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Last updated: July 23, 2013 7:23 pm
Turkey’s decision to raise its overnight lending rate for the first time in nearly two years underscores the dilemma facing developing economies as the end to US monetary easing draws near: focus on inflation or growth?
Until this week, Prime Minister Recep Tayyip Erdogan appears to have opted for bolstering growth ahead of elections due in the next two years, attempting to contain inflationary pressures caused by a lira that fell to a record low earlier this month by intervening in the currency market.
He has even blamed the recent protests in the country over increasing authoritarianism on a shadowy international “interest rate lobby”, which analysts said may have been a key reason preventing Turkey’s central bank from raising rates earlier, despite the bank’s supposed independence.
But in a sign that $6.65bn spent this year to help bolster the lira was not adequately addressing the lack of market confidence in the country, particularly following two months of protests, the bank on Tuesday increased its overnight lending rate 75 basis points to 7.25 per cent, in line with median estimates of market economists. The lira reversed its losses for the day and edged higher.
It justified the move by saying it was due to recent price rises and a weakening of capital inflows since May as the US Federal Reserve’s plan to slow the pace of easing sent markets into turmoil.
“Although the committee sees these developments as temporary to a large extent, a measured monetary tightening is deemed necessary in order to contain a deterioration in the pricing behaviour,” the bank’s Monetary Policy Committee said.
Since the financial crisis, quantitative easing, or QE, has delivered a rush of capital to many emerging markets, allowing them to run loose monetary policies and giving a boost to credit and growth. The promised tapering of the policy has raised the prospect that emerging market central banks will have to tighten in response. But they do not all face the same problems.
Turkey’s large current account deficit, in common with other countries such as India, makes the strength of its currency a critical issue. If foreign investors pull out as a result of QE tapering, and if political uncertainty continues, the lira will continue to weaken and drive up the deficit even further.
So Turkey has been forced to raise rates in spite of the threat to growth. The government’s target is for 4 per cent GDP growth this year, up from 2.2 per cent last year. That is unlikely without a boost to domestic demand, which will suffer under higher rates.
In contrast, Hungary cut interest rates on Tuesday. It has the luxury of a current account surplus, allowing it to focus on growth.
Turkey’s central bank announced additional tightening measures on Tuesday, including a decision on certain days not to further sell foreign currency, effectively reducing liquidity, although Barclays Capital said that this did not “in principle” exclude discretionary intervention. The central bank also said that primary dealers will not be able to access their lending facility at the normal discount of 50 basis points.
Burcu Unuvar, senior economist at Istanbul brokerage Is Yatirim said that during these additional tightening days the de facto rate rise is not 75 bps but 125 bps. She predicted that there may be more tightening needed ahead, while others argued that the central bank would do what it could to avoid hiking rates further.
“In effect the bank wants to signal that the stick is still in its hand,” she said. “The bargaining game between the market and the CBT [central bank] will continue, and the volatility of the market will continue whenever there as an adverse event.”
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