Calls for Rate Cut as Dollar Drops

Pressure continued to mount this week for a cut in Turkey’s interest rates, after the Central Bank had taken the unusual step of intervening in support of the US dollar the previous Wednesday. The flight out of foreign currency and into the strong Turkish Lira (TL) also caused growing concern with exporters, anxious that an overvaluation might damage chances for further growth.



With interest rates on TL-denominated government bonds now much higher than inflation - and a more appealing bet than foreign currency, traditionally a safe bet for investors - the US dollar had fallen to TL1,450,000 by lunchtime May 22. Over the previous 12 months it had been trading around the TL1,650,000 mark, jumping as high as 1,800,000 during the Iraq war on fears of a collapse in US-Turkish relations.



Central Bank intervention on May 22 saw the dollar push up to TL1,492,000 - yet by the middle of the following week it had slumped back down to TL1,452,000 on the free market.



"We are watching the changes in the foreign currency rates carefully," Trade and Industry Minister Ali Coskun told TV channel CNN Turk. "We know all of the problems and we know all of the measures to be taken."



However, criticism over interest rates policy continued. The Central Bank last cut its
short term rate late April, bringing it down to 41%. Yet, with market polls revealing year-end inflation expectations of around 26% - which is also roughly the current level - this appeared to indicate an important discrepancy. Demand for TL has led to widespread views that the currency may now be around 15% overvalued.



The semi-official Anatolian News Agency reported May 28 that International Monetary Fund Turkey desk chief Juha Kahkonen had commented that while the nation’s macroeconomic balances were on the right track, steps had to be taken to bring rates down. This view was also supported by Economy Minister Ali Babacan, who told the daily Milliyet the same day that "We have to bring down high interest rates".



The burden of the heavy debt stock was proving a problem, Babacan added, though he appeared to change his mind the following day when speaking to the daily Radikal, when he said that this burden "should not be a cause for any real concern".



Babacan’s earlier view that a rate cut was necessary was also in keeping with the views of a clutch of other government ministers. Both Prime Minister Recip Tayyip Erodgan and Finance Minister Kemal Unakitan have voiced this opinion in recent weeks, with State Minister for Foreign Trade Kursad Tuzmen adding his support for this view May 28.



The minister warned that the strong TL was in danger of weakening the country’s export-import ratio, with any fall from 70% towards 60% causing "dire consequences" for the country.



Nonetheless, Central Bank Governor Sureyya Serdengecti told Anatolian the same day that interest rate policy would not be based on market polls alone. He did however concede at a briefing for opposition republican People’s Party (CHP) deputies that rates might have to be curbed a little, but that time would tell.



The Central Bank has a legal mandate to pursue disinflation and is worried that any relaxation in rates will cause prices to begin climbing again. The Bank is also independent of government control, which, as Tuzmen pointed out, "is to enable them to make moves without creating controversy about their independence," a vital point given historical concerns over too close a link between government and bank.



Tuzmen’s warnings on exports did however also came against a background of highly satisfactory results in this area. Deputy Prime Minister Abdullatif Sener told reporters in Ankara May 28 that "the markets have a positive expectation of the economy" and that exports were up.



He said that Turkey’s exports had grown steadily in the first four months of 2003 and now stood at USD14bn for the year so far. Sener said the government was expecting a record-breaking USD40bn for exports by the year’s end.



However, imports too are also on the rise and the current account deficit continues to gallop ahead - with the government’s USD3.5bn end of year prediction for the deficit severely undermined by a USD2bn deficit in the first quarter alone. Market watchers are widely predicting an end of year current account deficit of around USD6.5bn.



The pressure is therefore on for more exports - with the demands of foreign trade a likely major factor in Serdengecti’s current deliberations.