Turkey has been an interesting experience for economists in many aspects. A central bank keeping the real interest rates extremely low in a period when the country suffers from savings gap and high inflation may be among them, despite a good economic performance.
Pretending that the central bank is the only game in town is inherited by the world of quantitative easing, where developing economies are besotted with a cheap money which has been in place for almost a decade. That decade is over and audience does not have any opportunity for a curtain call.
So far you have read a story which you are probably familiar with. From now on, we are solicitous to provide some insight supported by some data about how effective Turkish central bank has been in shaping the credit markets through interest rates. At this point, we look for correlations between loan rates and the average cost of funding rate, which was originally made in Turkey, through a system called “interest rate corridor” in which the central bank can determine the effective fund rate in a considerable wide margin.
The chart above show the 36-week trailing correlation between the effective interest rate between implied by the central bank and the rates for direct consumer, mortgage, commercial lending and deposits.
There has been cycles when apparently central bank lost its control over credit markets. The first cycle, in our view, was solely based on this unorthodox monetary policy framework as discussed above. Having said that, the following two cycles are products of banks’ weakening appetite for lending growth.
We attach important to the last two because it shows when loans to deposit rates when through the roof, banks deliberately lift their rate that loans and deposits carry without a tightening signal for the reserve bank. That is simply how to be functionless in determining the interest rates for the banknotes you issue. This view is also supported by lead-lag analysis that suggests loan growth surprisingly lead interest rates.
Headline inflation in October came out at 1.44% m/m pointing to an annual inflation rate of 7.16%, fell behind the expectations of 1.58% but slightly higher than our estimate of 1.40%. Meanwhile downward trend in core indicators continued, as I-index y/y change declined 7.04% in October and from 7.69% in September. In our view, October reading was another relief provided to the central bank on the inflation front, however, we do not think that clear skies are ahead.
We expect core inflation to be on the decline until yearend, and peak at 9% in mid-2017. Pass-through effect from a depreciated local currency may even lead further deterioration in inflation.
On the other hand, inflationary pressures from cost channels appear to be weak.
Going forward we expect the central bank to continue to implement a growth-friendly policy using liquidity tools rather than interest rates. Our prospect is for an average cost of funding rate remaining at 7.75% for some time to come, which is 25 bps higher than 12-month forward-looking inflation expectations.
At a time when some argue that Turkey is on a path to being more state-sponsored economy owing to the Treasury guaranteeing large scale projects, the performance comparison of public and private banks gains importance. Thus, we aim to compare both groups in terms of lending growth, funding capacity, capital adequacy, and liquidity position in order provide some insights.
Public commercial banks have been outperforming the private peers in lending growth since May 2013 when the so-called taper tantrum hit emerging markets as well as Turkish assets. The gap between lending growth rates has seemed to remain steady. However, there are clear signs of lending recession as the volume growth has slackened systemwide.
Remember that TRY loans-to-deposits ratio for private banks currently stands at a record high of 140%. Despite their strong FX deposit base, private banks apparently feel more constrained to finance their assets when compared to public banks. With a lower l/d spread public banks enjoy their strong local currency deposit base which is primarily compromised of retirement and civil servant salaries.
Having been way stronger than private banks regarding the capital adequacy for a long time, public banks posted a lower figure for the first time in March. This demonstrates public banks are on the ball when the market is in the doldrums.
It is easy to relate this to l/d spreads given above, but, public banks interesting have been weak set of results for liquidity requirements as they have been under the threshold of 100% which all the banks in Turkey must comply. Public banks can’t be given a pat on the back for their maturity management.
To sum up, Turkish government might play hardball to support the economy through state-run banks as it already has the capacity due to its perfect debt metrics. The differentiation explained between private and public banks would be prognosticating.
You can view the charts and the official data here (PDF).