Sep 10 2018

Turkey needs big rate hike despite looming recession – Nomura

Turkey’s central bank needs to hike rates by at least 550-600 basis points to steady the lira and prevent more damage to the economy, Nomura Holdings Inc said in a report, cautioning that it doubted whether such steps would be made.

The hike, which Nomura called for despite predicting a recession from the third quarter, would take the central bank’s benchmark rate to at least 23.25 percent from 17.75 percent. Policymakers will meet on Thursday.

“Right now, we believe the policy mix should be geared towards stabilising the financial markets so as to prevent a deepening of the economic slowdown,” Nomura economist Inan Demir said in an e-mailed report. “In this regard, it is crucial that the TCMB deliver a substantial, orthodox hike.”

 “However, we do not have a high conviction that this will be the case,” Demir said. What is more likely is a 200-250 basis point increase in average funding costs, possibly using various lending instruments, he said.

Nomura made the rates call after the government reported a slowdown in annual economic growth to 5.2 percent in the second quarter from 7.3 percent in the first three months. An economic expansion in Turkey is slowing to levels last seen in the aftermath of a 2016 coup attempt after the lira slumped 40 percent against the dollar this year in what investors term a currency crisis.

Economists diverge on whether the central bank will hike rates and how big the increase will be, citing the economic slowdown, local elections in March and President Recep Tayyip Erdogan’s aversion to higher interest rates, which he says cause inflation. The inflation rate in Turkey stood at 17.9 percent in August and price increases are expected to accelerate further in September.

Turkey’s government has pledged to battle inflation and the central bank signaled last week that it would raise rates, saying it would re-adjust monetary policy in light of price increases. Treasury and Finance Minister Berat Albayrak promised a “total struggle” against inflation in a statement on Monday without mentioning monetary policy such as rate hikes, according to local press reports.

Nomura's Demir is among a swathe of economists in Turkey and abroad who are calling on the authorities to prioritise financial stability over economic growth and hike rates substantially. But the Institute of International Finance has already predicted a reversal in the widening current account deficit, a major economic frailty of Turkey's, into a possible surplus as the impact of lira weakness slashes imports..

Demir said that the lira’s declines and central bank rate increases in May and June had yet to be reflected in economic growth figures. A much deeper financial shock in August is also hitting Turkish corporates, he said. Companies in Turkey are saddled with more than $220 billion of unhedged foreign currency debt, which is becoming more difficult to repay as the lira slides.

“We expect a sequential GDP contraction in H2 2018, weighing on the full-year growth rate, which we expect to come in at around 3 percent,” Demir said. “For 2019, we still have a positive GDP growth forecast of about 1 percent penciled in, but historical precedent suggests the risk of an outright contraction is significant.”

The lira fell 0.8 percent to 6.46 per dollar on Monday, partly erasing gains made late last week. The embattled currency briefly hit a record low of 7.23 per dollar in August, spiraling lower due to a political crisis with the United States. It has since strengthened, partly on expectation that the central bank will increase interest rates substantially.

(Story was updated with further comment on rates in fourth paragraph.)