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    Who is to blame for the confusion?

    Fatih Özatay, PhD17 April 2012 - Okunma Sayısı: 1035

    It doesn’t matter if the CBT increases the one-week repo rate, which it calls the “policy rate” but actually is not.

    Central Bank’s Monetary Policy Committee (CBT - MPC) will hold a routine meeting tomorrow. The release issued after the MPC meetings refer to an interest rate called the “policy rate.” This corresponds to the interest on CBT lending to banks via one-week repo auctions. The rate has been standing at 5.75 percent since 4 August 2011. For some time now, there has been going around a meaningless discussion on whether or not the CBT should raise the rate.

    I find such discussions meaningless as the rate per se is not of significance anymore. The reason is quite simple: For a very long time, banks have been borrowing from the CBT on a short-term basis. Under these circumstances, in order for the rate that is declared by the CBT or that appears as a result of its certain transactions to be called the “policy rate”, it has to equal the interest rate on CBT’s lending to banks. The CBT however has been pursuing a different policy since 29 November 2011, under which the interest on lending to banks is set on overnight basis. The interest rate which the CBT calls the “average funding cost” has stood at a minimum 7 percent since November and has been floating between 7.7 percent and 10.2 percent since March 23. While I was writing these lines, the interest rate for Friday equaled the latest funding cost available, which stood at 9.4 percent. The rate reached as high as 11.9 percent by the beginning of January.

    In short, the funding cost is the actual policy rate for the CBT. It is not that the CBT does or should announce a single rate. In fact, there are a number of rates the CBT announces. For instance, overnight lending rate is 11.5 percent and overnight borrowing rate is 5 percent. In the context of the late liquidity window applying for transactions between 4 pm and 5 pm, a bank which could not sell the liquidity to another bank via the interbank market receives zero interest for lending to the CBT. If a bank in need of emergency liquidity between 4 pm and 5 pm, it borrows from the CBT at a 14.5 percent interest. These, therefore are penalty rates. Moreover, a market maker banks can borrow from the CBT at an overnight rate of 11 percent instead of the regular 11.5 percent. There also are the rediscount rate at 17 percent and the advance rate at 17.75 percent. Lastly, different interest rates are implemented on the FX accounts of citizens residing abroad depending on the currency and the maturity of the deposit.

    Nevertheless, we are not interested in each and every one of these rates varying between zero and 17.75 percent. Evidently, for a bank which has to meet the deficit after 4 pm, the 14.5 percent late liquidity rate is of importance. The rate that is of interest to the financial markets as a whole, however, is the CBT’s lending rate, given the fact that the banking sector has been borrowing from the CBT for a significantly long period now. And as I also stressed above, this rate is not the one which the CBT calls the “policy rate.” It is rather the “funding cost” that has lately been floating between 7 and 11.9 percent. To cut it short, the CBT has already been implementing a tight monetary policy since 29 November, evident from the fact that it has increased the interest on (the cost of) lending to the banking sector, considerably. In this context, it doesn’t matter if the CBT increases the one-week repo rate, which it calls the “policy rate” but actually is not, from 5.75 to 6 or 6.75 percent. Such an action can only give a signal to the markets but not else.

    There is one thing that matters, however: the overnight lending rate at 11.5 percent and the overnight borrowing rate at 5 percent constitute the upper and the lower limits of the interest rate corridor. The weekly repurchase rate, which the CBT calls the policy rate but actually is not, and the rate, which the CBT calls the funding cost but is actually the policy rate; have to remain within the corridor. Therefore, possible changes in the upper and the lower limits might be of importance and might have many signal effects which I will handle one by one later.

    Apology: I know I used extremely long definitions such as “the weekly repurchase rate, which the CBT calls the policy rate but actually is not.” But I think it I’m not to blame for the confusion, right?

    This commentary was published in Radikal daily on 17.04.2012