From here to there

ACTUALLY, the unforgettable classic movie’s name was ‘From here to eternity’, but we can’t reach that far amid incredibly noisy signaling and suchlike. Not only is the surrounding politico-economic space at large noisy, i.e. Eastern Mediterranean, Libya, Greece, U.S. elections, etc., but also the monetary policy space itself is – or was – so until recently. That said, some political problems are deeply rooted. The dispute with Greece over territorial waters and sovereignty rights is nothing new. Yet the current noise level and the veracity of the dispute are two different matters.


As the CBRT stops raising the effective funding rate, the policy mix becomes unintelligible anew and signal extraction becomes a problem again. People and analysts alike feel that instead of addressing the serious problems caused by economic woes, institutional design errors, structural malaises, and finally the spread of the outbreak, politics toys with foreign policy, gas finds and such. If most citizens see that as a political diversion, who can blame them? Maybe Biden’s rising odds of winning is an important concern for market players, but that’s about it.

Just one example: Israel had announced the discovery of the rather large Leviathan gas deposit back in 2010, but nothing could be extracted from there until 2019. Hence, gas finds and other political news aren’t really today’s burning issues. The economic impact would come in 5-10 years, if at all. On the contrary, FX debt, currency stability, inflation, unemployment, health consequences of the pandemic, market volatility and what not are today’s burning problems. So, let’s return to matters that matter, and matter immediately. Actually, a single right interest rate decision that might come at the right moment could generate inflows in such an ample dollar liquidity universe, and at least temporarily alleviate the problem. We have been through similar episodes time and again. If you wait, you do what you have to do all the same, but the longer you wait the higher the price is. Delaying the inevitable only creates market volatility, and that in turn stifles both demand and growth. Contrary to what some folks believe, there are times when even outright contractionary monetary policies can trigger growth. Fiscal spending ought to be generous in the time of corona, but monetary policy has already been unduly loose for 12 months. Furthermore, the situation has been clearly understood recently. So, don’t delay.


In a sense it all began in late April 2018. First, the idea that inflation was being caused by the interest rate was voiced, and fund managers didn’t buy the idea obviously. Then the offshore swap market was nearly killed, and short selling was declared a speculative practice. Well, in all general equilibrium classes, students compute equilibrium with short selling. It is standard. So? Portfolio outflows followed suit, and the Pastor Brunson affair added insult to injury, carrying TRY/USD from 4.91 by the end of July 2018 to 7.23 in 25 days. The CBRT hiked, and after the affair ended, the lira gained strength. It fell all the way to 5.11 in a couple of months, showing the bubble component or the extent of overshooting during the stressful summer. Yet the hardship caused by the TRY liquidity squeeze, a policy-driven one, left an indelible dent in the back of overseas investors’ and fund managers’ minds. Slowly but surely the swaps market in London dried up. The response was to swap out FX deposits from Turkish banks, a practice that gained speed after late 2019. So fund managers and other analysts and foreign investors not only try to assess investment opportunities and evaluate policies, but in a sense they are impelled to ‘see through’, which limits exposure.

This time around liquidity was provided so hedging was possible to a certain extent, but the hedging space that was finally carved was a bit ‘too little too late’. This is why in a world of extremely elastic liquidity surface, especially after Jackson Hole, Turkish markets can’t benefit much. Backdoor FX interventions had been notoriously infamous. Also the observation that CBRT reserves are deeply in negative territory if the swap book is netted out is so pervasively held that defending level after level is no longer possible. The current mix looks also unsustainable to almost all. Why is that so?


Liquidity was so amply provided that now there is reverse course. By the same token, the credit boom is over. Now consider just one date: May 24, 2013, two days after Bernanke spoke and initiated the ‘taper
tantrum’. Residents’ FX deposits amounted to USD 111 billion back then. Today they stand at USD 185 billion. That day, TRY/USD was 1.845; today it is 7.42, after so many billions of reserves being depleted. GDP was equivalent to USD 950 billion in 2013, but only to USD 754 billion in 2019. FX deposits/M2 stood at 28.76% in May 2013; today it is 49.81%. So it jumped from 29% to 50% in 7 seven years. Dollarization is slow maybe, but it is firmly anchored. It affects attitudes toward risk, and it changes the outlook of the citizenry towards TRY-denominated assets, nominal and real. Foreign investors’ domestic bond holdings were 20.65% of the lot in January 2014. Now they are holding only 4.53%. Even equities’ share fell from 61.29% to 51.65% since then. In a sense, because the London swaps market’s transaction volume has also fallen; financial openness is receding back to past days. How can overseas investors bear an impact on bond rates and such with such a meagre share of holdings? No, whatever happens on the exchange rate market and whatever impact the exchange rate may have on interest rates, they are both homemade. Dollarization is a local and persistent phenomenon. nd now there is also the domestically issued FX-denominated debt issue, a problem in fact, rising again. We all thought at least this kind of unpleasant monetary – not monetarist – arithmetic episode was over, but alas.


Uncertainty is surely pervasive. Yet given ample evidence, it isn’t extrinsic. It can be calculated. It isn’t the outcome of speculative attacks from the outer world. Actually, there aren’t much overseas investors left to
engineer such an attack. Rather it is the idea that whenever there is a problem the fault must lie somewhere in outer space that is part of the problem. This atmosphere constantly re-creates an unstable backdrop. Still, it is clear that a 1-3% GDP contraction in 2020, the year of the pandemic, isn’t bad per se. In Q3 we will witness a marked recovery, a V-shaped rebound. I think with some luck the 1-3% GDP contraction forecast and the 11-12% CPI forecast will both prove correct. Rather, the problem lies with 2021, and 2021 is surely a lot more difficult to make forecasts about. Because the budget deficit runs high, and it will reach to over 5% of GDP possibly, the stimulus from therein must be weak. The economy needs foreign investments in any form. A peace with swap markets, and a timely and visible change in monetary policy, would help tremendously, especially given that jobs are lost for good, the foreign trade deficit is soaring, and tourism revenues have faltered, etc. Swaps or no swaps, the first and foremost thing to do is to prevent the lira from depreciating in a jump-start fashion. There is no way to stage a crawling peg-like scenario again, because it was tried already. It ended up with little economic momentum, but a lot of newly-created debt and an erosion of FX reserves.


Policy mixes that have been tried and proved unsustainable ought to be abandoned quickly. I don’t think a “try again’ or ‘try a 40-40-20 mix’policies would wash. Monetary policy better be an Orthodox straightforward perfect foresight policy for some time to come. Not to miss turning points is the least one can do. Because if one does, a behind the curve position might result. Being consistently ‘behind the curve’ when it comes to rate hikes causes habit formation. As time goes by investors don’t believe the right policy changes will be pursued at the right time. All this causes more uncertainty, more volatility, and a delayed and steep reaction becomes likely. Policy reactions are steep mostly because they come late. In monetary policy games, timing is of the essence.

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