Has Turkey made the right decision to raise interest rates despite government opposition?

Bloomberg News, Thomson Reuters News, and a whole host of news agencies reported on January 29, 2014 that overnight, the Turkish Central Bank announced quite an alarming decision in raising interest rates across the board. The overnight lending rate was raised to 12.0 percent from 7.75 percent, its one-week repurchase agreement (repo) rate to 10.0 percent from 4.5 percent, and the overnight borrowing rate to 8.0 percent from 3.5 percent. The Turkish Lira currency strengthened overnight to 2.18 to the US Dollar following the announcement of the decision, up from 2.25 late on Tuesday, and after hitting the 2.39 earlier on Monday, January 27, 2014, which was one of the latest series of lows that were impacted by emerging markets selloff since last week.

The latest decision coming from Turkey Central Bank governor, Mr. Erdem Basci, runs counter with Prime Minister, Tuyyip Ergodan’s overall economic growth objectives as the government is embroiled in several high profile political scandals involving corruption, and it is now facing an election due to be scheduled in two months’ time. He has advocated for lower borrowing costs, criticising those opponents who seek for low economic growth which could potentially worsen the entire set of economic fundamentals going forward. This latest disagreement between the legislation and the Central Bank is one of the best cases for illustrating Central Bank independence. It is only through independent analysis of the economic environment, making forward projections, analysing the impacts that Central Banks are able to function effectively, and not subject its policies to the whims and fancies of the government.

A Thomson Reuters poll of 31 economists on Monday have forecasted a 2.25 basis points (bps) rise in the lending rate, and only one of them forecasted a move that is quite significant as shown by the latest interest rate hikes coming from the country. It clearly shows that the Central Bank has shown no hesitation in stemming the potential systemic financial contagion that might arise if the ongoing market turmoil were to impact the proper functioning of the Turkish economy.

The latest moves by the Turkish Central Bank are quite significant considering that the Turkish Lira has made a dramatic comeback to strength. However, there are some questions that many might ask will be issue of sustainability and stability of the Turkish economy going forward given this latest dramatic set of interest rate hikes. It is quite difficult to tell given that Turkey has seen various episodes of significant volatilities to the Turkish Lira currency dating back to as far as 2001 due to its relatively undeveloped financial markets, and so-called ‘financial repression’ where fiscal and monetary policies are not being managed properly using independence, tight oversight and forward looking perspectives.

The Turkish Lira currency has since returned to some form of normalcy for now, but does it guaranteed that future occurrences of such magnitudes in the currency moves will not happen in Turkey? The Central Bank governor, Mr. Basci has chosen to bow down to political pressures by developing a mechanism involving multiple benchmarks, which will allow him and his team to tighten policy without raising rates, and vary monetary conditions day-to-day within an interest-rate corridor. It is designed to be flexible in order to meet any potential sizeable moves to the Turkish Lira currency and interest rates. Earlier, the latest interest rate hike decision was done in a manner that appeared to indicate that the Turkish Central Bank has ran out of all options in a bid to calm the financial markets. Following these latest series of market turbulences, and in order to fend off any future volatility, the Turkish Central Bank decided to go ahead and simplify its operational framework. It also wants to have the necessary so-called monetary ‘bullets’ in order to remain vigilant in future potential financial contagion events such as this latest case.

I believe that Turkey together with India with its similar rate hike decisions made yesterday, January 28, 2014, were intended to remove any uncertainties and have largely been welcomed by the global financial community. Going forward, Central Bankers and government policy makers of many of these emerging economies have to be prepared for future market gyrations following the latest series of domestic currency declines against the US Dollar. The implementation of capital controls must not be introduced unless the Central Bank policy makers have clearly ran out of options. In the wake of the US Federal Reserve (US Fed) slowly reducing its bond purchases, there is an urgent need for many policy makers in these emerging economies to start implementing investment friendly reforms including free trade, property rights, encouraging local entrepreneurships, among others so as to be prepared for any unexpected events such as the latest series of global market turmoil.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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