The appreciating lira and monetary policy.
At the beginning of the year, when a speculative depreciation of the Turkish Lira started following the US Federal Reserve's announcements that it would tighten its monetary policy as well as the political troubles caused by the graft scandal of Dec. 17, the nominal exchange rate of the Turkish lira against the US dollar reached the shocking level of TL 2.39, meaning real depreciation of above 20 percent. The reaction -- rather late -- of the Central Bank of Turkey took place by the end of January. The central bank increased its various interest rates tremendously "in order to contain the deterioration in inflation expectations and pricing behavior," according to a recent central bank report on inflation.
The speculative depreciation could have been stopped and reversed as risk sentiment improved. The nominal exchange rate stabilized around TL 2.20 to the dollar. This exchange rate still gave an appreciable degree of competitiveness to the Turkish economy. The real exchange rate index had almost returned to its 2003 level by the end of March; it was at around 102.
Let me mention that in the last decade, there have been some episodes when the real exchange rate index reached levels higher than 130, signaling a strong overvaluation of the Turkish lira. The central bank decided to have a look at the real exchange rate in the framework of balanced growth -- requiring a positive contribution of net exports to GDP growth.
So, by the end of March, the central bank was very comfortable with the levels of both the nominal and real exchange rates since there was room for a limited decrease of the nominal exchange rate, allowing some appreciation of the Turkish lira. Nonetheless, by the end of April the real exchange rate index reached 108 due to two evolutions. On the one hand, the inflation rate jumped by over 8 percent while on the other, the nominal exchange rate decreased to TL 2.13. During the first days of May this decrease continued and the exchange rate is currently around TL 2.08. If this level of the nominal exchange rate continues throughout May, the real exchange rate index value will be close to 120, the upper limit of the overvaluation, partly because of the nominal exchange rate decrease and partly because of the difference in inflation rates between Turkey and its trade partners. We can be sure that the index will be over the 120 mark by the end of June, even if there is no further decrease in the nominal exchange rate.
This is, of course, good news for the expected reversal in the inflation trend but quite bad news for the desired balanced growth. One expects a positive contribution of net exports to GDP growth -- exports growing more rapidly than imports -- in the first quarter and one hopes that this positive contribution will continue during the following quarters so that balanced growth will be maintained. With an overvalued Turkish lira, this is not achievable.
How will the central bank react to this challenge? Personally, I think that priority must be given to dealing with overvaluation. It should be noted that the priority is to avoid excessive exchange rate volatility, which is one of the jobs of the central bank.
The daily US dollar sales of the central bank have already been cut by more than half. However, this measure will probably not be sufficient to prevent future inflows. Last Friday, the governor of the European Central Bank (ECB), Mario Draghi, claimed that capital worth 160 billion euros left Russia because of the Ukrainian crisis. According to some bankers quoted in the Turkish press, $5 billion of this capital landed in the Turkish financial market, pushing the exchange rate down. These massive hot money inflows might be considered transitory but do not forget that Draghi also announced that the ECB is ready to implement a quantitative easing policy by June.
In this context, I believe the central bank has no choice other than to loosen its tight monetary policy by narrowing its interest rate corridor to some extent, but also by widening it. It has done this before when excessive capital inflows appeared. However, this move is expected to come after June, once "there is a significant improvement in the inflation outlook," as stated in the last inflation report. If the move happens this month, I will not be surprised. (Seyfettin GE-rsel/Today's Zaman)
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|Publication:||Cihan News Agency (CNA)|
|Date:||May 13, 2014|
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