IF you want to know what old fashioned, hard-core monetary policy used to look like – the kind that those readers who lived through the UK’s European Exchange Rate Mechanism (ERM) humiliation will remember – look no further than what happened to Turkey, a country at the epicentre of the growing emerging market crisis, last night.
In a desperate bid to regain credibility and to halt the slide of the lira, the central bank raised its overnight lending rate to 12 per cent from 7.75 per cent, its one-week repo rate to 10 per cent from 4.5 per cent and its overnight borrowing rate to 8 per cent from 3.5 per cent. These were eye-wateringly gigantic rate hikes. SocGen called it “punchy, aggressive and credible. An amazing job.” Others may prefer to view it as crazy, almost masochistic stuff. But most in the markets loved it: astonishingly, the lira had bounced back 9 per cent last night compared with its value when it announced the emergency central bank meeting the previous day.
The sharpness of the tightening – which caught everybody by surprise – sent an immediate signal to the markets that the authorities were serious, but the cost of the move could yet be immense. It’s reminiscent of that fateful Wednesday in September 1992 when UK interest rates were hiked first from 10 per cent to 12 per cent, and then it was announced in the afternoon that they would go up to 15 per cent to prop up the sinking pound – before the government surrendered, allowed the pound to float freely and cut rates back to 12 per cent and then 10 per cent. That sort of nonsense destroys economies and demolishes parties’ economic credibility, in Turkey, in Britain and everywhere else.
The immediate impact of Turkey’s move will be positive for the country as it will stabilise jittery markets. The country needs higher rates to reduce strong credit growth; but it also has deep-seated problems which won’t go away. The country suffers from a large current account deficit and external debt burden, excessively loose fiscal policy and dangerously low foreign exchange reserves, while the political situation is deeply worrying.
The news follows India’s move to increase interest rates the previous day. Brazil has hiked rates by 3.25 per cent in under a year and intervened heavily in the forex markets. Argentina is in real trouble: its inflation hit 25 per cent last year. Moody’s believes that its currency will collapse by another 50 per cent this year and that inflation will reach 30 per cent.
In an act of desperation, it has slapped a punitive cap on the amount of dollars citizens can buy, further increasing the gap between the official and parallel exchange rates. Economic freedom is fast vanishing in that country, with ever more draconian and often contradictory restrictions being imposed by a short-sighted, failing government.
Elsewhere, the tragic crisis in Ukraine is reaching its apogee; and the emerging markets as a whole, once the bright spot for the world economy, have suddenly become the source of all of its problems.
Many of these issues are self-inflicted. But it is also clear that the Fed’s belated tapering is playing a key role in all of this, with much nervousness in the markets. It is clear that US monetary policy has had huge side-effects on emerging economies, with liquidity flowing out of the American economy and fuelling bubbles and distortions all around the world. The emerging nations should have understood this and taken action to prepare themselves for when the cheap money eventually stopped; sadly, some failed to do so. But while we can’t blame the Fed for all of the world’s problems, it is an uncomfortable reality that years of deeply selfish monetary policy across the Western economies and China is one of the reasons for the chaos we see today across many emerging economies.