More on Turkish Monetary Policy
My 3200 character limit again prevented me from saying all I wanted to say in my latest Hurriyet Daily News column, which was also posted here at the blog. So I would like to provide a little bit more detail on some of the topics I touched upon, but before I do that, let me summarize the latest monetary policy developments- I know it has been three days since the column was published, but nothing is quiet on the Turkish monetary policy front these days:
Latest Monetary Policy Developments after the column
On Friday, the Central Bank intervened in markets big time, as if trying to make economist Mahfi Egilmez, whom I quote in the column, eat his words: About USD 1.5bn of direct intervention on top of the USD 750mn auction. What was going on? Economist (and friend) Atilla Yesilada entertains three possibilities:
- Massaging data (as I mention in the column): Making current account and USD GDP look better.
- A New Year’s present to companies who have been harmed by the depreciated lira and were trying to close their open FX positions.
- The Bank has started to target a level.
Whatever the motive was, the key point was that the Friday’s intervention was unsterilized, hinting of what was to come. A short note on Monday cleared things up a bit, as the Bank was again burning some reserves:
PRESS RELEASE ON MONETARY POLICY TO BE IMPLEMENTED DURING EXCEPTIONAL DAYS
End-year inflation, which will be announced tomorrow, is likely to materialize slightly above 10 percent. In order to contain second round effects under current circumstances, it is important that disinflation starts sooner than market expectations. In this context, Central Bank of the Republic of Turkey has delivered an additional monetary tightening since December 29, 2011.
Additional monetary tightening is mainly implemented via open market operations. Liquidity funded to the market at the policy rate may be reduced temporarily below the lower bound announced for normal days.
Unsterilized (effective) foreign exchange sales and interventions may also be used as a complementary instrument when necessary. The aim here is to prevent inflation expectations to be adversely affected from exchange rate movements detached from fundamentals.
Additional monetary tightening is intended to be strong, effective and temporary. The duration of the implementation may vary depending on the speed at which main factors affecting inflation outlook turn favorable.
Central Bank of the Republic of Turkey will continue to monitor developments regarding inflation outlook and take the necessary measures in line with the main objective of price stability.
All these points were mentioned again in the latest (and final, as the Bank is returning to one-on-one meetings) economists’ meeting the next day. The presentation itself seemed like a carbon copy of the Governor’s London presentation a few weeks ago, but the Governor made some important remarks: For example, now we know that there isn’t one monetary policy strategy, but two: Tight and extra-tight (additionally-tight), as was hinted in the Monday note. Moreover, there is no single policy rate, but 4: 5 percent (the overnight borrowing rate, or floor of the interest rate corridor), 5.75 percent (one-week repo rate, or the rate that was formerly known as the policy rate), 12 percent (interest rate on borrowing facilities provided for primary dealers via repo transactions) and 12.5 percent (the lending rat, or the ceiling of the interest rate corridor). I know this is all confusing, so I have it all in one neat graph:
Oh, BTW, Basci declared officially that the policy rate is dead; that’s why I referred to it as “the rate that was formerly known as the policy rate”. The Central Bank will not be doing auctions at the policy rate for a while, opting instead auctions where the price (the interest rate) will be determined by the markets. As an anecdote, Basci said that he had wanted the reference to the policy rate taken out in earlier CBT documents, but they were not removed, which more or less proves my point on communication.
Basci also gave a lot emphasis to the fact that reserves are sufficient. He noted that the Central Bank is planning on switching some of its reserves to gold in the long-run (he did not specify the rationale for it), so he urged economists to include gold while accounting for CBT’s reserves, and I have duly done that in the graph below. However, I do not agree with the Governor that reserves are sufficient: Although reserves may seem abundant in an absolute sense…
… they look much less robust when you look at net reserves (calculated by subtracting the CBT’s FX liabilities & adding in the Treasury coffers), or when you look at traditional (or less traditional) reserve adequacy indicators.
BTW, at 10.45 percent, inflation did indeed hit two-digit territory the next day, so I started the year with an accurate forecast:) The Central Bank has again put the blame on food prices, but as I argued before, food inflation should not dismissed as merely as a temporary supply shock. Despite all the recent emphasis on inflation, I still feel the Central Bank is downplaying inflationary risks.
