HAKAN TAŞÇI

A year on with the new Central Bank of Turkey governor

The Turkish economy has faced a couple of simultaneous challenges in recent years »»

The Turkish economy has faced a couple of simultaneous challenges in recent years due to internal and external shocks. While maintaining high growth on the real economy side, the current account deficit (CAD) has had to be controlled together with domestic credit expansion and inflation.

This is often a big puzzle for central bankers. One has to prioritize some of the issues and implement key policies to achieve targets while communicating with the public without jeopardizing the credibility of the bank. As one can imagine, this requires management skills and an understanding of the importance of marketing, rather than merely employing quantitative methods. Strategic and flexible thinking are also required and not everyone will be happy with these policies.

As always, central bank governors are tested by the markets early in their terms. Their adaptation and flexibility determine their long-term credibility. A year after Dr. Erdem Başçı took office as the new governor of the Central Bank of Turkey, one could say that he has delivered a number of times in a challenging environment. The inflation report announced last week makes the case for him quite openly and honestly.

His advantage is his ability to align the bank's policies with those of other independent bodies and the government in an effective way, in order to coordinate the targets and priorities of the past year and the coming years. He is often criticized for sacrificing the bank's independence, but the truth is really the other way around. He can be more effective by aligning his policy with other institutions to strengthen the effects of the policies implemented. The real example here is controlling credit expansion in the domestic market. This was clearly announced by the governor very early in his career. While keeping the target interest rate at the same level, monetary tightening is implemented and, of course, this naturally decreases the profitability of the banking sector without jeopardizing the banks' financial strength. This is not something applauded by the banking sector and critics who mostly have originated from that sector. But the efforts of the Banking Regulation and Supervision Agency (BDDK) and the communiqués of the economic policy makers definitely serve to show the dedication of these bodies to the same targets.

The most critical challenge the Turkish economy has faced is the CAD. There are short-term and long-term reasons behind this problem and coordination between policy makers is an absolute must for pushing it down to sustainable levels. Savings have to be increased while efforts must be made to address the energy deficit, increase the competitiveness of exporters and control domestic import demand.

All of these cannot be achieved merely with isolated administrative policies or by central bank targets. A coordinated approach is required and this is what happened last year during Başçı's first year.

A controlled depreciation of the Turkish lira helped limit imports and new investment incentive laws were introduced by the government to lower the import dependency of exporters by investing in production of more value-added intermediate goods and, at the same time, new energy investments targeted the import dependency of the energy sector. Newly announced retirement systems and accounts -- much like 401Ks -- subsidized by the government will also encourage savings. Of course these measures are not enough, but they are the right steps in the right direction. Does this mean a less independent Turkish Central Bank? Definitely not; this is the coordination of the policy makers trying to control the same problem through a joint effort.

Another issue for the Turkish economy is inflation, and this is probably the main weakness of the central bank, but we also have to bear in mind that not everything can be done at once. While prioritizing credit control and targeting the CAD via exchange rate policies, you will lose control over inflation targets. That is why the bank did not increase target interest rates to increase the short-term investment profitability of international portfolio investors in the domestic market, since this policy would decrease the effects of depreciation in a highly liquid international environment. Commodity prices and tax policies in the domestic market did not help and we now see two-digit inflation levels.

But if you check the central bank balance sheet, one can easily see that inflationary policies were implemented by the previous governor. From the end of the second quarter of 2009 until the first quarter of 2011, the money supply was increased by 22 percent; compare that with the paltry 7 percent increase during Başçı's term. Please also remember the lag inherent in monetary policy; the effects of expansionary policies will start to be seen in a year or two. But if we fail to do so, we will actually blame the new governor for the policies of his predecessor. It's worth mentioning at this stage that both governors worked together to implement the same policies a while ago, but I have to point out that those years -- 2009-2010 -- were right after the global financial crisis and restoring high economic growth was the ultimate priority back then.

There may be communication problems, but the new governor has definitely proved his ability and credibility. And it seems that there is a long road ahead of him as the governor of the central bank.

2012-05-01

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Columnist:: HAKAN TAŞÇI