Monday, October 4, 2010

Weekly Hurriyet Column: You don’t mess with the CBT

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. I managed to come up with another cheesy title, which, in hindsight, turned out to be a very good choice, but you'll have to wait for my addendum for why.

Speaking of that, since I again have a lot to say and I want to get the piece out to my blog readers ASAP, I will have another separate addendum in the next 24 hours, where I will explain, among other things, why the movie reference in the title turned out to be a smart choice (Hint: Think about what the Bank of Israel had been doing as an exit strategy even before CBT President Durmus Yilmaz was talking of exit)...

Anyway, on to the column:

The Central Bank of Turkey, or CBT, has been quite active for the past couple of weeks.

First, it finally delivered the much-awaited rate cut, at least if you were to believe the papers. 

Actually, by cutting the overnight borrowing rate, the Bank simply commenced with the second stage of its preannounced exit strategy by widening the spread between its effective lending, the one-week repo, and borrowing rates. The former, which is also the key policy rate, was unchanged.

More unexpected was how rapid the Bank continued with this second stage. Shortly after hinting it would do so at the one-page summary of its rate decision, it not only increased the lira and foreign currency required reserve ratios, but also surprisingly halted paying interest on lira reserves.

These two moves should be seen in conjunction. The first one is discouraging banks to borrow from the CBT and encouraging interbank lending. By improving money market efficiency, the CBT can then achieve more with less. The second set of measures has pushed the overnight money market rate towards the policy rate. The idea is to eventually have a policy rate similar to the U.S. federal funds.

As an added benefit, the CBT is able to tackle the robust credit growth with textbook economics. But I would still label the measures as policy normalization rather than tightening, as the recent rise in capital inflows, thanks to the new wave of money flooding into emerging markets in the aftermath of the Fed’s quantitative easing II, has significantly reduced the need for the Bank to provide temporary liquidity via repo auctions.

Just as the global climate seems to have helped the CBT in moving ahead with its exit strategy, it also makes sense to view the Bank’s most recent action of adding some discretion to its foreign currency auctions under an international lens, especially after comments by the Brazilian finance minister Guido Mantega that an international currency war has broken out.

I would not go as far as to label the CBT’s move as a sign that Turkey has taken its place on the trenches. The Bank has simply come up with a smart way to counter lira appreciation pressures and build reserves. Unfortunately, the ample liquidity means that the interventions are likely to be sterilized and therefore have a muted effect on the lira.

However, more discretion means more uncertainty, and the new system could work by making foreign currency trading more dangerous and signaling speculative capital that you don’t mess with the CBT. But uncertainty is a two-edged sword, and the Bank would have to make sure that it is not perceived as pursuing a managed floating regime - just ask George Soros the consequences of that.

The bank has also increasingly been emphasizing financial stability of late. Never mind that this is a contested topic globally or that there is already an institution in Turkey for that task. Or that financial stability is not in CBT Law. Or that the Bank has no say in most of the necessary macroprudential regulation tools. The CBT has just found another excuse to delay the rate hikes, so its recent actions are unlikely to be followed by one anytime soon.

While these new measures point to a brave new CBT, I wish the Bank had been more vocal in voicing its concerns over fiscal policy, especially since fiscal policy could more effectively cope with capital inflows. I also have not figured out why it has not taken a more active stance against the over-appreciated lira lobby, which is likely to start whining again soon.

A more vocal Bank could have also told me what would happen if the sum of all fears, a strong lira and slowing growth along with sticky inflation, were to materialize.

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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