Central Bank Gamble Won't Pay Off
BMI View: Although the Central Bank of Turkey has indicated its rate hiking cycle has come to an end, it has not done enough to restore confidence in its monetary policy and stabilise the lira. With under three months of import cover, ongoing FX reserve sales will prove insufficient to stem capital outflows and lira depreciation, and we continue to believe a 50 basis point hike to its main policy rate will be necessary before end-2013.
Despite a sharp and sustained sell-off in the Turkish lira that risks stoking inflation and exacerbating capital outflows, the Central Bank of the Republic of Turkey (CBRT) has gambled that its recent monetary policy tightening measures will prove enough to stabilise investor sentiment. On September 4 CBRT Governor Erdem Basci reiterated his commitment to leaving policy rates at current levels while signalling a greater tolerance for lira weakness. By ruling out the use of its most effective policy tool and failing to announce any significant change to its strategy of using its relatively meagre FX reserves in defence of the lira, we believe the CBRT has ensured volatility will remain elevated. In our view, the CBRT has not yet done enough to restore confidence in its monetary policy, which has been damaged by its complexity and perceived pro-growth bias, and continue to believe a hike to the main policy rate will be necessary to stabilise the lira before end-2013.
The CBRT utilises an interest rate corridor that allows it to adjust the cost and duration of liquidity it offers on a day-to-day basis. As such, the weighted average cost of CBRT funding ( see chart) is the best gauge of policy rates. Viewed in this way, the CBRT has brought its policy rate from a low of 4.52% on May 31 to as high as 7.16% on August 23, a 264 basis point change since capital outflows began accelerating. This means that the CBRT has tightened policy on par with other current account deficit emerging markets such as Brazil and Indonesia, whose central banks have hiked policy rates to stabilise their currencies.
|Lira Sell-Off Not Over Yet|
|Turkey - CBRT Interest Rate Corridor & TRY/US$ Exchange Rate|