For example, the CBT is assuming that extra ECB liquidity will cause more flows to EM, leading to appreciation pressures on the lira. Basci referred to this scenario several times during his presentation, which worried me a bit, as I saw it as “leaving monetary policy and inflation to the global winds”. But the Bank is also dead-serious about inflation, or at least it would like to seem that way. For me, the most surprising remark on Tuesday was that “monetary policy would be kept tight until everyone believed inflation would fall!” According to Basci, tying the duration of tightening to inflation is good for predictability purposes as well.
Anyway, the Central Bank’s interventions and tight liquidity management continued on Wednesday and Thursday (see the graph below for the auctions, the interventions will be revealed in two weeks).
Having summarized the latest developments, I can go on with the addendum to the column: Since this is a very long post, I have organized it by topics:
On Central Bank’s Success:
I did not mention this in the column, but the latest trade data, announced last Friday, show that adjustment is under way:
These trade figures (and simple calculations) reveal that the current account deficit will actually improve in Nomember, probably by a few hundred million dollars or so.
However, I still do not expect a huge improvement in the current account deficit next year unless the economy crash lands and oil rices continue to hover above USD 100/barrel. The main reason is that, as the Central Bank has argued many times recently as well, the lira has done more or less all its done for the deficit. Citi Turkey economists also argue that it will take much more than a weak lira for the current account deficit to decrease substantially. But Yapi Kredi Research does not agree (with me and Citi), as they contend that the lira depreciation will have a larger-than-expected impact on the current account- I strongly recommend you to listen to the whole thing, as it is important for you to see the contrarian (to mine) view.
As for credit, it is likely to slow down considerably in the first half of next year, owing to the economic slowdown. In any case, the Bank is comfortable with current levels of FX-adjusted credit growth of around 15-20 percent in total loans, and 10 percent consumer credit loans.
As for inflation, the Central Bank’s thinking, as reflected in the Governor’s speeches last week, is very easy to grasp: He says that the contribution of the FX weak lira and administrative price hikes are 5 and 1.6 percent respectively. Since these effects won’t be around in 2012, the Bank can attain its 5 percent target. As I explain in a recent column, which was also posted here at the blog, this is kind of optimistic. For one thing, it is ignoring price rigidities, but have a look at my recent post for why I am not convinced inflation will not fall as much as the Central Bank is envisaging.
On the interest rate corridor:
I did a trilogy on Turkish monetary policy a couple of months ago, just around the time the Bank was announcing the interest rate corridor. You can read about all my arguments against it in the second column, whereas the last of those articles adopts an empathic approach by looking at it all through the Central Bank’s lens.
One issue I did not address at those columns are the governance implications of the corridor. See, monetary policy is supposed to be decided in the monthly Monetary Policy Committee, or MPC, meetings. If there is need, you can convene a special MPC meeting, as was done back in the 2006 mini-crisis. Making the policy rate meaningless with such a corridor feels like “bending the rules” to me, and so I am surprised no journalist covering the Turkish economy looked at the issue from this perspective.
Understanding the Central Bank:
It is best to refer to a reader question, which was posted at the comment on my short piece on USDTRY at the end of last week:
I actually listened to a few of his speeches and answer sessions on the tube. Afterwards, I have concluded that he is either extremely intelligent, leaving me to stupid to comprehend or his intention is to keep everyone guessing. I do admit he is much smarter than me. My question; is Mr. Basci following someone’s theory of economics that he may have studied during his education? Maybe you know the theory from your studies at Yale or Harvard…or is this really unorthodox and he is the first to behave in such a vital position?
What the Central Bank is doing is certainly way orthodox. For one thing, as I have argued many times, they are trying to crack the “Impossible Trinity”, which is as unorthodox as you can get. But here’s what I told my reader as a reply to his comment below the same post: He (Basci) is smart. He is a decent economist, although not near the likes of Paul Krugman (but then who is?). But then why is he so outside the orthodox approach? I can think of two reasons: First, I believe the CBT is extremely adverse to standard rate hikes for political reasons (basically, the PM doesn’t want it); that’s why they are undertaking these “stealth measures”. But perhaps more importantly, Basci and his team really wanted to prove themselves to the world with these supposedly ingenuous measures, which have obviously (at least IMHO) backfired.
