Turkey’s central bank raises rates via the backdoor

Turkey’s central bank this week raised rates in all but name, in effect using a method that seems to skirt President Recep Tayyip Erdogan’s deep aversion to higher borrowing costs. The question is can it work?

For two days now, the central bank has stopped lenders from drawing liquidity through its usual auctions of one week cash, forcing them instead to borrow overnight at a penalty.

At the one-week window, banks can borrow at 17.75 per cent, overnight it costs 19.25 per cent — raising the price of financing by 1.5 percentage points.

Berat Albayrak, finance minister, told members of the ruling Justice and Development party on Tuesday that Ankara ““will continue to take steps that implement all instruments, sticking with the rules of the free market” to soothe the financial turmoil that Turkey has witnessed in recent weeks.

The lira has recovered some of its losses. The central bank’s move may have helped. According to its own figures, banks drew TL13bn at the overnight rate on Tuesday alone after only TL2bn on Monday.

But if Mr Albayrak hopes a backdoor rate increase can tame the wild gyrations in the lira — and convince investors Turkish policymakers are serious about bringing the overheated economy under control — he will probably be disappointed.

Markets have long called for the central bank to raise rates to combat inflation, which is now at 16 per cent and is expected to rise further. In recent weeks, those calls have reached fever pitch as the Turkish currency hit record low after record low against the dollar. However, investors had much more aggressive increases in mind.

“This is classic Central Bank of Turkey. They tweak things on the margin and expect it to work, but it won’t,” said Nafez Zouk, economist at Oxford Economics, a research outfit. “The economy needs drastic measures at the moment. But the central bank will never really do that one shot hike that would show the markets that they are serious.”

Central banks’ power is based not only on what they do but what markets think they will do.

The ideal scenario is that by convincing markets that they will shift monetary policy in one direction or the other to keep the economy stable, central banks can let expectations that they will act — rather than action itself — do most of the work for them.

For policymakers in Ankara, such a goal may be out of reach.

Instead investors increasingly suspect the central bank is unwilling to anger Mr Erdogan — who earlier this year referred to high interest rates as “the mother and father of all evil” — by lifting borrowing costs aggressively. Those suspicions will only be allayed if the central bank engages in shock and awe tactics, not tweaks.

“We are seeing the currency fall 18 per cent over the course of the day, that’s something most people have never seen in their entire career. In a situation like this, you need rates to be between 5 and 10 per cent above inflation,” said Mr Zouk. “That means a rate hike of around 800 basis points.”

Without a drastic signal from the Turkish central bank that it is willing to stand against the president and raise rates substantially, doubts about policymakers’ credibility will persist — and so will the turmoil.

Additional reporting by Ayla Jean Yackley in Istanbul

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