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Turkey Cuts Interest Rates to Single Digits Despite High Inflation

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BM.GE
24.11.22 21:00
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Turkey’s central bank cut its key interest rate for a fourth consecutive month on Thursday to single digits, intensifying a monetary policy demanded by President Recep Tayyip Erdogan despite the country’s high inflation rate.

The bank’s monetary policy committee said it cut its benchmark interest rate by 1.5 percentage points to 9%.

Turkey was plunged into a currency crisis last year after the central bank implemented a series of rate cuts at the urging of Mr. Erdogan, who favors lower rates as part of an unorthodox strategy to encourage economic growth. The crisis wiped more than half the value off the lira and pushed millions of Turkish people closer to poverty.

Mr. Erdogan’s government has also said that rate cuts would eventually lead to lower inflation, contrary to what has been observed historically in global economics. Central banks throughout the world have been raising interest rates this year to calm rampant inflation resulting from high energy prices, global supply-chain disruptions and Russia’s invasion of Ukraine.

Turkey’s inflation rate is above 85%, according to the state statistics agency, the seventh highest in the world. Independent economists at ENAG, a research group that studies inflation in Turkey, say the actual rate of inflation is likely more than 185%.

The response this year from financial markets and the Turkish public to recent interest-rate cuts has been more muted than last year, when the lira went into free fall. The lira was flat against the dollar on Thursday.

The Turkish government has taken a series of steps to prevent a more precipitous slide in the national currency, spending more than $60 billion in foreign currency to defend the lira this year, according to economists. The government also set up a special savings program that encourages people to keep their money in lira and introduced a rule that forces exporters to sell 40% of their foreign-currency revenue to the central bank.

Turkey is funding its unusual economic approach in part with an influx of money from Russia. Mr. Erdogan has deepened Turkey’s economic relationship with Russia this year, boosting trade and allowing Moscow to turn to Turkey to ease the effect of Western sanctions.

In July, Russia transferred $5 billion to Turkey for the construction of a nuclear-power plant on Turkey’s southern coast, the Turkish state-run news agency reported. Russia was expected to send another $10 billion for the plant, the agency said.

Turkey’s deepening relationship with Russia raised concerns in Washington and other Western capitals earlier this year that Turkish institutions could be helping Russians evade sanctions. Two Turkish banks in September dropped the use of Russia’s Mir payments system after the U.S. sanctioned the chief executive of the system. The Treasury Department also issued a warning to Turkish businesses in August, urging them not to work with sanctioned Russians.

Mr. Erdogan has also sought to leverage warming ties with Gulf Arab states into benefits for the Turkish economy. The Turkish president since last year has normalized relations with the United Arab Emirates, Saudi Arabia and other rivals, calming for now a regional struggle over influence in the Middle East. The U.A.E. agreed to a nearly $5 billion currency swap with Turkey in January.

Central banks usually raise interest rates to calm inflation and lower them to encourage growth.

Given the Turkish central bank’s unusual approach, many entities in the Turkish banking system haven’t passed on the lower interest rates to customers due to high inflation, according to banking analysts.

“The policy rate doesn’t mean anything. They made it unimportant in terms of controlling inflation. Actually, they are not focusing on inflation at all,” said Omer Gencal, a former bank executive who is now an official with a Turkish opposition party.

Turkey has also raised the requirements for banks’ holdings of government bonds, encouraging them to take on more of the risk of inflation, economists say.

Selva Demiralp, a former economist at the Federal Reserve Board and now an economics professor at Koc University in Istanbul, said lenders risked losses in the future if the central bank were to return to a normal monetary policy and raise interest rates. Turkish banks are also trying to attract more lira deposits due the risks of holding bonds, she said.

“We are thus in this bizarre world where rate cuts by the central bank are followed by increases in deposit rates,” she said, WSJ reports.