The Kapali Carsi

Turkey’s monetary policy soap opera

Turkish Prime Minister RecepTayyip Erdogan’s criticism of the Central Bank of Turkey, to which I had referred to in my last post, set the economic theme for the week. Not only the PM carried on with his criticism, other cabinet members got involved as well, and on both sides. Actually, there is only one side at the moment, as Governor Erdem Basci has not answered back:), but Deputy Prime Minister (and economy tsar) Ali Babacan and Finance Minister Mehmet “nominal” Simsek sort of came to his rescue.

You can read a summary of what is going on in my latest Hurriyet Daily News column. There is no way I could fit all I wanted to say in the confines of 3,000 characters, and so I have plenty for this post: I have everything: Drama, tragedy, comedy, economic analysis, gossip, market predictions, which will undoubtedly be wrong:), etc etc… So read on…

OK, so let’s start by summarizing the gist of the matter: PM Erdogan is criticizing the Central Bank for not cutting rates as much as he would like. He believes that higher rates beget higher inflation. I had already taken on this theory in a former blog post, and I will address it again in Monday’s HDN column, but in any case, I see this just as his cover. The real reason Erdogan would like lower rates is to ensure that he will be elected President in August.

I have lately been observing a dichotomy between production and consumption indicators. For example, while industrial production turned out to be strong in April, mainly thanks to exports (Istanbul think-tank Betam recently predicted exports would do well this year because of the economic recovery in Europe), credit growth remains weak, consumer confidence fell again after recovering for two months after the local elections, and the construction sector is not doing well. Real estate data company REDIN recently noted that there are one million unsold homes (in Turkish).

But Erdogan is making a grave mistake: For one thing, the economy is not doing bad enough to cost him the Presidency. Besides, March-May budget figures show that the pork barrel spending that had started before the local elections is continuing unabated. Just have a look at the rising wedge between revenues and non-interest expenditures. In fact, what would cost the election would not be half a percentage fall in growth or rise in unemployment, but the mini-financial crisis that could hit if he gets what he wants and lower interest rates cause a sudden stop of capital flows/ tumbling lira.

On the other hand, as Radikal columnist Ugur Gurses explained in his column today (in Turkish), there is a very easy way to bring down interest rates, at least the interest rates Erdogan cares about. If the government were announce a credible tight fiscal plan, and even implement the long-forgotten fiscal rule, long-term interest rates would come down. Just think about the economic program after the 2001 crisis. But as I explained above, the government is doing exactly the opposite.

Moreover, I don’t think rate cuts would manage to boost the economy, at least not in time for the Presidential elections . For one thing, if Erdogan’s chief economic adviser Yigit Bulut had known any economics (more on him below), he would have told Erdogan that monetary policy would not affect the economy in less than 2-3 months. So even if there was a major cut in June, it would not have a major impact on the economy before the Presidential elections in August.

Besides, I am not sure if cutting rates would work in the current state of the Turkish economy. For one thing, if people don’t have purchasing power, or if they don’t feel confident in the economy, the won’t buy even with zero real rates. And consumer confidence is still low, as I noted above.  As for businesses, despite some improvement in recent months, capacity utilization is still low as well. Would you undertake new investment because loan interest rates have fallen if you had a lot of spare capacity?

Even if Turkey does not end up with a crisis, and the rate cuts end up working, Erdogan would be meddling with the much-needed economic rebalancing. As anyone following the country will tell you, the Turkish economy needs to shift from domestic to external demand- and reduce the current account deficit, which is widely regarded as Turkey’s Achilles’ heel. And that is starting to happen, as the balance of growth has started to shift from consumption to exports. Lowering rates and boosting imports would hinder this process.

BTW, will Erdogan get what he wants? But before that, what is it that he wants? How much of a rate cut would satisfy him? Well, Erdogan did not specify a specific amount, but his newspaper Sabah (the Gulenist phone taps revealed that for all practical purposes, Erdogan is the owner of several newspapers and TVs, making him Turkey’s top media boss) explained: The Bank raised rates by 5.5 percentage points at the end of January. Since the lira appreciated 25 percent since then, the Bank should have cut rates by 1.25 percentage points, which is 25 percent of 5.5 percent.

I don’t know where to start: That 25 percentage of 5.5 percent is not 1.25 percent? Or that the actual rate hike was more like 2.5-3 percentage points, as I explained in the column. Or that I don’t get this reasoning at all, despite having been a student, teacher and professional in the economics profession for two decades! I guess I should not start at; I wouldn’t know where to stop:)

Anyway, coming over to the question at hand: I suppose so, at the cost of putting the economy at risk and tarnishing the Central Bank’s already-damaged credibility irreparably. Basci has accommodated Erdogan in the past, and there is no reason to think this time should be different. In fact, Erdogan is accusing him and the Bank to consistently have missed their inflation targets, which were missed precisely because Basci was too accommodative. Go figure…

Not that Erdogan has any official power over Basci. If the Central Bank decided to stand firm, he would need to change Central Banking Law to have power over the officially-independent Bank. For example, he could change the composition of the monetary policy committee by putting in government representatives, or even change the Central Banking Law. According to Erdogan’s flagship newspaper propaganda outlet Sabah, the government is actually considering the former and will start with “rinsing off” Gulenist members of the MPC. The latter was actually suggested by Numan Kurtulmus , one of Erdogan’s deputies at the Justice and Development Party (AKP), last week. Some believe he was brought in from his (he was the head at the time) small Islamist party to become puppet PM when Erdogan ascended to the Presidency. However, Economy Minister Nihat Zeybekci stated this week that they had no intention to change the Law. However, most analysts do not think Basci will able to stand his ground.

