Page 73 - BNE_magazine_12_2019 dec19

bne December 2019
Opinion 73
this could then see more scope for the CBRT to extend and deepen its current rate-cutting cycle – thereby pleasing its political master.
It’s possible then to present a benign outlook for fixed income markets, with growth and inflation surprising on the downside, and with the authorities continuing to micromanage the exchange rate, the lira might remain relatively stable (surprising towards appreciation) – notwithstanding potential geopolitics, hiccups.
But then returning to the political context, with support
for the ruling AKP and Erdogan lagging and risks of early elections due to potential leadership changes at the MHP, can Erdogan risk low-balling growth? It seems unlikely – and this suggests extreme pressure then on the CBRT to do more to cut policy rates, on the Treasury to loosen fiscal policy and on banks to boost credit expansion.
Another Credit Guarantee Programme?
Now if developed markets policymakers keep policy loose, and global liquidity plentiful, the market might be forgiving of a scenario where nominal policy rates might be pushed well into single digits, real policy rates close to zero, and fiscal policy loosened, with risks to a rising current account deficit again. But I have my doubts in the context of the past two years’ experience of the Turkish policy setting where we know that if the lira cracks, and the CBRT needs to hike policy rates, Erdogan will only allow policy tightening when it is too late.
I would also question the willingness of portfolio investors
to commit to local TRY GB trades, when the offshore swap market remains broken, and hedging opportunities are limited. We pushed policymakers on this very issue. The response was not very credible. A first response was that this was not a policy prescription but just reflected the result of dollarisation, which resulted in local banks being flush with dollar liquidity and in need of no more provided through offshore SWAPS – they also preferred TRY. A second, was that the blame rested with foreign banks which could provide TRY liquidity onshore to foreigners, but had been unwilling
to sufficiently boost their capital to enable such liquidity provision. There was little acceptance that this was a specific policy response to offshore shorting of the lira in the summer of 2018, and restricting liquidity to the offshore market helped to stabilise the lira, albeit at the price of limiting portfolio inflows subsequently to the TurkGB market. Indeed, on the latter note it is striking that in an environment where policy rates have collapsed by over 1,000bps, and the lira has remained stable, portfolio inflows have flatlined this year, and foreign holdings of TurkGBs have stayed only around 10%, from peaks closer to 25%. In previous years when similar disinflationary trends have been evident, portfolio inflows have totalled around the USD20bn mark.
This now seems a very micromanaged market. Dollarisation means banks are flush with dollar liquidity and can meet offshore FX liabilities falling due. This dollar liquidity is
also available to state-owned banks which if market makers are to be believed have been supporting the TRY at times of geopolitical stress and post recent rate cuts. Long-term TRY liquidity is though in short supply – banks complain that swapping FX liabilities for TRY is expensive and longer-term liquidity is in short supply. With foreigners also reluctant to participate in Turk GBs, while the CBRT continues to aim to push short-term rates lower, this would suggest a steepening of the yield curve and crowding out at the longer end of the funding equation.
This also comes as the Treasury likely needs to borrow more and will want to move back out of the Turk GB curve to extend its maturity profile again. Net-net this again suggests that credit growth will disappoint and with it real GDP growth and job creation. The so called V-shaped recovery required to list Erdogan’s lagging poll ratings will be elusive. And this then risks more risky and unorthodox policy responses from the Erdogan administration. This might be a year or so out from here but the concern is that when this reckoning comes, what we know is that the CBRT will be unable to respond as it did in 2018. It will be unable to hike policy rates, because President Erdogan has made his position totally clear in this regard – interest rates cause inflation.
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