The CB’s new policy either did not contribute to the process or made a negligible contribution.

The Central Bank of Turkey (CB) introduced a new monetary policy in October 2010. One pillar of the policy aimed to lower domestic credit growth by raising the reserves banks are obliged to keep at the CB. Required reserve ratio was raised starting in October 2010. The latest major interventions were in January and March 2011. The process ended with a limited raise that covered a few maturity types in April 2011. Before the introduction of the policy, credit growth rates had reached significantly high, particularly in the second and third quarters of 2010. For instance, average annual credit growth rate for lira loans was 34.9 percent in the third quarter of 2011. Nevertheless, the rates did not decrease much for a considerable period after the policy (namely first three quarters of 2011). In fact, the rate reached a record-high 39.1 percent in the second quarter.

Europe went down into turmoil in August 2011. This on the one hand augmented future uncertainties, lowering investment appetite and credit demand. Also, it encouraged cautious behavior across banks. On the other hand, due to the sharp increase in exchange rate, the CB starting in October 2011 allowed market interest rates to surge, which in turn lowered credit demand. In addition, the Banking Regulation and Supervision Agency introduced effective measures to limit credit supply in June 2011. Also, we can assume that over the same period banks were “encouraged” for lower credit growth via “telephone diplomacy.”  In consequence, credit growth rate eased remarkably in the last quarter of 2011 and remained low.

In short, the mentioned pillar of the CB’s new policy either did not contribute to the process or made a negligible contribution. I have written over and over starting in the late 2010 that the CB’s policy would not work. Yıldız Akkaya and Refet Gürkaynak of Bilkent University share this view in an article at İktisat, İşletme ve Finans (June 2012). I would like to cite from the section where the article discusses the CB policy (pp 103-106):

“The problem here is a negative externality resulting from credit expansion. Economic theory tells us that the optimal policy would be a tax that will directly eliminate the externality. The action to take here would be to increase the price and thus to reduce the quantity of credit growth. Since the CB does not have any tool that will directly accomplish this aim, it raised reserve requirements pushing up the cost of credit rather than directly increasing the price of extending credit. The policy promotes credit funding with resources other than deposits (like swap borrowing) as it taxes not credits but liabilities (particularly deposits). Therefore, this policy will change the deposit-asset ratio rather than altering the credit behavior and thus will fall short of influencing credit growth rate.”

If you are wondering what the title of this piece has to do with the content, please wait for the one which will address the provocative question I have asked last Thursday.

Here goes the question: was it the conventional interest rate policy alone that yielded results? Next week will face a data bombardment. I will address the question as soon as it ends.

This commentary was published in Radikal daily on 08.12.2012