Turkish monetary policy: Madness or Isparta

I am discussing Turkish monetary policy with Central Bank of Turkey Gov. Erdem Başçı at Süleyman Demirel University. I lose my temper and shout, “This is madness!” The Gov. answers back, “Madness? This is Isparta!” and pushes me into the dark abyss below with a straight kick to my beer-tummy. I wake up, sweating all over.

 I have been having this nightmare every night since Gov. Başçı revealed the action plan to strengthen the lira along with the Inflation Report on Wednesday. At first look, there weren’t many surprises: The Bank revised its year-end inflation forecast to 8.3 from 6.9 percent, due to the recent tax hikes and lira depreciation, while keeping next year’s projection at 5.2 percent.

 The action plan itself was mostly in line with expectations as well. The share of required reserves that can be kept in foreign currency was increased to 40 from 20 percent. The Bank also said it could cut lira reserve requirement ratios, or RRRs, after the EU Leaders summit, and it duly cut RRRs for maturities less than one year after European leaders reached a deal with Greek debtholders and agreed to increase the firepower of their bailout fund on Thursday.

 The big surprise was the Bank’s disclosure that it had two interest rates: The one-week repo rate (the policy rate), which is at 5.75 percent, and the overnight lending rate, which was recently increased to 12.5 percent. Başçı noted that they had the discretion to utilize the lending rate or the policy rate.

 This means the Bank can change the interest rate on a daily basis, by tightening or loosening the liquidity it provides to banks through the weekly repo auctions. The Bank had actually signaled its intentions at the rates meeting two weeks ago, and both overnight rates and benchmark bond yields had already risen considerably before Wednesday’s announcement

Erdem Başçı at Süleyman Demirel University. I lose my temper and shout, “This is madness!” The Gov. answers back, “Madness? This is Isparta!” and pushes me into the dark abyss below with a straight kick to my beer-tummy. I wake up, sweating all over.

 I have been having this nightmare every night since Gov. Başçı revealed the action plan to strengthen the lira along with the Inflation Report on Wednesday. At first look, there weren’t many surprises: The Bank revised its year-end inflation forecast to 8.3 from 6.9 percent, due to the recent tax hikes and lira depreciation, while keeping next year’s projection at 5.2 percent.

 The action plan itself was mostly in line with expectations as well. The share of required reserves that can be kept in foreign currency was increased to 40 from 20 percent. The Bank also said it could cut lira reserve requirement ratios, or RRRs, after the EU Leaders summit, and it duly cut RRRs for maturities less than one year after European leaders reached a deal with Greek debtholders and agreed to increase the firepower of their bailout fund on Thursday.

 The big surprise was the Bank’s disclosure that it had two interest rates: The one-week repo rate (the policy rate), which is at 5.75 percent, and the overnight lending rate, which was recently increased to 12.5 percent. Başçı noted that they had the discretion to utilize the lending rate or the policy rate.

 This means the Bank can change the interest rate on a daily basis, by tightening or loosening the liquidity it provides to banks through the weekly repo auctions. The Bank had actually signaled its intentions at the rates meeting two weeks ago, and both overnight rates and benchmark bond yields had already risen considerably before Wednesday’s announcement.

But the Bank put its new policy to full use on Wednesday when it did not open a repo auction despite the TL 11 billion redemption, forcing banks to use the overnight lending facilities. As a result, the overnight rate, at which banks lend to each other, shot up from 9.5 to 11.5 percent in a single day.

 I will take Başçı’s word that “there is no other central bank across the world stronger than us in terms of implementing daily policies”, but that has come at a huge cost. The commercial banks’ funding costs have not only increased, they have also become very volatile, making it more difficult to carry government bonds as well as lend.

 This Central Bank-induced uncertainty could lead to a larger-than-desired slowdown in economic activity. I have again started to receive emails from confused readers. A simple policy rate hike, followed by gradual cuts as conditions improved, would have done the trick without creating this ambiguity.

 King Leonidas of Sparta, the inspiration for my recurring nightmare, lost the battle against the Persians at Thermopylae, but his defeat eventually led the Greeks to victory at Plataea. With its latest measures, the Central Bank will likely win the battle against the exchange rate and perhaps even against inflation. Let’s hope that hard-earned macroeconomic stability is not lost in the process.