Turkey’s central bank is betting the farm against market fears that a Fed tightening is around the corner and that the undefended lira is dropping.
Turkey’s central bank is betting the farm against market fears that a Fed tightening is around the corner and that the undefended lira is dropping.
But a message this week from the Fed’s future chairwoman seems to bear out the Turkish Central Bank’s course, signaling that the world’s most powerful bank isn’t about to change its monetary policy in the near future.
Janet Yellen, who was recently nominated as the Fed’s next leader, released a statement on Wednesday saying the US economy has “farther to go to regain the ground lost in the crisis and the recession,” a signal that the Fed would maintain the low interest rates it hopes will fuel US recovery.
The announcement is good news for Central Bank Governor Erdem Başçı, who in August pledged to keep Turkey’s own interest rates at a growth-spurring low after the economy grew just 2.2 percent in 2012. That promise seemed bound to be broken when Fed Chairman Ben Bernanke signaled late this summer that the Fed would likely raise interest rates, sending currencies plunging in developing markets the world over. The era of cheap dollars and easy foreign financing was at an end, market wisdom held.
“The central bank made a bet that the fears over higher dollar borrowing costs were a blip,” said İş Yatırım analyst Uğur Küçük. “It saw a lot to be skeptical about in the US recovery data, so it thought it was safe from a big policy change.” The Turkish lira plunged from TL 1.78 to the dollar to nearly TL 2 in late summer when fears of tapering were at its highest, but the bank won its bet that it could keep borrowing costs low — the backtracking at the Fed kept the lira from sliding further and prevented any major pullout of foreign funds, said Küçük.
This week, the lira faltered further to TL 2.05 to the dollar amid strong jobs growth data from the US, a signal global markets again interpreted as a sign that tapering could be near. The central bank sold off $160 million of foreign reserves to protect the lira and announced that it would sell $520 million more in the coming week, though the announcement did little to stem the lira’s fall.
“The bank seems more or less committed to its course and is only going to use ‘unorthodox’ measures to defend the currency,” said Finansbank analyst Gökçe Çelik. Çelik pointed out that in a Nov. 1 announcement by the bank, it predicted a sluggish global recovery that might necessitate lower rates for the next three years.
Refusal to raise rates saw the bank last month earn the harsh rebuke of the International Monetary Fund (IMF), which criticized the bank for burning over 15 percent of its foreign reserves defending its currency while keeping interest rates steady. Turkey’s primary interest rate, the benchmark one-week repo rate, has been set at 4.5 percent for most of this year. At the root of the IMF’s fears was the country’s massive current account deficit (CAD). “The market reappraisal of advanced economies’ monetary policies has exposed Turkey’s main vulnerability — its external imbalance. A weakening or a reversal of capital flows presents a major challenge,” said the report.
The biggest risk to the economy, the IMF suggested, was a Fed tapering which would see a quick exit of foreign dollars and leave Turkey unable to finance its gaping trade deficit. Such a scenario would easily send the economy into a recession, it said. “This is a situation the bank seemed confident of avoiding because it simply wasn’t optimistic enough about the global economy to believe that tapering would happen,” said Küçük.
But the lira, undefended, poses its own risks to the economy after falling 12 percent in value against the dollar this year. This week a report by Yapi Kredi predicted that a drop of more than 20 percent in the lira would “significantly impair” the private sector’s ability to service its debt. Bloomberg estimates that roughly 40 percent of loans in Turkey are in foreign currencies.
Such a drop is unlikely to cause major shocks to the economy, however, argued Standard Bank’s head of emerging markets research Tim Ash. “I do not think this would create systemic problems,” he said, suggesting that the economy was better balanced to handle currency shocks than when it saw a recession in 2001 and 2009. “This time around the underlying strength of the Turkish economy is much better,” Ash said.
Küçük agreed, but cautioned that the currency was still at the mercy of international markets. “There’s been a lot of turbulence around rumors of a Fed tapering and that’s what is hitting the lira. The bank may be certain that it is not at risk from the Fed, but it is still vulnerable to what the rest of the market thinks,” he said.
Today’s Zaman