The Turkish central bank’s unorthodox monetary policy was initially criticized but now it is increasingly hailed as a success
The unorthodox monetary policy put in place by the Turkish central bank was controversial but has gradually earned praise for its governor, Erdem Basci, as time has passed.
In late 2010 and early 2011, Turkey cut interest rates and raised banks’ reserve requirement ratios to combat inflation by curbing credit growth while trying to fend off capital inflows by depreciating the currency.
The bank also resorted to adjusting overnight lending rates, one-week repo rates and currency intervention among its unorthodox policy measures as part of a strategy to shift growth from a domestic demand-driven to an export-driven model.
Eric Curiel, strategist at Esemplia Emerging Markets, an equities manager, says Basci had pushed through his “unorthodox” policies in the face of scepticism. “We have seen the economy accelerate nicely, and the current account deficit has narrowed, and the lira has been pretty well behaved,” he says. “This is testament to the fact that he has done a really good job.”
One result of the policy was a jump in inflation. In 2012, inflation spent the first half of the year in double digits and twice the bank’s 5.5% target, but fell to single digits in June and July.
Michael Ganske, head of emerging markets research at Commerzbank, praised the central bank’s decision to accept relatively high inflation and a current account deficit. “They didn’t tighten policy, and that’s why they ended up with 8.5% growth. From a long-term perspective you would expect Turkey to get hammered, but they didn’t. The central bank did a very good job.”
Gaëlle Blanchard, emerging markets economist at Societe Generale, says the unorthodox policy worked, as the central bank managed to cool credit growth while keeping the currency under control.
Murat Ulgen, HSBC’s chief economist for central and eastern Europe, says Basci engineered a “new equilibrium on inflation prospects, financial stability and the exchange rate.
“I would say it is going well, partly because of monetary policy and partly because of structural reforms and partly because of the confidence that is provided by stability of policymaking,” he says.
David Lubin, head of emerging markets economics at Citi, says that while it might seem “odd” to give an award to a central bank that failed to meet its inflation target, the currency depreciation had given Turkey a competitive gain. “To its credit, the bank has captured the mood of central banks globally: it may not make sense to be too rigidly committed to pure inflation targeting in a world full of threats,” he says. However, he adds that a “clearer communication” of their objectives might have been welcome.
Blanchard says that Turkey needs to make structural reforms, which are more of a long-term issue, and warns that “a big boom in domestic demand would derail the train again.”
“[The policy] has been successful,” Blanchard adds. “Will it last? Politically it’s difficult to push too much on the demand side. The slowdown is not a hard landing so far; it’s a soft landing
EM INTERVIEW Emerging markets have learned the hard way that the cost of preventing financial crises is much smaller compared with the cost of going through a financial crisis, Erdem Basci, Turkey’s central bank governor, says.
“The Turkish economy is no exception,” he tells Emerging Markets. “The banking crisis of 2001 cost the Turkish taxpayers 30% of GDP.”
That crisis, which started when $6.4 billion flew out of the country in just 15 days at the end of the year 2000, and overnight interbank interest rates surged to 1,700%, only became worse in 2001 after a brief respite. In 2001, interbank rates hit 5,000%, stock prices collapsed and many banks became insolvent.
The prudent policies and structural reforms that followed that crisis have improved the resilience of the economy and the financial system, Basci says.
He believes the global financial crisis of 2008–09 and the eurozone debt crisis have been “important stress tests” for the Turkish economy. “The post-2009 recovery was very rapid and V-shaped. We were able to use monetary policy in a counter-cyclical fashion for the first time in recent Turkish economic history.”
The bank noticed “an extremely rapid credit growth” in 2010 due to solid fundamentals, low leverage and strong growth prospects, with the pace of the increase exceeding 35% by the end of that year, driving the current account deficit to historically high levels of nearly 10% of GDP. The exchange rate was also “overvalued” at the end of 2010, Basci says.
“Therefore we chose to tighten macroprudential instruments to curb the excessive credit growth while keeping short-term interest rates at relatively low levels until the last quarter of 2011,” he says. “Towards the end of 2011, the eurozone debt crisis intensified, this time causing an undervalued currency. Therefore it was appropriate to use monetary tightening while easing the macroprudential instruments to some extent.”
“The richness of the set of instruments and the ability to adjust the policy mix as the circumstances warrant produced desired results,” Basci adds, noting that credit growth slowed to 25% by the end of last year and to “more sustainable levels” of around 15% recently.
“The currency is among the least volatile compared to emerging market currencies, the external balance is improving, and inflation is seen to fall to the target of 5% by mid-2013 despite elevated food and energy prices,” he says.