“Dramatic” is not an adjective often associated with central banking. Yet it is the only word to use for what happened last night in Turkey.
At an emergency midnight session, the country’s central bank more than doubled its main weekly repurchasing rate, to 10 percent from 4.5 percent, and raised its overnight lending rate to 12 percent from 7.75 percent. In doing so, the bank finally broke Prime Minister Recep Tayyip Erdogan’s spell over monetary policy, bringing hope not just for Turkey’s ability to bring its economy back, but also for emerging markets as a whole.
Governor Erdem Basci’s decision, though late, restores to the bank some of the vital credibility it lost as a result of his increasingly Byzantine attempts to respond to risks in the economy while obeying Erdogan’s demands that interest rates not be raised. Markets had ceased to trust in the bank’s independence, much less understand what it was doing.
Erdogan said before the central bank’s decision that he remained opposed to raising interest rates and that the bank would be held responsible for any damage done to the country’s growth. He’s wrong about that. Erdogan’s hostility to the charging of interest, rooted in his religious beliefs and exacerbated by his wild theories about a global conspiracy to destroy Turkey’s economy, prevented the use of an essential monetary policy tool. So he shares responsibility for any consequences of this delay.
Last night’s increase had to be sharp, both because it has been put off for so long and because the bank’s disused policy rates had to leapfrog the sleight-of-hand measures that Basci was using to drive up effective market rates. So at least half the increase simply caught the policy rates up to reality, enabling the bank to return to orthodox, transparent central banking. The gyrations of the lira after the bank’s decision demonstrate how hard it will be for the bank to regain its credibility.
Turkey was always going to be vulnerable to the moment when central banks in developed economies -- in particular, the U.S. Federal Reserve -- started winding down their asset purchases. So-called hot money has flooded into Turkey in search of higher yields during the financial crisis; Turkey’s current account deficit stands at 7 percent of gross domestic product, a staggering 80 percent of which is financed by short-term loans.
Yet Turkey is still enjoying small net capital inflows, so the departure of hot money can’t be the main reason the lira lost more than 30 percent of its value between early last year and last week, when it reached its nadir. That honor goes to the perception of rising political risk, largely caused by Erdogan’s destabilizing responses to last summer’s popular protests and to the more recent corruption allegations against his government, as well as his distortions of monetary policy.
To shore up growth, Erdogan will have to restore faith in his stewardship of the Turkish economy. That means ending the persecution of businesses associated with Erdogan’s political opponents; calling-off a purge of the judiciary and police forces that is undermining the rule of law; halting political interference in the conduct of monetary policy; and reviving membership talks with the European Union, for the sake of the economic and institutional reforms that go with them.
Basci’s move last night was an essential first step to stabilize the currency and inflation, and more may soon be required -- from him and his country’s prime minister.
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