Turkey is pressuring banks to keep commercial loan rates low

Turkey is pushing commercial banks to cut interest rates charged on loans to businesses after the central bank moved this week to stimulate the economy with a surprise rate cut, according to Bloomberg.

The monetary authority today published rules that will force banks to bring commercial lending rates closer to Turkey’s policy benchmark, in a bid to counter signs that the $800 billion economy may be slowing.

The regulations follow the central bank’s decision on Thursday to cut its policy rate to 13 percent, even as inflation runs at a 24-year high of 80 percent. The intended goal is to keep relatively cheaper cash flowing to businesses and create jobs as Turkey prepares for elections in 2023.

Banks will also have to move more government bonds in pounds to adjust, a requirement that could trigger a rally in Turkish debt markets like the one that followed similar measures in June.

The monetary authority said the regulations would strengthen its so-called transmission mechanism, or its ability to influence the cost of money banks lend to their customers.

However, most of the changes are aimed at reducing the cost of loans for corporate customers. Lenders who charge too much or lend too aggressively will have to park a greater amount of sterling assets with the central bank.

Lenders asking for interest rates of 22.85% to 29.4% on new commercial loans will have to lock in sterling bonds worth 20% of the new credits to the monetary authority. For even higher interest rates, the ratio rises to 90%.

The new regulations apply to loans that will be extended until the end of the year and the interest rate band will remain linked to the official policy rate.

Why now;

In recent months, there has been a sharp divergence between Turkey’s official policy rate and the cost of borrowing in the banking sector. Lenders now charge more than double the central bank’s interest rate, which had been held at 14% since December until Thursday’s cut.

The average interest rate on commercial loans in pounds soared to 30% in July, the highest in four years. While it has eased slightly amid complaints from businesses about tight funding, it was still at 27 percent as of Aug. 12, according to official data.

Stimulating the economy through credit is a policy long favored by the governments of President Recep Tayyip Erdogan. After an attempted coup in 2016, Turkey’s government introduced the Credit Guarantee Fund, through which companies could access state-backed borrowing.

This approach ultimately failed, as abundant credit caused the economy to overheat and contributed to the collapse of the pound in August 2018.

More recently, boosted by the ultra-loose monetary policy favored by the president, Turkey’s economy has shined ahead as it emerges from the pandemic and has continued to grow at one of the fastest rates in the Group of 20.

But the central bank warned this week of “some loss of momentum in economic activity” at the start of the third quarter.

Exchange problems

The sharp resumption of monetary easing puts the pound, one of the world’s worst-performing currencies this year, at risk. The currency weakened as much as 1 percent against the U.S. dollar after the rate decision, hitting its lowest level since Dec. 20, before paring losses.

Turkey’s policymakers are following Erdogan’s determination to reduce borrowing costs as much as possible ahead of elections scheduled for June. But price increases are emerging as a major threat to the Turkish leader’s popularity, and the new regulations hardly make a convincing case that the monetary authority sees inflation as its number one priority.

Forcing banks to lend at lower rates increases concerns about overheating and will not only do nothing to tackle inflation but make it worse, said Tim Ash, emerging markets strategist at BlueBay Asset Management.

The central bank this week revised its 2022 inflation forecast higher by nearly 18 percentage points and now sees year-end inflation at 60%, 12 times the official target, with inflation peaking around 85 % expected within months.