The Whirling Dervish: Turkey’s Monetary Policy Tools

dervish

Author: Tanya Rawat

Post Lehman, Turkey considered it prudent to adopt a mix of macro-prudential measures (MPM) as a supplementary objective to support price stability rather than outright capital controls with the intent of keeping domestic demand in tandem with the external demand. The measures have enabled Turkey to weaken the link between capital flow cycle and external imbalances without directly imposing capital controls which they deem hard to implement and easy to circumvent.

In the traditional inflation-targeting framework, central banks mainly aim at keeping inflation in line with the target by using a single policy instrument of short-term interest rates. However, in the new policy approach due to the tradeoff that may occasionally arise between financial stability and price stability, additional tools are needed besides policy rate. As a result CBRT diversified its policy tools before adopting the new policy mix.

The tools:

The Interest Rate Corridor – Similar to the discount rate in the U.S., which is one of their tools to control money supply, this is used to manage exchange rate and credit growth volatility induced by capital flows. The upper rate/‘ceiling’ is the rate at which CBRT lends to the banks and is meant for domestic borrowers. The lower rate/‘floor’ is meant for foreign investors. Banks that wish to borrow from the CBRT aren’t told in advance what rate they will be offered. The width of the ‘corridor’ indirectly helps determine this. In this structure, the width of the interest rate corridor determines the range of overnight interest rates that can be set by the CBRT. In other words, the width signals the maximum possible change that can be engineered in the short-term market rates via daily liquidity operations. Thus by managing liquidity through daily operations, the CBRT is able to smooth asymmetric outflows and erratic movements in the exchange rates. At times of high capital inflows, to ensure a ‘soft landing’, the ‘corridor’ is widened downwards by lowering the floor to reduce the attractiveness of short-term carry trade without creating excessive credit growth. When there is a threat of an outflow, it is narrowed by mostly increasing the floor rate and/or increasing the upper rate concurrently or independently, thereby effectively smoothing the weighted average funding to a higher end. If there is a threat of inflation, raise the ceiling rate thereby widening the ‘corridor’ to a higher end.

One-week repo – Under the current structure, as the CBRT provides funding mainly through weekly repo transactions, this is the ‘policy rate’.

Required Option Mechanism (ROM)– Allows the banks to voluntarily hold a certain fraction of their Turkish Lira reserve requirements in FX and/or Gold and thereby acts as an automatic stabilizer. Additionally, the Reserve Option Coefficient (ROC) is an increasing function of the usage of this facility.

Weighted average funding – Turkish banks’ borrowing costs as measured by their outstanding debt to the national lender and includes including one-week repo auctions, overnight loans, and as of Jan. 21, the extraordinary day rate.

Consistent funding rate – This was introduced in December 2013 as a reference to the one-week repo rate and O/N lending rate.

Late Liquidity window – Akin to the U.S. Federal Reserve’s emergency window, CBRT charges Turkish banks a premium over the O/N Lending rate and near 0% deposit rates just before markets close.

Extraordinary day rate – This was introduced recently in January 2014 meeting; the 9% rate will be applied to all borrowers when CBRT declares daily additional monetary tightening and withholds one-week repo auctions to squeeze liquidity. Yet another indirect methodology to a rate hike whose effectiveness hinges on the frequency of extraordinary days–subject to CBRT clarification.

Turkey continues to seek the right mélange of tools, much like the followers of the Mevlevi order practicing dhikr.

References:

Akçelik, Y., Başçı, E., Ermişoğlu, E., Oduncu, A., 2013. The Turkish Approach to Capital Flow Volatility, TCMB Working Paper, No. 13/06

Alper, K., Kara, H., Yorukoglu, M., 2012. Reserve Options Mechanism. TCMB Economic Notes.

Alper, K., Kara, H., Yorukoglu, M., 2013. Alternative Tools to Manage Capital Flow Volatility. TCMB Working Paper, No. 13/31

Kara, A.H., 2012. Monetary Policy in Turkey After the Global Crisis, TCMB Working Paper, No. 12/17

Kara H., 2013. Note prepared for the BIS Meeting of Central Bank Chief Economists, Basel.

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