Analysts bashed Turkey’s central bank following a surprise cut on August 4 that brought the policy rate to 5.75% from 6.25%. The move formed part of a broader policy mix that, on balance, resulted in monetary easing.
The main bone of contention is that many analysts believe Turkey’s economy is overheating, making a rate cut seem reckless. However, a variety of data suggest overheating concerns are misplaced and point to a sharp global downturn as the bigger worry, as I will detail below.
While the central bank (CBRT) could certainly improve its signaling of policies, I am willing to give the CBT the benefit of the doubt for now. The real test will be whether the CBT proves as proactive at raising the policy rate when conditions require it.
Criticism of the CBT
The quote below from Tim Ash of RBS, as published by the FT, is representative of many in the overheating camp:
“The danger with this totally out of the box move is that investors will seriously begin to question the credibility of the CBRT as an institution, given that foreign investors prime concern at present on Turkey are fears of overheating as reflected in the CAD.”
Also, see this comment from Danske Bank:
“Turkish GDP growth is still in double-digit territory and the current account has clearly grown to an unsustainable level. Any normal inflation targeting central bank with this kind of data would tighten and not loosen monetary policy.”
Rejoinder to Overheating Claims
The domestic economy is showing signs of moderating, rather than overheating. Yes, GDP has grown strongly, but this has to be seen as part of a natural bounceback in the wake of a sharp downturn. This rapid pace of growth is not expected to continue.
Below I highlight some data that suggest Turkey’s economy is not overheating.
Figure 1: The capacity utilisation rate sits below pre-crisis levels and dipped in July
Figure 2: The annual rate of growth of industrial production has fallen steadily for the past five months
Figure 3: The real sector confidence index – an indicator of business conditions and an important leading indicator of growth – dipped in July to its lowest level since 2009
Figure 4: Inflation is above the year-end target of 5.5%, but not far above, and it’s quite low in a historical context
Sidenote: Many in the overheating camp point to a high current account deficit, approaching 10% of GDP in 2011, to support their claims. The current account deficit is certainly high and this is quite worrisome. However, the deficit is largely structural (owing to Turkey’s heavy dependence on energy imports as well as a chronically low savings rate). This means that it’s not a short-term problem and neither the central bank nor government can simply wave a magic wand and fix it. I will tackle this issue in a later blog post.
Worrying Signs in Advanced Economies
While the domestic economy is showing signs of moderating, the data above do not by any stretch of the imagination justify a rate cut. So it’s necessary to look at the worsening outlook in the US and eurozone, which I detail below, to understand why the CBT opted to slice the policy rate. As the global financial crisis showed, Turkey’s economy is quite vulnerable to developments in the advanced world.
- The Fed Open Market Committee recently highlighted the downbeat state of the US economy in its August statement and said economic growth in 2011 is slower-than expected.
- In July, the US government released its latest set of growth figures – including revisions going all the way back to 2003 that show the recession was worse than expected. The contraction in real terms, from peak to trough, was 5.1% – one percentage point worse than thought. See related article from BBC.
- In his August 26 speech at the Jackson Hole conference, Bernanke noted that output in the US has still not returned to pre-crisis levels and that unemployment continues to hover at rates of over 9%. He also said that the Fed has revised down its US growth outlook. At the same time, he made no commitment to any new quantitative easing measures.
- There is no resolution to the eurozone crisis on the horizon given ongoing political wrangling, and problems seem to be intensifying with Italy moving into the spotlight. The ECB’s bond buying is only a stopgap measure, as Marc Chandler notes in his recent post: Why I Am Going to Worry About Italy on My Summer Vacation.
In an April presentation, the CBT notes its desire to keep interest rate differentials as low as possible in order to prevent large inflows of speculative capital into Turkey. The concern is that such flows can rapidly reverse in the event of an external shock or shift in investor sentiment. The CBT’s decision to cut the policy rate supports this objective as it narrows the interest rate differential vis-à-vis advanced economies.
Note of Caution: Political Pressure May be a Factor
Yavuz Canevi, who helmed the CBT in the mid-1980s, gives voice to worrisome rumblings that pressure from the government may have helped motivate the surprise rate cut.
According to Bloomberg, Canevi said: “I really would not say that the central bank had pressure, but psychologically you can call it pressure. The current governor is much closer to Deputy Prime Minister Ali Babacan than the previous governor. They were childhood friends” and Basci is trying “to accommodate the policies of the current government.”
I believe the real test will be whether the central bank proves as proactive at raising rates when conditions change and this is something to carefully track.
A range of indicators show domestic economic activity is moderating. Turkey has a wide current account deficit, but that’s largely a structural problem (a very big problem!) and there are no quick fixes. Meanwhile, the global economy looks headed for increasingly choppy waters.
In light of these events, the central bank’s decision to cut the policy rate does not look so absurd and could even be hailed as ahead of the curve. While part of the CBT’s motivation to cut rates may be due to indirect political pressure, I am willing to give it the benefit of the doubt for now.