ON THE CBRT INTEREST RATE CUTS
Central bank: tcmb | Type: decision | Date: 2003-06-04

Number:2003-25
June 4, 2003
PRESS RELEASE
ON THE CBRT INTEREST RATE CUTS
I. GENERAL EVALUATION
achieve price stability as stipulated in its Law. A ccordingly, the CBRT’s first
priority is to hit the inflation target, determined together with the Government.
Short-term interest rates, which are the main polic y instrument of the CBRT,
are adjusted by considering only and only to which extent the future trend of
inflation is compatible with the inflation target. In other words, the CBRT’s
decisions on the short-term interest rates are neve r destined to affect any
variables other than inflation.
2. It is no doubt that, the inflation rate cannot be considered separately
from other variables in the economy. As has been an nounced several times by
the CBRT, there are a series of variables influencin g inflation. The common
conviction of various academicians who have studied the inflationary process in
Turkey is that the main variables shaping the cours e of inflation are i) the rate
of increase in exchange rate, ii) the expectations ab out the future trend of
inflation, iii) the prices in long-term contracts m ade in line with these
expectations such as wage increases, and iv) the dem and pressure determined
according to the direction and the size of discrepa ncy between the current
output level and the potential output level.
3. In this framework, the following points must now be very clear:
a) The CBRT is carefully monitoring the factors having an effect on
inflation by considering not only the current indic ators, but also
the future probable trend of variables.
b) The current and future probable movements in the va riables
affecting inflation are drawing the course of future inflation. And
these considerations, in turn, are influencing the decisions of
CBRT on short-term interest rates.
c) For example, the gradual appreciation of Turkish lir a suggests
that the downward trend in inflation will be streng thened,
provided that the other variables do not act against this trend.
d) It is obvious that bringing short-term interest rat es down by
looking at such a trend has nothing to do with the current
exchange rate level. The aim is only to come closer to an interest
rate level in line with the inflation target in the disinflation
efforts, and to give a signal to the public that th e general course
of economy is in good progress.
e) In addition, the relationship between short-term in terest rates
and exchange rates is many-sided and complex. The fol lowing
three examples can be considered to provide sufficie nt proof for
the complexity of the situation.
f) Firstly, other variables being the same, the declin ing yields of
financial instruments in TL may exert an upward pres sure on
exchange rate by increasing the demand for foreign e xchange in
the detriment of Turkish lira demand. This is what expected of
those who establish a reverse correlation between i nterest rate
and exchange rate.
g) Secondly, the CBRT’s short-term interest rates cut i n line with
the price stability goal will enhance the confidenc e in the current
program, and will reinforce the reverse currency su bstitution
process even further, being a favorable signal both for inflation
and for general business climate. In this case, the pressure on
exchange rates will be relieved, in contrast to the above-
mentioned effect.
h) Thirdly, contrary to the first two effects based on economic
fundamentals, there may be some movements in exchang e rates
unrelated to economic rationale. Although such developments tend
to be temporary, it is obvious that they can continue for a certain
time and make the relationship between short-term i nterest
rates and exchange rate even more complex.
i) In the economics, exchange rate is one of the areas that has
mostly been made subject of academic discussions, a nd there is
nearly a consensus that the theories developed thereon are not at
desired level yet. Moreover, if we consider the inf luences of
expectations on debt sustainability over exchange rat e and
interest rate, not found in standard text books, it becomes clear
that the subject of exchange rate calls for the exper tise at an
advanced level.
j) It must be kept in mind that in line with the incre ased confidence
in the current program, the portfolio shifts from f oreign
exchange to Turkish lira is a desired result. It is true that such a
development or increase in the foreign direct inves tments in the
longer term may result in excess foreign exchange sup ply, putting
pressure on exchange rates. The solution lies not in cutting short-
term interest rates with the aim of intervening in exchange rate
only independently from future trend of inflation, but in
sterilizing the excess foreign exchange supply by the CBRT
through transparent methods consistent with the flo ating
exchange rate regime. In fact, the excess foreign exch ange
supply resulting from reverse currency substitution started in
May 2003 is being sterilized through buying auctions. The CBRT
will continue to pursue effectively its sterilizati on policy in the
medium and long-term as well considering the develo pments in
foreign exchange and Turkish lira liquidity, in comp liance with the
public domestic debt management policies.
k) The exchange rate and interest rate relationship sho uld be
evaluated in the light of the above-mentioned information and the
analyses thereof should be made more comprehensively and multi-
dimensional.
