Turkish Central Bank's simplification move a return to normalization

The Central Bank of the Republic of Turkey (CBRT) announced Monday that it has completed the simplification process for the operational framework of its monetary policy after two years of work. With this move, the CBRT has joined the club of central banks that "normalized" their policies after deploying non-traditional monetary policies since the global financial meltdown of 2008. The CBRT's decision to implement a single rate policy via a one-week repo set at 16.5 percent is highly expected to ensure financial stability within the framework of a conventional tight monetary policy as the current global context allows for normalization.

The CBRT designed a policy in which it used a broad interest rate corridor and active liquidity policy together since 2010 when the concerns over the global economic growth rose. Accordingly, the concept of a wide interest rate corridor was introduced to the Turkish market with a view to taking immediate action against the shocks ensuing from global volatility.

This multilateral monetary policy of the central bank tried to ensure a flexible framework based on active liquidity policy whereby it used asymmetrical and wide corridor.

However, the bank took the first concrete step toward simplification when it published a report titled, "Roadmap in the Normalization Process of Global Monetary Policies" in August 2015. In the March-September period of 2016, the CBRT gradually lowered the upped bank of the corridor by 250 basis points in total.

In 2016 October, the bank had to raise the upper bank of the corridor in accordance with the global economic developments and sustained this policy in January 2017. The central bank did not change the interest rates in 2017 and deployed late liquidity window (LLW) as the main instrument, increasing the average main funding rate. In December 2017, it raised the LLW rate to 12.75 percent.

The bank again raised interest rates in April and May and increased the LLW to 16.5 percent at an emergency meeting on May 23 by 300 basis points, continuing to apply extra instruments and measures because of the high currency volatility.

With the latest simplification move that came on Monday, the central bank set the one-week repo at 16.5 percent as the benchmark and equalizing it with the current main funding rate, late liquidity window. The decision of the CBRT will be applicable as of June 1.

The one-week repo, currently standing at 8 percent, was previously the CBRT's main funding tool, however the bank has not been using it in setting the main funding rate since January 2017.

The overnight lending and borrowing rates will be set at 18 percent and 15 percent, respectively up from 9.25 percent and 7.25 percent, according to the bank. As a result, the bank's interest rate corridor was narrowed down to 15-18 percent and LLW remained as an emergency tool.

Meanwhile, CBRT Governor Murat Çetinkaya and Deputy Prime Minister Mehmet Şimşek were scheduled to attend a meeting with investors in London yesterday. Ahead of this meeting, the CBRT's decision was construed as a strong message to investors both at home and abroad.

Beforehand, Şimşek said that they would meet 90 portfolio managers, bank executives and analysts in London.

Following the financial crisis of 2008, all markets across the world, particularly emerging markets in need of external financing, have become sensitive to monetary policies. The situation accordingly created the necessity for instruments that will ensure on-time reaction to abrupt changes in the global risk appetite and liquidity conditions, leading to the emergence of non-traditional monetary policies.

Currently, central banks around the world are observed to adopt more simplified policies, ditching non-traditional monetary policies after 10 years as they want to eliminate the impacts of the global economic crisis.

The normalization process began with the U.S. Federal Reserve (Fed) and European Central Bank (ECB), and Bank of England (BOE).

With the financial crisis that began in the U.S. in late 2007, Fed started to deploy expansionary monetary policies, which was followed by ECB and Bank of Japan. Accordingly, unconventional policies took the sway of central banks across the globe.

Then-Fed Chair Ben Bernanke implemented an expansionary monetary policy, which was the most aggressive policy since Fed deployed since the Great Depression of 1929. The expansionary policy that began when the Fed balance sheet was $700 billion to $800 billion ended in October 2014 when the balance sheet hit $4.5 trillion.

The end of the expansionary policy was seen as the first step toward normalization and the move continued with an interest rate hike by 25 basis points in December 2016.

By raising interest rates by 25 basis points to 1.50 percent to 1.75 percent in 2017, the Fed moved away from historic low rates of the post-crisis period. Moreover, the Fed expedited its normalization of monetary policies by contracting balance sheet in 2017.

The market expectations mainly point that the Fed is likely to increase the interest rates two more times in 2018, at the June and September meetings. The fact that the balance sheet reduction process will continue also confirms that the steps towards normalization will continue throughout the year.

It seems that the Fed's nine-year "monetary expansion" adventure, which started with Bernanke, entered the path of normalization under the leadership of Janet Yellen and continued with Jerome Powell, who took over the chair in February 2018.

While European countries come to the fore among the most affected by the global economic crisis, the movements of the European Central Bank (ECB), which manages the money of the 19 the eurozone member states, are closely monitored in this scope.

In Europe, which faced problems in the banking system before the effects of the global economic crisis were fully overcome and also went through difficult times due to debt problems in some of the countries affiliated to the eurozone, the regional economy suffered serious damage with the addition of the Brexit process.

The ECB, which organized its asset-purchase program at the last meeting of last year, reduced the amount of monthly asset purchases by 20 billion euros to 60 billion euros and gave its first signal on the way to normalization, despite extending the program until the end of 2017. Meanwhile, since the beginning of the year, the signals given by the euro zone data that the growth in the regional economy has lost power have caused the ECB to make no moves this year and halt the normalization steps.