Turkey does not have the chance to put price stability on the back burner or give such impression.

Now it is time to assess the policy recommendations of the IMF for Turkey. The IMF maintains that Turkey needs to tighten its fiscal policy given the current milieu signified by a substantially high current account deficit and the resultant increase in the foreign exchange (FX) requirement increasingly met via short-term borrowing. To this end, it recommends the tightening of the budget excluding transient revenues. I have stated this recommendation several times before. It would have been useful to act like a “foresighted businessman” when circumstances were suitable, particularly during 2010 and the first half of 2011. Now, however, uncertainties are high and Turkey might face a weak growth performance or even contract in the event that the global crisis intensifies. If the circumstances evolve adversely, these measures will be neither politically feasible nor economically meaningful, particularly in the case of an economic contraction.

The recommendation for FX reserves is sound

Given the current circumstances, the recommendation that the Central Bank of Turkey (CBT) should avoid spending FX reserves in order to reduce the exchange rate is a sound one. A couple of weeks ago, I warned that given the current circumstances, it is useless to try to limit the upwards tendency of the exchange rate. Because the main reason behind this movement was the substantial increase in the risk perception in global markets. The CBT cannot eliminate this perception via selling FX in daily auctions. Of course, the CBT can (and does) take measures to improve the FX liquidity in order to relieve the domestic financial system. But it does not need to go beyond further. The IMF recommends the CBT to focus on price stability. In other words, it believes that objectives of the CBT to slowdown the credit growth and discourage short-term capital inflows (prevent the overshooting of the lira) and the tools employed to this aim damage the understandability of the monetary policy. What is more, the IMF implies that such practices raised questions about the commitment of the CBT to price stability. I would also like to note that the two objectives the IMF mentioned applied until August when the global crisis strengthened and that the milieu is quite different now concerning the monetary policy.

Credibility must not be damaged

I partially agree with these recommendations. With the lessons learned from the crisis and upon the understanding that focusing solely on the price stability was insufficient, central banks and academics started to seek for a new monetary policy framework. In such a milieu, it is natural that the Central Bank also embarked on this quest. In this context, it is acceptable that the CBT made effort to slowdown rapid credit expansion. Thus, I do not agree with the recommendation that the CBT has to focus solely on price stability. However, the IMF is right in that it is important not to damage the price stability target while focusing on financial stability. For instance, it is not acceptable if the CBT, in the event that it became apparent that the year-end inflation target cannot be met, states that next year’s target will definitely be achieved and employs no monetary policy tool to put the inflation rate back on track. This evidently harms the credibility of the target. On the other hand, the CBT has to understand that it is useless to throw away the monetary policy tools if the cooperation of relevant institutions is necessary to make sure that the steps taken to secure financial stability are productive. Recall that the CBT’s efforts to slowdown the rapid credit expansion via raising the reserve requirement ratio in the late 2010 and the early 2011 did not pay until the Bank Regulation and Supervision Agency stepped in (after the elections). I have talked about the reasons several times, so there is no point in repeating them. In consequence, Turkey does not have the option to put price stability on the back burner or give such impression. Monetary policy must contribute to financial stability always keeping this into account. Otherwise, both financial stability and price stability will be risked.

This commentary was published in Radikal daily on 27.09.2011