officials probably believe that belt-tightening, austerity actions are a must, it would be surprising to see anything above a further 100 basis tightening this time around. I could even go further and predict a no-move outcome from the upcoming meeting. They have talked the talk after the first hike, but it remains to be seen if they continue to walk to walk. If my life depended on it, I would surmise that they hold off a rate hike despite the worrying economic numbers and the possibility of the Lira sinking once more.
The problem with Turkey is that it needs foreign capital to finance its current account deficit. Turkey needs in access of $200B annually just to fund it. The country’s foreign currency reserve is just shy of $85B, which means without foreign injection, Turkey may theoretically be at the doorstep of a default. And if the government decides that paying their debt at a higher interest rate is unappealing, foreign capital will continue to flee the country -especially now that Turkey’s debt rating is basically junk, and Fitch has recently put 25 Turkish banks on their negative watch list. Add to that the growing number of business conglomerates requiring their debts to be restructured: Ankara’s Gama Holding was the latest to ask for a restructuring deal for their $1B outstanding debt. The private sector’s debt is around 70% of the GDP, which is alarming -not in its sheer size, but rather in the scale of its rate of increase in the last decade. Low interest rates have made the private sector borrow more than they need, and they used these funds in bad investments such as real estate. Now that the bubble has burst, we are face to face with a scenario not unlike the financial crisis the US went through in 2008. To add fuel to the fire, Turkey’s GDP growth estimates have recently been halved to 2.5% for 2018 and as little as 2% for 2019. And remember, these estimates are based on Turkey’s cautious approach to monetary policy.
Erdogan’s Chief Economy Advisor Cemil Ertem has gone on record to say that the central bank has room to raise the interest rates -which should normally soothe the markets. But considering that Mr. Ertem said anything at all, even if it was the right thing to say, points to the fact that Central Bank still needs Erdogan’s approval when making monetary policy decisions -and that is precisely what has been irking the investors. It shows Turkey’s central bank is nowhere near independent, and without Erdogan’s “go” they won’t have the audacity to act in the economic interest of the people they were appointed to serve.
When we take all of these under consideration, the chances for a rate hike on June 7 are about fifty-fifty. Call me cynical, but the reason the Central Bank waited until the last minute to act the last time around was, I think, to allow for less time until the elections when the effects of the rate hike begin to show. They have shown that they can act -as long as it doesn’t affect their standing in the polls. Traditionally it takes up to 12 months for the monetary policy actions to be felt throughout the economy. Thus, most people have not seen an adverse consequence from the 300-basis hike -yet. If Erdogan and his advisors are convinced about the need for a tighter economy, they are unlikely to unleash it in full force before the elections. And for this reason, we must expect to see either a symbolic move of 100 basis, or no move at all, to send their contrived message to the public that they will not heel to the imaginary ‘interest rate lobby’.