Where there’s a will, there’s a way
This is a crucial week for Turkey’s economy and the Central Bank of Turkey’s credibility. Tomorrow we have the CBRT’s monetary policy meeting and the market expects a rate hike of just over 300bp, according to Bloomberg’s market consensus.
For some time market participants have accused the CBRT of being behind the curve, while there is also a perception that the central bank’s decision-making has been influenced by President Erdogan’s comments that, in his opinion, high interest rates have a detrimental effect on an economy. Inflation is currently running at close to 18% and due to further Turkish lira depreciation, most economists expect it to breach 20% very soon, hence the need for urgent and drastic action by the CBRT.
At the previous CBRT meeting in late July the decision to keep rates on hold came as a complete surprise to markets. At that time the CBRT had said the domestic demand slowdown had begun and so following a couple of emergency hikes in proceeding weeks it appeared to adopt a ‘wait and see’ approach. Fast forward six weeks or so and EM sentiment has deteriorated, trade talks between the US and China have worsened, Turkey-US relations are at new lows and the lira has suffered a severe decline against the dollar. Growth in Turkey has indeed decelerated as Monday’s release of Q2 GDP figures show.
Due mostly to the lira being 40% lower compared to the end of June, the slowdown in Q3 will be far more pronounced, as domestic banks have been forced to tighten financial conditions. The lira has been a little more stable over the last few days after the CBRT said its monetary stance would be adjusted at the September meeting and investors, ourselves included, are hoping the central bank doesn’t under-deliver.
The current economic situation in Turkey certainly has a lot to do with macro-economic imbalances and overheating, but it also has to do with credibility. Right now markets do not take what the CBRT says at face value because credibility has been eroded after several quarters of it being unable or unwilling to control inflation and the exchange rate.
We would like to see a rate hike of at least 400bp tomorrow, to help restore confidence that the central bank is actually committed to fighting inflation. The quicker confidence returns, the less time rates need to be at these elevated levels, but for confidence to return markets need to see a big hike. However, an effective rate hike is a necessary but not a sufficient condition for confidence to return on a more permanent basis. We also need the government to play its part via a reduction in its external funding needs. In other words, a lower deficit and a higher savings ratio. All eyes on Thursday for now.