The Central Bank of Turkey (CBRT) raised its key interest rate by 200 basis points after its meeting on September 24th, 2020. The 1-week loan rate (repo) rose to 10.25 %.
This is the first monetary policy tightening of the CBRT in two years. Its objective is to “restore the process of disinflation and support price stability”.
The decision does not come as a surprise. As reported in August, in the face of downward pressure on the pound and lack of room for maneuver on the foreign reserve side, the CBRT had no choice but to tighten monetary policy.
As a reminder, key rate was lowered from 24 % to 8.25 % between July 2019 and May 2020.
Inflation remains high. In August, it stood at nearly 12 %, while the central bank’s target was set at 5 %. With an aggressive monetary easing cycle that started a year ago, the real rate is very negative.
At the same time, the country’s financial vulnerability has increased. Twin deficits have widened and foreign currency debt has risen, putting Turkish companies and banks at risk of default.
In fact, Moody’s downgraded Turkey’s credit rating to the speculative (“junk”) category of B2 on September 11th, along with those of 13 national banks. Fitch, meanwhile, lowered the outlook for all banks from “stable” to “negative”.
Weak foreign exchange reserves
In this context, further tightening of monetary policy is possible at the next meetings. On the one hand, CBRT aims to bring inflation back below 10 % by the end of the year. On the other hand, raising the key rate despite opposition from the Erdogan government does not restore the credibility of the central bank and does not in any way rule out the risk of further capital outflows.
Downward pressure on the lira is expected to persist due to negative real interest rates, worsening fiscal and current accounts, and mounting external debt.
Importantly, if volatility increases, intervention in the forex market should again be very limited. The central bank’s foreign exchange reserves were at their lowest level in fifteen years in September.
Finally, further tightening of monetary policy will further complicate the recovery of the economy. This one is slow so far. In addition to the financial turmoil, the gradual deconfinement is still having a strong impact on service activity, particularly on the tourism sector.
In total, GDP will contract by 4.8 % in 2020. This will be the worst performance observed since the 2009 crisis.
Source : Thuy Vân Pham, emerging markets economist, Groupama Asset Management.