It has been two months since Turkey’s new economic team took over and some progress has been made. Under the new minister of treasury and finance, Mehmet Şimşek, and the new governor of the Central Bank of the Republic of Turkey (CBRT), Gaye Erkan, market normalization has begun and the risk of a balance-of-payments crisis has been reduced. At the same time, however, inflation is gaining new momentum, the budget deficit is sharply worsening, and no reform agenda has yet been announced to tackle these threats. Apart from perennial pessimists who point to President Recep Tayyip Erdoğan’s continued tenure in office and undaunted optimists who highlight the credibility of the new officials, no one really knows if the new economic team and its approach will prove successful in the near to medium term. Although two months is a short time to reach conclusions, the actions taken so far can still provide some insights.
Rate hikes and credit cap changes
The CBRT initially hiked the main policy rate by 650 basis points (bps) to 15% in June and then raised it by another 250 bps to 17.50% at its last meeting in July. More hikes are expected and will probably be delivered in smaller increments. However, the terminal rate, or long-term interest rate target, may be a disappointment for market participants expecting the bank to tackle rising inflation with positive real interest rates. A terminal policy rate of between 20% and 25% is likely. In the event of unexpected financial turmoil, the upper band could be raised to 25-30%; President Erdoğan and CBRT Governor Erkan implicitly closed the door to further hikes though. Erkan, who gave an impressive performance in her first official press conference for the quarterly inflation report released at the end of July, was glad to stop the recent increase in deposit rates, a critical barrier to curb the shift to non-lira-denominated assets.
Instead of applying a more conventional interest rate policy, the focus is on trying to gain more credibility by making new appointments to the CBRT’s top management. Three new deputy governors, all of whom are well-educated and one of whom has even worked for the U.S. Federal Reserve, were appointed at the end of last month. In addition to the interest rate tool, credit policy has also been significantly revised by simplifying regulations for banks and partially liberalizing the interest rates they can charge to their clients. With the cooperation of the CBRT and the Banking Regulation and Supervision Agency (BRSA), the Turkish banking regulatory authority, the cap on interest rates for commercial loans has been raised from 29% to nearly 38%. Loans for small and medium-sized enterprises, farmers, exporters, and entrepreneurs for new investment facilities are capped at 30%. Consumer loans are already hovering at around 50%, while mortgage rates are lower, but their loan sizes are very small compared to house prices. All of these caps will be revised slightly upward when more policy rate hikes are delivered.
The impact of all of this is likely to be mixed. On the one hand, loans are undisputedly more expensive than they were before the May 2023 elections. However, with the new caps, credit rationing among the private banks may end, and an increase in lending could undermine the promised contractionary monetary policy aimed at fighting inflation. On the other hand, government bond yields are still as low as 15-20% and there is less possibility of normalization for the bond market as the budget deficit is skyrocketing. New hikes in policy rates may push them slightly above the 20% threshold, but rates in line with inflationary expectations are not likely as the upcoming local elections in March 2024 will require more deficit spending to support populist promises and government mega-projects.
Inflation ramps up…
Fiscal policy moves…
Looking for cash abroad…
Outlook…
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