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What does the statement by the Central Bank imply?
Yesterday, Central Bank of Turkey (CB) made important statements. How will the changes to be implemented in the monetary policy in the context of this statement affect the corporate sector and consumers? It will not. There is nothing much that is our concern. However, I want to discuss the statement anyway. I will first want to apologize as this will be a technical comment to a large extent.
The first policy response to the negative impacts caused by the global crisis came from the CB. Monetary authority announced the first measure against the crisis in October 2008 while the first response in the context of the fiscal policy was heard in March 2009. When noting this difference we should also underline one thing: the main reason for this time difference was most probably the fact that the money markets felt the impacts of the crisis much sooner. Back then, optimistic growth estimates were made throughout the world. However, also relying on the experiences from the previous crisis, the Central Bank immediately took the right step in the right direction.
The earthquake that emerged from the financial system of developed countries first led to problems in the foreign exchange market. So, the first measure the CB took was geared to the foreign exchange market. Soon the impacts of the crisis were also felt in the transactions in lira terms. The weakening of confidence as a result of the ambiguity distorted the functioning of interbank money market. Lira liquidity problems appeared. Therefore, the CB also started to lend to banks with a longer maturity than usual.
The impacts of the crisis were seen also in the credit market. After October 2008, amount of credits bank extended started to fall. This downward trend lasted until spring 2009. So, in order to ease the liquidity problems of banks and improve at least the potential amount of credits bank could extend, required reserve ratio for lira deposits was reduced. This decision was made in fall 2009.
Yesterday the CB declared in which method and timing the decisions made during the crisis period will be altered. The statement reminds that the CB did does not issue Dollars or Euros and so there is a limit for the Bank's support to the foreign exchange market. They warn the public for managing their foreign exchange liquidity taking this fact into account. If the conditions are not reversed, the Bank will first increase the required reserve ratio for foreign exchange deposits. Then, it will raise the interest on and shorten the maturity of the foreign exchange deposits lend to banks during the crisis.
Among the statements concerning the lira side, two are of critical importance. First, it appears that the CB puts great importance on the 'credit channel'. It does not want to see a drop in the amount of credits extended by banks. So, the Bank will not yet change the required reserve ratio that banks have to keep at the CB in account for their lira deposits. The CB wants to keep this ratio at the level after the drop introduced in October 2009. It appears that this ratio will be increased if the credit markets 'heat up'. And such a risk is not yet present.
The second important point is about the benchmark interest rate. If we let details aside, Monetary Policy Board (MPB) announced two important interest rates each month: interest rate for CB's lending to banks and for CB's borrowing from banks. However, discussions considering inflation rate focuses on one interest rate: benchmark interest rate. If the Board expects that inflation rate will diverge from the target, it changes the benchmark interest rate.
If banks hold excess liquidity, interest rate on CB's borrowing becomes important. Therefore, in such cases the MPB discusses and decides on the borrowing rate in the meetings. Lending interest rate is then decided on the basis of the borrowing rate. In the near past there was excess liquidity in the credit market. So, the benchmark interest rate for the CB was the borrowing rate. However, this situation changed especially after 2008. I will skip the technical details and put it shortly: liquidity shortage emerged.
The CB foresees that this will be a permanent trend. Therefore, after a while (defined as the second phase in the statement) the benchmark interest rate should be changed (but nothing will change in the first phase). Beginning with the second phase, the CB will fund banks through weekly repurchase auctions to eliminate the liquidity shortage. That is, the CB will purchase one-week bonds and provide liras in exchange. A week later, bonds will return to banks and the liquidity will return to the CB. This way, liquidity needs of banks will be fulfilled by the CB.
In these auctions the CB will announce an interest rate which will become the new benchmark interest rate. As the interest rate decided to be in line with the inflation rate is 6.5 percent, the CB has to converge the repurchase interest rate, the new benchmark rate, to 6.5 percent. So this is what will be done in the second and the third phases. The CB declared that this will be done step by step, not at once. But I will not bore you with further details.
At the beginning, I said that these decisions will not affect us. Let me be clearer: first, the benchmark interest rate which is determinant for inflation is not changed. Second, required reserve ratio for lira deposits, which is of importance for the level of credits to be extended is not changed either.
This commentary was published in Radikal daily on 15.04.2010