The question I want to answer is whether the Central Bank’s actions fit the purpose of not.

Let’s say that you are considering bringing short-term funds to Turkey in order to invest in Turkish lira denominated financial assets. Compared to interest rates in advanced countries, even the minimum interest rate Turkey offers is remarkably higher. Take the lower limit of the Central Bank’s interest rate corridor, for instance: last Tuesday it was cut from 4.75 percent to 4.5 percent. It is still high enough.

On the other hand, interest on lira assets is not the only variable a foreign fund manager takes into consideration. The levels of exchange rate at the present and at the date when you are planning to convert lira assets to FX are also important. Assume that the monetary authority believes that short-term fund inflows disturb financial stability and hence aims to discourage short-term FX inflows. And assume that it has communicated this objective to the public. Does minimizing the exchange rate volatility cater for your objective?

After all, the lower exchange rate volatility, the lower will be the risk on the short-term fund manager. It will be easier to estimate the exchange rate on the date he or she decides to leave the Turkish market. From the viewpoint of the investor, Turkey will be more attractive than other emerging market economies where exchange rate volatility is larger, even if the latter offers higher interest rates. Talk to a few short-term fund managers or economists; you will see that they appreciate low exchange rate volatility.

Please note that I am not discussing whether exchange rate volatility is good or bad for the overall economy. The point I want to raise is rather simple: the monetary authority has an objective that I take as given. The question I want to answer is whether its actions fit the purpose of not. Maybe Central Bank researches have an answer to this.

In the second half of 2012, credit growth was at the level desired by the Central Bank, slightly below 16 percent with the Bank’s calculation method. Starting with the mid-December, however, the rate tended up. The latest credit growth figure is for February 1^st. Average credit growth for the last six weeks excluding the present week was 20.1 percent. It reached 24.1 percent in the last week.

A contradictory outlook

The latest Monetary Policy Committee decision put emphasis on the acceleration in the credit supply growth and increased the required reserve ratio for Lira loans by a slight 25 basis points. The raise was limited probably because of the signals that the level of economic activity has been lower than desired. In the final quarter of 2012, industrial output level was sluggish. Later in January, capacity utilization ratio and automotive sector output diminished by large. The credit growth rate exceeding the level targeted by the economy management on the one hand and output volume being weaker than expected on the other have produced a contradictory picture for policy decisions. If production performance was stronger, the Central Bank would probably raise reserve requirements further.

Instead, it chose a middle way, which evokes the potential dangers of pursuing a multi-objective monetary policy. I think the Central Bank researchers must think on this issue.

This commentary was published in Radikal daily on 21.02.2013