US Federal Reserve (Fed) falconry will rock emerging markets including Turkey. The biggest concerns are capital flight and rising borrowing costs. However, unlike other developing countries, Turkey is not prepared for this process.
The US Federal Reserve’s (Fed) rush to raise interest rates on concerns about high inflation could weigh heavily on emerging markets, including Turkey.
As the Fed accelerates rate hikes, the dollar is expected to strengthen and growth to slow. For this reason, the Fed’s decisions are followed with concern by the markets. However, many experts believe that the rapid increase in inflation has forced the Fed officials to make this decision.
The Federal Open Market Committee (FOMC), which sets the Fed’s monetary policy, began raising interest rates at its most recent meeting, raising the federal funds rate by 25 basis points to 0.50 percent from 0.25 percent. The FOMC will hold its next meeting in May.
However, the ineffectiveness of the 25 basis point rate hike against inflation led to discussions about accelerating monetary tightening. Consumer inflation in the US is currently at 8.5 percent. The Fed’s inflation target is 2%.
AGRICULTURAL SIGNAL
Fed Chair Jerome Powell indicated that monetary policy would be tightened with more aggressive steps from now on and said the central bank would discuss a 50 basis point rate hike at the May 4 meeting.
Growth and inflation warnings were also issued in the April issue of the Beige Book report, which contains the Fed’s views on the US economy.
As discussions continued about accelerating Fed tightening, how the US rate hike would affect developing countries was also discussed.
HOW ARE DEVELOPING MARKETS AFFECTED?
An article by Jasper Hoek, Emre Yoldaş and Steve Kamin, published on the Fed Blog in June 2021, explained that historically, rising interest rates in the United States have increased debt burdens and triggered capital outflows, adversely affecting the economy emerging markets impacted .
However, the article found that in economies with higher macroeconomic vulnerabilities, financial conditions are more sensitive to US interest rate hikes.
“Higher US Treasury yields could lead to a significant tightening of financial conditions in emerging markets. However, such effects are highly dependent on local conditions.
BANKS CAN ALSO BE AFFECTED
Rating agency Moody’s said in a statement in February that developing countries had become vulnerable to tighter US monetary policy.
Moody’s said the Fed’s rate hike would slow capital flows to emerging markets, weaken countries’ currencies and economic growth, and trigger credit risk at heavily dollarized banks.
FEAR OF CAPITAL EXIT
Likewise, the article by Stephan Danninger, Kenneth Kang and Hélène Poirson, written for the IMF Blog in January, noted that rapid Fed rate hikes could shake financial markets and tighten global financial conditions.
“These developments may slow demand and trade in the United States and lead to capital outflows and currency depreciation in emerging markets,” the article said.
RISKS TO TURKEY
Experts say there are several risks for emerging markets if the Fed hikes interest rates. These risks include accelerated capital flight and rising borrowing costs.
While international direct investor inflows into Turkey gradually increased until 2015, this figure began to fall sharply after 2015, when the Fed began raising interest rates. According to CBRT data, foreign investment, which was $12.2 billion in 2015, has fallen below $6 billion in 2020. In 2021, that number surpassed $7.5 billion.
However, some experts believe that these data may not be heavily influenced by recent rate hikes as capital flight has been high in Turkey in recent years. However, some experts believe that capital flight could continue. In addition, it is noted that the Fed’s interest rate hike will increase the debt burden.
COST OF DEBT WILL RISE
Economist Mahfi Eğilmez, in his assessment of the issue on his own blog, stressed that interest rate hikes to be implemented by central banks of developed countries would increase Turkey’s borrowing costs. Eğilmez wrote the following statements in his March 26 article:
“The fact that the central banks of the developed countries are raising interest rates and then starting to tighten monetary policy will increase the borrowing costs of Turkey, which is already able to find external funds at a very high cost. Interest payable by the Treasury Department, which issued $2 billion in bonds this month, hit an all-time high of 8.62 percent. This is a very annoying development for Turkey, which is dependent on foreign loans because of its current account deficit.”
WHILE ALL INCREASED INTEREST, CBRT DECREASED INTEREST
Due to all these risks, the central banks of the developed countries worldwide changed their interest rate policy and prepared for the Fed wave.
However, the Central Bank of the Republic of Turkey (CBRT), in contrast to other countries raising interest rates, gradually lowered the key interest rate by 500 basis points to 14 percent late last year. This data means that according to current inflation, the TL has a negative yield of minus 47 points.
While the easing cycle caused the exchange rate crisis and indirectly fueled inflation, rising global energy costs after Russia’s invasion of Ukraine in February further fueled price increases.
Despite the rise in inflation, the CBRT did not change the policy rate at its most recent meetings. The bank gave no signals that it might change the interest rate later.
In addition, the economic management, which has suppressed the exchange rate with the application of the currency-protected deposit, further increases the burden on the treasury by the move to suppress the exchange rate. As such, the Turkish economy is preparing to face the wave that the Fed will launch at one of the most fragile times in its history.
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