NEWS ECONOMY NEWS        20/11/2020

Fitch says return to credible monetary policy for Turkey will take time

International credit ratings agency Fitch Ratings said in an insight analysis on its website that it will take time to rebuild the credibility of Turkey’s monetary policy, but that the increase in Turkey's one-week repo rate and the reversion to a single policy interest rate is a step towards improving credibility.

 

Fıtch Ratings’ analysıs is as follows:

“The Central Bank of the Republic of Turkey (CBRT) increased the one-week repo rate by 475 bp to 15% on 19 November, bringing it into line with the average weighted cost of CBRT funding, which had steadily increased to 14.9% from a low of 7.3% in mid-July. The CBRT said all funding would now be provided through the one-week repo rate, which should make monetary policy more transparent and predictable, and strongly emphasised its commitment to tackling inflation.

 

We noted the possibility of an improvement in monetary policy credibility when Naci Agbal was appointed CBRT governor on 7 November. The lira has appreciated by nearly 11% since his appointment and that of Lütfi Elvan as Finance Minister.

 

However, it will take time for the CBRT to rebuild monetary policy credibility. This had been undermined by the extent of policy loosening earlier in the summer and the scale of CBRT FX interventions, which also suggested that the prior, long-standing commitment to a flexible exchange rate had weakened. The sacking of two CBRT governors over the last 16 months underlines the lack of independence from political pressure, and President Erdogan has continued to state his opposition to higher interest rates.

 

The real policy rate (using current inflation) is now 3.1%, from a low of minus 4.4% in June, above the average of the other "Fitch 10" major emerging market economies of 0.1%. Credit stimulus has also continued to slow, with aggregate lending growth of less than 10% (13-week, annualised) in early November, from a high of 45% in early July.

 

This policy tightening will provide some support to Turkey's external position, as well as disinflation prospects. Lira weakness had contributed to high inflation, which was 11.9% in October, and increased inflation expectations. It has also driven a steady rise in the proportion of bank deposits held in foreign currency to 57% from 50% in July. It has also led to greater holdings of gold which, alongside the collapse in tourism and higher imports due to earlier strong policy stimulus, pushed the current account into a deficit of 4.2% of projected GDP (non-annualised) in 9M20. Faster corporate sector external deleveraging (partly reflecting earlier low domestic borrowing costs) also contributed to the downward trend in FX reserves.

 

Gross reserves have fallen by USD 23.3 billion this year to USD 82.4 billion at 13 November and net reserves by USD 24.7 billion to USD 16.4 billion. This is despite support from a USD 44.5 billion increase in FX swaps with the CBRT to end-September (the latest available data). Net reserves minus swaps have fallen to minus USD 46.5 billion from USD 22.7 billion at end-2019, although this trend has become less negative since August. More effective monetary policy tightening, a partial recovery in tourism next year, and a reduction in CBRT FX interventions should support a stabilisation in external finances, but we do not anticipate a marked improvement in Turkey's FX reserve position in the near-term.

 

Similarly, Turkey has a record of high inflation, which averaged 11.7% in 2015-2020, and it is unclear how much tolerance the authorities will show for a sustained period of tighter policy settings to address this issue. September's revised New Economy Programme targets economic growth averaging 5.3% in 2021-2023, alongside a fall in inflation to 4.9% and the current account returning to balance in 2023. We believe this combination of targets is unrealistic, and it remains to be seen how policymakers will resolve the trade-offs between boosting growth and reducing external and domestic imbalances over time.”

 



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