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May 23 (The following statement was released by the rating agency)
The Central Bank of the Republic of Turkey's (CBRT) decision to cut its main interest rate while leaving other rates unchanged sends a mixed message regarding monetary policy that may dent its credibility, and highlights the risk that policy reversals could undermine economic adjustment, Fitch Ratings says.
The CBRT on Thursday unexpectedly cut its one-week repo rate by 50bp to 9.5%, while leaving its overnight borrowing and lending rates unchanged at 12% and 8% respectively. Cutting the main policy rate as inflation continues to head upwards towards double digits reinforces our judgement that policy coherence and predictability remain weaker in Turkey than in some of its rating peers, a point that we highlighted when we affirmed Turkey's 'BBB-' sovereign rating last month.
Keeping the overnight borrowing rate above the policy rate may support the Monetary Policy Committee's assertion that "a tight monetary policy stance will be maintained until there is a significant improvement in the inflation outlook." But the cut in the one-week repo rate is partly a response to a recovery in investor appetite for Turkish assets, and a stabilisation in the Turkish lira, that was in part driven by the CBRT's large rate hikes at the end of January.
Continued lira strengthening and the approach of presidential elections in August could set the stage for a further rate cut this summer. Easing via the repo rate while inflation remains a risk (last month the CBRT revised up its inflation forecast for end-2014 from 6.6% to 7.6%) could damage the CBRT's credibility as a policy making institution, which was bolstered by January's rate increases and accompanied by a commitment to greater transparency in monetary policy. Inflation rose to a two-year high of 9.4% yoy in April. Tighter monetary policy has started to deliver some economic rebalancing. Domestic lending growth has slowed to slightly below the CBRT's reference rate of 15% per annum. Externally, the 12-month rolling current account deficit narrowed to USD60bn in March, from a peak of USD65bn in December, reflecting stronger export growth and a modest decline in imports. The CBRT expects net exports to make a positive contribution to growth this year. Tighter monetary policy has also contributed to our lower growth forecasts of 2.5% in 2014, and 3.2% in 2015.
But Turkey remains vulnerable to external shocks. 1Q14 balance of payments data showed that net capital inflows had fallen to close to zero, leaving net errors and omissions (USD6.6bn) and drawdowns on the international reserves (USD4.9bn) to fund the current account deficit of USD11.5bn.
Broader macroeconomic risks associated with untimely policy reversals include a resumption of rapid credit growth, widening current account deficits and rising net external debt over the medium term, which would be rating negative. A material and durable reduction in the current account deficit, coupled with an improved external financing mix and a track record of lower and more stable inflation, would be credit positive.