The writer is a former chief economist of the Central Bank of the Republic of Turkey and a professor of monetary policy and financial markets practice at Bilkent University in Ankara
Turkey has banned temporarily six international banks from betting against the Turkish stock market, including JPMorgan, Goldman Sachs and Credit Suisse.
This is the latest in a series of moves that represent a step back from a longstanding regime of free capital markets towards a more protectionist, inward-looking approach that uses micromanagement tools to run the economy.
Today, interest rates, prices, exchange rates and private bank balance sheets are partly controlled with unconventional tools and moral suasion. Authorities have also made it harder for foreign financial institutions to trade the lira, imposed costs on foreign currency transactions and eroded the central bank’s already low foreign exchange reserves.
It might look like the best of all worlds: if a country can control the actions of key economic actors, it may be able to enjoy low interest rates, stable exchange rates and even decent employment growth with low inflation. But it carries dangers for long-term economic health.
A significant risk is that less predictable policymaking will discourage long-term capital expenditure and inflows of foreign capital. With its young population, limited natural resources and relatively low saving rates, Turkey needs foreign direct investment and technology transfer to catch up with advanced economies; but FDI has been on a persistent downward trend in recent years.
Moreover, imposing complicated restrictions on financial institutions may distort their incentives to channel resources to productive uses. Overall, the process could have a negative impact on Turkey’s potential economic output in the years ahead, stifling employment growth — with long-term social consequences.
The authorities have been trying to target interest rates. But the resulting currency weakness, rapid credit growth and accompanying inflation runs the risk of persistently elevated risk premium and a reversal in interest rates, hampering economic recovery in the medium term.
It doesn’t have to be that way. There is an alternative path to achieving sustainable low and stable interest rates: establishing greater credibility in the fight against inflation.
Turkey’s persistently high inflation — which stood at 12.6 per cent in June — is at the root of many of its economic problems. Uncertainty over the purchasing power of the lira causes domestic savings to shift to the foreign exchange deposits, a phenomenon known as dollarisation that weakens the effectiveness of monetary policy. The share of deposits held in foreign exchange has reached 50 per cent recently.
High inflation also hampers long-term planning, discourages investment and distorts income inequality. Bringing inflation down would help promote long-term sustainable growth, fuller employment and stability in interest rates. That would also alleviate the policy trade-offs by reducing sensitivity to capital flows.
Achieving a stable inflation rate does not have to be difficult: the central bank simply needs to be allowed to do its job. Years of experience and research suggest a credible central bank with the autonomy to set its own tools is the key to achieving price stability.
Further, our post-coronavirus world offers an opportunity for Turkey to bring down its inflation rate at relatively low cost. After massive depreciation over the past eight years, the lira is now at historically competitive levels. Globally, long-term interest rates are likely to stay low for some time. Under such conditions, a credible plan restoring Turkey’s inflation-fighting credentials would help attract longer-term foreign finance, curb dollarisation and fill the hard-currency gap created by a pandemic-induced collapse in tourism revenues. That would help stabilise the exchange rate and inflation and support economic growth.
To be sure, low inflation will not fix all the problems immediately. These efforts will be effective only if they are accompanied by a sound and predictable policy framework to strengthen the resilience of the economy. Yet, getting serious about Turkey’s chronic inflation would be an important step. It would help the country navigate the current challenges without resorting to the perils of evermore restrictive measures on the free flow of capital.
Source: Economy - ft.com
