MNI INTERVIEW: CBRT On Track, But Risks Remain - Ex-Vice Gov

The Central Bank of Turkey should succeed in bringing inflation close to target this year, but continued pressure on the lira, coupled with geopolitical uncertainty and pressure from opponents of the CBRT’s return to conventional monetary policy, mean the outlook is far from stable, a former senior official told MNI in an interview.

New Governor Fatih Karahan, who said in a statement Feb 4 following the weekend resignation of Hafize Gaye Erkan that he was determined to keep policy as tight as necessary to bring inflation to the 36% target, could face reverses in the first half of the year, said Fatih Ozatay, who served as vice governor from 2001 to 2006.

Critics of the CBRT’s pivot towards policy orthodoxy under Erkan, who resigned following nine months in office after denying accusations of improper behaviour, may pounce as annual inflation, running at 65% in January, rises towards 70-75% in April-May, Ozatay, a professor at Ankara’s TOBB University of Economics and Technology, said in an interview.

“For those people who don't want or like rate hikes it will allow them to say, ‘Look, since the start of the programme 10 months ago inflation has risen to 70%, plus 7% monthly inflation, while growth is coming down.’ That's a risk,” he said, noting that the central bank may be tempted to make a tradeoff between reducing inflation and fostering economic growth, which the government has targeted at 4% this year. (See MNI INTERVIEW: Turkish Cenbank To Balance Growth Vs Inflation)

Finance Minister Mehmet Simsek voiced his support for Karahan's appointment on social media. He said the government remains "committed to supporting the disinflation process through restoring fiscal discipline," and will continue to "do what it takes" to implement structural reforms.

LOWER INFLATION ACHIEVABLE

An annual inflation average this year of 40%, mid-way between the official 36% target and the tolerance limit of 42%, remains achievable, helped by stable oil prices and market expectations of monetary easing in the U.S. and the eurozone, with, so far, little sign of negative spillovers from the Middle East crisis, Ozatay said.

But while the CBRT’s retreat from unconventional monetary policy has bolstered sentiment, investors remain wary of the potential for a relapse into old habits, while upwards pressure on prices is likely to continue to come from lira depreciation, he said. The appeal of lira-denominated assets has been reduced by the CBRT’s practice of shoring up its dollar reserves in regular swap auctions, which by providing domestic banks with lira at slightly below the repo rate have the effect of suppressing retail deposit rates, he added.

“Because the central bank cannot increase its foreign exchange reserves in net terms, it has entered in swap agreements with some domestic banks - but this only means gross increases in its net reserves, not a net increase. The impact of this on interest rates, the cost of these swaps to domestic banks, is lower, which creates an incentive for domestic banks to borrow from the central bank, not from depositors, which is a problem,” Ozatay said.

FISCAL POLICY

Recent lira weakness “did worry the central bank a lot,” he said, though they will not want the currency to appreciate “significantly” in real terms. The CRBT raised its policy rate by 250bps to 45% in January.

But somewhat tighter fiscal policy might help the central bank’s cause, and potentially boost inflows of foreign funds, Ozatay said.

“In 2023 our expectations for the budget deficit to GDP ratio was rather high, but the authorities succeeded in decreasing it to more manageable levels. It’s now around 5% of GDP, compared with expectations around 9-10%,” he said. “Some of that, of course, arises from the earthquake issue, and that will continue to be an issue this year and for the next year or so. What is important is whether the authorities are able to convince the markets that they are going to control the budget deficit to GDP ratio excepting those costs arising from the earthquake.”