MacroScope

The thin line between love and hate

August 19, 2011

The opinion on Turkey’s unorthodox monetary policy mix is turning as rapidly as global growth forecasts are being revised down.

Earlier this month, its central bank was the object of much finger-wagging after it defied market fears over an overheating economy by cutting its policy rate. It defended the move, arguing that weaker global demand posed a greater risk than inflationary pressures.

Investors were not persuaded. When I told one analyst about the Turkish rate move, he practically sputtered down the phone: “You’re not kidding?!”

The lira sold off, dropping to 2-1/2 year lows against the dollar.

But the central bank could yet be vindicated. With fears intensifying over weakening global demand, its decision to cut rates looks increasingly prescient. As my colleague Sujata Rao has pointed out, other emerging-market central banks have followed the Turks.

Witness Societe Generale’s head of emerging markets strategy Benoit Anne‘s mea cupla in a note issued just two weeks after Turkey’s controversial rate decision:

“I guess I need to apologize to the Central Bank of Turkey which on many occasions had been the object of my sarcasm over the past few months: the Central Bank of the Republic of Turkey is actually at the forefront of policy-making in the emerging-markets universe. And I bet some other central banks will follow suit with rate cuts in the pipeline.”

Turkey would not be the first emerging market to have its policies met with initial derision before qualified approval.

Investors pilloried Hong Kong when it intervened in its stocks and futures markets at the height of the Asian financial crisis to fend off speculative attacks on its currency. Pundits practically wrote obituaries for the Malaysian economy when the country imposed emergency capital controls in 1998 to prevent the capital flight that sent some of its neighbours cap in hand to the International Monetary Fund.

What seemed shockingly radical then now seems conventional, especially following the hundreds of billions spent by U.S. and European governments in 2008-2009 bailing out banks.

Brazil, South Korea and Taiwan have curbs on foreign capital inflows and none have suffered much reputational damage among investors. These days, even advanced Western economies have bans on short-selling.

Rightly or wrongly, the success of government or central bank policy is often judged by whether the country’s currency or securities respond by rising or falling. This is especially the case for emerging economies which have historically been more dependent on foreign capital flows.

Yet what is anathema to investors in the near term could prove over time to be the best policy option.

As emerging economies build up greater fiscal buffers in the form of foreign-currency reserves, they will increasingly be able to defy near-term market consensus without fear of significant repercussions on their asset prices.

On opposite end of the spectrum, the high levels of sovereign debt in the Europe and U.S. could leave their policy-makers more in thrall of investor opinion even at the expense of longer term economic interests.

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