Writer who is president of Queens’ College, Cambridge, and advisor to Allianz and Gramercy
Tried to defy internal and external economic logic by repeatedly cutting interest rates, Turkey selected this week for a new set of unorthodox measures to stabilize its currency.
Whether the authorities are ultimately more successful this time around revolves around a simple question: whether Turkish households and companies see this “circuit breaker” as a bridge to a series of More comprehensive measures aimed at addressing the underlying causes of economic and financial instability, instead, as a destination that soon proved inherently unstable?
It’s hard to put into words how chaotic the Turkish currency market was on Monday afternoon. The lira has weakened to a level in excess of 18 TL per US dollar, causing it to halve in value in just two months.
The pace of devaluation is gaining momentum, as is the chaotic nature of trading despite the central bank’s intervention, thus further depleting its international reserves.
It is only a matter of time until all this leads to another increase in inflation rates already above 20%. A growing segment of the population has chosen to protect their savings by converting lira deposits into dollars and other hard currencies (what economists call “dollarisation”).
The proximate cause of all of this is that the domestic policy rate has been cut by 5 percentage points since September at a time when both internal and external conditions were bullish. Inflation is rising, currencies are under pressure and global monetary policy conditions are starting to tighten, especially in the emerging world.
Desperate for a circuit breaker, the authorities opted this week for a set complex measures best described as an interest rate balancing mechanism with a guarantee to maintain the real value of lira deposits when denominated in hard currency.
In addition to reducing the fiscal incentive further, this approach appears to have three side benefits that the Turkish authorities are interested in. First, it avoids the potential and partial impact of a rate hike on the rest of the economy. Second, since the guarantee applies to deposits of 3-12 months, it encourages an extension of the average term of such deposits. And third, it helps ease inflationary pressures that are getting heavier.
All of this at a time when, prior to the announcement, the currency was trading in “overshoot” territory by most economic measures.
These advantages come with significant risks. This mechanism places a heavy financial burden on central bank/financial accounts unless other measures are taken to control inflation and limit the renewed pressure on the currency from the restriction. reign. If this mechanism fails, it will further erode the credibility of policymakers, making it difficult for follow-up measures to be implemented quickly even if they are comprehensive and relevant.
It is a large fraction of Turkish lira depositors that will decide the outcome within a few weeks. If they trust the policy response and are less worried about possible collateral damage, they will encourage others to buy local, local and foreign currencies. Governments can help this process by reliably signaling that the latest measures are not the end but a bridge to a more comprehensive set of policies.
This would include a central bank rate hike that is clearly, at this point, still necessary but no longer sufficient. Turkey will also need to look for other internal anchors, such as tightening fiscal policy, and perhaps external factors, such as an agreement on an IMF program to provide both financing. external support and validation.
All of this will need to be done while avoiding the conceivable temptation of controls that could undermine a robust open growth model and still have historic impacts, both economically and socially. economic and financial, exploiting Turkey’s many “competitive advantages”.
Through a new set of unorthodox measures, Turkey has bought itself artificial stability. This is unlikely to translate into real stability unless the Turkish people believe their currency crisis has indeed passed.
This will only happen if the government quickly moves to a more inclusive – and, yes, more mainstream – policy approach. Failure to do so will further erode the country’s strong economic attributes. After all, there are limits to continuously defying the laws of both economics and finance.