Erdem Basçı: The Architect of Unorthodox Monetary Policies

Erdem Başçı who has been appointed as the governor of Central Bank of Republic of Turkey (CBRT) in April is known as a key player of the Central Bank's unconventional monetary policies. While Turkey is being warned against overheating because of the hot money inflow, the CBRT is raising reserve requirements on banks and lowering interest rates. Erdem Başçı talked to The Turkish Perspective on the global financial markets, the bank's next instruments and how Turkey should deal the challenges ahead.
You came to the helm of the Turkish economy's monetary policy a short time ago. Can you provide a general assessment of the Turkish Economy and the country's financial performance?
The Turkish economy has been one of the top performers during the recovery period after the Lehman crisis, thanks to prudent macroeconomic policies and a healthy financial system. The growth rate of 8.9% in year 2010 is the highest among the OECD countries. In this period, the faster-than-expected economic recovery and relatively low interest rates helped Turkey's fiscal performance while the current account deficit driven by the disparity between domestic and external demand growth emerged as a risk factor for financial stability.
To give you a more recent bird's eye view on economic activity, industrial production remained robust in the first quarter of 2011. Recent leading indicators however point to a slowdown in economic activity in the second quarter. Private consumption and investment growth rates are moderating after a strong rebound in 2010. Meanwhile, employment continues to grow rapidly and unemployment rates have already reached the pre-crisis levels. Recently, political and economic uncertainties
in the Middle East and North Africa (MENA) region and Europe have restrained the recovery in Turkish exports.
Yet, the Turkish economy is on its way to a sustainable and healthy growth path thanks to its prudent policies and solid macroeconomic foundations.
Many economists view the current account deficit as a structural problem of the Turkish economy, believing that a surefire solution is only possible via long term structural reforms. Do you agree with this view?
The Turkish current account deficit has both structural and cyclical elements. As a matter of fact, in the 1984-2010 period, our economy posted current account surpluses for only six years, almost all of which coincided with periods of economic contraction.
As for the structural elements, we can mention energy dependency and the young population. Turkish economy is highly dependent on energy imports due to a shortage of local sources. The detrimental effect of high energy bill is especially apparent at times when the price of energy related commodities rise which puts the cyclical effect to the forefront. Also as a country with young population, low saving rates is another major structural cause of the current account deficit.
Hence reforms to promote energy investments and to increase private and public sector savings are essential.
Do you think that the Turkish economy has heated up so much that it cannot be cooled down via fiscal and monetary measures?
On the one hand, increased participation of women in the labor force keeps wage inflation and hence services sector inflation benign. On the other hand, low capacity utilization rates and a weak external demand keep the total demand far from reaching levels to put upward pressure on goods inflation. So, for the time being, I can safely say that there is no overheating in the sense of upward inflationary pressures in our economy. We do see however a rapid expansion of credit, in the order of 35 percent year-on-year growth rate, which we label as "excessive borrowing” rather than "overheating”. Yet, after a significant degree of macroprudential measures taken so far, latest data releases indicate a credit growth rate in line with the seasonal averages. A more desirable 25 percent credit growth would be achieved by the year end if this trend continues. In addition, seasonally adjusted growth in imports, excluding energy, halted starting from April 2011 and seasonally adjusted growth in exports continues, despite at a slower pace. We expect the improvement in 12 months cumulative current account deficit to become visible in the last quarter of this year.
Do you believe that such CBRT instruments as the reserve requirements and interest rates will be enough to slow down the growth rate of the current account deficit? Are you considering using supplementary instruments?
In the last quarter of 2010, current account deficit emerged as a risk factor for financial stability. The measures we have taken so far were geared to keep credit growth at a desirable rate, balance the domestic and external demand, and thereby contain the current account deficit. The content of our policy mix however, may differ depending on factors such as external demand, capital flows and the speed of credit expansion.
