Some Unpleasant Monetary Arithmetic
A chronically low saving rate and a large current account deficit are well known features of the Turkish economy. What is somewhat less well-known, or appreciated, is the constraint that this imposes on Turkish central bank’s ability to create lira and achieve ‘financial deepening’ in the absence of significant capital inflows.
Last year was fairly special in this regard: Turkey ran some $32 billion CAD, but only one-third of this was financed by capital inflows. Unidentified inflows partially came to the rescue, but could not stop some $12 billion hemorrhaging of central bank’s reserves. The Bank responded by generously funding the market through open market operations, but because of inadequate deposit growth and already stretched on the lending side, banks nevertheless began to feel the lira squeeze more acutely.
All this matters, because unless we see a structural and permanent improvement in lira liquidity, which is possible only through a build-up of CBRT’s net foreign assets and the “de-dollarization” of the deposit base, the ongoing easing cycle is likely to have a limited effect on reducing lending rates and accelerating credit growth – aside from the usual risk of leaving the system exposed to a sharp lira depreciation.
In this sense, the CBRT, under political pressure, seems to be putting the cart in front of the horse, so to speak: instead of easing short-term rates in a hurry, a more cautious policy stance would —arguably-- serve the Bank better by encouraging more permanent and stable inflows, discouraging dollarization, and lowering longer term rates more decisively as a result.
Now read on...
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