00:00Turkey's central bank said on Sunday it would resume weekly repo auctions at its 37 percent policy rate.
00:06The decision is a step towards normalizing funding conditions as the central bank bets.
00:11The worst of the Iran war's economic fallout has already passed.
00:16So joining us now to discuss this is Selva Demiralp, professor of economics at Koch University.
00:22Selva, good morning. Good to have you with us this morning, of course, after that report came out about the
00:2637 percent return.
00:28Do you think the confidence that the fallout or the worst of the fallout from the Iran war has already
00:34passed and that this decision is in the right place?
00:40Yes, I think this is a signal that the central bank views the worst of the war is over, at
00:47least for the Turkish economy.
00:49But when I say that, I should note that what central bank is focusing on is financial stability as opposed
00:57to price stability.
00:58So I don't think the central bank thinks inflationary pressures or the worst of inflationary pressures is over per se.
01:06However, in terms of reserve accumulation, for the last three weeks, the central bank was able to accumulate reserves.
01:14And that's why I think this move towards normalization is consistent with the central bank's reaction function.
01:21But in terms of inflation, for example, when we look at the August survey of Koch University household inflation expectations,
01:29we see that inflation sentiment for the last 12 months actually went up from 51 percent to 53 percent.
01:36So it's not because central bank thinks that their inflationary pressures are coming down, but reserves are accumulating.
01:44Capital inflows are at a healthy pace. That's why I think they had the green light.
01:51Okay. And Silvia, how much room do you think the central bank can maneuver around rates, especially with inflation still
01:59above 30 percent?
02:03Yes, that's why I wanted to emphasize that inflationary outlook doesn't permit the central bank to consider aggressive easings.
02:13But I think the first step that was announced over the weekend is to bring policy rate back to 37
02:22percent, the effective policy rate, funding rate to 37 percent, which already happened yesterday, by the way.
02:28We were expecting perhaps a more gradual move towards 37 percent, but it happened right away.
02:36Now, until the end of the year, I think the central bank perhaps has another two percentage points room for
02:43additional rate cuts.
02:44That's because they have to be careful about the dollarization trend in Turkey.
02:49And because of the high inflation rate, it is the real interest margin has to be sufficient to convince Turkish
02:57households to keep their deposits in Turkish denominated assets.
03:02And for that reason, I think the central bank will continue easings, consistent with the decline in inflation to keep
03:10the real rate intact.
03:13Okay. But what would it take to reverse course?
03:18Do you think a weaker lira?
03:20Do you think a surge in oil prices or a re-escalation in the geopolitical tensions?
03:25Would any of that cause the CBRT to change course, essentially, or reverse the trend?
03:34When we think about a traditional central bank reaction function, we think about the Taylor rule with the output gap
03:41and the price gap.
03:42But for me, our central bank's reaction function has this major international reserves as the primary trigger for rate changes.
03:52So what the central bank will be looking at is whether reserve accumulation, which at the moment, the gross reserves
03:58are around $183 billion.
04:01If they can maintain their reserves around those levels, I think they will be able to cut.
04:06But if they observe a decline in international reserves, which would be closely related to what happens to the war,
04:14in that case, they may have to slow down.
04:17And they may even consider to go back to 40 percent, an informal increase in interest rates.
04:24But I don't think that's what their baseline scenario is.
04:29And, Silvia, how much does this normalization impact the transmission of monetary policy into the real economy, especially after months
04:39of tighter financial conditions?
04:44So the transition is going to be slower than a traditional monetary policy rate change.
04:53That's because we also have tons of macroprudential tools in place.
04:57One of them is the bank's 60 percent requirement to keep the Turkish denominated deposits relative to total deposits.
05:07And what is happening is that with the debasement of the dollar, with the appreciation of gold, banks' foreign deposits
05:16are appreciating in value,
05:18which means that banks need to attract more Turkish denominated deposits to maintain their 60 percent,
05:24which means they won't be able to cut deposit rates in parallel to the easing of the central bank's funding
05:32rate.
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