Turkey shouldn't have cut rates on Tuesday.
Economic activity has stalled lately, along with industrial production. The 55% drop in oil prices (Brent crude) since June should help lower the currency account deficit and inflation. These trends doubtless help justify the central bank's 0.5% rate cut, to a 7.75% refinancing rate. But the central bank ought to be cautious.
President Recep Tayyip Erdogan has had no qualms about telling the central bank exactly what he thinks it should do. Last week he publicly asked what the CBRT was waiting for, as the rest of the world’s central banks seemed to be cutting rates.
This echoes the events of January of last year — when he was prime minister with an eye on the presidency. Erdogan was playing the same game, being vocal in his opposition to the central bank raising rates to combat high inflation. Analysts at that time were rightly sceptical that the CBRT would tighten policy and risk slowing growth in an election year. But that same month the CBRT delivered a colossal 225bp hike in the lending rate, and won itself some much needed credibility.
The bank was right to ignore Erdogan then and wrong to cave in now.
Turkey still remains one of the emerging market countries most beholden to international confidence. The country relies heavily on international capital markets to cover its current account deficit – the sovereign raised $7.2bn in 2014. Syndicate officials are also expecting a run of international capital deals from Turkish banks this year.
The country needs international investors on its side, and a central bank cowed by a president seemingly hell-bent on lowering rates won’t help. Erdogan’s strident calls for cuts directly contribute to or even cause weakness in the lira — a currency that in the last two years has felt the full force of investor uncertainty.
Turkey weathered the "taper tantrum" well. But Emerging Advisors Group has pointed out that the increase in the credit to GDP ratio, banking system credit to deposits ratio and current account deficit in recent years are all eerily similar to the bubbles in central Eastern Europe and the Baltics in 2000.
It may require a renewed bout of volatility to throw Turkey into turmoil, but the US Federal Reserve's first rate rise could be approaching and the outlook for emerging markets remains uncertain. In this environment, an independent and capable central bank is more valuable than ever.