Turkey’s Authorities Aim for Soft Landing

With inflation more than double the 5% target, Turkey’s central bank left its headline policy rate on hold at 8% last week. Instead, policymakers opted to increase the late liquidity lending rate by 50 basis points to 12.25%. The Bank has decided against hikes in the one week repo lending rate in recent months, instead utilising its interest rate corridor to increase banks’ average funding costs. So while the one-week repo rate has been on hold all of 2017, the weighted average cost of central bank funding has increased from 8.3% to 11.8%.

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As banks pass on those higher rates onto corporate and household borrowers, credit growth should slow. That is particularly important as Turkey’s economy has become very reliant on credit to fuel activity. Since 2000, bank lending to the private sector has outpaced nominal GDP growth for long periods. Indeed, credit to the private non-financial sector now tops 80% of GDP, and is more than 20 points above its ten-year moving average. It is at levels associated with increasing risks of crisis.

Turkey’s economic stewards will hope to manage a soft landing, where credit growth eases and domestic demand is replaced by external demand. The stealth tightening should help to rein in bank lending, while improved competitiveness has encouraged foreign demand. The real effective exchange rate was 18% below its ten-year moving average in March, helping to lift annual export growth (in US dollar terms) to 14%. A weaker currency has been supported by a global economic upswing, including in the European Union – destination for around half of Turkey’s exports.

While risks remain skewed to the downside, the previous pessimism baked in to Turkey’s economic outlook appears overdone. Investors have noticed: the Turkish stock market has increased by 20% in US dollar terms year-to-date, outperforming a 7% increase in the S&P 500.

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