MNI INTERVIEW: CBRT Seen Easing Later In Year, Lira Permitting

A stable lira could allow the Central Bank of the Republic of Turkey’s next significant monetary policy move to be an
interest rate cut later in the year to stimulate growth, accompanied by a likely admission that the inflation target will be missed, a leading Turkish economist told MNI.

While inflation stood at 68.5% in March, almost double the CBRT’s 36% target, and is expected to hit 70% by May, it should ease in the second half of the year, as the base effects of the significant lira depreciation following last year’s general election wear off, said Selva Demiralp, adding that this might be sufficient for policymakers to reduce their key policy rate from 50%. (See MNI EM INTERVIEW: Lira Key To Inflation - ex-CBRT's Ozatay)

“I suspect they might relax the tightening extent, aiming for a growth rate around 3% instead of 1.5%,” she said in an interview. “Consequently, inflation won't drop to 36%, My colleagues from Koc University and I expect 51% inflation by year's end.”

Historically, Turkish central banks have sizably increased their annual inflation forecasts towards year-end, with hardly any exceptions, Demiralp noted.

“If they start easing in the last quarter, it implies they're content with 50% inflation.”

SURPRISE HIKE

The CBRT surprised markets when it hiked rates by 500 basis points immediately before last month's local elections, a decision former Federal Reserve economist Demiralp called a “strong signal”, indicating its relative operational freedom from the government of President Tayyip Edrogan, who has previously been open in pushing for easy policy.

“President Erdogan has repeatedly endorsed the economic team and their policies, stating that we must wait for inflation to decrease, which he expects to start in the second half of the year,” Demiralp said. “Overall, the government is aware that we can't turn back and has already paid the political cost in the local elections.”

The likelihood that the CRBT will adhere to its current course is boosted by broad recognition that a policy U-turn would meet with a negative market reception, Demiralp said.

The currency is set to weaken in nominal but not in real terms in the coming months, and any prospect that the pace of depreciation might overtake the inflation rate could prompt the central bank to hesitate before easing, Demiralp said.

“The president is sensitive to the exchange rate because of its adverse effects on the growth rate. The central bank is focused on inflation, but the government is focused on growth.”

With its policy rate at 50%, the CBRT may already have reached the limit of what Erdogan is currently prepared to tolerate, said Demiralp, noting that the central bank also took another tightening measure when it raised rates, by widening the interest rate corridor for borrowing and lending.

“They may not want to push him too hard. Additionally, they've put restrictions on the credit supply side to limit monthly credit growth to 2%. It's likely they'll try to tighten the economy more through the credit supply channel, as real interest rates aren't high enough to slow down loan demand.” (see MNI INTERVIEW: Turkey QT May Only Delay Rate Hikes- Kara)

FISCAL TIGHTENING

Fiscal policy will continue to tighten in the coming months, Demiralp said, as subsidies in areas like energy reduction are removed. This will have a one-off inflationary impact, but that is a cost the government is willing to accept, she said.

Finance Minister Mehment Simsek could adjust value-added tax, to even out disparities between rates, but he has indicated that no major tax changes are likely.

Turkey remains an attractive environment mainly for speculative foreign capital flows, Demiralp said.

“I do expect speculative or short-term capital inflows to accelerate post-election, as there's room for profit in Turkey. However, long-term foreign direct investment might wait, as we don't yet have an elaborate stabilisation program or austerity package like the IMF's, nor are there structural reforms in place.”