Domestic economic policy will make a limited contribution to growth. All we can do is hope that international conditions do not deteriorate

In the first three quarters of the year, growth rate was significantly below the potential, translated into rigidity of unemployment around 9 percent. Yesterday, unemployment rate for June was announced at 8.9 percent (seasonally and working day adjusted), which verified the rigidity once again. Then, what can be Turkey’s economic policy response to the slow growth?

Latest figures, remarks by the minister of finance and stories highlighted in press reveal that fiscal loosening is not a viable option on economic grounds. So, we have to focus on monetary policy. First things first: Turkey’ monetary policy was relatively loosened lately. The average cost of Central Bank (CBT) lending (that is the actual policy rate for the CBT) floated around 8.6 percent over the first seven months of the year. As of August, average funding cost decreased considerably to 6.6 percent and is around 6.2 percent as of the last week.

Of course, this might raise the following question: “upper and lower limits of the policy rate corridor are predefined. The upper limit is 11.5 percent currently. Then, the rate can reach as high as 11.5 percent – or slightly below – at any moment. This is a source of uncertainty for banks. Then, would banks continue regarding high levels of loan cost taking this uncertainty into account?” This is a legit question. There are hints that banks generally act in this fashion. Yet, with the expected decrease in inflation in the fourth quarter, the rise in capital inflows and the growth rate weaker than projected, a sudden hike in the policy rate is least likely. Still, by lowering the lower the upper limit or both upper and lower limits of the interest rate corridor, the CBT can reduce this possibility for banks and ensure a certain decrease in interest on deposits. In addition, by lowering the required reserve ratio, the CBT can help banks keep more funds to extend credits. However, we should note that the CBT reduces the efficiency of such policy by laying down as a condition that a part of funds shall be kept in foreign exchange or gold.

Evidently, it is a bit naïve to think that such steps will immediately stimulate domestic demand. After all, banks’ appetite for offering credits must be accompanied by a rise in credit demand. Limited fall in interest on credits alone cannot enable a considerable rise in credit demand. Risks stemming from international markets also must fade. Latest decisions of the FED, European Central Bank and German’s Constitutional Court have lowered international risks. In a couple of months, however, the debate on the debt ceiling for the US Treasury will once again become a top agenda item. If Obama wins the election, how will Republicans react? Will their reaction force the US tighten the budget at the wrong time? These questions are yet to be answered; there exist profound uncertainties. Therefore, we must not anticipate an instant recovery in private sector consumption and investment loan demand. Still, the fall in interest rates might enhance the demand for consumer loans.

The multi-objective strategy of the CBT makes it harder to interpret the economic outlook. The recent fall in the actual policy rate of the CBT also has to do with the growing foreign fund. In fact, the CBT previously stressed that “extreme” capital inflows would be disturbing. In the end, whatever main objective(s) of the CBT are, the continuation of the current monetary policy loosening is possible only for a short time; sustaining a stronger loosening policy for a longer time frame is not probable. The loosening can be sustained “for a short time” because inflation will decrease substantially in the last quarter. This, coupled with the weakening of domestic demand can justify some loosening. The magnitude and term of monetary policy loosening, however, cannot be extended as oil prices are high. At the end of the year, inflation rate might be realized at a rate quite above the CBT estimate at 6.2 percent. Furthermore, international risks mentioned above will fall into place by the end of the year. Under these circumstances, domestic economic policy will make a limited contribution to growth. Put in a nutshell, all we can do is hope that international conditions do not deteriorate in 2013.

This commentary was published in Radikal daily on 18.09.2012