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Babacan Says Turkey Central Bank Showed It Can Raise Rates

Turkey’s stated aim of zero real interest rates is an “ideal” scenario and the central bank proved last month that it’s ready to raise borrowing costs when needed, Deputy Prime Minister Ali Babacan said.

While the government has a “keen intention” of reducing historically high rates to more “reasonable” levels, it won’t sacrifice inflation or financial stability, Babacan said in London today. Prime Minister Recep Tayyip Erdogan’s goal of zero real rates is a long-term target, he said.

“We don’t want high interest rates and we don’t want high inflation either,” Babacan said. The central bank has a “long-term approach and will take short-term clever steps to achieve its goals” of price and financial stability in a volatile global environment.

Central Bank Governor Erdem Basci on Oct. 26 announced new policies that enable him to vary bank borrowing costs on a daily basis between the benchmark rate of 5.75 percent and 12.5 percent. The bank says that is the right mix to manage volatile capital flows, and that it will provide funds at the lower end of the range on days when the lira isn’t falling. It kept the benchmark one-week repo rate unchanged today.

Turkish economic authorities are battling to reduce a current-account deficit of about 10 percent of gross domestic product by boosting exports and curbing domestic demand for imported goods. The gap widened during a credit-driven boom that saw the economy grow at an average annual pace of almost 10 percent in the six quarters through June.

‘Started to Hurt’

Growth in output and bank lending is now slowing, and the adjustment will be helped by a weaker lira, according to central bank forecasts. The currency fell about 17 percent against the dollar this year

The lira’s decline helped push inflation to a one-year high of 7.7 percent last month, above the year-end target of 5.5 percent. Babacan said Turkey will get closer to next year’s target, which is 5 percent.

The decline in the lira was intentional on the part of the central bank “until it started to hurt inflation,” Babacan said. Then the bank became more active in supporting the currency, he said.

Since the lira reached a record low on Oct. 3, the bank has stepped up purchases of the currency in auctions and direct interventions, and adjusted the reserve requirements for banks’ lira and dollar liabilities.

Rating Outlook Cut

Fitch Ratings Ltd. today cited the twin challenges of reducing Turkey’s “large current-account deficit and above-target inflation rate” when it cut its outlook on the country’s debt rating to stable from positive.

The lira extended losses after the announcement, dropping 1 percent to a one-month low of 1.8697 per dollar at 3 p.m. local time. Yields on two-year domestic debt rose 17 basis points to 10.68 percent.

Turkish authorities have argued that the country’s credit rating, one level short of investment grade at Fitch and two short at Moody’s Investors Service and Standard & Poor’s, doesn’t reflect its financial strength.

The government says it is on track to post a budget deficit equal to about 1.7 percent of economic output this year, and has slashed debt to about 40 percent of GDP. In the medium term Turkey will keep fiscal policy tight and post budget surpluses before interest payments, Babacan said.

Lower Yields

Turkey’s euro-denominated bonds maturing in 2020 trade at yields of about 5.5 percent. That’s more than a percentage point below yields on similar debt of investment grade-rated European Union members Italy and Spain.

The current-account gap is the main source of worry for an economy that has strong banks and a sound fiscal position, Babacan said. The gap will narrow only “gradually” in the months ahead because of Turkey’s dependence on imports such as oil and gas, and its vulnerability to a slowdown in Europe, which takes almost half of its exports, he said.

Additional liquidity provided by authorities in the U.S. and Europe may give Turkey two or three years of breathing room to reduce its current-account deficit, Babacan said.

“When the excess liquidity is pulled back, maybe in two or three years, we need to be ready,” he said. The government has plans to support local production in selected industries and is spending more on education and encouraging research and development, he said.

Still, the weakness of European economies poses a risk to Turkey’s goal of 4 percent economic growth next year, Babacan said, adding that addressing the problem may require “unprecedented” actions by Europe’s central banks.

Fitch today forecast growth of 2.2 percent in Turkey next year, as well as lower inflation and a narrowing current account deficit.

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