TR Monitor

Economic policy choices


are three options. The first is capital THERE controls. In its pure form, this option requires vast natural resources or any other marketable and exportable commodity production such as grain. It is basically a closed economy model. In the 1990s, after the Tequila and Asian crises, left-wing economists suggested that “hot money” was the culprit. “Hot money” is the money that comes in and goes out fast, and it is unrelated to economic fundamenta­ls. So, with the speculativ­e attacks on the British pound and the Swedish krona in the early 1990s, “hot money” was thought to be the cause of financial crises. It can be true or untrue or partially correct, but Tobin tax was once again a central motto of the day. This has nothing to do with the current situation because foreign investors have already quit, and the exodus took place a couple of years ago. Consider the stock exchange and the domestic T-bill market. Exactly five years ago non-residents were holding 64.44% of the stocks and 15.1% of government bonds: now their shares are 29% and 1.44% respective­ly.


Capital control means you are closing the economy and unless you have enough FX earning capacity even when you become a basically closed economy you can’t do that. Even if your capitalism is kind of political and you can secure funds under various guises from diverse countries, this isn’t sustainabl­e. It is more than financial repression. Financial repression channels funds to the state, and reduces savers’ money by constraini­ng them to borrow funds at negative real interest rates. However, even the public sector’s cost of borrowing can go up because there are lots of CPI-linkers and FX-indexed bonds. There is also the exchange rate-protected deposit scheme that still attracts savers and therefore the Treasury bears an ever increasing financial burden Also, the government might incur higher borrowing costs abroad –such as high Eurobond rates- and the country risk premium could go up sporadical­ly. Under these conditions, in a small open economy that runs a large current account deficit and indexes its domestic debt to either inflation or to the dollar, it is impossible to knock down public debt simply because the real rate of interest is negative. However, full capital control is even worse than that. Unless a country doesn’t have enough reserves or a sustainabl­e source of foreign currency except exports she shouldn’t do that. In the foreign currency market many exchange rates could form, and rationing scarce resources of foreign currency may become inevitable down the road. You may not import much, and with the current economic structure if you can’t import you can’t export. This would be akin to a regime of disguised or latent but persistent balance of payments’ crisis. This wouldn’t do. There is no way to go back almost half a century and reshape the behaviour of businessme­n. They have to access to foreign currency and invest, save, and export or import according as they choose. In the 21st Century nobody can be expected to behave as they did in the old days of import substituti­on.


The most likely base case scenario involves a sustained effort to go on as before for another ten months. Because the new target for the government is to win back municipali­ties in the major cities it will try to control the exchange rate. By control I don’t mean fixing the mean but rather reducing the variance. The nominal exchange rate is likely to head north but the economic management would prefer that to happen gradually. They already know that jump-starting causes an inflation wave, but this is possibly not the most obvious reason not to want another currency shock. Shock waves don’t help exports and blurs the forecast horizon: it degenerate pricing behaviour into a seemingly unruly seam of chaotic ups and downs. Also, the exchange rate is the first and foremost yardstick with which Turkish urban –even rural- middle classes measure the success of economic policy. Just as the government tried to stabilize the level of the nominal exchange rate beginning from the summer of 2022 and succeeded to do that for almost a year, it could restage the same scenario ahead of municipali­ty elections in March 2024. Why not once more? Can it be done? Swaps, FX deposits secured from abroad, the exchange rate-protection scheme that transferre­d billions of dollars from the FX deposit accounts to dollar-indexed TL accounts all helped to do that. However, the ammunition is largely spent and both the open position of the public sector and the net reserves of the CNRT are at record high lows today. Perhaps asset sales could provide some room for manoeuvre.


If inflation rises, you raise the interest rate. This much is obvious. The insistence on lowering the policy rate when doing so is unwarrante­d calls for an explanatio­n. One explanatio­n is that Islam forbids interest – which interest, how, when, why? I don’t buy the claim that it is all ideologica­l. It could well be (also) perfectly rational. A large wealth transfer has occurred over the last one and a half years. Of course everyone

knows that if you raise the TL rate, inflation will fall –at least to some extent. Everybody also knows that the deposit guarantee option –FX protection- could trigger inflation further. This wasn’t a foregone conclusion, but it was likely. Because policy rate cuts did only cause Treasury bill rates to go up in the first stage of the new game, policy rate cuts imposed an additional burden on the Treasury. Money supply has increased and I think further monetizati­on of the budget deficit is more than probable. After the minimum wage rise, and the accompanyi­ng increases along the wage curve, monetizati­on has become sort of natural. This is one reason why there is a huge difference between the official inflation and what is perceived by the people in the market place, but people don’t vote based on simple economics alone. Given this, raising the policy rate today wouldn’t add an iota to the burden; in fact it can be easily done as it was done ten years go via the late liquidity window etc. On the contrary a measured effective funding increase would curtail the budget deficit going forward. Consider also the CDS, rising Eurobond rates, and the extra cost those bring about. Yet a complete return to Orthodoxy is unlikely.


Let’s go back to the beginning of 2022 when the exchange rate-protected TL deposit scheme was initiated. Suppose the Lira stabilized and stayed put around its then current level for many months to come. Holders of currency risk-guaranteed TL accounts would only get 14% interest facing 40% or more inflation. This was the way it was in February 2022. Why rush to the new instrument then? Well, there were reasons. In case the exchange rate stayed constant, TL holders that had already signed up for 3-6-9 month time deposit contracts, and couldn’t move until the embedded option strikes on the day of maturity, would lose big time. In the end they would get nothing more than the usual TL interest but they would be “grounded” for 3 months, unable to buy or sell. If the exchange rate depreciate­s by only 14% next year, and if TL interest rate is 14%, nothing extra would be paid to them. But if ex post inflation is 40%, 26% of TL deposits’ real value would erode although savers have waited so long. There is no time value for their deposits. Indeed, the new scheme could easily turn into a trap that erodes the real value of both government debt and time deposits. Second, either the guaranteed TL interest rate FX-protected accounts could rise or the exchange rate would depreciate significan­tly. In both cases holders of protected accounts would benefit. This is what is happening now. For the exchange rate not to explode, guaranteed accounts offer up to 40% net interest. They have again become fashionabl­e. There is no exit from this in the short term.


As the name of Mehmet Şimşek is frequently mentioned these days, people think a return to Orthodoxy is a viable option. Although zigzagging is normal in this country, I don’t think an openly declared return to Orthodox monetary policy is on the table. First, however improbable it looked ten months ago, the muddling through approach worked once more, and elections are won. Why change now? Second, there are perhaps deeper reasons why the government had opted for such an unlikely policy mix in the beginning of 2022. So, the message would emphasize that hidden rationalit­y and could be a mixture of the two options.

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