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Partly back to the conventional
The CB’ decision will increase the predictability of short term market interest rates. From one perspective, this in a sense indicates a return to a more “conventional” policy framework.
The Central Bank of Turkey (CB) declared that the interest on overnight interbank operations (short term market rate) will be kept at a level close to the upper limit of the interest rate corridor at 7.75 percent. The CB has the tools and the authority to do this. The banking system is in liquidity shortage and it has to borrow from the CB. Despite this statement, however, the common view is that due to certain technicalities, the average cost of the CB’s lending to banks will stand around 6.75 percent.
Apart from the 7.75 -6.75 percent confusion, this decision will increase the predictability of short term market interest rates. From one perspective, this in a sense indicates a return to a more “conventional” policy framework. From another perspective, however, there is no sign of a return to the conventional: the CB could have increased the predictability of short-term market rate via choosing a strictly conventional monetary policy, say simply by narrowing down the interest rate corridor. But it did not.
I read the main reasons as follows: first, financial markets are surrounded by uncertainties, chief among these being what the Federal Reserve (FED) will do and when. Second, albeit all the uncertainty, one thing is clear: the FED will eventually take the anticipated steps and as a result net capital inflow towards Turkey will decrease and exchange rate will be pushed up. Third, this might accelerate inflation depending on the magnitude of the exchange rate hike. And please note that Turkey’s inflation is already high.
In response to this atmosphere, the CB wants to be flexible and tries to maintain a wider interest rate corridor. Yet, the corridor being wider blurs the way market rate will follow. With lower net capital inflows, the CB wants to avoid uncertainties that would discourage inflows and thus tries to enhance the predictability of interest rates. On the other hand, given high inflation, it tries to keep interest rate within the corridor.
Another step that fits the “conventional” monetary policy framework is that the task to limit credit growth rate was left to the Banking Supervision and Regulation Agency (BRSA). Lately the world is almost in consensus that rapid credit growth invites crises. Steps that could ensure financial stability by keeping credit growth below the threshold of “danger” have been discussed all around the world.
To this end, the CB has increased the required reserve ratio several times starting in the late 2010. I have written over and over why that attempt would most likely fail. By the early 2012, the required reserve increase had an undesired outcome: before the CB realized the step, it had to implement a decision in the opposite direction. It was then understood that required reserve ratio is not a flexible policy tool.
If the objective is to limit credit growth, it is the BRSA who has the tools and who should handle the task. Otherwise, the CB’s efforts run into the ground and the monetary policy framework becomes more complicated for no reason. The BRSA has initiated a series of steps lately to lower credit growth rates and the CB stopped using required reserve ratio for this purpose. Eventually, the right move was made.
This commentary was published in Radikal daily on 21.11.2013