Monday, April 19, 2010

Weekly Hurriyet Column: No way out for the Central Bank

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 loosely referring to the 1987 thriller with a young, slim and non-balding Kevin Costner, before he danced with wolves and way before he danced with Turkish Airlines. Speaking of that, I am not sure what to make of all the Hollywood stars (or protostars/ black dwarves for that matter- and no, I am not being racist!) starting to appear on Turkish ads. It somewhat brings to mind the image of Japan, but I can't decide whether that is a good thing:).

As for the column, I don't have much to add, except to remind you that I explained the banking system's liquidity bind recently...

I now know that the Central Bank of Turkey, or CBT, has a completely different notion of a strategy document than mine. While I was not expecting a daily timetable in the Bank’s much-anticipated exit strategy document, I was disappointed by the lack of specificity and the laundry list nature of measures to be removed.

With foreign currency liquidity profuse, hiking the reserve requirement will not have a market impact. The same goes for other measures like reducing depo facilities, which have been redundant for several months anyway. As for Turkish Lira liquidity, it is what the Bank is not doing that matters. With liquidity shortage having become a structural phenomenon, it would not have made sense for the CBT to unwind the three-month repo facility and increase the required reserves on deposits, and the Bank has noted that it does not intend to scrap those measures for now.

The CBT has also mapped out the technical rate adjustment as a three-stage process. It would start by gradually funding the markets’ liquidity needs less aggressively and inducing interbank lending, which has become an important drag on liquidity, as I explained last week.

Then would come the technical rate cut, with the one-week repo rate, set 0.50 percent above the overnight borrowing rate, becoming the new policy rate. With that rate hovering around 6.85 percent of late, that would mean a small rate hike. Banks would bid the amount they want to borrow at this rate, with the CBT effectively rationing credit by deciding on how much to fund banks at this rate. Finally, the Bank would widen the band between its borrowing and lending rates and the one-week repo rate.

But I myself learned more about the constraints facing the CBT’s exit strategy from the releases of the data-heavy last week. On the real sector front, while consumer confidence finally managed to break free from the 78-82 range it had been hovering around for the past six months, contrary to the consensus view, a fast recovery is not in the bag, especially if once you adjust for last year’s low base.

Even with a fast recovery, unemployment is likely to decrease very slowly, as last week’s January release shows. It is maybe this employment outlook or maybe the looming referendum and general elections that are preventing the government to curb non-interest expenditures, but whatever the reason, fiscal policy is not supportive of the Central Bank’s gradual exit strategy.

As was the case in previous releases, March budget data is deceivingly strong on the surface. But once you decide to look under the tip of the iceberg, it is hard to overlook the real increase in current transfers and personnel expenses. Most of the improvement in the budget has come so far from revenue increases on the back of the economic recovery, but a look at past data suggests that there is not much room to go on that front. Moreover, the government’s strategy of covering up holes in the budget with indirect-tax patches is not sustainable in the medium-run.

To make matters worse, February’s Balance of Payments does not paint a rosy picture, with the stall in exports and the artificial support of the current account deficit from net errors & omissions becoming hard to ignore. And I am beginning to suspect that the low private sector rollover ratio, a major drag on financing, is a demand problem as much as supply. Whatever the reason, such fragile capital flows could be preventing the Central Bank from stepping up foreign currency purchases, which would be an easy temporary fix to liquidity problems.

With the economy not really supportive of its exit strategy, I am afraid that the Bank could soon find itself in a bind if the inflationary outlook becomes worse.

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

No comments: