Cautious optimism as Central Bank signals 'measured' rate increase

Central Bank Governor Erdem Başçı speaks during a recent press conference in Ankara. 

Long exhausted by lingering uncertainties in global and domestic markets, the Turkish stock exchange and the lira were given a chance to pare gains on the week's first trading day following a signal from the country's central bank that it will consider raising interest rates.
The bank's statements followed a meeting in İstanbul on Sunday with Prime Minister Recep Tayyip Erdoğan, a critic of higher borrowing rates. Monday's signal shows that the central bank appears to be ready to take action to support the currency, even though Erdoğan will be reluctant to see a rate hike that slows economic growth. Observers argue that the government's reaction here will be critical, considering recent speculations over a "high interest rate lobby" which Erdoğan blamed for instigating recent anti-government protests. To many, Monday's statement is now a clear indication that the bank will hike the top end of the rates corridor.
In a rare written statement ahead of a monetary policy committee meeting, Central Bank Governor Erdem Başçı said global policy uncertainty and volatility would not be allowed to damage financial and price stability in Turkey. "A measured step to widen the interest rate corridor will be on the agenda of the next monetary policy committee meeting," Basci said in the statement ahead of the meeting scheduled for July 23.
That suggests the bank is ready to try to stabilize the market by raising its overnight lending rate, the upper end of the “corridor” or gap between the rates at which it lends and borrows money to keep markets and the currency steady.
The central bank's overnight lending rate is currently at 6.5 percent, its one-week repo policy rate at 4.5 percent and its overnight borrowing rate, the lower end of the corridor, at 3.5 percent. Raising the lending rate would effectively increase the real interest rate on lira assets, making them more attractive to foreign investors.
The main benchmark index Bourse İstanbul (BIST) gained 2.45 percent at 75,370 by Monday's afternoon trading session while the US dollar retreated to 1.939 from last week's record 1.974.
The bank intervened in markets heavily last week to shore up the currency as it sank to record lows. Scrambling to stabilize a plunging lira, Başçı's team so far sold $6.3 billion in US dollars to markets. This includes a latest injection of $50 million on Monday. The sale came as the greenback tested a rally against the lira earlier in the day. Meanwhile, the two-year benchmark yield, another critical data, declined to 8.85 percent on Monday from last week's record 9.5 percent.
Emerging markets like Turkey have been hit hard since early May, when the US Federal Reserve (Fed) signaled it may begin withdrawing its stimulus, the first hint of a U-turn in the easy policy the world's major central bank has implemented since the financial crisis. Last month's anti-government protests across Turkey added to pressure on the lira. Fed Governor Ben Bernanke is expected to share new comments on Wednesday.
"The central bank bows to the inevitable. It is acknowledging by these actions that its prior strategy of using foreign exchange reserves to defend the lira simply was not working, and risked just blowing scarce reserves away... clearly indicating that it will hike the top end of the rates corridor," said Timothy Ash, head of emerging markets research at Standard Bank.

Burning up reserves

The central bank had stepped up its foreign currency auction sales since June 11 in a bid to underpin the currency and has now sold $6.3 billion this year. But analysts have pointed out that this only runs down the country's net reserves, which bankers calculate have fallen below $40 billion.
Bankers say the central bank may have to raise the upper end of the rate corridor by at least 100 basis points to stop the currency slide.
"The announcement shows that the bank is ready to take action to calm the markets. This announcement is likely to stop the speculation that the [central bank] is against any kind of rate hikes," JP Morgan analyst Yarkın Cebeci said in a note.
Erdoğan said on Monday the central bank and other institutions were acting "with determination" in response to market volatility and the hints of a tighter Fed policy.
The central bank has been reluctant to hike rates following a credit-fuelled boom, while Erdoğan, aware of the negative impact on Turks of higher borrowing costs, criticized what he called a "high interest rate lobby.”
The lira has lost some nine percent of its value against the dollar since the start of May due to concerns over the outlook of US Federal Reserve's policy as well as last month's anti-government protests across Turkey. The Fed's statements make it even more difficult to maintain foreign capital in emerging markets such as Turkey. It has put pressure on these markets to hike interest rates.
In order to support the lira, the central bank has so far maintained foreign currency auction sales. But analysts say this strategy may be insufficient as its foreign exchange reserves have limits.
Gökçe Çelik from Finansbank said in an e-mailed note that the term “measured hike” is likely to translate into an increase by 1 percentage point in the overnight lending rate, from 6.5 percent currently, up to 7.5 percent.
“We doubt if a hike of 1 percent would be enough to stand against the depreciation pressures of the lira against a backdrop of upward adjusting global yields and thus, expect a bolder increase, i.e. 2.5 percent. … Bernanke's testimony on Wednesday might also be seen as a potential game-changer on the eve of the central bank meeting on July 23,” the note emphasized.
According to economist Süleyman Yaşar, the central bank opted to first reassure markets with a statement but may opt to wait for another month to increase interest rates. Yaşar believes the bank should capitalize on the demand for US dollar in markets and sell the greenback at relatively higher prices. “Let investors buy US dollars while it is profitable for the bank. … We should not be afraid of the lira's depreciation until at some point; an interest rate increase will be made one way or another. If they are going to increase interest rates, the bank should not make the same mistake they did in 2006 and raise interest rates by very high percentages,” he explained.

H1 budget surplus at $1.6 bln, gov't to revise targets

Turkey's central budget posed a TL 3.2 billion ($1.64 billion) surplus in the first half of this year, Finance Minister Mehmet Şimşek announced on Monday, adding that global risks have urged the government to revise its year-end economic targets.
The minister told reporters on Monday in Ankara that Turkey's budget revenues surged by 10.7 percent between January and June over a year ago while tax revenues enjoyed a 20.7 percent increase in this period. The country's primary surplus reached TL 26.4 billion in the first half, Şimşek's press conference on Monday revealed. These figures translate into a strong public financial balance for Turkey. The country, however, has to deal with a structural problem of a high current account deficit (CAD).
In an anticipated move to boost morale in markets, Şimşek said the government is “in full control” of economic developments in Turkey and it “has taken all the necessary steps to mitigate structural weaknesses.” He said the growth in loans and consumer confidence signaled a relatively more resilient domestic market this year.
The minister, however, added that the government is considering introducing a “new Medium-term Economic Program or OVP” following the end of the month Ramadan -- the first week of August. “Turkey is not an isolated island … but is well integrated with global markets and we are monitoring global risks closely,” Şimşek explained.
Observers argue the government is now more worried than before that a lingering eurozone crisis will hurt domestic markets. On Monday, the central bank revised its year-end growth expectations to 3.6 percent from an earlier 4 percent.
Meanwhile, Başçı also said on Monday that the central bank would also double the credit line provided to exporters through Turkey's Eximbank. "This will not only support exports but also increase the pace of accumulation of the central bank's net reserves," Başçı said in the statement.

, , ,


Write Down Your Responses