MANAMA: The Turkish central bank’s decision to increase interest rates reaffirms Fitch Ratings’ view that the authorities are prepared to adjust policy settings to combat shocks to economic stability. By acknowledging the higher premium investors have been demanding to hold Turkish financial assets, the move may reduce the sovereign’s vulnerability to short-term capital outflows and could ease pressure on the lira and reserves.
Rate increases will dent domestic demand and could renew concerns about an economic “hard landing”. But the fall in the lira and improved prospects for global economic recovery, particularly in the Eurozone, hold out the prospect of higher net exports and a faster current account adjustment as and Fitch estimates the current account deficit exceeded 7% of GDP in 2013.
The CBRT’s action shows that monetary policy adjustments are still possible despite the political desire to maintain growth. It acknowledges the limitations of macro-prudential measures to restrain the current account deficit and inflation, and of FX intervention to halt the lira’s depreciation.
These substantial rate increases also should serve to reinforce market confidence in the CBRT’s independence and its credibility as a policy making institution. Moves to “simplify the operational framework” and put greater emphasis on transparency are important developments: we have consistently said that the framework’s multiple and shifting objectives and tools has created policy and investor uncertainty.
The authorities continue to stress the importance of cautious fiscal and financial sector policies, but a modest loosening of fiscal policy would not be surprising ahead of local and presidential elections.
The CBRT’s action also broadly supports Turkish banks’ credit profiles, by reducing overall risks to macroeconomic stability. A more stable lira would lessen banks’ foreign exchange risks resulting from FX lending to sometimes unhedged corporate borrowers. Higher rates also make a return to the rapid credit growth seen during the first half of 2013 less likely.
“However, higher rates will reduce the affordability of debt repayments and could lower economic growth, both of which could weaken banks’ asset quality. Higher rates may also weigh on margins as deposits continue to re-price more quickly than loans, pushing up short-term funding costs. Slower growth and rising rates were among the risks we identified in “2014 Outlook: Turkish Banks,” Fitch in a statement said.
“The central bank’s rates announcement on Tuesday followed an emergency policy meeting after the lira continued to fall, despite currency market intervention and the creation of a new “extraordinary day rate” by the central bank at its scheduled policy meeting. Market pressure on the lira had intensified after that meeting.”
“The CBRT has raised its overnight interest rates, one-week repo rate, and the lending rate at its late liquidity window (the borrowing rate stayed at 0%). All the increases are substantial, between 425bp and 550bp, and the main policy rate has risen to 10%.
“We rate Turkey ‘BBB-’ with a Stable Outlook. Our rating and sector outlooks for Turkish banks are also stable.”