Within the new policy framework, the question of which policy tools are to be employed and how, will be determined by factors affecting the outlook for financial stability and price stability. Given the high level of uncertainty arising from global economic conditions, we believe that it would be more appropriate to remain flexible regarding the exact composition of our policy mix. In any case, having access to more than one monetary policy instrument turns out to be quite helpful both in theory and in practice.
Last but not least, the importance of fiscal austerity as well as supportive macroprudential regulations by other relevant government agencies is crucial. In the forthcoming period, we will continue to jointly use short-term policy rates and macroprudential tools in order to achieve price stability on a permanent basis, while maintaining financial stability.
Would the Tobin tax and similar practices help keep the inflow of hot money into Turkey under control? Or would such practices bring more harm than benefit?
The global financial crisis has transformed the monetary policy implementation in advanced economies significantly. The policy rates are pushed down to zero and quantitative easing policies are deployed to quench the thirst for liquidity. Of course these policies are essential to avoid another Great Depression but their side effects are visible without delay. One such side effect is on emerging markets
in the form of fueled domestic credit and demand, lifted asset prices and excessively overvalued currencies.
Emerging economies in contrast, relied on quantitative tightening measures to counter potential spillovers from the additional quantitative easing programs in advanced economies. Some major emerging economies even resorted to capital flow measures like the Tobin tax that you mentioned, with limited success, I must say.
Turkey, in contrast, focuses more on extending the maturity of these inflows and channeling them to more productive uses.
The crisis that hit European Union countries is continually deepening. Other than the financial disruption it causes in these countries, could public debt problems in Portugal and Greece have a negative effect on the real economy and money markets in Turkey? Is it possible for Turkey to take precautions against this?
The ongoing concerns about the European sovereign debt problem do cause some fluctuations in the global risk sentiment. This however has little,
if any, detrimental effect on emerging markets with favorable fiscal policies and outlook. Yet, Turkey is affected mainly through the external trade channel
since the share of Europe in our exports is quite high. As a precaution, Turkish exporters have diversified their target markets in order to compensate for falling demand in Europe.
Likewise, in order to alleviate the effect of public debt problems in Europe on Turkish money markets, prudent monetary and fiscal policies will be the key. We are confident that the healthy dynamics of the public debt burden and relatively low budget deficit figures in Turkey highlight the strong fundamentals for a promising future.
The effects of credit on the current account balance can be varied. While some forms of credit, cause the current account deficit grow, investment credit has the opposite effect. Will the CBRT consider this distinction as it takes new measures in the upcoming term?
I concur with the view that investment credits will have a positive effect on the current account deficit in the longer term. However in the short run, all types of credit have a similar contribution to the external deficit. We already have differentiated reserve requirement ratios in a way to incentivize extending the maturity composition of the banking system liabilities. We believe that this longer term average maturity of deposits and other liabilities will be helpful for long term credits that are required for investments. Likewise recent decisions by the bank regulation and supervision authority directly favor business loans over general purpose consumption loans.
Lastly, is there anything else you wish to communicate to our readers?
Monetary policy will continue to focus on price stability while preserving financial stability as a supplementary objective. To this end, the impact of the macro prudential measures taken by the Central Bank of Turkey and other government authorities on the inflation outlook will be assessed carefully. Strengthening the commitment to fiscal discipline and the structural reform agenda in the medium term would support the improvement of Turkey's sovereign risk, and thus facilitate macroeconomic and price stability. Sustaining the fiscal austerity will also provide more flexibility for monetary policy and support the social welfare by keeping interest rates permanently at low levels.
In this respect, timely implementation of the structural reforms envisaged by the Medium Term Program and the Acquis Communauitaire of the European Union remains to be of utmost importance. Especially the fiscal rules designed for the European Monetary Union countries are quite useful benchmarks. The problem evidently arises when there is no will to implement them. Turkey distinguishes herself with successful implementation of the European Union rules and
proves that they are, if implemented, indeed helpful for a better economic performance.