The Kapali Carsi

How Central Bank of Turkey saved P.M. Erdoğan’s derrière

I couldn’t help but notice several misconceptions about Tuesday’s midnight’s emergency rate hike.

Here is the introduction to my latest Hurriyet Daily News (HDN) column. One of those misconceptions gave the column its title. To quote directly from the column: “Some have also argued that the rate hike hurt the ruling Justice of Development Party’s (AKP’s) chances in the local elections, proving the Central Bank’s independence.” I correct this and other misconceptions in the column. As always, you can read the whole thing at the HDN website– I don’t copy paste it so that I can get more hits to my beloved newspaper:) Anyway, let me not get too much off the track, as I have quite a few addenda to make:

First of all, the reaction of the economy’s top brass to the rate hike disproved their longstanding claim that the weak lira would have limited, if any, impact on the economy. For example, Finance Minister Mehmet “Nominal” Simsek had been claiming that corporates’ FX debt didn’t matter, as their short-term FX open position was only $13 billion. I explained in detail, in Monday’s HDN column, which I posted here as well, that his reasoning was very misleading. And supposing he was right, why did he then sound relieved after the rate hike?

Another misconception about the interest rate hike is the comparison to Soros’ breaking of the pound more than 20 years ago. OK, I see the similarities, but for one thing, the pound was pegged to the Deutche (did I spell that right?- and I almost minored in German) Mark.

Moving on, I would like to make a few points on PM Recep Tayyip Erdogan’s comments during his return flight from Iran, to which I referred to in the column. First of all, I would like to point out the irony: One moment Erdogan is saying that the Central Bank is independent. The next moment he states that he will give the Central Bank some time to see if the hike will work- if it doesn’t, he will act. I guess his advisers, econ tsar Ali Babacan and FinMin Mehmet Simsek all had him memorize the “independence line”, but he just can’t help it, right:) And by the way, what is his criterion of success? Interest rates, currency and stock prices! I told you- these guys are obsessed with asset prices!

Speaking of independence, do I think that the Central Bank is independent? Unfortunately, that is still not an affirmative:( So I believe Erdogan had to be convinced, probably by Babacan more than anyone else, to let the Bank hike rates. And if things do not go as planned, the Sultan is sure to be pissed, not only at Governor Erdem Basci, but also at Babacan…

OK, let me get a bit wonky: How did I calculate my forecast for the average funding rate? Well, the Bank will generally fund banks with the one-week repo at 10 percent, but there will probably some funding at the overnight lending rate (12 percent, 11.5 percent for primary dealers), and so the average funding rate will probably settle slightly above 10 percent. In a similar vein, interbank repo rates could hover around 11.5 percent for a while while the Central Bank increases the size of the one-week repo funding.

Last but not the least, how did I figure out that “it will take at least four or five months for the full effects of the hike to be felt on the economy”? I used time series techniques called VAR and ARDL. Don’t ask me what these are- I should not really be allowed to play with econometrics in the first place:) But joking aside, there are no serious academic studies on the monetary transmission mechanism in Turkey because of data limitations. My quick take used less than 200 or so data points (monthly interest rates and industrial production), so I wouldn’t put too much confidence on it. But I am confident it is not as long as in the U.S., which should be around one year or so for real effects…

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