Even in conditions of global turmoil, few monetary authorities have cut policy rates as audaciously as the Central Bank of Turkey (CBOT). In slashing its overnight lending rate from 16.75% to 7.75% between October and August, the bank has put historically-rooted fears of capital flight and currency collapse to rest, while perennially high inflation has touched 40-year lows of under 6%.
Governor Durmus Yilmaz refuses to take any personal credit for the bank’s correct call. “It has been teamwork from top to bottom,” he says, adding: “We inherited a culture both in terms of central bank independence and our institutional capacity to analyze data and take the appropriate decisions.”
The governor insists that the bank has not put growth concerns before inflation. “Our first concern is price stability... By interpreting the data correctly we have been able to bring inflation down first and then interest rates. It’s not the other way round.”
Yilmaz’s three years in the post have not been easy. He began inauspiciously as a last-minute compromise candidate and was soon grappling with domestic political noise and global liquidity tightening. In the summer of 2007, the CBOT hiked policy rates by 425 basis points as the lira wobbled. A year later it was obliged to abandon its inflation target of 4% in the face of soaring commodity prices, settling instead for 7.5% in 2009, 6.5% in 2010 and 5.5% in 2011.
Yilmaz stands by both moves. The rate hikes, he argues, “turned out to be a blessing, because we have been able to contain inflation, and because it gave us room to slash interest rates as much as we have done under the current circumstances.”
Adjusting the inflation targets, he recalls, was “very painful”: “If I were to give advice to any central banker it would be ‘Don’t do it.’ Because it involves credibility... It’s a double-edged sword: if you don’t change the target and you don’t achieve it, you lose credibility. But if you change the target you also lose credibility. We took the risk, and we changed it and increased interest rates at the same time so that our determination to bring down inflation should be read correctly by the markets.”
Yilmaz is not content with the current level of inflation, but he believes that reducing it to an internationally acceptable 2–3% must be a gradual process. “It has to be sustainable. Let’s say one year you reach the acceptable target and the next year you are not able to maintain it. That’s not price stability... And secondly, going very fast has welfare costs, economic costs, output costs...”
When the world economy recovers, a rise in commodity prices will pose inflationary risks for Turkey, Yilmaz notes. Another key issue is fiscal policy: “Turkey has an opportunity to maintain single-digit interest rates, but... the government has to commit itself to a fiscal rule in which both the expenditure and the income must be clearly stated, and Turkey still needs to target some sort of primary surplus.
“This is not only true for Turkey. The question for the world is, how the fiscal measures are going to be unwound and the timing and their impact on the budget deficit. It’s not a promise to keep the interest rates very low for a very long time; it’s a conditional statement...’