What if Central Bank does not hike interest rates?

Countdown begins to Central Bank’s decision this week on interest rates. Different views of the economists are clashing before the highly anticipated meeting on September 13th, while a majority of the economists expect, they even want Central Bank to increase the cost of funding up to 23%.

And the rest of them predict that any rate hike by the Central Bank would not drive investors to show interest in TRY-denominated assets, USD/TRY would first start falling then rising again if CBRT fails to take reassuring steps following the rate hike. And I happen to agree with them.

As a matter of fact, any hike move by the CBRT would only mean, “I know what is going on. I am just putting the brakes on further problems” In other words, Central Bank is the one that provides anaesthesia or helps economy wake up from anaesthesia. If interest rates are to be increased, then it’s time for CBRT to administer drugs to the economy. And once the economy is under anaesthesia, the procedure begins.

In previous terms, CBRT used the interest rates to provide “fine tuning” to the economy. Under the present circumstances, however, a possibility of a fine tuning seems quite remote since the balance is already broken. But, if CBRT must hike rates, it then should start implementing structural reforms immediately. In this case, we would need to make our peace with the possibility of a lower economic growth rate until the end of 2019. However, as it seems like another “site cleaning” is ahead, I think we will be able to see the light at the end of the tunnel once the painful process is over.

If Turkish economy attempts to survive only with the help of rate hikes, we may face the risk of a negative growth and 36-month economic slowdown. This remedy would maybe help reduce the current account deficit, but the budget deficit would not go down at the same rate due to inevitable tax collection problems. Banks would have no other choice but to seek to recover the non-performing loans and risky debts, which would ultimately lead to a financial crisis in real sector.

“Positive scenario – negative scenario…”

In case of a negative scenario, GDP growth would slow down over the upcoming quarters. As you may remember, I said the other day that a growth above 5.5% would come out as a big surprise. Thus, confirming my previous estimates, Turkey’s GDP turned out to be 5.2%. The next thing we should do is to keep close track of the effects of recent exchange rate rises on the economy. If the abovementioned negative scenario becomes reality, we should then expect a growth by around 2.5% in 2018 and 1% or 2% in 2019. However, if the Government decides to implement a stability program so as to eliminate the problem, 5% growth expectations would then be projected for 2022.

In the event that the Government unveils the highly anticipated reforms after the CBRT’s rate hike, GDP growth rates may be 4% and 3% respectively for 2018 and 2019, in which case Turkey would achieve an acceptable growth rate by 2020.

But, what if CBRT does not hike rates? I think this is an option that we should all take into consideration. However, if neither the Treasury nor the CBRT makes any moves, I strongly advise them to get ready for a bombardment of harsh criticism and rapidly rising exchange rates.