4. On the other hand, the main determinant of the v ariables affecting
inflation and real interest rates is the current ec onomic policies. In this
context, especially fiscal policy comes first due to Turkey’s sui generis
conditions. Undoubtedly, the reason is the still hi gh level of public sector debt,
despite its downward trend under the current program.
5. As has been underlined many times in our previous announcements, the
fiscal discipline is the sine qua non condition for reducing the ratio of public
debt to the GNP permanently. Such a declining trend will boost the public
confidence in the debt sustainability and then both the borrowing maturities will
extend and the real interest rates will come down.
6. As clearly understood by majority of the public, real interest rates
cannot fall by reducing nominal interest rates arti ficially. Such a behavior would
only disrupt the equilibrium established with great efforts, and would not bring
real interest rates down. Correct treatment can onl y be possible with a correct
diagnosis. Accordingly, real interest rates can be reduced through achieving a
permanent fiscal discipline and reducing inflation. In fact, when the program
implementation is examined since the beginning it c an be easily seen that all
increases in real interest rates have resulted from the likelihood of a deviation
from the current program, or just a perception ther eof, except for exogenous
7. The current program is an indivisible integrity. The main goals of the
program are to achieve price stability, which is th e pre-condition of the
sustainable growth, and to reduce the ratio of public debt stock to GNP, and the
main pillars are the monetary discipline and struct ural reforms. Failure in any of
these pillars or the likelihood of failure would ca use the disruption of the whole
program. Therefore, what must be done is to remove convincingly the failure or
the failure possibility, instead of looking for sol utions in the areas that are
unrelated to the source of the problem.
II. EVALUATION ON THE INFLATIONARY TREND
8. Especially since April, cost-push pressures have st arted to lessen
together with the declining exchange rates and oil p rices. By predicting that
these favorable developments would cause an obvious break in inflation
expectations the CBRT cut the interest rates by 3 poin ts on April 25, 2003. In
fact, April inflation remained well below the marke t expectations, which were
2,1 percent and 2,8 percent. Moreover, increases of p rivate manufacturing
industrial prices stood at 0,7 percent. The depreciat ion in exchange rates
continued in May and reduced the cost-push pressure s considerably. An
improvement was observed in general business sentim ent. With the atmosphere
of confidence and the removal of cost-push pressure s, the expectations have
turned favorable since the mid-April. The year-end CPI inflation expectations,
increasing from 24,8 percent in January to 28,4 percent in the first period of
April, retreated to 26 percent in the second period o f May, although not
satisfactory.
9. However, in the design of its interest rate policy the CBRT is taking
great pains in establishing whether the break in in flation trend is permanent or
not. It is obvious that the failure or delay in tak ing steps specified under the
program will immediately disrupt the favorable atmo sphere started in April.
Such delays are leading to discrepancies between th ose who expect a fall in
inflation and a reduction in short-term interest ra tes by looking at the current
indicators only, and the CBRT’s expectations and eval uations that considers also
the future course of fiscal policy and the variables affecting inflation.
10. Since the beginning of May, the CBRT has observed some delays in
structural reforms and measures envisaged in the program such as restructuring
the social security system and addressing the redun dancy in public sector. The
CBRT has also observed the possibility of extra burde ns to the budget due to
deficits in the energy sector, and the necessity of taking some measures in
order to meet the target of primary surplus. Under these conditions, a monetary
authority that is focused on disinflation efforts s hould be well advised to be
cautious in its decisions on interest rates, waitin g for the whole picture to
become clearer. As a matter of fact, due to the dev elopments stated above the
CBRT refrained from reducing interest rates in May.
11. However, the determination to achieve the program targets has
recently been observed during the 5 th . IMF Review, by compensating for the
delays. In fact, some measures for improving the social security system, which is
the biggest obstacle to reaching the year-end prima ry surplus target, have
already been taken. Cost-reducing steps are being t aken in the energy sector.
