Late action is more expensive
It would be wise to hang the following quote by Josiah Charles Stamp at the entrance of the Turkish Central Bank in Ankara: “It is easy to dodge our responsibilities, but we can’t dodge the consequences of our responsibilities.”
The Turkish Central Bank must have seen that both the price and financial stabilities in Turkey are at the edge of a cliff that two weeks later it raised its one-week repo rate further by 1.25 percentage point to 17.75 percent on June 7. For this or that reason, the price of the Central Bank’s belated action has been very costly. We do not know the extent of further damages that will be incurred in the upcoming months. But there will be damages. The situation is like an accident happening because of driving the vehicle much above the speed limits and not hitting the brakes on time when approaching a wall. All of us have watched this in “slow motion.”
The interest rate even after being raised is still below the money market interest rates. But the new rate has gone down well with the financial markets. Because the expectation of the financial market was that the Central Bank “could have” raised the interest rate at most by 1 percentage point. The important difference is that what the Central Bank “can” and “should” do have always varied. The rise on June 7 was above the expectation of what the Central Bank “could do,” but its movement toward “what it should do” is an important sign of the change in its stance.
Since the beginning of this month, the Central Bank started to simplify its money policy and use the one-week repo rate as the main funding tool. Increasing the weekly repo rate once again on June 7 by 1.25 percentage points is a sign of the end of overnight interest rate corridor. It is clear that the overnight borrowing or lending rate window will not be used as a policy tool, other than in the exceptional cases when some banks cannot adjust their liquidity position. The main monetary policy instrument will be the weekly repo rate.
But what the Central Bank is deficient in is the issue that it fails to make its “reaction function” go public, which undermines its credibility. It says, “Until an apparent improvement in inflation is maintained, we will continue to keep monetary policy tight. Keeping a close eye on other factors affecting inflation expectations, pricing behaviors, and inflation, if needed, additional monetary tightening can be carried out.” What is the “apparent improvement” level? Is it 8-9 percent levels in the days of excess liquidity? In which situation will an “additional monetary tightening” be carried out? Once the stance that will bring credibility becomes clear.
A costly lesson has been learnt in the last few months. Once fiscal parameters go out of control, it is very difficult to go back to the former balance; or you’d have to pay a very heavy price. We’ll be left with deteriorated balance sheets by currency depreciation, increasing production costs, loss in households’ disposable income, increasing financial burden and a slowdown in the economy in the forthcoming days. Politicians who have merely watched this situation for a long time will say that this slowdown is a “rebalancing” and “the current account deficit has been controlled” under the pretense of good news.
What was the situation that persuaded the Central Bank to hike the interest rate by a total of 4.25 percentage points in 15 days, with the determination of “We will do it again if necessary,” after merely watching the exchange rate increase by more than 25 percent before that?
When it is no longer possible that the monetary authority can do its job, the upsurge in the exchange rate becomes inevitable. And merely watching this situation makes the exchange rate soar higher. And this is what happened. The grapevine stepped into action, spreading the whisper that “since no intervention took place via normal tools, steps regarding the exchange regime and capital movements are on their way.” Despite Turkey being an open economy with capital movements taking place quite freely, the ongoing state of emergency has fueled the worries of property seizures. So, if you are late to raise the interest rate, even if you do it successively afterwards, it becomes very difficult to pull the economy together.