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Turkey surprises investors with first interest rate hike in two years

Analysts welcomed the step, saying it could help Turkey avoid a balance of payments crisis
A currency exchange office worker counts Turkish Lira
A currency exchange office worker counts Turkish Lira banknotes in front of the electronic panel displaying currency exchange rates at an exchange office in Istanbul (AFP)
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The Turkish Central Bank raised interest rates for the first time in two years on Thursday, surprising investors and economists who had expected the bank to use other measures to stabilise the embattled Lira.

The move, which has seen interest rates rise 200 base points from 8.25 percent to 10.25 percent, comes amid a rapid deterioration of foreign reserves and the accelerated devaluation of the Lira, which has tested new shrinking records against the Dollar over the last month.

The Lira has lost nearly 30 percent of its value since the beginning of the year, while the Central Bank's net reserves are calculated to be below zero.

Economists have criticised the Turkish government in recent months for encouraging huge credit growth amid the coronavirus slowdown.

'They are not out of the woods yet, but they have given themselves a fighting chance,'

- Timothy Ash, Turkey analyst

Various experts said the government's policy to lend an unprecedented amount of money to the market to drive the automobile industry and house sales pushed inflation upwards, inflated imports and undermined the Lira.

Credit ratings agency Moody's warned earlier this month of an increasing risk of a balance of payments crisis.

"Economic activity is recovering markedly in the third quarter owing to gradual steps towards normalisation and the strong credit impulse," the Turkish Central Bank said in a statement.

"Recent monetary and fiscal measures that aim to contain negative effects of the pandemic on the Turkish economy contributed to financial stability and economic recovery by supporting the potential output of the economy."

After Thursday's announcement, the Turkish Lira recovered by 0.95 percent, with one dollar fetching around 7.62 Lira.

'Massive surprise'

Timothy Ash, a Turkey analyst at BlueBay Asset Management in London, described the move as a "massive surprise" and "positive".

He said the decision suggests the Central Bank listened to the market and decided to move against a disorderly devaluation and potential balance of payments crisis.

"They are not out of the woods yet, but they have given themselves a fighting chance," he said.

Alvaro Ortiz, the head of BigData at BBVA Research, said that so far the move was satisfactory. "[It is] enough, but they will have to closely monitor inflation and [the] exchange rate," he said.

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One question that remains to be answered is Turkish President Recep Tayyip Erdogan's stance on the issue.

Last year, Erdogan fired the previous governor of the bank for resisting a cut in interest rates, which greatly undermined the credibility of the bank's independence. Erdogan has been outspoken in an unorthodox policy line which suggests lower lending rates would decrease inflation.

"I just wonder if the Central Bank management went to the presidential palace to get sign-off for this," Ash said.

Others were less excited by the decision. Ugur Gurses, a respected Turkish economist, said the Central Bank only made official the rate it had been discreetly using in the markets to calm the volatile Lira, and therefore the move wasn't a huge step.

"[The] Turkish Central Bank began offering liquidity through so called conventional repo where banks bid on the interest rate they are willing to borrow from, which wasn't 8.25 percent as the Central Bank determined," Gurses said.

"Average funding interest rate has been around 10.6 percent. With today's decision, the bank only officialised it."