These developments are promising for the future inflation.
12. Yesterday’s announced annual CPI inflation figur es as of May, which
rose from 29,5 percent to 30,7 percent, should not be per ceived as unfavorable.
The reason is twofold. First, as we have already an nounced, the downward trend
in annual inflation rates will be observed starting from the second half of the
year. This can be accounted for the “base” effect c reated by fluctuations
around the main downward trend in inflation during 2002. There are two distinct
movements around this main trend in 2002: The seasonal ly adjusted monthly
inflation rates during the first half of 2002 stood at low levels due to nominal
appreciation of Turkish lira and low rate of increa se in food prices. However,
monthly inflation rates rose relatively in the seco nd half of the year owing to
the high increments in public prices and the increa sing exchange rates following
the political uncertainty occurred in May 2002.
13. Second, the developments in agricultural and food prices, which are
greatly influenced by natural conditions that are n ot under the control of
economic policy, should be taken into account. Howe ver, for a healthy analysis of
the main trend in inflation the course of consumer prices excluding foods
becomes important. In this framework, the annual CPI inflation figures
excluding foods are giving promising signals for the inflation trend. CPI inflation
excluding foods has been falling since the first mon ths of 2002. The annual CPI
inflation excluding foods, which stood at 31,5 percen t at the end of 2002, went
down to 29,3 percent in April and to 28,6 percent in Ma y. Another promising
development for the inflation dynamics is being obs erved in private
manufacturing industry prices. Not much affected by seasonality aspects, this
index shows that the monthly prices have been on a d ownward trend since the
New Year. As a matter of fact, the rate of increase in private manufacturing
industry prices, which stood at 3,6 percent in January, came down to 1,6 percent
in March, to 0,7 percent in April, and to 0,3 in May.
14. Despite the reduction in cost elements, the favor able expectations
and developments in the consumer prices excluding fo ods and in the private
manufacturing industry prices, a relaxation in fisca l discipline in the future will
be a serious economic policy mistake. As the Centra l Bank we believe that the
utmost care will be shown by those concerned in ord er not to commit such a
policy mistake. The other sections in the economy m ust share the same belief,
and must be convinced that i) the fiscal discipline would be continued
uncompromisingly for bringing inflation expectations in line with the program
targets, ii) public sector incomes policy would be implemented in line with the
program targets and iii) structural reforms would be completed as scheduled. In
this context, apart from the speed of structural ref orms, the increments in
public sector wages and salaries will be a vital indicator for the markets.
15. On the other hand, domestic demand starts showing signals of revival
in line with the increased confidence. Although it is early to pronounce a definite
judgment, it is thought that the increase in domest ic demand is slightly limiting
the downward trend in inflation. In the next period, the fight against inflation
will be greatly helped if the public sector as well as private sector pursues their
incomes and price-setting policies in line with the inflation targets, and do not
adopt an opportunistic behavior by taking advantage of revived domestic demand
to increase their profit margins with short-term considerations . Otherwise, we
have to underline once again that the fight against inflation will become more
difficult and costly.
III. THE CENTRAL BANK INTEREST RATES
16. In the light of the evaluations above, starting fr om June 4, 2003, the
CBRT has decided to cut short-term interest rates ap plied at CBRT Interbank
Money Market and Repo-Reverse Repo Market at Istanb ul Stock Exchange as
a) Overnight Interest Rates: Borrowing interest rate was cut to 38
percent from 41 percent and lending interest rate to 45 percent from
48 percent.
b) Other Maturity: One-week borrowing interest rate was cut to 38
percent from 41 percent.
c) Late Liquidity Window Interest Rates: In the framework of Late
Liquidity Window application, the CBRT overnight len ding interest
rate applicable between 16:00 – 16:30 at Interbank Money Market
was cut to 50 percent from 53 percent. Borrowing interes t rate of 5
percent remained the same.
Moreover, the interest rates on overnight and one-w eek maturity borrowing
facilities provided for primary dealer banks via re po transactions in the
framework of open market operations were cut to 41 percent from 44 percent.