The ‘attack’ on the Turkish Lira and vulnerabilities

Central Bank head Murat Çetinkaya made a presentation to MPs on the state of the economy on April 10. Everyone agrees that Çekinkaya can realistically diagnose the growing problems in Turkey’s economy. However, the main issue is not the diagnosis but the cure to heal problems in the economy.

As Çetinkaya spoke at the meeting with lawmakers, the Turkish Lira was hitting new record lows against the dollar and the euro, while the Treasury’s borrowing costs hit a record high. The next day, the lira dropped to yet another record low.

Çetinkaya told deputies that there was “an attack on the lira” and the Bank is closely following developments. I hope he did not claim that this was a “speculative attack.” Developments affecting the currency are global, not limited to the lira. But in such circumstances the Turkish economy inevitably becomes more vulnerable and the lira comes under further stress.

In his presentation, Çetinkaya said high inflation posed a risk to pricing behavior. He underlined that the rise in inflation also affects exchange rates and the price of imported goods.

To summarize, the Central Bank admits that inflation remains high and it is not able to change peoples’ expectations. He also believes that the main factor behind the deterioration in the economic outlook are exchange rates and imports, which have been rising because of exchange rates and the revival in global economic activity.

Reiterating that inflation will gradually drop to single digits, Çetinkaya underlined that the Central Bank aims to bring inflation down and keep it permanently at low levels. He acknowledged that “monetary policy should be based on price stability,” but in practice that is not happening. If it had been, inflation would have not be hitting its current levels.

So Çetinkaya’s diagnosis is right, but it is doubtful whether the Central Bank is really focused on targeting a “continuous decline in inflation.” If that really was the Bank’s target, inflation would not have hit double digits and expectations that it would fall to single digits would have not evaporated. Practical realities expose the Central Bank’s claims.

Moreover, recently flared-up discussions on interest rates have intensified. Those in power now openly and harshly criticized past interest rate cuts by the Central Bank. It has become a commonly held view among market participants that given this outlook it is much more difficult now to take decisions that may help bring inflation down.

In the same presentation, Çetinkaya also noted that the current account deficit continues to rise and debt rollover ratios remain high. The analysis put forward by the Central Bank is not complete but it still sufficiently summarizes the deteriorating economic outlook. If it makes the right diagnosis then the treatment must be clear.

The economy is growing and because of this expansion borrowing requirements and interest rates are rising. And this is happening at a time when external financing is becoming scarcer. In order to secure the inflow of external financing and reduce the adverse effects of exchange rates on inflation, the currency needs to become more stable. To ensure this stability, interest rates must be raised, as widely expected by the markets.

However, the government recently dropped a bomb for the economy with the mooted idea of “reducing interest rates through administrative measures.”

Market interest rates and the Treasury’s borrowing costs have increased. The gap between those rates and Central Bank rates has widened. Is it possible to forcibly reduce interest rates?

It is clear what the diagnosis entails. Let us see what the Central Bank does.