Turkey's new policies

Tight monetary policy increases interest rates, making it more expensive to borrow money.

Transition from tight monetary policy to loose monetary policy. Tight monetary policy increases interest rates, making it more expensive to borrow money. In contrast, loose monetary policy lowers interest rates by making money easily available for lending and borrowing.

-Tight monetary policy

Tight monetary policy is a tool that a country's central bank uses to slow inflation by reducing the money supply in the economy.

It highlights the implementation of three prominent contractionary monetary measures, namely increasing open market operations such as selling government-issued securities, raising the discount rate, and increasing required reserves.

Such measures reduce the consumption and production of goods and services and slow the economy in the long run.

Some of the negative effects of monetary policy tightening include higher unemployment and a decline in the country's economic growth.

-Loose monetary policy

Loose or easy monetary policy is the opposite of tight monetary policy. When deflation occurs, the rate of growth slows, overall consumer demand in the economy decreases, and price levels fall. As production declines, firms lay off their workers and stop further investment. Foreign exports may also fall. Therefore, adopting an expansionary policy becomes essential to minimize this.

The central bank can follow an easy monetary policy to increase the economic activity of the country. However, the same bank may follow a contractionary or tight monetary policy if inflation rises and the government wants to keep it under control.

The Monetary Policy Committee's August rate cut and its reasons. The Monetary Policy Committee (MPC) decided to lower the policy rate (one-week repo auction rate) from 14% to 13%.

The weakening effects of geopolitical risks on global economic activity continue to increase. Global growth forecasts for the upcoming period are being revised downwards and recession is increasingly considered as an inevitable risk factor.

While the negative effects of supply constraints in some sectors, especially in basic food, are alleviated by strategic solutions facilitated by Turkey, the upward trend in producer and consumer prices continues on an international scale.

In addition, central banks in developed economies emphasize that the increase in inflation may take longer than expected due to rising energy prices, imbalances between supply and demand, and rigidity in labor markets. Due to the different economic outlooks of central banks in developed economies, differences continue in monetary policy steps and communications. It is observed that central banks continue their efforts to develop new supportive measures and tools to cope with the increasing uncertainties in financial markets.

The strong growth at the beginning of the year continued in the second quarter with the support of foreign demand. Compared to peer economies, job creation has been stronger. When we look at the sectors that contribute to the increase in employment, it is seen that the growth dynamics are supported by structural gains. While the share of sustainable components of economic growth is increasing, the stronger than expected contribution of tourism revenues to the current account balance continues.

On the other hand, the high course of energy prices and the possibility of recession in the main trading partners keep the risks on the current account balance alive. Sustainable current account balance is important for price stability. The loan growth rate and the allocation of funds for real economic activity are closely monitored.

In addition, it is evaluated that the increase in the difference between the policy rate and the loan interest rate in the last period reduces the efficiency of monetary transmission. In this framework, the Board decided to further strengthen the macroprudential policy set with tools that support the effectiveness of the monetary transmission mechanism.

CBRT's macro precautionary measures and “liraization” strategy. CBRT Governor Mr. Şahap Kavcıoğlu, in his article titled "Liraization Strategy" on the bank's blog, said that Turkey has recently started to implement a new economic model that prioritizes sustainable growth by ensuring permanent price stability through investment, employment, production and exports.

However, he said that the bank is focused on permanent reforms that will ensure sustainable price stability within the framework of free market dynamics. While designing its monetary policy decisions, the Bank is faced with the structural problems of the Turkish economy, especially regarding a sustainable external balance.

In this process, instead of easy but temporary solutions, the focus is on permanent, long-term solutions that cannot be achieved despite years of efforts despite short and medium-term difficulties.

Kavcıoğlu said that the main priority of the Bank is to solve the problem of high currency substitution, which has been a structural problem in the fight against inflation for many years:

"The sustainability of the external balance, supported by macro and micro precautionary measures, will now accompany the strong balance in public finances, and thus the goal of achieving and maintaining price stability will be realized," he said.

Current situation and expectations. According to the country's medium-term economic program, the Turkish economy is expected to grow by 5% this year and next year.

According to the 2023-2025 roadmap of the Turkish economy, gross domestic product (GDP) growth is projected to accelerate to 5.5% for the next two years - 2024 and 2025.

The government aims for GDP to reach $867 billion by 2023, $952 billion by 2024, and $1 trillion by the end of the program.

The economy grew by 7.6% on an annual basis in the second quarter of this year, and by 7.5% in the first quarter.

Currently at its peak, Turkey's annual consumer inflation is expected to officially decline to 65% by the end of this year, then to 24.9% in 2023.

Will the CBRT cut interest rates again? Nick Stadtmiller, EM director at Medley Global Advisors:

“Macroprudential policies that affect the cost and allocation of credit will be far more important than dealing here and there with the policy rate of 1% or 2%.

The CBRT has the opportunity to continue to intervene in the foreign exchange market for now, with seasonal tourism inflows and deposits from Russia in the last period.”

“The CBRT has ample room to maintain its policy mix of low interest rates and sustained currency intervention to slow the lira's decline. The longer they maintain this mix, the greater macro imbalances will occur. For now, however, they can maintain these policies. I think there's a place where they can keep that going until the end of the year and possibly the middle of next year."

Conclusion? The Central Bank of the Republic of Turkey (CBRT) made a shock rate cut at its August 18 meeting. The CBRT cut the one-week repo rate by 100 basis points from 14% to 13%. Analysts had expected the Bank to stand firm on the backdrop of very high domestic inflation and tightening global monetary policy. After the announcement, the Turkish lira depreciated.

Rate Cut: Lira fell after the central bank unexpectedly cut the policy rate. Source: Bloomberg

The bank's decision stemmed from high-frequency data pointing to a loss of momentum in the economy. In the Bank’s view, “it is important that financial conditions continue to be supportive to maintain the growth momentum at a time of heightened uncertainty over global growth and escalating geopolitical risk”. In addition, the CBRT stated that, in its opinion, “the updated level of the policy rate is sufficient under the current outlook”. Although inflation continued to rise to 80.2% throughout August, the drivers of higher price pressures are considered beyond the scope of impact by the Bank. Moreover, the CBRT expects that the measures it has taken before will lead to disinflation.

In the press release, the Bank gave a similar tone to its previous meeting. The CBRT reiterated its commitment to the “liraization strategy until strong indicators point to a permanent decline in inflation and the medium-term 5% target is achieved”. However, the Bank's unorthodox policy stance apparently leads to the opposite; The lira depreciated in response to the decision. Still, the President Mr. Erdogan, who will face re-election in June 2023, remains a strong opponent of rate hikes.