ZTo combat chronic inflation and the weakness of the local currency, the lira, the Turkish central bank is raising the key interest rate by 4.75 percentage points to 15.00 percent. An increase of that magnitude was expected on the foreign exchange market, so rate fluctuations were limited. Shortly after the decision was announced, the dollar was quoted at 7.70 lira and one euro cost 9.03 lira.
The interest rate decision is interpreted as a fundamental change in the central bank’s previous policy of keeping the key interest rate as low as possible. However, the rupture had emerged after Turkish President Recep Tayyip Erdogan, who had previously always insisted on low interest rates, surprisingly dismissed the previous central bank governor, who he appointed in mid-2019, two weeks ago and also appointed a new treasury minister after his finance minister resigned .
After the government had accompanied the personnel change with market-friendly comments and reform promises, the lira had already gained significant ground in the previous week. Previously, this year alone it had devalued more than a third against the dollar and the euro and is among the worst performers among the currencies of the emerging countries.
The ongoing currency collapse had heightened concerns about a payment crisis in the country because Turkish companies and the state are heavily indebted in foreign currencies. In addition, Turkey imports more goods and goods than it exports. According to the judgment of economists, this contributed to the fact that the current account was in deficit even before the outbreak of the corona pandemic.
Loss of income due to the slump in the important tourism business is currently worsening the situation, which is also characterized by the fact that the central bank had used up its foreign exchange reserves in the vain defense of the Lira rate. One will “firmly maintain the tight monetary policy, taking into account all factors that influence inflation, until a permanent decline in inflation is achieved.
The new central bank governor Naci Agbal justified the decision after the first meeting he chaired with the fight against inflation. The delayed effects of the lira depreciation, the rise in food prices and the deterioration in inflation expectations had a negative impact. “Accordingly, the committee decided to undertake a clear and strong monetary policy tightening in order to remove the risks to the inflation outlook, to control inflation expectations and to restore the disinflation process as soon as possible.”
Under his predecessor Murat Uysal, the central bank had already raised the rate by 2 percentage points to 10.25 percent in July and otherwise tightened the banks’ money supply through the use of other monetary policy instruments, so that there was already talk of interest rate hikes through the back door in the markets to push real interest rates out of negative territory. The weighted average financing costs of the bank had risen to 14.72 percent.
However, this was not enough to contain the inflation rate, which at an annual rate of 11.89 percent in October was well above the actual target of five percent, or to reassure international investors. At the end of the week before last, the lira had therefore hit a historic low. For one dollar, 8.58 lira had to be spent, for one euro just under 10.20 lira – more than ever before.
With the appointment of new posts there is also the hope that the president will interfere less in monetary policy and that central bank governor Agbal will get a free hand. The new finance minister Lütfi Elvan had just said on Tuesday that he had instructed senior officials of the Turkish central bank and heads of other financial institutions to “do what the law says” and affirmed that the Turkish central bank was “of course independent, its statutes are clear “.
Erdogan, who had rejected interest rate hikes for a long time because they slowed the economic upturn in Turkey, emphasized on Wednesday that the main thing now is to combat inflation. Turkish media quoted him as saying: “Our aim is to achieve single-digit inflation immediately by maintaining fiscal discipline and implementing structural and micro-reforms.” He also wants to focus on growth, exports and employment. He is “determined to do whatever is necessary”. However, he then restricted that again by pointing out that “our investors should not be allowed to be crushed by high interest rates”.