Q: What is Turkey's medium-term economic outlook?
A: The economic outlook for the coming three years has been recently announced in the Medium Term Economic Programme for 2015 to 2017. The programme’s number one priority is to bring inflation down to the target of 5% through the three-year period. The second priority is to keep the improvement in the current account balances in tact and have a sustainable current account deficit going forward. The growth is projected to be 3.3% for 2014, 4% for 2015 and 5% for both 2016 and 2017.
The general government budget is projected to be very close to balancing and the primary budget surplus is [predicted to be] 1.8% at the end of that period. So this will bring the government public debt burden from about 33% as of the end of 2014, all the way down to 28% at the end of 2017. This [will provide great] support to the disinflation efforts that we are already [undertaking] with an appropriately tight monetary policy.
Q: What is the strategy behind your interest rate policy?
A: After three-and-a-half decades of extremely high and volatile inflation, Turkey is now in a disinflationary phase. The inflation rate has come down to single-digit levels permanently, thanks to fiscal prudence and the independence of the central bank, and it has been hovering between 6% and 10% during the past decade.
Our ambition is to bring inflation all the way down to 5% and ensure that both expectations of inflation and inflation itself are at about 5% for the coming five-year period. Next, we should target a figure further below 5% so that we will have an even lower level of inflation that is more compatible with the price stability definition for emerging markets. This level is envisaged in the 10th Development Plan as 4.5% for 2018. Therefore we have to first make sure that the inflation falls to 5% and then take some further disinflationary measures to ensure price stability for Turkey.
Q: How high are your foreign exchange [FX] reserves currently and what is your FX strategy?
A: The gross reserves of the central bank, including gold, stand at $132bn. This figure has constantly increased since 2002. This increase in our FX reserve buffers is due to various means, such as the increase in reserve requirements, the introduction of the reserve options, FX purchases directly from the market during times of strong capital flows, and the contribution from our funding for exports programme.
In this latter programme we basically lend to our exporters in domestic currency and they redeem in a foreign currency: either euros or US dollars. Thereby, we continue to accumulate finance by providing some short-term financing to our exporters.
Q: What was the reason behind asking banks to replace their euro-denominated reserves, deposited under the reserve option mechanism, with US dollars?
A: The reserve options mainly serve two functions. One of them is to reduce the intermediation cost of the Turkish banking system by allowing the banks to deposit foreign currencies rather than domestic currency for their domestic currency reserve liabilities at the central bank. The second function is to boost the official reserves of the central bank.
In the past, the banks had the option of using either US dollars or euros to reduce the intermediation cost and to have FX liquidity at the central bank. But recently, since we are basically paying zero interest on these options, we would not be able to channel negative deposit rates to our banking system. Therefore we have ruled out the use of euros as part of reserve options.
Now the banks can reduce the intermediation costs by depositing only US dollars at the central bank. Since we are mainly following an asset liability-matching strategy in our reserve management we are also holding more US dollars in our reserves as a natural consequence of this recent development of negative nominal rates for short-term euro-based assets.
Q: How would you describe the health of the Turkish banking sector?
A: The banks in Turkey are well capitalised, liquid, profitable and they are operating in quite a competitive environment. The ownership structure is also well diversified. As of September 2014, the capital adequacy ratio was 15.9%, and the liquidity coverage ratio is compatible with international Basel III standards. The banks comply with the leverage ratio and net stable funding ratio that will soon be in effect globally. The average return on assets is 1.3%, and the average return on equity is 11.5%.
The pace of credit growth is quite robust, and we have been taking steps to ensure sustainability of the pace of credit growth and improve its composition. So far all the measures that have been taken on the macro-prudential side have delivered the desired results and the credit composition and growth is sustainable and supportive of balanced economic growth.
Q: What are the main challenges and opportunities in the banking sector?
A: Turkey has a young population and a very dynamic economy. Job creation rates are quite high. Moreover, the labour market participation rates keep increasing, especially for women. Therefore, the combination of favourable labour market dynamics, a gradually improving business environment and an emphasis on both human capital development and research and development in the government’s ambitious reform agenda increases the growth potential for Turkey in the coming years.
In line with the growth potential of the country, opportunities for the banking sector are also quite significant. Credit quality is very high, and the composition of credit favours small and medium-sized enterprise support and business loans over consumer loans.
On the other hand, the challenges are well known: namely the relatively slow growth in Europe and the geopolitical risks. The banking sector resilience, however, has been tested by quite severe shocks throughout the past 18 months. Therefore, the challenges are relatively manageable and small compared with the opportunities.
Q: Research from several official sources notes that the Turkish banking sector has a high level of foreign currency debt and that this could become problematic in a stress scenario. What is your view on this and what would you propose to resolve the situation?
A: In the current global environment, the major central banks are following accommodative monetary policies. This has significant implications on financing opportunities in emerging markets, including Turkey. As, in particular, the leverage of households is quite low and in general macroeconomic and financial stability has been achieved in Turkey after several decades of high and volatile inflation, there is ample demand for credit. On the household side, this demand is in the local currency, which banks in Turkey can quite easily accommodate by borrowing from abroad and lending to residents through their intermediation function. That being said, they have to be quite careful regarding the currency and maturity composition while delivering this function. Banks in Turkey are strictly regulated in this regard.
For currency composition, regulations require banks to have an overall balanced position on their FX exposures. Therefore, they have to hedge all of their open currency positions [through] off-balance-sheet hedging instruments.
Regarding the maturity mismatches, banks in Turkey are subject to regulations on the liquidity coverage ratio and will be subject to the net stable funding ratio restrictions soon. Moreover, they are also subject to additional liquidity requirements such as relatively high reserve requirements from the central bank. In this framework, banks in Turkey are borrowing more and more in long-term [funding], and are trying to match the extension of maturities on their asset side. Furthermore, we have recently introduced a new incentive scheme for them to rely more on core liabilities, namely equity capital and domestic deposits in the coming months. We are remunerating the reserve requirements according to the relative degree of dependence on core liabilities so as to provide such an incentive to the banks.
Q: Is there a need for any new regulation in the Turkish banking sector?
A: As of now, Turkey has implemented Basel III regulations which are determined and set by the Financial Stability Board and the G20. After the finalisation of the net stable funding ratio globally, the Turkish banking regulator will work on it and it is going to issue a timetable for its implementation. Implementing the new net stable funding ratio will further improve the already adequate liquidity buffers of the Turkish banking system and it is going to ensure compatibility with international standards.
Erdem Başçı is the governor of the Central Bank of Turkey.
