What You Should Never Lose
Mar 23, 2006
Serhan Cevik (London)
Credibility — the most valuable asset of policymakers — is difficult to gain but easy to lose. Appointing new governor and vice governors to the Central Bank of Turkey has turned into a mysterious political game that, in our view, is a blow to institutional credibility of the central bank and raises doubts about the government’s commitment to the independence of the central bank. Even though the term of the last governor, Sureyya Serdengecti, expired on March 14 and three out of four vice governors have also resigned, we still do not know the new management of the most important institution for the economy and financial markets. The awkward tradition of leaving such critical decisions until the last moment is no excuse, in our view, in today’s increasingly risk-averse global environment and, especially, in light of Turkey’s aspiration for further institutional advancement. All in all, we do not expect major policy changes, but we believe the way the government has handled the appointment process threatens the perceived independence of monetary policy and the resulting uncertainty may actually delay the expected reduction in interest rates.
Fuelling uncertainty, when global financial markets are already tense, hurts the Turkish economy. Turkey has come a long way in terms of normalising the macroeconomic landscape and improving public finances. Indeed, above-trend income growth and rapid disinflation, thanks to prudent policies and structural reforms, have even started delivering socio-economic improvements. However, becoming a ‘normal’ country is the easiest part of the ultimate goal of achieving real convergence (see After Normalisation, February 27, 2006). In order to keep the economy on a welfare-enhancing path, the authorities must focus more on microeconomic adjustments as well as maintaining macroeconomic stability. This is a challenging task that is becoming even more difficult as higher interest rates in developed countries reduce investors’ appetite of riskier assets. Although today’s Turkey is far less vulnerable to the unwinding of leveraged positions in global capital markets, the country still has a long way to go towards achieving price stability and lowering real interest rates to a less distortionary level. That, in our opinion, requires fiscal discipline and an unscathed record of an independent central bank with a mandate to focus exclusively on price stability. Turkey is in a pivotal moment, facing critical post-stabilisation challenges. Fiscal consolidation has no doubt played a critical role in ending Turkey’s self-fulfilling inflation process and improving the effectiveness of monetary policy. However, the government’s commitment to multi-year fiscal programming is just one of the underpinnings of disinflation. Along with a variety of structural changes, the increased institutional independence of the central bank has enhanced policy credibility, better anchored inflation expectations to ambitious targets, and thereby led to a significant reduction in the country’s risk premium. Accordingly, any challenge, however insignificant, to the central bank’s institutional credibility would now bring about an adverse shift in expectations and consequently an increase in real interest rates. The Turkish economy already faces new policy challenges, as the influence of macroeconomic normalisation fades away, and the last thing it needs is a credibility crisis. Turkey’s economy and financial markets need policy consistency and greater transparency. In a country, like Turkey, with a record of macroeconomic instability, the central bank’s legal and de facto independence is sine qua non to gain credibility. As Turkey’s own experience shows, an unambiguous political commitment to bolstering the credibility of monetary policy and achieving price stability minimises the cost of adjustment and raises the economy’s actual and potential growth rates. This is not to suggest that there should be no bureaucratic changes. On the contrary, we believe that a better working relationship between economic institutions would improve the end results. However, with the adoption of inflation targeting, the stakes are now much higher and, in spite of the better-than-expected accomplishment on the inflation front, Turkey is yet to achieve price stability. This is why, given that de-dollarisation remains incomplete and the composition of capital inflows is still susceptible to increasing volatility, Turkey’s economy and financial markets need policy consistency and greater transparency.
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