The current ‘incomplete’ economic program faces significant challenges in terms of fighting inflation. The first challenge stems from the fact that the exchange rate was allowed to jump so much after the May elections. By bringing forward the date of the first MPC meeting – by holding an extraordinary meeting – the policy rate could have been raised front-loaded. Then a gradual increase could have followed. The fact that the program had no other elements other than interest rate and tax rate hikes, and that a comprehensive program was not put into practice, also played a major role in the exchange rate jumping so much. These shortcomings raised suspicions of a U-turn. As a result, the exchange rate jumped senselessly. At the end of May the dollar exchange rate was 20 Turkish liras, by mid-July it was 26, and by mid-October it was 28. Inflation rose in tandem.
Some of this is behind us. But the program’s shortcomings remain significant. For example, steps to make the Central Bank politically independent were not taken. The structure of the Turkish Statistical Institute (TurkStat) could have been changed to restore confidence in the statistics released; this was not done. But it is possible to do these things in the coming days. These steps will provide some assurance that there will be no U-turns and no more actions reminiscent of the period that was deemed irrational. It would be much easier if steps were also taken towards a fair and fast legal system, but that seems unlikely too.
The second challenge is that inflation will rise in the coming months. By April-May, inflation will reach 70-75 percent. January inflation, which will be announced next week, will also be quite high. These developments are already included in the Central Bank’s end-2024 inflation forecast of 36 percent. In other words, taking these unfavorable developments into account, inflation at the end of 2024 was predicted to remain within a range with a mid-point of 36 percent and an upper limit of 42 percent. But starting from the day January inflation will be announced, we will hear a chorus. “Raising interest rates won’t work,” they will say, and of course they will not say what they propose instead. Likewise, we will hear from most representatives of the export sector that they will say at every opportunity and in every environment that they wish “the dollar exchange rate to be 40; 45 will not be enough, and if 45 is enough, then 55 will not be enough after a few months” – and they have already started to do so.
The third difficulty is that there is not enough foreign exchange flowing into the country because there is no economic program that includes the minimum elements I mentioned above. The Central Bank cannot increase its net foreign exchange reserves; instead, it is trying to at least increase its gross reserves. It lends lira-denominated funds to banks by temporarily borrowing foreign currency from them. The maturity of these swap transactions can be up to three months. In other words, it does this to increase its gross (not net) reserves for three months. It means it can lend to banks with maturities of up to three months at rates well below the one-week lending rate announced at MPC meetings.
As such, interest rates on lira-denominated deposits are not attractive enough to curb the tendency of residents to switch to foreign currency and to pull down the increase in consumption expenditures. The Central Bank publishes weekly data on the weighted average interest rates (at the compound level) charged by banks on deposits of various maturities. The latest data is for the week of January 19. The interest rate on deposits with maturities up to three months, where deposits are concentrated, is 49.9 percent. In the week of December 22, it was 52.6 percent, a drop of nearly three percentage points. The weighted average interest rate on all lira-denominated time deposits is 45.9 percent. Deposits up to three months are actually mostly 32-day deposits. 49.9 percent corresponds to 3.67 percent per month. Considering the four-month inflation in the January-April period, it is clear that the 3.67 percent monthly interest rate (15.5 percent compounded over four months) will be significantly below inflation.
Moreover, strange things happened last week: 16.5 billion dollars worth of swap transactions took place and in return, banks were lent around 500 billion liras. If you move the ‘milestone’ back to Tuesday of the previous week, the foreign currency received reaches 21.5 billion dollars and the amount of lira given reaches 648 billion liras. Now hold tight. On the last working day of last week, the amount of funds the Central Bank borrowed from banks overnight through weekly deposit auctions and the lower end of the interest rate corridor was 737 billion liras. The predominant transaction was deposits. Yes, you did not read it wrong. It lends and borrows at the same time. In other words, it both lends liquidity and withdraws liquidity. Moreover, the amount of both is very high. And on top of that, while it lent liquidity at an interest rate slightly below the old repo rate of 42.5 percent (i.e. 42 percent), the interest rate it borrowed at the deposit auction on Friday was 44.5 percent, i.e. higher.
Despite all this, end-2024 inflation is likely to be somewhere in the Central Bank’s forecast range. The further away from the upper bound and the closer to 36 percent, the better. Of course, this prediction is valid under current conditions. On the other hand, by the end of 2023, only 10 countries out of 190 have inflation above 35 percent. So, there is still a long way to go.
