What should the Central Bank (not) do?

The other day, a news agency called me and asked me the following question: “What do you think the ideal level of exchange rate is?” Here is my answer:

“Your question is incorrect; because, whatever market says happens. The trouble here, however, is a global one. Turkey is running a large current account deficit for years and there is a massive debt accumulation in its private sector. That’s why Turkey can’t avoid catching flu whenever the sharp winds blow over global markets. Rises in exchange rate and high fever are pretty much alike. An exchange rate uptrend is a reaction by the market against Turkey’s economic fragilities just as fever is a defensive reaction by the body against infectious disease. We should make the right diagnosis in lieu of considering these reactions ‘good’ or ‘bad’.”

Besides, given the fact that more than 85% of Turkish imports consist of raw materials, intermediate and investment goods, we must always be ready to gracefully embrace the side effects when manufacturing industry and exports are on the rise. According to CBRT’s survey, external dependence with regard to low value-added goods and services remains around 20% whereas reliance on high-tech imports reaches over 40%. That is to say, the amount added to the value of products slips through our fingers. It’s not something we can prevent by imposing high import tariffs. We need to come up with better ideas to improve Domestic Production.

“Hike the rates! That’s easy for you to say…”

Obviously, everyone is aware of the fact that Turkey is running a huge current account deficit because of sectors failing to provide high value-added products and that foreign currency borrowers have borrowed a little too much due to high Turkish lira interest rates. A potential rise in exchange rates, as outcome of the abovementioned circumstances, will negatively affect inflation rates as well as confidence indexes. This is just unavoidable.

Following the inflation data released yesterday, more and more people are saying that CBRT can hike the interest rates anytime now to keep the exchange rates under control. I highly doubt whether this would be an effective solution; because, a drastic hike in interest rates may be required to bring exchange rates and inflation under control. That’s why CBRT should make a proper analysis first on the advantages of a rate hike and then its potential adverse effects.