Let’s start with some humor in last week’s surprise announcements at the Inflation Report. There were some quite funny tweets right after the Central Bank announced that it had two interest rates, the policy rate and the overnight lending rate, i.e. that the policy rate would now move in a band between these two rates. Here are my favorites:
- @Benjaminharvey: Turkey’s bank policy has been called unconventional, unorthodox, neo-modern, neo-post-modern. What’s it now? Bi-polar-neo-post-modern maybe?
- @SpineSideburn: great. two benchmarks. monetary policy by schrodinger
- @EmreDeliveli (there is nothing wrong with liking my own tweet, is there?): Basci:”We are central bank of #Turkey ;we can use either lending or policy rate”.I shout”This is madness!”He shouts”THIS IS ISPARTA!”:)
But it was the comments that came in afterwards that stole the show: Atill Yesilada called the new measures “vibrating interest rate policy” (I would have preferred “oscillating”), which caught on with several economists, as I noticed in the Bloomberg HT interview with ex Central Bank Governor Gazi Ercel Monday morning. And IMHO, the highlight was the Zaytung piece on Central Bank’s intervention on sheep prices by supplying more sheep to markets (unfortunately, in Turkish): A reader informed me that the Central Bank would also allow commercial banks to hold 40 percent of required reserves in sheep:), and a couple of people told me they thought there were plenty of “sheep” in markets in the first place, but as an economist noted, if the Central Bank is providing joke material to Zaytung, then Houston, we have a problem
My latest Hurriyet Daily News column, which was posted here as well, got quite a few interesting comments as well. For example @neaydinonat likened all this to an action/thriller/comedy: “How will our heroes, who have destroyed macroeconomic stability, will save themselves from the situation?” @aenguscollins was noting that “the Bank seems to assume that ‘unorthodox’ moves are a sign of sophistication rather than a source of confusion”. A couple of readers who had read about my ban from the Central Bank’s monthly meeting with economists noted, after reading my column, that I should forget about attending those meetings in the foreseeable future!:)
Getting more serious, one of my points in the column was that the latest measures were unnecessarily confusing. A reader who is a banker, and has a Ph.D. nonetheless, noted, after I had emailed her a detailed explanation of what the Bank was trying to do, that “monetary policy in Turkey is really confusing.” My point in the column is that it need not be; a simple monetary policy hike would have done the same tightening trick without the confusion. But that’s not what the Central Bank wants becaause 1. it wants the extra flexibility of the band. 2. It is creating tightening by uncertainty and volatility, as Radikal economics columnist Ugur Gurses had noted right after the measures had been announced.
To its credit, the Central Bank signaled its intention regarding the latter progressively leading to the Inflation Report: First, it signaled it was tightening via the liquidity channel by increasing the overnight lending rate at the rates meeting. Then, Governor Erdem Basci clearly said that they were tightening by making using of volatility and uncertainty at a speech in Warsaw right after the rates meeting.
Speaking of Erdem Basci, he was unusually tense at the presentation of the Inflation Report. Responding to a Nomura report about Turkish inflation that had been published a few days before the Inflation Report (and blown somewhat out of proportion), he took out a bill from his pocket, and with his hands trembling, stated that the success of their policies would be seen from the strength of the currency and if Nomura thinks like that, they should not bother coming to Turkey anymore! Quite intense stuff…
The Governor was at his usual good mood at the monthly meeting with economists a few days later. As I mentioned in a previous post, I am banned from those meetings, under the pretext that I am an economics columnist (even though there are many market economists who write regular columns for Turkish dailies and continue to attend those meetings), but that did not prevent me from learning all the details of the meeting, which I summarize here for your convenience:
The Governor opened the meeting by noting that a selection from the Central Bank’s art collection was in display in a special exhibition at the Pera Museum called Beyond the Apparent. Basci noted that those who could not make sense of the Central Bank’s monetary policy should see the exhibit and buy the exhibit’s book, twenty or so copies of which were available at the meeting. I am sure the usual court jesters rushed to get a copy right away, although I am not sure if Nomura left any for them, as I have been hearing that the Japanese investment bank undergoing serious cost (and job) cuts is keen to make peace with the economic policymakers, if their latest note would be any guide. I am of course kidding; in fact, tomorrow is my ale-day at the British Consulate near Pera, so I am sure to see the exhibit, since I really cannot make any sense of what the Central Bank is doing. Hell, I might even by the book and send it to Ulus, Ankara for an autograph…
And if you feel the same way, I would recommend you to start with a short note written by Citi, describing all the different Turkish interest rates out there. And while you are at it, you could also read Citi’s take on the Inflation Report or the bank economists meeting. You might also want to have a look at a couple of FT articles describing the new policies.
As for the actual meetings, my understanding from my conversations with my friends, is that the Centrak Bank has given a clear leading indicator of whether it would keep interest rates closer to the one-week repo or the overnight rate: If there is volatility in the lira, the Central Bank will engage in sterilized interventions, and the ruling rate will be the policy rate. If, however, the lira is depreciating strongly, then, the Bank will intervene in the level with a unsterilized interventions, and since lira liquidity is being drained, the relevant rate will be the overnight lending rate.
