Monday, April 12, 2010

Weekly Hurriyet Column: Ignorance is strength

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News website since March, you won't see much of a difference between the two. As for cheesy references, I am continuing with the seventh art with silver screen adaptations of George Orwell's two most famous works.

As for the column itself, I will illustrate what I mean by saying all banks are equal, but some are more equal than others when I post the Roubini Global Economics version of the column.

One of the maxims of Oceania, George Orwell’s fictional super-state in 1984, is ignorance is strength. That definitely seems to be true for analyzing the Turkish economy.

For example, it is often assumed that there is a one-to-one relationship between inflation, the output gap, which is simply how far away the economy is from potential output, and Central Bank, or CBT, policy rates. As a result, a stronger-than-expected growth outturn, like the GDP readings from the last quarter of 2009 released at the end of March, can cause some to pencil out their inflation and policy rate forecasts for higher numbers.

There are many problems with that hastiness. For one thing, it is the composition of growth that matters, and on that front, as I discussed last week, the data simply do not point to a robust recovery. It also does not make much sense to base one’s forecast on lagging statistics. You could argue that more recent figures such as Industrial Production and Purchasing Managers Index look quite strong, but these volatile indices paint a mixed picture at best after making the necessary seasonal or working day adjustments.

At a more basic level, assuming a direct relationship between the output gap and inflation comes down to assuming that inflation is mainly a demand-pull phenomenon. But inflation is also influenced by cost-push factors such as energy prices and the exchange rate as well as expectations, and these do not warrant a rate hike for now- and I am not even going to get into monetarism. I do think the CBT will have to start raising rates earlier than market expectations of the third quarter; it is just that we are not there yet, so Tuesday’s Monetary Policy Meeting should bring in more cautionary tone but no rate hike.

Similarly, liquidity and interest rate policy are often confused. That’s why the Central Bank’s announcement that it would disclose its exit strategy on Wednesday caused a big stir. Rather than an uncalled-for rate hike, the Bank is likely to disclose the timetable for pulling back some of the liquidity measures it had enacted through the crisis.

Most of the measures were actually for foreign currency liquidity; annulling those measures would do more harm than good at this point. Of the two lira-based measures, the 1 percent decrease in the reserve requirement was a quantity measure, which provided more than 3 billion Turkish Liras of liquidity, whereas the three-month repo auctions were more of a price one, as lengthening the maturity of repos brought down banks’ costs.

Both could be scrapped soon, but more importantly, with the CBT providing liquidity of around 20 billion liras through open market operations for some time now, it seems that liquidity shortage has become a structural phenomenon, exactly of the sort that would induce the Bank to alter its liquidity framework, as outlined in its Monetary and Exchange Rate Policy for 2010.

Moreover, a look at the composition of open market operations reveals that all banks are equal, but some are more equal than others: Open market operations is a net figure, including Central Bank mopping up liquidity as well as funding it, and the Bank has been draining around 10 billions. In other words, some banks have been preferring to lend to the CBT rather than to their compatriots.

Canceling the three-month repos would induce banks to lend to each other to some degree. But the much-talked about technical rate cut would be a huge help, as the Central Bank’s borrowing rates would be set at least a full percentage point below the one-week repo rate, which would be the new policy rate.

Big Brother was right: As much as a little knowledge is worse than no knowledge, ignorance is strength.

Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at

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