Eyes Wide Open

What will be the focus of monetary policy in 2014?

The main objective of the Central Bank of Turkey (CBRT) is to achieve price stability. The CBRT is closely monitoring the recent deterioration in the inflation outlook and expectations. It is envisaged that factors adversely affecting inflation will keep inflation indicators considerably above the 5% target for some time. Against this background, the CBRT has underlined that it would not tolerate any deterioration in price stability in the medium term. To this end, it opted for strong and front-loaded monetary tightening at the interim meeting of January 28, 2014 to prevent deterioration in the inflation expectation and pricing behavior. A tight monetary policy stance will be sustained until there is a significant improvement in the inflation outlook, while the liquidity policy may be tightened further if deemed necessary.

How will the US Fed’s decision to taper its quantitative easing program by $10 billion per month affect Turkey’s economy, and how will the CBRT respond in 2014?

Capital flows into emerging economies remained weak in 4Q2013. The Fed’s announcement that it would maintain its exit strategy from quantitative easing was influential in this development and outflows continued, particularly for portfolio investment. Since most of the re-pricing in financial assets was done in the early days of the announcement of the exit strategy, price movements were more limited during the initial implementation. Although this development shows that uncertainty over global monetary policies has partially faded, ongoing risks to the pace of global economic recovery in the upcoming period feed into uncertainty about the quantitative easing exit process and other monetary policy components, such as forward guidance. Following the domestic developments of 4Q2013, Turkey has slightly diverged from other similar economies. In this period, compared to economies with similar economic conditions, Turkey’s exchange rate depreciated more against the US dollar and its relative risk premium indicators increased. In response, the CBRT implemented strong monetary tightening to contain the negative impact of these developments on inflation and macroeconomic stability. Tightening monetary policy under current circumstances will not only contribute to price stability, but also support macroeconomic stability through a reduction in exchange rate uncertainty and risk perceptions. The CBRT is aiming to contain the volatility led by capital flows on the domestic economy. One of its specific objectives in 2014 is to decrease volatility in domestic markets. Increasing the predictability of monetary policy would be helpful amid weakening capital inflows.

How can Turkey reduce its vulnerability to the withdrawal of foreign capital?

Various instruments have been devised and used in response to a changing global and domestic economic conjecture. These instruments include the asymmetric use of the interest rate corridor, the reserve option mechanism developed by the CBRT, and other lira and FX liquidity management tools. Turkey’s high current account deficit (CAD) makes its economy particularly sensitive to cross-border capital flow volatility. Therefore, one of the crucial aspects of the CBRT’s new monetary policy framework has been a reduction in the cyclical component of the CAD, and hence mitigation of the accumulation of macro financial risks that would arise in case of a sudden stop in capital inflows. This policy naturally complements other structural policies that would reduce the CAD in the medium term. Therefore, macro-prudential policies by the CBRT and the Banking Regulation and Supervision Agency (BRSA) must be seen in the context of reducing the sensitivity of the Turkish economy to capital flows that may be prone to excessive volatility arising from purely external monetary and financial conditions.