‘Fed’ up with Turkish monetary policy

Many Turkey analysts and economists interpreted the U.S. central bank Federal Reserve’s (Fed’s) decision to keep its policy rate on hold on Sept. 17 as something positive for the Turkish economy and assets.

Their argument makes sense at first glance: Capital flows to emerging markets (EMs) would slow down considerably, if not come to a full stop or be reversed, once the Fed started raising rates. Countries like Turkey, which rely heavily on such flows and are deemed economically vulnerable, would be hit the hardest.

This line of reasoning seems to have been verified by data as well: According to statistics from the Institute of International Finance, an international industry association of financial institutions, there have been strong portfolio inflows into EMs since the Fed decision, reversing five straight weeks of outflows.

However, another strand of thought argues that the outflows were not because of the imminent rate hike but the uncertainty surrounding its timing and extent, and not only the first increase, but the whole hiking cycle. Since that ambiguity has only temporarily dissipated, the recent flows could be nothing more than the result of a respite.

There may be something to this view: Turkish assets rallied on Friday, but not in response to the Fed’s inaction, but upon learning that former economy tsar Ali Babacan was running in the upcoming elections. In any case, the Fed may have damaged the Turkish economy more by keeping the Central Bank of Turkey on hold than uncertainty in place. The Bank had already signaled that it would follow the Fed’s lead. Therefore, it was no surprise that no rates were changed at its own rate-setting meeting on Sept. 22.


The one-pager accompanying the decision was virtually the same as last month’s, which suggests that the Bank does not believe much has changed since then. Never mind that the lira depreciated around 5 percent against the dollar, which means that the exchange rate weakness will continue to take its toll on inflation. The Bank itself noted, during its regular meeting with economists on Sept. 23, that “inflation is expected to rise further in September due to exchange rate effects.”


Inflation expectations deteriorated considerably in the Central Bank’s latest monthly survey of expectations, which was released on Sept. 18, as well. All in all, price developments were definitely warranting a proper rate hike, something more substantial than the ongoing gradual increase in the average funding rate. 


But I kind of sympathize with the Central Bank. After all, there is no way President Recep Tayyip Erdoğan will allow a hike right before the elections – not with each economic data release turning out to be worse than the last. For example, according to the latest statistics released on Sept. 21, consumer confidence is at its lowest since the global crisis. Retail confidence indices released the next day were similarly near all-time lows. So I wasn’t surprised at all when Erdoğan emphasized the importance of lower interest rates for investment on Sept. 23.


Just like in January 2014, the Bank will eventually need to hike rates significantly to avert an economic crisis. That won’t be Erdoğan’s problem, though; he can put the blame on Gov. Erdem Başçı and replace him with a crony when his term is up in April.