MNI INTERVIEW: Turkish Cenbank To Balance Growth Vs Inflation

The Central Bank of the Republic of Turkey is likely to increase interest rates to 45% later this month in what looks to be its last hike of the cycle, but it may be tempted to ease later in the year to support economic growth with inflation still above target, a former Fed economist and leading Turkish commentator told MNI.

While the CBRT insists it will keep a tight stance for as long as necessary to ensure sustained price stability, Selva Demiralp said inflation is likely to total 50% this year, rather than the Bank’s target of 36%.

“If the central bank surprises us by maintaining its tightening cycle for a longer period of time, then we might actually revise it downwards. But right now, it seems to me that the risks are on the upside,” said Demiralp, an economics professor at Istanbul’s Koc University.

Remarks such as those by Governor Hafize Gaye Erkan, who reportedly told New York investors that tightening will be completed “in a short period of time”, suggest January’s hike will be the last in the cycle, Demiralp said in an interview, noting that the 4% GDP growth rate set as a target by the government in its September mid-term report was “not very compatible” with the inflation goal.

GROWTH OR INFLATION

With the full effect of the tightening cycle begun in May 2023 becoming most visible in the second half of this year, the bank may have to choose between its inflation and growth targets, she said.

“I think the choice will be towards 4% rather than 36% inflation, but maybe we are going to see a compromise of 3% growth and 40% inflation,” Demiralp said.“The question then will be how long will they be able to keep the rates at 45%.”

The central bank hiked by 250bp to 42.5% in December, having tightened by 500bp in previous months, saying in its statement that the policy rate is now “significantly close to the level required to establish the disinflation course.”

But, with year-on-year price rises now close to 65%, even the 39% inflation foreseen by market analysts may be out of reach, Demiralp said, especially given last year’s public sector pay rise of 45% and minimum wage adjustments of 46%.

“According to the central bank’s most recent inflation report, a 1% increase in the minimum wage increases the inflation rate by seven basis points,” she said. “So from that analysis a 46% adjustment to the minimum wage can increase inflation by about 3.5%,” she said.

Political interference remains a risk, with Demiralp expecting fiscal easing ahead of March’s key local polls.

“We don’t know the extent of fiscal support before the elections. We don’t know how fast the fiscal policy will revert to a tighter stance after the elections either,” she said.

CREDIBILITY BOOSTED

Still, the TCMB’s credibility has been bolstered by its return to conventional monetary policy after a period of low interest rates, she noted, adding that if it maintained an orthodox approach, confidence in its independence will be further reinforced, lowering interest rate expectations and boosting capital inflows. In this case some easing might be appropriate in the fourth quarter, she said.

“What is critical is whether Turkey will be able to attract capital inflows, which started towards the end of last year,” she said, “You have to bring reserves to positive levels first, then Turkey might start removing the restrictions and regulations on capital inflows.”

Recent lira weakness is within the tolerance band set by the central bank to pursue its disinflation policy while also allowing for growth, she said.

“When you look at the path that the exchange rate follows, it doesn't look like a free upward trend, because we don't see much volatility around the trend. It's more like a controlled gradual trend, with the slope of the trend controlled by the central bank.”

Sticking with orthodox economic policies will also be crucial to regaining market confidence in sovereign bonds, Demiralp said, adding that Turkey’s credit rating could return to investment grade within five years or sooner with appropriate policies.