Things are tougher for Basci these days also because Deputy Prime Minister (and economy tsar) Ali Babacan, who managed to convince Erdogan to the necessity of the July 2013 and January 2014 rate hikes, does not have much clout over Erdogan anymore. Some believe he is not resigning only because he doesn’t want to be known as a deserter. Moreover, just as resigning is not in the AKP’s genes, firing is not in Erdogan’s, and so Babacan will probably stay until the 2015 elections, when the AKP’s rules would prevent him running for the Parliament anyway- so it would be sort of a smooth transition. However, he may be left out of the cabinet in the new government if Erdogan becomes President in August and installs the Putin-Medvedev model, either with Kurtulmus or another loyal servant. BTW, Babacan continued with his implicit support of the Central Bank at his speech at the Turkish Association of Banks on Thursday (May 29).

All in all, Basci will probably not need to make good use of those running shoes I advised him to wear to his Council of Ministers presentation on Monday, and Erdogan will get his coveted rate cut at the June MPC meeting. This will in turn erase any doubt that it is Erdogan (and his chief economic adviser Yigit Bulut, yes yes more on him below), not Basci or the MPC, that is determining monetary policy- especially since Bank officials were emphasizing, right after last week’s rate cut, the cut did not mean more cuts were on the way. In Brazil, analysts heed the President’s word on monetary policy more than the Governor’s. We’ll probably switch to that model after the June MPC meeting:(

By the way, I am sure you are wondering who is advising Erdogan on economic policy these days if Babacan is indeed more or less out of the picture? Probably Yigit Bulut, his chief economic adviser, whose name literally translates as “Brave Cloud“. It was rumored that Erdogan told Babacan, when the economy tsar was trying to convince the PM to let the Bank hike rates in January, “But that’s not what Yigit is telling me, Ali”. Bulut’s knowledge of the dismal science is probably less than a freshperson (I am just being PC) who aced her first-year econ courses. To make matters worse, he is the foremost of the “phalanx of sycophantic advisers” mentioned in the wikileaked cables. If he were to replace Basci or Babacan, investors’ confidence in the Turkish economy would get hit seriously. After all, this is dude who claimed certain powers were trying to assassinate Erdogan via telekinesis. Yep, Dr. Jean Grey/Phoenix!:)

Last but not the least, I would like to warn you to be cautious on Turkish assets over the next few days. Not only there is a chance (although small) Basci’s presentation to the Council of Ministers on Monday may go sour, we may see a repeat of last year’s protests. Demonstrations are set to mark the anniversary of Gezi on Saturday in Taksim Square. 25,000 police officers and 50 water cannons will be waiting for them!:( So just pause and watch what’s going on for a few days…

In return for this valuable service, all I am asking you is to #RememberBerkin, #RememberEsther and #RememberSoma– although you are more than welcome to contribute to the fund Esther’s friends set up for her parents and her 16-month son

4 Responses to “Turkey’s monetary policy soap opera”

LHD207May 30th, 2014 at 11:19 am

Hi Emre,

You note that the construction sector is not doing well, citing statistics on unsold homes. How does that square with recently released building permits data from Turkstat, which shows a massive surge in Q114? Given the tight links between government and the construction sector, no doubt much of this is being orchestrated from the top.

From Turkstat press release…
"In the first three months of 2014 compared with the previous year, number of buildings, floor area, value of buildings and number of dwelling units increased by 76.8%, 89.1%, 110.0% and 71.5% respectively according to the Construction Permits given by municipalities to the buildings."

Emre Deliveli edeliveliMay 30th, 2014 at 12:26 pm

Yep, exactly there is a supply demand mismatch…. That data comes from far behind, and so they will eventually stop building… Think of it as the tree falling after someone said timber, but all in very slow motion:):):)

LHD207May 30th, 2014 at 12:46 pm

Thank for your response!

Correct me if I'm wrong, but most of this construction activity is privately financed (albeit taking direction from government), so would not show up in government budget statistics? So this creates the probability for, as you allude to, unproductive investment and a supply/demand mismatch – but not necessarily an erosion of government finances (at least in short term).

Unless the construction activity is large infrastructure projects, in which case the government debt guarantee and contingent liabilities come into play…

Emre Deliveli edeliveliMay 30th, 2014 at 12:52 pm

Yes and no. They are private, but TOKI, the state-housing admin is involved as well. But that is not a part of the budget, as far as I know. It is a complete black box…