Turkey: Taking action

The central bank (CB) took several measures in August in an effort to reverse the sharp decline of the lira against global benchmark currencies. Since November 2010, the lira has lost approximately one-quarter of its value, and slid 13.5% against the US dollar so far this year, as international investors have steadily removed their money from Turkish markets.

A multi-pronged effort is designed to correct the nation’s growing current accounts deficit, while addressing several additional problems identified by the bank. The CB’s Monetary Policy Committee lowered its key policy rate to 5.75% from 6.25% in early August. At the same time, the bank is seeking to control volatility it attributes to short-term borrowing, and thus it raised its overnight lending rate to 5%, from 1.5%.

Finally, the CB announced that it would resume foreign exchange auctions as needed, beginning August 5. The last such auction was held by the CB in April 2009, and the bank had additionally suspended foreign exchange buying as of July 25, 2011, having purchased some $21.3bn in the intervening months.

Turkish Prime Minister Recep Tayyip Erdoğan defended the measures in early August, saying they would stop Turkey from feeling the effects of global economic turmoil. He added that recent economic data shows that Turkey’s economy is “far from fragile”.

The moves come after several months of criticisms that the Turkish economy is overheating, and followed directly on the heels of an announcement by the ratings agency Moody’s that the country needed “to strengthen its resilience to external shocks by restraining domestic demand”.

However, the CB’s efforts took global markets off guard, and with the debate over whether Turkey’s economy is actually overheating ongoing, the measures garnered a mixed reception.

Moody’s noted that the while public finances were stable, with public debt at roughly 40% of GDP, the government needed to quicken the pace of reforms that could reduce volatility in the economy, including reducing the high minimum wage, reining in the unregistered economy and increasing competition to lower energy costs. Moody’s also noted that only 44% of the workforce is currently employed, the lowest rate in the OECD.

According to some analysts, however, the economy has, in fact, not been overheating at all, and the CB’s measures are instead part of an effort to prevent a slowdown. Much of the country’s current accounts deficit is contained to the private sector, and as private holders have demonstrated no difficulty in paying their obligations, this should not pose a serious threat to the economy.

The Turkish economy saw growth of 8.9% over 2010, and 11% in the first quarter of 2011, outstripping China to post the fastest growth of the Group of 20 industrial and developing nations. Indeed, much of the growth could be seen as a strong recovery from the global downturn. Turkey was well positioned for a rebound – not a single Turkish bank failed during the crisis and a strong lira helped hold inflation in check.

Thus, while many analysts had posited that the Turkish economy was indeed overheating, it was in pointing to these indicators that Pascal Lamy, the director general of the WTO, highlighted the health of the economy in late May 2011. Lamy pointed to Turkey’s low lever of public debt, at 48.1% of GDP, and its foreign reserves of $78bn as two signs of the economy’s strength.

In July, the consumer price index was down 0.41%, and the annual inflation was 6.31%, while the prices of durable goods also declined, as did those of agriculture (6.06%). Several key markets did see inflationary price growth, including energy (0.3%), manufacturing (1.34%) and gold (5.28%).

According to its inflation report from early August, the CB said it expects consumer inflation will be between roughly 5.9% and 7.9%, with a midpoint of 6.9%, by the end of 2011. Consumer price inflation is expected to stabilise at 5% over the long term, and the CB said it could be between 3.5% and 6.9% in 2012.

The measured response of the CB is expected to contain volatility, as low interest rates are currently among the best tools for maintaining financial stability in the country.