A new dimension in discussions on interest and exchange rates
There have always been discussions on interest and exchange rates but in the end, the markets set the course.
That is why market players generally shrug off such discussions. However, the most recent debates on interest rates signal that things are a little different this time and we have moved to another level.
Even though debates have taken a different form, the markets will look at past discussions and will not panic. Foreign market players who see the “market-friendly” approach in private meetings with officials still tend to have trust. At the end of the day, if they stay calm when they speak with officials, it means they still have some confidence.
By looking at past experiences, it could be said that foreign investors believe the officials will do “what is necessary.” Despite sometimes being irked by statements made by politicians, they continue to think what will actually happen will be different. The gap between “what is said to the public and what foreigners are told” may not be good for the public but foreigners do not mind.
When their local partners give examples from the past and tell them “do not care what they say, they will raise interest rates if needed,” this comes as a further relief to foreigners. Those who invest in short term funds thinking “Turkey is still a profitable market because no other market offers such high interest rates” continue to do so as long as their concerns do not grow. They try to maximize the profit they share with their partners. The higher the profit they make, the higher their bonuses will be.
The first reason for the inflow to stop is if there is an increase in interest rates. The funding will leave countries like ours and return to where they came from. We see some clues of this happening but not as fast as expected. The first countries where the money is slowly pulled out from are decoupled negatively from the others. It is obvious Turkey falls in this group.
The second reason for the pull out of funds are concerns that the country’s economy may deteriorate. Even if there is not a general pull out, the pull out may start with increasing expectations that the economy will worsen. We have experienced this from time to time. Inflation and the current account deficit especially seem to be parameters of serious deterioration.
What to do to improve economic outlook
When foreign investors start to see that the macroeconomic equilibrium is destabilizing, they look at whether that country’s government takes measures to restore that balance. This could be through fiscal or monetary measures.
At the top of monetary measures is hiking interest rates. If there is high inflation and a destabilization in macroeconomic equilibrium, you need to offer a risk premium as an additional return in order to defend the value of the currency, so that foreign investors remain in the country.
As such necessary measures have been taken up until now, foreign investors have not taken out their money and returned home for a long time, despite their concerns every now and then. We know very well what happens when they collectively do that.
There is a difference with the current debate. There are rumors that the most trusted figure by the markets, Deputy Prime Minister Mehmet Şimşek, will resign and there will be a cabinet reshuffle. Now, top politicians not only criticize the high interest rates but the interest itself.
There are reports suggesting that a package is being prepared, which aims to reduce the interest and exchange rates through administrative measures without the need for legislative measures. If Turkey intervenes in interest rates through administrative measures by giving directives or setting a cap on the rates for state-owned banks or for the entire financial system, it means things are taking a very different turn. I hope our fears will not become real.
We know from our past experiences that we do not have to wait too long to see what happens if non-market solutions are dictated. This is what has always happened; mistakes have been corrected but often too late.