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    What steps will the Central Bank take next?

    Fatih Özatay, PhD13 November 2012 - Okunma Sayısı: 872


    The only factor that could possibly limit foreign exchange inflows towards Turkey and its peers is the risk of a fiscal cliff in the US.

    Here is a quote from the Central Bank’s (CB) latest Inflation Report, page 12 (similar statements can be seen in the Monetary Policy Committee Meeting Minutes, Article 15): “a resurge in short term capital inflows may slow down the rebalancing process through rapid credit growth and appreciation pressures on domestic currency. Should such a risk materialize, the CBRT may keep short-term rates at low levels while tightening through macroprudential tools such as reserve requirements. Moreover, the automatic stabilizer nature of the Reserve Option Mechanism will support financial stability.”

    Conditions highlighted here are the conditions that have been affecting Turkey since the late 2010. Can Turkey face a similar situation in the period ahead? Unless external conditions deteriorate, Fitch’s upgrade on Turkey’s credit rating to investment level will strengthen foreign exchange inflows. If the two major credit agencies besides Fitch also increase Turkey’s rating to investment grade, we should expect foreign exchange inflows further strengthen.

    Such upgrade is not expected in the next months, however. Therefore, it will be useful to review the external conditions. Risks that stem from Europe are weaker compared to the first eight months of the year, thanks to the latest ECB decision in September. There still are several risks; but markets were relieved after the ECB’s declared that on the condition that crisis countries take the required steps, it will take action in support. Right after, the FED announced that a new quantitative easing was on the way and the decision is effective currently. Interest rates are extremely low in Europe and the US both. On the other hand, European growth is sluggish and this week growth estimates for 2013 were revised downwards at a large degree.

    Given this picture, it is by nature that abundant liquidity will flow towards Turkey and peer economies. The amount of foreign fund inflow to Turkey recently was already above the fund requirement of the economy. The only factor that could possibly limit foreign exchange inflows towards Turkey and its peers is the risk of a fiscal cliff in the US. If Democrats and Republicans cannot reach a consensus, automatic tax raise and expenditure cuts will become effective by the end of the year, that is, before the economy fully recovers. Then, the debt-ceiling issue will come on the table. This as a whole is a major risk on the world economy.

    In this context, we shouldn’t expect extensive foreign exchange inflows towards Turkey and peer countries unless it becomes definite how the US will solve the fiscal cliff problem. Therefore, in the first phase, the CB will stick to the plan initiated in September. It will most probably lower the upper limit of the interest rate corridor and keep the average funding rate between the policy rate at 5.75% and the lower limit of the corridor at 5%.

    Given the current external conditions discussed above, the downwards pressure on the value of the lira will continue if the fiscal cliff problem is solved without any negative consequences on the recovery process and if the circumstances in Europe do not worsen. In that case, the CB will gradually put into effect the policy highlighted above:

    First, it will lower the interest rate corridor to further reduce and float the average funding requirement. Also, it may consider increasing the reserve options coefficient in order to encourage banks to keep more foreign exchange at the CB. We shouldn’t expect a raise in required reserve ratio without a sign of a significant increase in growth rate, however. This option will be come on the agenda later on.

    And please note that I am not raising these as steps that should be taken. I am just opening to discussion steps the CB can possibly take in the light of official statements.

    This commentary was published in Radikal daily on 13.11.2012