Turkey slashes interest rates to kickstart economy

Turkey's central bank has cuts interest rates more than expected after President Recep Tayyip Erdogan promised that the measure would reduce inflation and ease Turks' pain.

al-monitor Murat Uysal, Turkey's central bank governor, speaks during a news conference in Ankara, Turkey, July 31, 2019. Photo by REUTERS/Alp Eren Kaya.

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turkish central bank, recep tayyip erdogan, turkish economic policy, turkish economy, turkey elections, inflation, interest rates

Sep 12, 2019

ISTANBUL — Turkey slashed its benchmark interest rate more than expected on Thursday, delivering on an assurance from President Recep Tayyip Erdogan over the weekend that loans would become cheaper to boost economic growth.

High unemployment and steep price rises for food and other basic goods in the past year have dented support for Erdogan’s Justice and Development Party (AKP), which suffered a string of losses in nationwide municipal elections earlier this year. The president has sought to quickly resuscitate the economy through a combination of government spending and easy borrowing for consumers.

The central bank shaved 325 basis points off the policy rate, bringing it to 16.5%. The size of the latest interest rate cut exceeded the consensus of 275 basis points in a Bloomberg poll of economists. Yet it was less than the 500 basis points a pro-government newspaper claimed the bank would cut, and relieved investors likely helped buoy the lira by 1% against the dollar.

Erdogan has badgered the central bank, which is supposed to be independent of political influence, to keep interest low to encourage faster growth, especially as pre-election government stimulus dries up after the economy skidded into a brief recession this year.

The president fired the previous central bank governor in July because of his refusal to reduce rates following a currency crisis that erupted in August 2018 and devalued the lira by about a third. The new governor immediately dropped rates by 4.25 percentage points at his first monetary policy meeting in July, when the benchmark rate was a lofty 24%.

Erdogan had pretty much announced Thursday’s rate cut on Saturday and promised to lower interest to single digits “in the shortest time." He told party members, “After rates fall to single digits, inflation will fall to single figures too.”

Erdogan subscribes to the unconventional view that lower interest rates will slow inflation. That theory will soon be put to the test if banks open up their coffers and flood the economy with cash.

“Further sharp cuts mean that Turkish inflation won’t come down on a sustainable basis. As we have argued before, excessively loose monetary policy over the past decade has caused inflation expectations to become unanchored,” wrote Jason Tuvey, senior emerging markets economist at Capital Economics in London, in a research note.

In explaining its decision, the central bank cited a more stable lira, improvement in inflation expectations and growing domestic demand. “At this point, the current monetary policy stance, to a large part, is considered to be consistent with the projected disinflation path," it said, signaling more cuts are in the offing.

The benchmark rate is still above inflation, which slowed to 15% last month, and so is still attracting investors amid a broader low-rate environment as central banks around the world try perk up a slowing global economy.

“We doubt that the lira’s resilience will last [with further] sharp interest rate cuts,” Tuvey wrote. “As global economic growth remains weak, investor risk appetite is likely to wane. And the threat of the US imposing sanctions in relation to Turkey’s purchase of Russian defence equipment has reared its head again.”

On Monday, US Treasury Secretary Steven Mnuchin renewed the specter of punitive action against Turkey for its acquisition of the Russian-made S-400 antiaircraft system, which the US government has said will harm NATO infrastructure.

Erdogan has built his popular support on an economic track record that tripled output during his 16 years in power and lifted millions out of poverty. But voters have turned on the AKP during the slowdown, replacing ruling party mayors with opposition figures in Istanbul, Ankara and several other cities.

Erdogan is facing other political challenges. His former Prime Minister Ahmet Davutoglu faces expulsion from the AKP for his criticism of Erdogan’s perceived authoritarian style of rule and rumors he will lead a breakaway political movement.

And Ali Babacan, Erdogan’s influential former economy minister who is widely credited with engineering Turkey’s record growth until he left the cabinet in 2015, said this week he will establish a new political party before the end of the year.

In his first public comments since quitting the AKP in July, Babacan told Karar newspaper his views on the economy, human rights and the rule of law differed too sharply with his former boss to continue working for change from within.

“The central bank’s policy rate is completely in the hands of the authorities,” Babacan said. But “the economic problems are not due solely to economic policy. Investors are afraid because of a problem of trust in the laws of our country.”

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