It is also important to note that the Central Bank took the recent fashion in monetary policy a bit too seriously and literally. As I argued in the latest installment of my monetary policy trilogy, many academics and policymakers now believe that a Central Bank should not follow inflation targeting strictly and care about financial stability as well as inflation. But it doesn’t follow that you need to resort to untested policies and tools to achieve financial stability. You could as well include financial stability into the traditional Central Banker interest rate reaction function.
On Central Bank Communication
I kind of responded to Basci’s remarks at the Istanbul Chamber of Industry (ISO) quite harshly in the column, so now I would like to wear the cloak of empathy once more and try to reason with the Central Bank:
If you stop and think for a moment, you’ll see that Basci did not introduce anything major at the ISO conference. If anything, he and his fellow Central Bankers should have thought they were actually providing predictability with the announcement. After all, they limited the Central Bank’s available actions to a binary set. But the way they went about doing that was definitely not a masterpiece. Even before getting into the details, I should say I really don’t see why Basci made the announcements at the ISO presentation rather than the day before at the 2012 Strategy Meeting.
I think part of the problem seems to be that even though some of them are brilliant academics and bureaucrats, the Central Bank’s top brass have little or no markets experience. Having spent two years as a bank economist, I can tell you that it is an invaluable experience. On the other hand, the CBT’s capital markets division has lots of experience with markets, so maybe the CBT’s management should be listening to them more.
But there are serious communication problems in the Policy Strategy Document as well, as Radikal columnist Fatih Ozatay pointed out a few days ago (in Turkish). Basically, the Bank is trying very hard reconcile its rate cut in August with the stealth hike (through the corridor) in October. It is not having success because there is no way those two actions can be reconciled. The Bank simply messed up in August; its expectations did not materialize and it heavily underestimated inflation. So trying to defend that cut is only making it look worse.
In any case, shorting lira assets before every time Governor Basci spoke would have been a very profitable (and foolproof!) trading strategy last week. That’s really unfortunate, as I don’t think that’s what he was intending:)
What happened on December 23?
As I ways say, a picture is worth more than a thousand words, especially in this case:
This is the graph I used in the column, updated with the most recent auctions. As for what actually happened, there are a couple of alternative explanations that are competing. Some say that some banks tried their luck by making low bids, and the Central Bank just did not want to honor those:
But then as any trader would tell you, offers about 50bp below the actual exchange rate at the time would not be too low in the low liquidity environment of the last week of the year. In fact, as you can see above, the bids were even lower, compared to the exchange rate, at Friday’s USD 750mn auction. Besides, as one trader was commenting, a Central Bank should not behave like a trader. Because then markets will treat it as a trader as well…
Another related claim was that the bids were mostly speculative money, rather than genuine demand. But in retrospect, I’d say, by looking at last week’s auctions, that this should not be entirely true. A similar claim is that when they saw the USD 1.35bn auction, traders began to sell dollars with the expectation that it would lose value. But when the Central Bank sold only USD 50mn, all those shorting were squeezed and the currency jumped. According to this version, there is actually speculation, depending on how you define it, but only ex-post and only because of the Central Bank’s actions!…
What next for Turkish monetary policy?
I am no fortune-teller, but it seems we will muddle through until the next MPC meeeting, where we’ll see whether the Bank will pull other rabbits out of its hat. But it is fairly a safe bet to assume that the interventions and tight liquidity will continue until the next meeting at the end of January.
IMHO, the heavy Treasury borrowing during the first quarter will be important in determining Central Bank liquidity management as well…
3 Responses to “More on Turkish Monetary Policy”
Central Bank of Turkey Governor Erdem Basci had important announcements today, so there will be another monetary policy post coming soon…
[...] More on Turkish Monetary Policy My 3200 character limit again prevented me from saying all I wanted to say in my latest Hurriyet Daily News column, which was also posted here at the blog. So I would like to provide a little bit more… [...]
Great overview of Turkish monetary policy….I appreciate that you also provided links to contrary opinions.
I tend to take sides with Citi (and you) on the structural nature of the CA deficit – "Citi Turkey economists also argue that it will take much more than a weak lira for the current account deficit to decrease substantially."