In my view, however, the bank does not have full control over interest rates. It seems that those who deal with the phenomenon of interest have quite a weak notion of market processes and therefore attribute an exaggerated importance to some economic agents such as the central bank.There are many determinants of interest rates and, in my understanding, the central bank only adjusts to the situation. Developments in the three major categories of interest are given in the figure below. These are the interest rate on the Treasury's domestic barrowing, the central bank's short-term policy rates and, finally, the interest rate on time deposits.
The eruption of the 2001 crisis led to these rates reaching their maximum. Soon after the implementation of a stabilization program, rates started declining radically and reached their lowest level as of 2005. After mid-2006, in addition to resisting domestic inflation and a rising current account deficit, there were also serious signs of a US-led subprime mortgage crisis and a reversal in carry trade; interest rates of all major categories in Turkey started rising once again.
What were the dynamics that pushed the rates down? First, we should note that in Turkey higher interest rate policies were pursued due to a financial bottleneck of the public sector, particularly since the mid 1990s. Public sector deficits, which exceeded 10 percent of gross domestic product (GDP) as of 2000, stemmed mainly from underperforming state public enterprises. With the implementation of a new stabilization program and with the injection of a record level of fresh money from the IMF, interest rates started declining parallel to the improvements in budget deficits and a decline in public sector borrowing requirements (BSBR). As of 2005, the budget deficit rate declined to below 3 percent of GDP, an important Maastricht criteria, and parallel to that, the PSBR declined to almost zero. Therefore, one critical dynamic lying behind a high interest rate has been eliminated since 2005.
Obviously, inflation in Turkey has been historically driven by public enterprises, public sector deficit financing and overall inefficiencies of the economic sectors due to widespread monopolies, isolation from external competition, etc.
As Turkey's disinflation program has been a success story since 2002, credibility increased and risk premiums declined significantly. Therefore a declining risk profile and rising credibility created the second major dynamic to push for an interest rate decline.
Third, as the Turkish economy has been exposed to global competition in recent years, there has been a radical surge in productivity, and this created a serious pressure on markup pricing behavior of the private sector's monopolies.
However, there is an important factor which has not improved recently, preventing interest rates from declining: the saving-investment gap of almost 7 percent of GDP. Turkey's rate of investment fluctuates at around 23-24 percent of GDP, while the national saving rate fluctuates at around 17 percent. Thanks to foreign capital inflow, Turkey has been successful in sustaining this level of investment activity despite such a huge deficit.
To sum up, without a foreign capital contribution in closing the saving-investment gap, the surge in productivity, the improvement in public sector accounts, the success in disinflation programs and the declining risk perceptions, such a radical decline in interest rates would never take place.
However, in recent years, interest rates started rising once again due to upward pressure on inflation rates triggered mainly by global food, energy and financial crises and by domestics demand pressures, structural rigidities in private sector monopolies and labor market rigidities, current account pressures and rising uncertainties because of political chaos.
Therefore, the role of the central bank is secondary here to control interest rates. However, it needs to adjust to the progress to contain the second round of impacts brought on by rising input costs.
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