Ana sayfa English Edition Real cost of rate cut to be seen in a future downturn

Real cost of rate cut to be seen in a future downturn

Economic activity in Turkey was almost on standby in the first half of 2019 as the country was focused solely on the local elections of March, which were repeated on 23 June

Taking a decision which unnerved all investors but above all foreign investors, the government removed Central Bank (CB) Governor Murat Çetinkaya ten months prior to the end of his tenure; making a move rarely seen anywhere in the world. President Recep Tayyip Erdoğan announced that the reason for the governor’s removal was his refusal to cut the interest rate, and in doing so, he rekindled the debate regarding the autonomy of the Central Bank, a prerequisite for investors. As such, the Bank’s 25 July meeting was also its most significant in history. The Central Bank under new Governor Mustafa Uysal, went for a 4.25 rate cut, slashing Turkey’s key interest rate from 24 percent to 19.75 percent. This was the largest rate reduction announced by the Central Bank since 2002. Contrary to expectations, markets did not immediately react negatively to the massive rate cut, but it would be wise to say that this remains the case only for now.

A new door to
deeper cuts?

But what will happen next? Has the Central Bank done the right thing? Certainly, these are important questions that have yet to be answered. Economists note that this politically induced rate cut, and the government’s view that “we cut the rate by 4.25 base points and nothing happened to the markets” has opened a new door to many and more ambitious cuts. The most encouraging developments that made the move possible were the sharp monetary policy changes of the Europan Central Bank (EBC) and the US Federal Reserve. The inflation rate will fall in JUly and August, or in other words, the economic climate is having a sunny day, and that has made the Central Bank to go for a “prepaid” rate cut.

Lira left without defenses
However, economists say that the shield aound the Turkish Lira has weakened significantly owing to the Central Bank’s rate cut. Stating that lack of rain today doesn’t mean that it will not rain tomorrow, many experts warn Turkey will not be among the first nations to open an umbrella when the time comes. Experts note that rate cuts are always welcomed by financial asset owners and investment funds, as they push up assets prices. Analysts say that in a country like Turkey, which is potentially headed towards a profound crisis given its structural issues, it cannot be possible to solve problems by rate cuts. They also note that although in the short term the likelihood of further cuts might further increase asset prices, it also carries the risk of very sharp falls in the value of assets over the medium to long term. Additionally, experts say that the rate cut will not be able to create a new credit source for financial and real sectors, which are currently in the grip of a credit crunch. One banker has described the rate cut as “pulling the pin on a grenade,” adding that it is impossible to understand why the lira’s defenses were removed at such a time when Turkey risks possible sanctions from the US following the expected delivery of S-400 missiles it is purchasing from Russia.
Experts say that the Central Bank went for an early rate cut, trusting the recenlty changed global conditions and prioritizing growth. However, they are quick to warn that not much room is left for further cuts. Arguing that although the Central Bank cited improving inflation for the cut, and that the real sector might be glad of the rate cut today, economists say when tomorrow comes alarms might go off once again in the financial statements of companies when a strong lira and a low inflation rate are needed.