The new monetary policy makes me question whether the CBT is aiming to gradually weaken the short-term interest rate tool.

From 2002 to the late 2008, when the global economic crisis intensified, the main policy tool of the Central Bank of Turkey (CBT) was short-term interest rate. Before 2008, the banking system had a fund surplus and thus the short-term interest rate applied for the CBT's overnight borrowing from banks. After the global crisis, the CBT activated different tools in order to relieve the banking system and secure that interbank transactions continue.

The picture has changed after November 2010

All or a part of the mentioned tools had been used also in times of tensions in the financial system between 2002 and 2008 (in certain occasions in 2004 and 2006, for instance). Therefore, despite the diversification of tools, it will not be wrong to state that short term interest rate was still the main policy tool until the late 2010. This time, the financial system faced a fund deficit due to which the interest on the CBT's weekly lending to banks (the repurchase rate) became the main policy rate.

Since November 2010, however, the CBT has been implementing a different monetary policy. Short term interest rate is no longer the only policy tool. The CBT also used the reserve requirements and the width of the interest rate corridor (the difference between the interest on the CBT's overnight lending and that on borrowing). Short term interest rate became the main policy tool of the CBT following a troublesome process. A number of arrangements were initiated after the 2001 crisis to make this tool work. Disciplined fiscal policy, the CBT's switch to the implicit inflation targeting regime and the steps taken to revive the banking sector facilitated this process.

The new monetary policy that is in effect since November 2010 makes me question whether the CBT is aiming to gradually weaken the short-term interest rate tool. In my previous commentaries, I drew attention to certain issues with reference to this question. For instance, in order for the policy rate to serve its purpose, it has to be close in value to the interest rate emerging from the interbank transfers so that the interest rate decisions of the CBT can influence the interest rate on deposits and credits. Since November 2010, however, the CBT has been letting the interest rate fluctuate remarkably within the corridor and deviate from the policy rate, mainly due to the concerns about the exchange rate. Then, as you also know, the corridor was expanded significantly (and then narrowed down in August 2011).

Policy change?

On Monday, the Central Bank delivered a speech to bank economists in Ankara. Banks are obliged to keep a certain proportion of liabilities in Lira terms at the CBT. It is the required reserve ratio that set this proportion. In the meeting CBT officials stated that some part of this required reserves might be in dollar terms. The economy pages of all newspapers highlighted this news yesterday.

There is a relationship between the reserve requirement system and the interest rate, the main policy tool. Therefore, the mentioned possibility evokes the above question in my mind even more strongly. Does the CBT aim to gradually weaken the short-term interest rate tool? A second question: If so, does this risk the monetary policy practice in the future, when circumstances smoothen (When? In a couple of years?) I will revisit these questions occasionally from now on.

This commentary was published in Radikal daily on 08.09.2011