President Erdogan Statements and Expected CBRT Decision
November 11, 2020
President Erdogan made important remarks about the economic policy making and the priorities in the near term. President stated that government was working on forming a new growth strategy while economic policies will be based on price stability, financial stability and macroeconomic stability. Mr. Erdogan added that they will support the new CBRT Governor and Minister of Finance decisions, leading to a sharp rally in Turkish assets while USD/TRY saw 7.8765 at the lowest from around 8.10 before the speech. The President reiterated that interest is the cause and inflation is the effect, while he also added that it creates a difficulty to keep interest rates at least at the level of inflation. However, mentioning that it is the CBRT’s job to determine and implementing the monetary policy has led to a positive reaction in the market. President added that the economy management will focus on trust and credibility building for international investors as well as lowering country risk premium while they would prepare structural reforms on improving investment climate, financial market depth, the quality of public revenues and expenditures, good governance and preventing unregistered economy. Additionally, the President mentioned that they would take steps for empowering the rule of law as well as well functioning judicial system. All remarks by the President Erdoğan were on important factors that were creating uncertainty in the eyes of the investor. Today’s decision to extend swap limits by the BRSA have also led the market think that unorthodox policy making might be left behind and interventions to free market functioning might be reduced. As a result, investors will seek further action for normalization going forward. Following the statements, USD/TRY is hovering around 7.90 at the time of this writing while 5Y CDS is around 450bps and 2Y benchmark bond yield is down 50bps to 14.5%.
Market pricing reflects an expectation of a considerable rate hike in the next Monetary Policy Council (MPC) meeting to be held in November 19 as President Erdogan stated that they would not refrain from taking bitter pill to create a sound macroeconomic environment. Not only because rate decision will be a litmus test for the Bank’s independence and credibility but also whether the new Governor will use communication as an efficient policy tool will also be tested. What policy combination awaits us is a very hard question despite the general expectation that monetary policy will remain tight until inflation expectations improve. An ideal policy at that point will be a revision in the policy rate from one week repo to O/N lending as most of the funding is currently provided from O/N. Additionally, a simplification in the monetary policy framework by returning to symmetric corridor (let’s say 150bps) would also work well in terms of increasing predictability. If that would be the case, current O/N lending rate at 11.75% would be the new policy rate and we would expect a 375bps hike leading to an O/N lending rate of 15.50%. This is higher than the current weighted average funding rate at 14.30% as well as the average rate seen in the traditional repo auction which is close to 15.0%. Yet, the CBRT might not opt for such a dramatic change in the monetary policy framework hence might continue with current rate mix. In that case, we expect a 500bps increase in both one week repo rate at 10.25% and O/N lending rate at 11.75% while the difference between O/N lending rate and late liquidity window (LLW) might be reduced to 150bps again. Recall that in the previous MPC meeting, this difference was widened to 300 bps. This would lead one week repo rate, O/N lending rate and LLW to increase to 15.25%, 16.75% and 18.25% respectively. We may also see the Bank to cancel traditional repo auctions and open O/N lending limits to Banks for the sake of simplification. Those actions together with a clearly written statement would serve for building credibility and predictability hence help to contain exchange rate volatility. Further actions to manage reserves and setting the policy framework might be delayed to the release of 2021 Exchange Rate and Monetary Policy report expected in December.