Unorthodox monetary policy causes tensions with private banks

On April 18th Erdem Basci took over from Durmus Yilmaz as governor of the Central Bank of Turkey. Mr Basci was a long-standing deputy governor, which should ensure continuity at the central bank. However, he is seen as close to the deputy prime minister, Ali Babacan, which has given rise to some concern that the bank's independence from the government may be weakened. With the Justice and Development Party (AKP) government reluctant to tighten fiscal policy much ahead of the general election on June 12th, the central bank has had to shoulder most of the burden of tackling the financial risks associated with Turkey's ballooning current-account deficit, which has been fuelled by a credit-driven surge in domestic demand. This deficit is financed mainly through short-term capital inflows, which could quickly go into reverse in the event of tighter global liquidity or a deterioration in investor sentiment.

The central bank's unorthodox two-pillar monetary policy in place since December 2010 has combined steady increases in banks' reserve requirements at the same time as reductions in short-term interest rates. The aim of hiking reserve requirements on short-term liabilities is to curb the growth of bank credit, and hence domestic demand, while encouraging banks to increase the average maturity of their funding. As of February 2011, around 90% of bank deposits had a maturity of less than three months, and 40% less than one month. The latest changes, which took effect on April 15th, raised the reserve requirements on deposits and equivalent instruments with maturities of less than six months by up to 5 percentage points. Reserve ratios will now range from 5% for deposits with a maturity of more than one year to 15% for current accounts and deposits with a maturity of one month or less. The bank estimated that the latest increases in reserve requirements would reduce liquidity by TL19.1bn (US$12.5bn)-almost as much as the previous two adjustments, in December 2010 and January 2011, combined.

The objective of the cuts in its benchmark policy interest rate, the one-week repo lending rate, of 50 basis points in December 2010 and 25 basis points in January 2011 (following cuts during the global credit crisis of 1,025 basis points over the 12 months to November 2009) has been to dampen short-term capital inflows, which until late 2010 were driving up the value of the lira, increasing import penetration and thereby contributing to the rise in the current-account deficit. At its meeting in March 2011, the bank's Monetary Policy Committee (MPC) determined not to change its policy rates. The weekly repo lending rate remained at 6.25% for a second month, with the MPC expressing the view that the increase in the reserve requirements would provide the additional monetary tightening needed to offset the upward pressure on inflation of rising international commodity prices. Consumer price inflation has declined steadily decline since September 2010, falling to a 41-year low of 4% in March 2011, but is expected to rise again in the coming months.

The Central Bank and the banking sector watchdog, the Banking Regulation and Supervision Agency (BRSA), have set a goal of limiting bank credit growth in 2011 to around 25%, but so far credit growth has not shown any signs of slowing substantially. In late March domestic lending by deposit money banks (excluding Sharia-compliant "participation banks") was still rising by 40-45% year on year. Government ministers have praised the policies of the Central Bank and the BRSA, but Turkey's bankers complain that recent measures unduly punish the industry, pointing to the level of taxation on the sector and the fact that required reserves bear no interest. After registering record profit growth of around 50% in 2009, earnings growth at Turkish banks slowed sharply to 8-9% in 2010. Higher reserve requirements and tighter interest-rate margins are expected to squeeze profits further in 2011.