Turkey’s Monetary Tightening: Will Other Emerging Markets Follow?

Posted January 29, 2014 by rvillareal

The Turkish Central Bank surprised skeptical markets and pushed policy interest rates sharply higher last night.  The bank made the following adjustments: it increased the overnight lending rate from 7.75% to 12% (425 basis points), the overnight borrowing rate from 3.5% to 8% (450 basis points), and the repo rate from 4.5% to 10% (550 basis points)–a very large shift upward of the TCB’s interest rate corridor.[private]

• Will the measures work? if politics does not trigger a crisis, as has on occasion been the case in Turkey, the central bank’s decision to hike rates so sharply addresses a fundamental source of the lira’s instability. As investors eye the end of quantitative easing in the U.S. later this year, even if interest rate increases by the Federal Reserve are at least many months away, a reassessment of different markets and assets was inevitable.  The super-easy money era comes to an end, and interest rates will tend to move up.
• Other emerging markets are inevitably subject to the dynamics created by Fed tapering, and their interest rates will also tend to rise over the next 12-24 months.  But neither the pace nor the extent of interest rate adjustment needs to be as abrupt as in Turkey’s case.  In every case it will depend on a variety of key factors, including the country’s financing needs and current level of interest rates. A large current account deficit makes the respective currency vulnerable; other things being equal there may be a trade-off between a more stable currency and higher interest rates.  Some important EM countries that exhibit this trait: Turkey itself, Brazil, Indonesia, India.
• Despite the recent turmoil, as we have pointed out in an earlier note, the probability of a systemic and generalized crisis across EM remains low, on account of a variety of positive developments and structural changes that include debt reduction, low inflation, as well as currency flexibility, plus the fact that the most crisis-prone economies (such as Argentina and Venezuela) do not seem likely to play the role of a Greece or a Thailand in spreading the contagion.  BUT this is a very complex phase of the global business cycle, with significant cross-currents that can create volatility, lead to depreciation of EM currencies, and push risk indicators and financial costs higher for emerging markets.

1-29-14–EMG INDICATORS AND INSIGHTS (Turkey Monetary Policy)[/private]