Looser Turkish Interest Rates Finally Reaching Intended Audience

  • Overnight swap rates converge with CBT’s lending rate
  • Implied yield on lira overnight swaps falls 80bps since June 2

A move by Turkey’s central bank to simplify how it manages money supply to the nation’s lenders may have finally had the desired effect of driving down borrowing costs for the real economy.

In the four days since policy makers said they would give banks access to equal amounts of money each day of the week at auctions, doing away with a more irregular system, short-term funding costs for banks have fallen 65 basis points to 9.5 percent. This brings the yield on the overnight lira swap into line with the benchmark overnight lending rate by helping eliminate a financial blockage that prevented lenders fully benefiting from interest-rate cuts.

Central bank governor Murat Cetinkaya, who took over in April, is pressing on with plans to simplify monetary policy, making it easier for investors and banks to understand. In addition to the new liquidity schedule, the central bank also last week increased the amount of foreign-exchange deposits it accepts for collateral on short-term borrowing by 39 percent to $5 billion.

“The central bank took some measures to eliminate the unwanted tightening in liquidity conditions last week, which seem to have started to take effect,” writes Erkin Isik, a strategist at Turk Ekonomi Bankasi. “Swap rates are important for short-term funding of local banks, so the decline is as important as the central bank’s rate-cuts.”

Loan Pricing

Policy makers have reduced the overnight benchmark, the upper band of an interest-rate corridor, by 125 basis points since March as inflation slowed and the currency stabilized.

Turkish banks use the swap market to exchange their foreign currency for liras that finance lending at home. The rate paid on this short-term cash helps determine how they price their loans.

By offering funds evenly through the week rather than concentrating the auctions over two days, the new system will "enable banks to use their government bond portfolio more efficiently in their short-term funding," Isik said.

The central bank currently operates a multi-rate interest corridor allowing the flexibility to alter the composition of lira funding between its cheaper and more expensive rates, depending on external financial conditions. Last year it pledged to move toward a single rate, welcomed by investors who often found the existing system confusing.

Lira Demand

The decline in swap costs may reflect rising demand for Turkish and other emerging-market assets following weak U.S. jobs data as well as local households and businesses converting foreign-currency denominated savings to lira, according to Evren Kirikoglu, a strategist at Akbank TAS.

"The central bank’s announcements coincided with a switch in locals’ holdings of foreign exchange into lira and with foreigners closing their lira short positions after U.S. data,” Kirikoglu said. "This excess liquidity has to go somewhere and this is what’s bringing swap rates down.”

After erasing its losses for 2016 last week, the Turkish lira was trading 0.4 percent higher at 2.8851 per dollar as of 6:48 p.m. in Istanbul on Wednesday, up 1.1 percent this year.

Even so, Isik expects the impact of declining yields on the swaps to continue filtering through to real borrowing costs. The weighted average cost of cash loans in Turkey has dropped 40 basis points since the March 24 rate cut, to 17.56 percent as of May 27, trailing the decline in the central bank’s overnight lending rate.

“We haven’t seen a major decline in loan rates but we may see from here,” Isik said.

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