The Turkish central bank’s former chief economist said the country’s interest rates should go no lower for now after a months-long easing cycle drove inflation-adjusted borrowing costs deep below zero.
Hakan Kara, once seen by many as the backbone of the central bank’s monetary research after working closely with five governors since 2003, was removed from the job last August, a month after President Recep Tayyip Erdogan fired the bank’s chief for not cutting rates.
Speaking in an interview, Kara warned of risks from a combination of low rates, bond buying by the central bank and credit stimulus. “There seems to be no further room for monetary easing, both from the external and internal balance perspective,” he said.
Before last month, the central bank delivered 1,575 basis points of easing in nine consecutive steps, leaving Turkey’s real rates among the lowest in the world. Meantime, state lenders are unleashing credit through the economy while policy makers inject liquidity by scooping up government bonds. Most economists surveyed by Bloomberg in June still see lower borrowing costs at the end of the year.
But a worsening inflation outlook prompted the central bank to hold rates last month for the first time since Governor Murat Uysal took the job in July 2019. With core inflation and energy costs on the rise, it’s also blamed supply disruptions from the coronavirus outbreak for faster increases in food prices.
Annual price growth accelerated for a second month in June to 12.6%. In April, the central bank lowered its inflation expectations for the end of this year to 7.4%, from a previous forecast of 8.2%.
“The inflation path has been drifting significantly above the central bank’s April inflation report forecasts in recent months, limiting the room for further policy easing,” said Kara, now an economics professor at Bilkent University in Ankara. “The deep negative real rates, quantitative easing and the credit stimulus have eventually led to renewed pressures on inflation.”
Uysal says policy makers still provide a “reasonable” real rate of return based on projected price growth. The monetary authority, which predicts slower inflation in the second half, will announce its new base-case scenarios for prices on July 29, after it convenes next Thursday to review rates.
The central bank may prefer not to publish an inflation forecast that’s higher than the current policy rate of 8.25% at this month’s unveiling of its quarterly inflation report, according to Kara.
Divining the Future
“It may opt to wait for another quarter to gauge the course of food and administered prices before making a major revision,” he said. At the same time, the inflation overshoot “has further eroded the credibility of the projection and weakened its anchoring power.”
Meanwhile, the central bank’s foreign-currency reserves are running low because of state lenders’ interventions to defend the lira.
The depletion has been a cause of concern for some Turkey analysts since last year, when authorities began borrowing foreign currency from commercial lenders through swap agreements. State lenders spent an estimated $90 billion from the nation’s foreign reserves to prop up the lira since the beginning of 2019.
While the use of reserves for foreign-exchange interventions “can be a useful complementary tool,” Kara said it’s “not a substitute for the interest rate policy.”
A high risk premium for borrowing abroad is the biggest downside of Turkey’s policy of managing its international holdings, a consequence of its “nonstandard ways of using reserves to defend the currency and the opaque attempts to make up net reserves through various swap facilities,” he said.
“The authorities should formulate a better communication about why they are using this particular strategy and how it contributes to the stability of the economy and the welfare of the society,” Kara said. “Even the worst explanation would be better than not having one.”
Growing external imbalances are another source of pressure. Turkey’s current account has run a deficit for six months as exports dropped faster than imports amid a global economic slowdown caused by the coronavirus outbreak.
While the government’s target in 2020 is a deficit equivalent to 1.2% of gross domestic product, Kara said it could reach around 4% by the end of this year. A recovery in tourism revenue may help stabilize the current account, but a persistent shortfall makes a drop in gross and net reserves “inevitable,” he said.
“That means, given the low level of international reserves, the current-account deficit should not — and cannot -- exceed a certain threshold in the short term,” Kara said.
(Updates with Kara’s comments on current account in final three paragraphs)
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