The Governor also mentioned that they had used all their arsenal of weapons, except one: If FX liquidity gets squeezed, the Bank could put into use the interbank depo market, which lets banks borrow from each other in a “blind broker” system (don’t ask me HTF this works, I have no idea). This was used in 2006, but banks had not made much use of the facility at the time.
As for the new way of conducting monetary policy, Governor Basci emphasized that the interest rate corridor is the best way to deal with exchange rate weakness and volatility. When asked about whether the policy would hurt the banking sector, as argued recently in the Wall Street Journal, Basci noted that banks had already made their adjustment by increasing lending rates. Your friendly neighborhood economist begs to disagree: If the Central Bank plays with the interest rates a lot, it will be impossible for the banks to lend (or do much else) without knowing their funding costs- if you don’t find me convincing, try the JP Morgan note. And if they won’t, unless in extreme circumstances, as highlighted by Basci at Tuesday’s meeting, then why not got to the trouble of confusing markets?
As for the current account deficit, there wasn’t much new: The Bank said that it had done all it could regarding the current account deficit, and the rest was up to the government and the banking regulator. As for credit growth, we learned that the Central Bank would be very happy if its yearly growth fell to 10 percent by year-end, although the Governor also emphasized that the tightening was done to counter lira depreciation, not credit growth.
Speaking of the tightening, Basci also emphasized that even without the new measures, Turkey had one of the highest policy rates among emerging markets, repeating earlier claims that monetary policy was already tight. I would beg to disagree, but after last week’s measures, there is no question that monetary policy is tight, so it is not useful to debate the issue further. BTW, the Basci has also revealed that the Bank’s main scenario is still global recession. Basci highlighted that despite this, they had tightened policy rates since they were worried about inflation. Spoken like a true Central Banker!, at least IMHO. I wish they had not done that in a confusing, discrete and convoluted way… BTW, Basci highlighted in the meeting that inflation would have hit 10 percent by year-end had they not tightened policy. There is a nice slide in the Bank’s presentation as well as a box in the Inflation Report regarding that point.
The Bank also provided a data update: They noted that the September trade figure was because of Ramadan and gold imports, both temporary phenomena, so they have not changed their adjustment scenario. There was also a justification for the unchanged 2012 projection of 5.2 percent: According to the Bank, the output gap would widen a bit, taking off 0.2 percent from the original projection. The easing in commodity prices would shave off a further 0.2 percent. But the FX pass-through would add 0.4 percent, resulting in the unchanged 2012 projection. This is all great, but it doesn’t satisfy skeptics like me who think that the 5.2 percent forecast is not realistic to begin with (Citi economists explain why)! BTW, the careful Turkish Central Bank watcher would have noticed the Bank almost gave away its 2012 FX forecast: The Bank has revealed its more recent estimates of the strength of the FX passthrough, so using that you could come up with its FX projections. Maybe an exercise for a future post for me:)…
Finally,I have a couple of extra criticisms to the Bank’s current framework, which I could not mention in the column due to space constraints. First, the Bank had explained its reserve requirement ratio, or RRR, hikes for shorter maturities by saying it simply wanted to extend the maturity of deposits. That is a really noble goal, but the RRR cuts of the past week were all for shorter maturities. Talk about confusion.
Speaking of RRR cuts and confusion, here’s a reader question:
We do not understand why the central bank is thightening liquidity by raising interest rates “indirectly” by 675 bps and at the same time increasing liquidity by cutting reserve requirements. This seems to be contradictory in our view?
And my response:
You are perfectly right it is contradictory. It is also contradictory of their earlier policy of trying to increase the maturity of deposits by raising RRRs for shorter maturities more; the cuts were all in short maturities. That’s why people find the Bank’s policies confusing:)
But the main reason they are doing this is to cut the banks some slack. Here is my reasoning: The CBT will likely sterilize the RRR cuts this week by scaling back the one-week repo auction, so overall liquidity will be more or less neutral. Nevertheless, the term liquidity of the banks would improve as result of this action, which would help the existing pressure on the bond market, as banks own 60% of government bonds.
But if I am wrong, this added liquidity will cause depreciation pressures on the lira and further confuse markets- believe me you are not the first one asking me about this and you won’t be the last:)
I would follow the CBT auctions very carefully in the next couple of weeks to see what they are up to. In a similar vein, the share of OMOs in weekly repo and overnight lending is now very important as well.
This was written before the economists’ meeting, but from Basci’s comments I summarized above, I would say I might have been right. In any case, I hope someone from the Central Bank is reading this and noting how they are confusing rather sophisticated market players.
But more important than the small details on maturities, confusion and even the uncertainty, by focusing on the exchange rate so much, the Bank is threading very dangerous waters: If inflation expectations start to be formed based on the exchange rate as a result, the Bank will find itself at a very tough vicious circle- in the sense that it won’t be able to get out of intervening with the exchange rate.
Finally, I would like to thank the Central Bank for getting me in the Hurriyet Daily News most popular list by providing me the opportunity to write for a confusing and equally interesting topic:
I doubt the column would have been as well-read if the Bank had simply hiked the policy rate:)…