Why are the Turks obsessed with interest rates?
We have been here before. It was no more than a decade and a half ago that our country’s politics steered our economy into the ditch. We must not have learned our lesson. Perhaps it’s a problem with our abstraction skills. We are unable to identify a fixed pattern over time, so we are doomed to go through it endlessly. The first one was in 1994 and the new episode is now unfolding before our eyes.
What we have acquired during this period is an unhealthy obsession with interest rates.
It was another prime minister, Ms. Tansu Çiller, who started a crusade against the interest rate in 1994. She wanted to control the interest rate on government debt instruments (GDI), so she started cancelling GDI auctions. No new auctions, no high rates. Perhaps somebody should have told her that without those auctions, you cannot refinance your debt. It was like shutting your eyes before a blow.
Ultimately, the markets lost confidence in the government’s ability to manage the economy. The Turkish Lira depreciated by around 70 percent in the first half of 1994. Virtually overnight, interest rates hiked to around 700 percent from their pre-crisis level of 70 percent. The growth rate declined by 6 percentage points that year. All just because of the Turkish obsession with the interest rate. That was the first such example.
I recommend reading Fatih Özatay’s paper “The 1994 Currency Crisis in Turkey” for the full story. I remember a particularly telling reaction to Professor Özatay’s account of the crisis at an academic seminar. One participant noted how totally uninteresting they found the whole story. It was simply child’s play - anybody with a rudimentary understanding of economics would have known that if you do what was done in Turkey in 1994, you would crash. The really interesting part is how insanity could be permitted to lead a serious public policy decision to ruin the country.
That same dynamic is now recurring. It all started with that rather strange argument about how high interest rates cause high inflation. This time it is our elected president, who is leading the discussion, accuses the Central Bank of “treason” for not lowering the already high interest rates. Just last month, market rates started to rise from 7 percent to 8.5 percent in secondary market transactions of GDI. This time, high GDI outstanding is not the problem, so there has not been an attempt to cancel their auctions just yet. This time it is about private sector debt. So the lira has started to depreciate. If you take 2.20 as the base for last year, it is now around 2.62 lira to the dollar. The lira’s depreciation is now approaching 20 percent. That puts it close to the danger zone. The speed at which we have slipped from 2.20 to 2.60 suggests a serious lack of confidence. The trend is not going to reverse on its own.
We need a strong political statement to convince the markets that the captain is on duty and there is nothing to worry about. Until then, get ready for a bumpy ride with the lira.