Turkey’s Central Banks Surprises With Huge Interest Rate Increases

Turkey’s central bank just made a stunning “shock and awe” move in order to calm her mercurial financial, particularly the currency market. The central bank substantially raised interest rates by 400-500 basis points

From Bloomberg:

Turkey’s central bank raised all its main interest rates at an emergency meeting, resisting political pressure and reversing years of policy, after the lira slid to a record low.

The bank in Ankara raised the benchmark one-week repo rate to 10 percent from 4.5 percent, according to a statement posted on its website at midnight. It also raised the overnight lending rate to 12 percent from 7.75 percent, and the overnight borrowing rate to 8 percent from 3.5 percent. The lira extended gains after the announcement, adding 3 percent to 2.18 per dollar at 1 a.m. in Istanbul.

Turkey is one of the supposed member of the emerging market Morgan Stanley coined “fragile 5”—along with Brazil, South Africa, India and Indonesia.

Some have cheered that Turkey’s central bank’s surprising move may have contained the emerging market contagion, but such optimists may be overlooking the possible impact of these rate increases on the real economy.

The central bank’s action has been meant to stabilize the Turkish lira which has been in a collapse mode vis-à-vis the US dollar.

This is the historical performance of Turkey’s interest rates. Like everywhere else, Turkey rates has been zero bound since 2008. Yet the recent rate hike is still far from the highs of the 2008 crisis

What has been the outcome of the zero bound rates?

Again like everywhere else, the short answer is a Credit Bubble.

Loans to the private sector spiraled to the firmament. Turkey’s credit backed spending spree has led to massive deficits in her trade and current account balances. This means that her lavish debt financed spending depended also on foreign money to plug these holes. This is another symptom of the Credit Bubble.

Moreover Turkey government continues to spend more than she collects thus sustaining a budget deficit.

And this gap has been financed by external borrowing which has leapt since 2010. External debt has grown by about 40% from the 2010 lows.

So zero bound rates promoted debt financed spending of the private sector and of the government which had been funded by banks and by foreign money. 

This is very interesting because there are about $160+ billion short term external debt due this year according to Turkey’s Central Bank, mostly held by private banks and by the other sectors.

And the other concern is of the external financing requirements excluding short term debt.

Another point of concern is of the $350 billion worth of foreign banking exposure on Turkey. Should there be any default/s will these foreign banks not be affected?

Interesting no?

Some questions

Will the current shock and awe be enough to stabilize Turkey’s financial system? Or will this just have a short term effect, where the current hike could be the first of the series of many more rate hikes to come?

How will the current dramatic rate hike impact the real economy (private sector and the government)? Importantly how will the current interest policy affect Turkey’s government and the private sector’s capacity to service debt? 

The markets have already been pricing in higher probability of Turkey’s debt default via higher CDS spreads

Mind you, for all those singing hosannas that forex reserves serve as talisman from a crisis, so far Turkey’s massive record foreign exchange reserves has done little to contain the financial upheaval.

It’s very interesting because Turkey could function as a paradigm to a possible crisis contagion or ‘domino effect’ in emerging markets.

It's even more interesting for Emerging Markets and for Asia to pray that the US Federal Reserve, whom are meeting today, won't add to their woes by increasing the "taper"