The CBRT’s policy rate increase is positive; will there be more?

The Monetary Policy Committee of the Central Bank of Turkey (CBRT) raised the policy rate from 17.5 percent to 25 percent on August 24.

“The Committee decided to continue the monetary tightening process to establish the disinflation course as soon as possible, to anchor inflation expectations, and to control the deterioration in pricing behavior,” the Committee announcement published just after the meeting read. 

The downbeat mood was changed positively by the CBRT’s 750 basis point hike and the announcement that the monetary tightening policy would continue since it had been expected to be a maximum 20 percent increase before the meeting. Even some anticipated the interest rate to remain below 20 percent. Thus, there was a positive surprise in the name of rationalization in monetary policy.

The fastest reaction to such decisions almost always comes from the foreign exchange markets. About four hours after the announcement of the decision, the dollar exchange rate fell below 26 liras.

On August 25, although it rose slightly (around 09.56 in the morning), the dollar exchange rate was 26.4 liras. Regardless, before the announcement of the decision, it had been hovering around 27.2.

The 25 percent rate welcomed

Defining the triggering factors behind such dynamics in such a short period is challenging, especially if the subject is exchange rate movements.

In the final analysis, however, it is likely to emphasize that the decision was quite positively received unless there was an intervention in the foreign exchange market. Moreover, the CBRT does not have enough reserves to make a foreign exchange intervention that would lower the exchange rate to such an extent. If the interest rate decision had not been welcomed, even if the exchange rate dropped with the intervention, it would probably have returned to its previous level after a few hours.

Let us leave the exchange rate movement aside and elaborate on the decision. Let us approach “skeptically” first. It was thought there was an upper limit for the policy rate, a consensus that it was undesirable to be above 25 percent, and some considered the limit even lower. Note that the announced policy rate is also 25 percent. Nevertheless, the CBRT estimates inflation to be around 60 percent in mid-2024, and the year-end forecast is 33 percent. Clearly, 25 percent is ineffectual to bring inflation to 33 percent in sixteen months.

The September meeting is critical

Consequently, the question is if the rate hike process would continue and the policy rate would be raised to a level –fulfilling the short-term CBRT’s goal hereafter- aligned with inflation forecasts. In this case, the subsequent Monetary Policy Committee meeting becomes significant. If the policy rate is increased again at the September meeting, for example to 30 percent, it would mean the pressure on monetary policy is eased. Conversely, we will conclude that the 25 percent upper bound will remain in place with the unchanged policy rate.

The second point I would like to emphasize is on the statement issued after the committee meeting. The quotation in the first paragraph of this report displayed that the interest rate decision was favorable; it shed light that the tightening would continue, and we should not be so pessimistic. The statement already enhances the CBRT’s credibility with its alteration from the messages of the previous administration. More notably, the CBRT transparently tells us that there is an increased likelihood that the inflation forecasts in the third Inflation Report of the year, published on July 27, will deviate upwards—towards the upper end of the forecast range, not for end-2024, but for end-2023 and the period in between which is essential to enhance the credibility of monetary policy.

At the same time, it is also vital for the forecasts to serve as the desired anchor for inflation expectations.

Critical but not “hawkish”

The third point relates to the “hawkish CBRT” comments made immediately after the decision. I carefully underlined that the decision was favorable, though, in all fairness, the CBRT’s inflation forecast for mid-2024 is over 60 percent. How come the 25 percent rate can be hawkish?

Fourth, the increase in the policy rate also raises the upper limit of the loan interest rate, which is calculated by multiplying this interest rate by a certain ratio. Moreover, various statements have been made to raise this ratio. Furthermore, the lira appreciated considering the exchange rate level after the decision. Unless there is an adverse development, the burden of foreign exchange protected savings accounts on the CBRT will be reduced. When there was a limit on the policy rate, side roads had to be taken to curb inflation. It was easy to elevate the loan rate, whereas raising the deposit rate to an acceptable level to discourage savers from stashing their assets in dollars or gold or increasing their spending was complicated, which was one of the significant obstacles to a return to “rationalization” in monetary policy. Additionally, the rise in the policy rate will be reflected in the deposit rate, which is also positive in these respects.

Monetary policy is not exclusively enough to solve the issues

The fifth point is that solely getting monetary policy back on track would still be lacking. How do we address the economic risks accumulated over the last few years? How do we make growth sustainable? How do we reduce poverty? We need a detailed economic program. It is frequently said, “Do not worry; the MTP (medium-term program) will be announced soon.” Nonetheless, the classic MTP is not fully detailed. The example I have in mind is similar to the program designed in the stand-by agreements with the IMF; it is rather thorough.

It should be such a program that there is a road map of the fiscal policy steps to take: It explains what the public sector will do regarding FX-denominated revenue guarantees, designs how to close the gap between the public sector’s FX-denominated assets and liabilities, emphasizes that monetary policy is the CBRT’s assignment, announces realistic inflation targets instead of a vague “5 percent target” in the medium term, and clarifies how the BRSA and CBRT’s regulations made in the last two-three years will be eliminated.

Coordination by the Treasury

It is necessary to ensure that the entire administration conveys the same discourse. The contribution of the Ministry of Transportation or the Ministry of Agriculture, for example, to stability in their fields and what they will do to ensure structural transformation should also be included in the text. The Treasury should ensure coordination. Bureaucrats should meet periodically at the Treasury to discuss bottlenecks. The structural pillar of the program should consist of carefully selected reforms. The sine qua non is to make TurkStat independent. Removing certain regulations is necessary to make the CBRT politically independent.

All in all, it would be a program by which everyone knows what to do, and the institution -the Treasury- ensures coordination. The Transition to a Strong Economy Program implemented after the 2001 crisis can be an example. The texts signed within the framework of ‘stand-by’ agreements, more detailed than that program, are on the IMF’s website.