Turkey’s central bank gains in credibility but threats to economy remain strong

LONDON – Turkey’s central bank has probably regained some of the investor confidence it lost during recent market volatility, and may even have enhanced its credibility, a Reuters poll shows. But the survey also showed the lira is unlikely to recover to pre-crisis levels over the next year, while inflation and interest rate hikes pose a threat to Turkey’s economic growth targets for 2006 and 2007. Median forecasts in last week’s survey of 15 emerging market strategists showed the lira holding around current levels of 1.55 per dollar over the next three months and easing to 1.60 by the end of 2006. Inflation and political uncertainty have made Turkey vulnerable to sell-offs in emerging markets as major economies raise the cost of borrowing, and the lira fell to near 1.76 per dollar in mid-June from around 1.32 in early May. Analysts initially criticized the central bank for reacting too slowly. But it has since raised interest rates aggressively, bought up lira deposits and sold dollars at auction to buoy the Turkish currency and hold down inflation. Eight of the 12 strategists who answered the question said the central bank’s response had enhanced its reputation, three said its credibility had suffered and one said there had been no major impact. «Raising interest rates, the opening of lira deposit auctions and dollar sales – that was a really brave move and has enhanced its credibility,» said Yarkin Cebeci at JP Morgan. «The problem was they acted too late, so there was some erosion of credibility beforehand. It has started to recover.» But risks ahead include 2007 elections and tensions over accession talks with the European Union, including Turkey’s refusal to open ports and airports to EU member Cyprus. Turkey also has International Monetary Fund targets to meet. While inflation rose by less than expected in June, it was 10.1 percent year-on-year and is forecast to end 2006 at 10.8 percent, well above the IMF’s 5 percent year-end target. «At the moment we are in a period of relative calm because the inflation release was much better than expected,» said Michael Hart at Citigroup. «But as the process of global monetary tightening and liquidity retrenchment continues, the spotlight is going to shine on Turkey intermittently throughout the year, so I think it will be bumpy.» The IMF has praised the central bank for helping to calm markets last month by raising its key overnight borrowing rates by 4 percentage points to 17.25 percent, and lending rates by 6 points to 22.25 percent. Rates, inflation Median forecasts showed the overnight borrowing rate rising by 75 basis points to 18 percent by the year-end, then easing to 16 percent at end-2007. «Turkey is probably not out of the woods in terms of market volatility. There’s a risk there may be more interest rate hikes as we may not have seen the last of an upturn in inflation numbers,» said Debbie Orgill at ABN AMRO in London. Higher interest rates put economic growth at risk, and Turkish Prime Minister Recep Tayyip Erdogan last week forecast growth of 5 percent this year and next, slightly below a 6 percent target cited by Economy Minister Ali Babacan a few weeks back. The poll showed gross national product (GNP) growth of 4.6 and 4.0 percent in 2006 and 2007 respectively, and inflation slowing to 7 percent by end-2007 – just missing the IMF target of 4.0 percent with a two-percentage-point error margin. Strategists were divided on the outlook for Turkish eurobonds in the next three months, with six of 13 expecting performance in line with the wider emerging debt market. Some said that prices already reflected expectations that Turkey would complete its remaining reviews with the IMF to secure vital funds, while others said markets were underestimating inflation risks. «What the bond markets haven’t quite figured out is that the authorities might actually have to do a lot of work to bring inflation (down) next year. That could mean further tightening of interest rates,» said Tolga Ediz at Lehman Brothers. Cyprus issue Political uncertainties also risk unsettling markets, and strategists’ forecasts for when Turkey would join the EU ranged from 2014 to never. The EU has threatened to halt accession talks if Ankara does not make progress on economic and political reforms and meet its conditions over Cyprus, and is due to report on progress in late October or early November. «I expect the report to be quite critical on Turkey and we will also see a pickup in political noise as we get closer to the election,» said Murat Ulgen at HSBC in Istanbul.