Real interest rates at bottom: Nothing to worry about

The real interest rate, which refers to the difference between the nominal interest rate and the inflation rate, had recently been hovering below 1 percent. It even plummeted below zero percent, which had never happened in Turkey before, when, in 2009, the inflation rate was 6.53 percent while the key interest rate of the Central Bank of Turkey was 6.5 percent.

According to Yapı Kredi Bank chief economist Cevdet Akçay, the main reason why Turkish lira real interest rates have been hovering around 1 percent for some time and currently even below is the significant enhanced trust in the lira during and in the aftermath of the global crisis. Responding to questions from Sunday’s Zaman on the issue, Akçay mentioned that it is important to have a look at the broad picture. He recalled the situation of the Turkish economy a decade ago when the interest rates were extremely high in both nominal and real terms. They came down significantly after the 2001 crisis due to the successful implementation of the International Monetary Fund (IMF) programs and fiscal correction efforts that proved to be highly fruitful, he underlined. “Although the inflation rate has been brought down with considerable success to single digit levels prior to the outbreak of the global crisis, nominal interest rates were stuck at above 20 percent levels. The crisis and the ensuing economic contraction provided a golden opportunity for the Central Bank of Turkey to aggressively cut policy rates that culminated in compatible reductions in market interest rates. This was the first time the Turkish economy reacted to an economic crisis like a ‘normal’ economy, which was indeed the natural outcome of the ‘normalization’ in the Turkish economy that had continued interrupted for the six years until the subprime crisis,” Akçay noted. He continued by saying that in all previous crises, whether local or global, the reaction has always been contraction in output accompanied by interest rate hikes that were intended to stop the seeming depreciation in the lira.

“Markets and market participants observed for the first time that the lira remained extremely stable following some brief period of volatility in the initial phases of the crisis,” Akçay said. For him the stability in the lira is one of the most crucial reasons that led to a higher confidence in the currency despite lower interest rates that are still proved to be above the rates in most peer countries. Nevertheless, significantly higher trust in the lira led to lower risk premium demands in lira-denominated assets, which in turn perpetuated the low level of nominal interest rates, according to Akçay. He noted that the second factor determining the low real interest rates is the low inflation levels experienced during the crisis that he thinks is a breakthrough for the Turkish economy.

Of the sustainability of a low real interest rate, Akçay said Turkey is at a stage of rapid economic development at present and that in order to prevent the economy from losing steam, he stresses the significance of a stronger lobby for lower interest and inflation rates. “The recently blossoming corporate bond sector will prove to be the most potent member of that group. It is thus an extremely positive move forward to allow commercial banks to issue corporate bonds while staying on top of things with respect to due regulation,” Akçay said. He expects the real interest rates to rise a little bit in the period ahead and anchor in an interval between 1.5 and 3 percent, while any deviation from this interval will be temporary.

Professor Seyfettin Gürsel from Bahçeşehir University sees the low levels of the real interest rates as a normal consequence of the current global economic conjuncture. For him, levels around zero percent for real interest rates shouldn’t be regarded as too odd for Turkey since the recovery process from the global financial crisis is already pressuring interest rates downwards all around the world.

What is more, Gürsel avers, the “hot money” inflows, or the entrance of the short-term portfolio investments from abroad to the Turkish capital markets, is also holding down interest rates. The mechanism for this is fed by the interest rate differences between the Turkish and US Treasury bonds, which are hovering around 3 to 5 points. “Foreigners will keep investing in the Turkish capital markets when we have high interest rates compared to other countries. Also, if the government secures strong fiscal discipline, we will see the real interest around zero percent in the long term,” Gürsel stated.

Halkbank Assistant General Manager Süleyman Aslan also referred to political stability -- and the ensuing rise in confidence in Turkey -- along with a successful fiscal performance and a strong fiscal system, which leads to a low real interest rate, as the major factors that led to the current situation. In addition to these, he addressed two major causes, too: the central bank’s lowering nominal interest rates and a narrowing domestic demand, which ends up in a drop in the inflation rates.

Explaining the parameters behind the continuation of capital inflow from other countries to the Turkish markets despite low real interest rates, on the other hand, Aslan said: “In reality, hot money moves towards economies with high nominal interest rates without looking at their actual income, which is the real interest rate. Additionally, Turkey’s interest rates are still higher than many other economies. However, Turkey is no longer paying the highest interest on capital. If there is a capital inflow to Turkey, albeit at a low rate, this just proves how strong the economy is.” He expects real interest rates to float around the zero percent levels given that the expectations for inflation rate are referring to 5 percent for 2011.

Although the inflation rates sustained a mild increase in September to reach a 12-month cumulative figure of 9.24 percent in consumer prices, the prospects are still high that the year-end target of 7.5 percent for 2010 is pretty attainable. The central bank, in its latest inflation report for September, argues that the rise in the rate stemmed mainly from unexpected increases in food and energy prices, which it deemed to be temporary. Like the central bank, experts speaking with Sunday’s Zaman all underline the presence of seemingly invincible trust in the economy and a belief in political stability. As long as these two elements persist and even improve, Turkey will continue enjoying virtually zero real interest rates, experts say.

Interest rates always under spotlight 

The real interest rate is an important factor within finance, especially the banking sector. Banks are paying interest on deposit accounts but charge interest when giving out a loan. The spread between the two interest rates shapes the profit of a bank, simply explained. When the inflation rate in the market escalates to surpass the expectations of the research section of a bank’s Treasury department, it suffers a loss in its revenues as a bank determines the interest rate to be paid on savings accounts before the realization of real interest rates in the market. Therefore, it is highly crucial for banks to analyze the factors determining the inflation rate and hold their expectations accordingly to avoid suffering from smaller real interest rates. Similarly, if a central bank pulls down nominal interest rates, the interest revenues of the banks again sustain falls. Therefore, they have to have healthy assessments as regard the possible steps that a central bank may take.