At the eve of another Central Bank of Turkey (CBRT) rate meeting, opinion is divided regarding the direction of monetary policy. One school harks back to Erdogan’s recent outburst against high rates, fearing a rate cut. The majority school expects no change in rates, though there are some in this camp who would not rule out a 50-100 basis point hike.
Thirdly, there are conspiracy theorists, who claim Erdogan bashed high rates only to give governor Mr. Naci Agbal a chance to prove the independence of CBRT, hence a small rate hike.
Your Truly has radically different ideas about policy rates. First, the current level of policy rates will not have a noticeable impact on the progress of inflation in Turkey, which is set to rise, but the heavily indebted non-financial sector can’t bear anything higher. Secondly, it will be President Biden who will set Turkish policy rates as of March.
The problem with a 17% policy rate, which translates into 2.40% real rate ex-ante given year-end CPI of 14.60% is that only Turkstat believes those inflation numbers. Metropoll and Avrasya Research find that a majority of public thinks the true inflation is between 20-30% per annum. Thus, the perceived real rate for at least a half of the population is deeply negative. This explains why the Borsa Istanbul stocks are flying off the handle and why there is no pent-up consumer demand for 2021. With such negative real rates, people of Turkey invested into real assets, ranging from houses, cars to the more mundane. Yesterday, I had a conversation with my cigar shop owner who put all his excess cash into cigarettes, hoping to benefit from the bi-annual price hikes.
But, rehabilitating Turkstat and revealing the true rate of inflation would put CBRT in a deep quandary. If the true rate of inflation is , say, 20%, then the policy rate needs to be at least 23%, based on the generally accepted view that depositors would demand at least a 3% ex-ante real rate for foregoing consumption. A 23% policy rate would translate into a 28% prime lending rate, seeing which a bulk of Turkey’s heavily indebted and sales-deficient companies would raise the flag of insolvency. Already, there is a huge “pent up demand” for Chapter 11 applications ad outright liquidations, had they not been banned by the government or regulators.
Thus, despite rising core inflation, the 17% is the best that Naci Agbal can do. The job of reducing inflation falls upon Mr Erdogan who should shut his pie hole about interest rates and enact reform legislation which will create some clarity about where Turkey is going. Foreign financial investors will do the rest by flocking to TL assets, thus driving the exchange rate and lowering CPI through negative pass through.
President Erdogan will soon unveil a reform package, which is going to be full of hot air and fillers with no real impact on the captive judiciary, highly discretionary taxation and regulatory environment and the dismal state of human rights.
In a nutshell, Turkey is stuck in this sub-optimal political and economic equilibrium, where despite a lot of action to improve it, nothing changes. Because what one hand gives, the other takes away.
The person to push Turkey into a new equilibrium will be Mr Joe Biden who around March or April will demand President Erdogan to mothball his favorite toy, the Russian made S-400 anti-missile system.
If President Erdogan defies him, Turkey will have a re-run of the 2018 Pastor Brunson event, which would cause a currency crash, and subsequently higher interest rates. Or, Mr Erdogan will prove to be much more flexible than people give him credit for, settling his differences with Biden. Than, Turkey can rapidly cut rates lest the wall of money heading its way leads to overvaluation of the currency and an import boom.
Damon H. Grande