Soft Landing after 2010
With the help of these measures, the initial impact of the recent global crisis on the Turkish economy remained rather limited. In fact, after a contraction in 2008 and 2009, the economy started to recover rapidly. However, from late 2009 onwards, credit growth and then the current account deficit began to grow rapidly as well. The announcement of a second round of quantitative easing (QE2) in the United States in late 2010 further fuelled this growth, starting to create serious risks for macro-financial stability.
From Q4 2009 to Q2 2011, the current account deficit and credit growth increased from 2.1 per cent and 0.4 per cent of GDP, to 9.9 per cent and 14.8 per cent of GDP, respectively. At the same time, the quality of current account deficit financing deteriorated significantly, with shortterm capital flows almost completely replacing long-term flows. For Turkey, the stability (or the lack thereof) of capital flows has historically been a key factor in determining the national growth performance and macroeconomic stability (see Figure 9.11). In particular, a high current account deficit coupled with a high share of short-term capital flows in its financing has typically been associated with elevated risks for macrofinancial stability. Therefore, a key objective of the CBRT’s new policies and measures after QE2 has been to bring credit growth and the current account deficit to sustainable levels as well as to improve the financing of the current account deficit.
The first element in the new policy mix was a widened interest rate corridor. In particular, the overnight borrowing rate was reduced sharply while the lending rate was kept unchanged. This wide interest rate corridor allowed for significantly more volatility in short-term interest rates while leaving the average funding rate virtually unchanged. Open-market operations conducted via quantity auctions further intensified the volatility in the short-term rates (see Figure 9.12). Both of these actions worked to discourage the inflow of short-term foreign capital, thereby contributing
Figure 9.11 GDP growth and net capital flows/GDP
Figure 9.12 Interest rate corridor and average funding rate
to the overall stability of capital flows. This corridor policy is used countercyclical^. During good times, when the global financial markets lead to a surge in capital inflows, the corridor is broadened; whereas during bad times, when capital inflows are reversed or tend to follow a weaker trend, the corridor is narrowed.
Figure 9.13 Reserve requirements
The second important element in the new policy mix has been the Reserve Option Mechanism. Under this mechanism, banks are allowed to deposit foreign currencies or gold for their Turkish lira reserve requirements. This facility not only provides Turkish lira liquidity to banks in a more permanent way and lowers their cost, but also supports the CBRT’s reserves, which in turn reduces the adverse impact of volatile capital flows on the financial system and alleviates the appreciation and depreciation pressures on the Turkish lira.
At the time the interest rate corridor was widened downwards, the CBRT took a number of accompanying measures to slow down credit growth. Specifically, the remuneration of reserves was halted, reserve requirements were increased, and the coverage of reserve requirements were increased to include repos. In addition, reserve requirements were differentiated by maturities in order to alleviate the maturity mismatch concerns (see Figure 9.13).
With the help of this new policy mix, the economy began to move in the desired direction. Specifically, the increased volatility in short-term interest rates resulted in declines in the volatility of exchange rates (see Figure 9.14), encouraging long-term capital movements. The improvement in the quality of capital inflows became visible as early as early 2011 (see Figure 9.15). This also helped reduce excessive appreciation pressures on the Turkish lira, leading to depreciation in the real exchange rates (see Figure 9.16). As a result, the composition of demand started to move in the desired direction, slowing domestic demand and speeding up foreign demand. This rebalancing in the composition of demand, in turn, helped
Figure 9.14 Volatility in emerging market currencies (implied for the next 12 months, %)
Figure 9.15 Current account deficit and its finance
reduce the current account deficit to more reasonable levels. Hikes in required reserves coupled with a number of measures taken by the BRSA increased loan interest rates and began to impact on credit growth by mid- 2011 (see Figure 9.17).
Figure 9.16 CPI-based (developing economies) real effective exchange rate (base year = 2003)
Figure 9.17 Total credit change/GDP
Figure 9.18 Average growth rates