(Bloomberg) —
Turkey is pushing commercial lenders to drastically cut interest rates on business loans after the central bank moved this week to stimulate the economy with a surprise rate cut.
The monetary authority issued rules on Saturday that will force banks to bring commercial lending rates closer to Turkey’s benchmark policy rate, in a bid to counter signs of a slowdown in the $800 billion economy.
Erdogan got his rate cut and now the heat is on Turkish banks
The regulations follow the central bank’s decision on Thursday to cut its key rate to 13%, even with inflation at a 24-year high of 80%. The aim is to maintain relatively cheaper cash flow for businesses and create jobs as Turkey prepares for the 2023 elections.
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Banks will also have to hold more lira-denominated government bonds to adjust, a requirement that could lead to a rally in Turkish debt markets like the one that followed similar moves in June.
Penalize the banks
The monetary authority said the regulations will strengthen the so-called transmission mechanism, or its ability to influence the cost of money that banks lend to their customers.
But most of the changes are aimed at reducing the cost of loans for corporate clients. Lenders who charge too much or lend too aggressively will be required to deposit more lira assets with the central bank.
Lenders asking for interest rates of 22.85% to 29.4% on new commercial loans will be required to block lira bonds worth 20% of the new credit with 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 rate band will remain linked to the official key rate.
Why now?
There has been a sharp divergence between Turkey’s official policy rate and the cost of lending in the banking sector over the past few months. Lenders are now charging more than double the central bank rate, which had been held at 14% since December until Thursday’s cut.
The average lira commercial loan rate jumped to 30% in July, the highest in four years. Although it fell slightly amid complaints from businesses about a financial crisis, it was still at 27% as of August 12, according to official data.
Reviving the economy through credit is a policy long favored by the administrations of President Recep Tayyip Erdogan. Following a coup attempt in 2016, the Turkish government introduced the Credit Guarantee Fund, through which companies could access state-guaranteed loans.
The approach ultimately backfired as ample credit caused the economy to overheat and contributed to the lira crash in August 2018.
More recently, boosted by the ultra-loose monetary policy favored by the President, Turkey’s economy has surged ahead as it emerged from the pandemic and has continued to grow at one of the fastest paces 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.
The woes of currency
The abrupt resumption of monetary easing puts the lira, one of the worst performing currencies in the world this year, in danger. The currency weakened as much as 1% against the US dollar after the rate decision, hitting its lowest since Dec. 20, before paring losses.
Turkish policymakers are following through on Erdogan’s determination to cut borrowing costs as much as possible ahead of elections scheduled for June. But price hikes appear to be a major threat to the Turkish leader’s popularity, and the new regulations do little to prove that the monetary authority sees inflation as its number one priority.
Forcing banks to lend at lower rates heightens fears of overheating and will not only do nothing to fight inflation, but make it worse, said Tim Ash, emerging markets strategist at BlueBay Asset Management.
The central bank this week revised its inflation forecast for 2022 upwards by almost 18 percentage points and now expects end-of-year inflation at 60%, 12 times the official target, with a spike in inflation. about 85% expected within a few months.
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