The central bank cut the interest rate corridor by a quarter of a percentage point to 4.5% for the overnight borrowing rate and 8.5% for the lending rate and the lending rate for the late liquidity window to 11.5%.
The interest rate on borrowing facilities for primary dealers via repo transactions was also cut by 25 basis points, to 8%, a press release published on the Turkish central bank’s website said.
The reserve requirement ratios (RRR) for Turkish lira (TRY) liabilities with less than a year maturities were hiked by 25 basis points, while those for foreign exchange liabilities with maturities shorter than a year were hiked by 50 basis points, according to analyst Nilufer Sezgin from Erste Bank.
The central bank has not yet published on its website the press release detailing the decision on RRR but a statement from January shows the previous RRR levels as being between 6.25% and 11.25% for Turkish lira deposits maturing in less than one year and at 12% for foreign exchange deposits of less than one year.
In the statement regarding interest rates, the Turkish central bank said that credit growth “displays a significant acceleration amid strong capital inflows” and that therefore it considered keeping interest rates low while continuing to tighten via reserve requirements to be “the proper policy.”
“This is no surprise,” Sezgin said. “Prior to the meeting, we had stressed that the real exchange rate surpassed the CBT’s overvaluation zone and that credit growth had accelerated to above the CBT’s guidance.” The move highlights the “Catch-22” situation in which the Turkish central bank finds itself, according to Capital Economics economist William Jackson. On the one hand, the bank is under pressure to cut rates but on the other, it needs to prevent domestic demand based on credit growth from surging.
CREDIT GROWTH
Credit growth was just shy of 20% in recent weeks, whereas policy makers have said they want the pace of growth to slow to 15%, Jackson said.
“Rising bank lending leads to stronger domestic demand which tends suck in imports, and could thus cause Turkey’s external imbalances to widen again,” he said.
Turkey’s current account deficit, a major headache for the central bank, shrank to around 6% of gross domestic product last year from above 10% in 2011.
But Jackson noted that the increase in bank lending over the past few weeks seemed to have been funded, at least partially, by borrowing from abroad rather than from relatively stable deposits, adding to the banking sector’s already large short-term external debt stock.
“This leads us to a bigger point, namely that while attention is currently focused on excessive ‘hot’ inflows, Turkey’s large external financing requirement makes it highly vulnerable to any disruption to capital inflows,” he said.
Lowering interest rates while increasing RRR “seems to be the new policy mix of choice on the part of the central bank, still favoring a dovish bias on the rates front, just to make sure that the TRY does not strengthen too much but also keeping a close eye on credit developments,” Societe Generale currency strategist Benoit Anne said.
The Turkish lira may weaken temporarily after the announcement, but Anne believes being exposed to the bond market in Turkey “still makes total sense.”
“I like the country’s fundamentals and the way the authorities run their policies,” Anne said. “We used to think that Turkey needed to learn from Brazil a few years ago. I now think the opposite is true.”
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