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Is the fall in interest rates a good sign?
In my last article, I argued that the reason behind appreciation trend of Turkish lira or the downward trend in interest rates is the absence of a solid economic policy framework. I said this was an outcome of the economic contraction and the rising unemployment mainly, and of the recently rising global risk appetite to a certain extent.
I argued that banks' and firms' behaviors in credit market are a reason why interest rates have been falling down. Banks preferred purchasing Treasury bills the supply of which has increased rather than extending credits to firms whose riskiness have increased in the current climate. Additionally, they preferred to stay more liquid compared to the period before the crisis. Yet, the second behavioral pattern is not as intense as it was in the period when the crisis was deeper due to the recent positive climate.
On the other hand, borrowing and in particular demanding investment credits in an environment where domestic and foreign demand did not even show a sign of a wriggle was quite senseless for firms, who cut production and laid-off workers. Therefore, both demand for and supply of credits would decrease.
The natural result of the given behavioral pattern was that banks direct gradually higher proportion of the resources they hold to treasury bills. As budget deficit and thus the borrowing requirement of the treasury increases, supply of bills to meet this demand arises. In addition, expectations of a lower policy interest rate in the future increase the demand for bills now. As a result, price of treasury bills increase while the interest on the bills decreases.
The figure below shows the deposit to credit conversion ratio. The rate increases until fall 2008 when the global crisis gradually deepened: Banks convert gradually higher proportion of the deposits they collect to credits. However, in mid-October, the ratio starts to fall. The pace of fall has stabilized recently, but after all it is 12 points lower compared to the period where the ratio peaked. The same observation can be made as well considering the amount of bills banks hold. Latest data is for May. And the share of bills in proportion to total resources increases since October. The share of credit falls almost proportionally.
In brief: When assessing the outcome, it is also necessary to deal with how it occurred. This general fact is more valid in particular considering the interest rate issue. The reasons leading to the fall in interest rates are not much favorable.
Figure 1: Ratio of deposit to credit conversion: Jan 2008-July 2009 (%)
This commentary was published in Radikal daily on 09.08.2009