CREDIBILITY loss is in fact an instantaneous event. The literature tells us that building it is a long and painful process, but losing it may happen just like that. Still, the credibility of monetary policy has eroded slowly. It accelerated in the last couple of years, but it took time to erode what was accumulated after 2001, the triple audit of June 2001, BRSA restructuring, the independence of the Central Bank, inflation targeting and suchlike. They were all state of the art moves back then. It was so much so that after Lehman when policy rates were sequentially cut all the way down from 16.5% to 6.5%, at a faster speed than what the Fed did at that time, it helped banks to make monetary gains from the outstanding bond stock. Also the January 2009 move of the BRSA that allowed banks to provision only 1-2% of the possible NPLs instead of the on-going 80% in 2008, helped them strengthen their equity. All in all, banks posted 49.5% net profit increase and the equity capital grew at a 15% higher rate than trend in 2009. In turn, banks lent a lot in 2010, supporting the recovery. Now, what can banks do that hasn’t already been done, and in fact “overdone”? There is no ammunition left, which raises the importance of the export channel for 2021 and beyond. All went well during and after the Global Financial Crisis of 2008-2009, but all went sour after late 2010.
AFTER LEHMAN
Prior to the Lehman bankruptcy, the banking sector did not slow down at all. In fact, the September 30 quarterly financials show how credits continued to grow in the first 9 months of 2008. In fact, financial institutions contributed massively to GDP Q2 2008, and had it not been for lending to continue, GDP would have been near zero in that period. Lending was immediately curtailed after Lehman; TRY deposits continued to grow, albeit at a slower rate, but both TRY and FX loans nose-dived. FX deposits – adjusted for exchange rate fluctuations – fell. The narrowly defined crisis lasted for two quarters. The Q3 2009 results had already signaled a return to normalcy, a quick response to the crisis.
After March 2009, loan growth subsumed on the backdrop of VAT & SPT cuts, as demand for durables and cars spiked. Total loans grew by 24% between March 2009 and May 2010. Corporate lending returned to positive growth in March 2009 whereas SME loans only picked up after July 2010. NPLs peaked on October 23, 2009 at 5.35% and they stood at 4.59% in May 2010, returning to the May 2009 level within the span of 12 months. Again, a quick recovery it was, admittedly. The NPL ratio fell because the new NPL creation rate has fallen and some NPLs were sold. The NPL ratio increased by 13.2% in 9M 2009, only by 3.4% in Q4 2009, and dropped by 0.7% in Q1 2010. In Q2 2010 the decline reached 1%. The net FX position varied after Lehman between -1.7% and +2% for two years. At the peak risk, in March 2009, the EUR/USD basket hit the peak level of the past and volatility also rose. As a result, both on and off-BS positions were closed. Net FX short position-to-equity ratio stood at 2% in April 2010, as the basket reverted back to the October 2008 level. The credit spread fell to 3.9% in the first two months of 2010, but it rose again to December 2009 levels. The interest yield increased but the cost of funding did not change.
TWO-TIERED RECOVERY OF 2010
Everything looked okay, and even more than that. The equity capital of the sector grew at an accelerating rate after October 2008. By the end of 2009, the rate of increase in shareholders’ equity had grown by 39% since Lehman Brothers’ bankruptcy. The equity base of the system would have been TRY 112.8blln by the end of 2009 had it tracked its normal trend since 2002. In fact, the equity capital grew by over 15% above trend in 2009. No other banking system could manage that at the time. The growth in equity was due to 30% from retained earnings as the sector distributed 47% of net profits as cash dividends in 2007 but increasingly refrained from so doing as cash dividends fell to 27% in 2008 and to 16% in 2009. A hefty 26% was due to valuation effects, i.e. the securities portfolio booked as AFS (available for sale) gains value as interest rates fall and the gains go under equity unless such securities are sold; 25% rise from current period’s net profit; 18% capital increases. Perfect.
A BIT OF DATA
The data set consists of three interest rate series; money market rate, lending rate and deposit rate. Impulse responses almost die off after 3 months. Pass-through peaks at the second month. According to variance decompositions, 83% of 10-months effect is already there after two months for deposits, and 98% for loans. The pass-through from money market rates to both deposit and loans is rather fast. Loan rates move faster, but deposit rates response displays more inertia, albeit at a low level.
THE WRONG TURN IN LATE 2010, EARLY 2011
Very good moves indeed! Yet it was quickly reversed, in fact, without anybody noticing. Then the FX debt stock was much lower, and during the two-phased growth of 2010-11 EMs had attracted a lot of portfolio inflows. As a result, there was overheating, the CAD-to-GDP ratio neared 10%, and the economic administration then under Mr. Babacan announced a “soft landing” and “rebalancing”. At about the same time – or year – the CBRT began to resort to the “corridor”, and monetary policy has turned into heterodoxy more and more ever since. The policy rate was cut during overheating, but the “corridor” was introduced in 2011. It added flexibility yes, but resuscitating an idea of the 1990s wasn’t really a good idea in the end. It should have been used only for a short span of time. Eroding credibility is, as I said earlier, sometimes instantaneous sometimes a long process. Once this avenue opened up, macro prudential measures of all sorts stepped in, and left little orthodoxy in monetary policy for too long. What started as a success story right after Lehman worked, but monetary policy went sideways after a couple of years, believing that what had been done could be repeated every now and then.
GROWTH AND EXCHANGE RATE MISALIGNMENT
Two ideas emerge. First, a presupposition should obtain. There will be no “Dutch disease”- type long-run repercussions after your domestic market is awash with financial flows. And any currency shock need not end up in a ‘sudden stop’, old school-type that is. If these obtain, then the second idea tells us that the exchange rate shouldn’t be misaligned for too prolonged a period. In other words, the lira shouldn’t be allowed to over-appreciate if foreign capital inflows renew. By the same token, it can’t be left to remain undervalued for a long time for whatever reason. A constantly undervalued currency means poverty for all in the end. Typically, the “Dutch disease” – ‘sudden stop’ type of phenomena occur after the initial financial liberalization. Add to this the lending boom that happens because banks are bought by larger overseas banks and they may be allowed to get credit wholesale from their parent companies. Then, also because there is a ‘global savings glut’ or because major central banks cut rates and ease quantitatively, there is cheap funding for so many years. In the first round, the lira over-appreciated. If sustained, this causes misallocation of resources and financial fragility. Now, the real exchange rate is the relative prices of tradeable goods in terms of non-tradeable goods. A real exchange rate appreciation – if it lasts for many years and if it borders over-appreciation – allocates scarce resources, mainly capital, to the more profitable non-tradeable goods sectors such as construction. These episodes need not be simultaneous. A t-1 episode appreciation that doesn’t extend to period t can still cause a capital over-accumulation in the non tradeable sector in period t because production takes time.
QUALITY
This is exactly what happened here after Lehman. Because myopia is very real and because the world was awash with cheap dollars again for a second round, capital accumulation basically took place in non-tradeables while manufacturing, the locus classicus of ‘catch up’ and productivity, lagged behind. The quality of GDP growth and its sustainability are hampered as a consequence. The profit squeeze theories that are ‘in the air’, so to speak, from time to time, are so because tradeables don’t perform. It is almost never an economy-wide phenomenon in the presence of technical change. As a result, the potential growth rate is lower now because the quality of growth, when there was growth anyway, was low for too long. Similarly, the exchange rate misaligned prior to 2008 and misaligned again after 2017 in the opposite direction. Again market plays look for a new rate hike. That may or may not do the trick. If it does it might help the lira stabilize around a fairer value, but the issues of credibility loss and low quality growth will remain with us for a long time.