Capital Flows, Financial Stability, and Monetary Policy S. Tolga Tiryaki Central Bank of Turkey National Seminar on Developing a Programme for the Implementation of the 2008 SNA and Supporting Statistics in Turkey 10 September 2013 Ankara, Turkey

Outline

1. 2.

3. 4. 5.

Monetary Policy since 2001 Capital Flows and Implications for Monetary Policy New Monetary Policy Framework New Policy Instruments Evidence and Conclusion

2

Monetary Policy Since 2001



2001-2006: Implicit Inflation Targeting (IT)



2006-2008: Full-fledged conventional IT



2009-2010: Adjusting to the post crisis conditions



Late 2010-to date: Incorporating Financial Stability Objective into the Inflation Targeting Framework

(with special emphasis on capital flows) 3

Capital Flows and Implications for Monetary Policy

4

Portfolio Flows to Emerging Economies Equity and Bond Flows to Emerging Market Economies (4-Week Moving Sum, Billion USD) 30

Bonds

Equities

25 20

Collapse of Lehman Brothers

15 10 5 0 -5 -10 -15

04/13

01/13

10/12

07/12

04/12

01/12

10/11

07/11

04/11

01/11

10/10

07/10

04/10

01/10

10/09

07/09

04/09

01/09

10/08

07/08

04/08

01/08

10/07

07/07

04/07

01/07

10/06

07/06

04/06

01/06

-20

Source: Emerging Portfolio Fund Research (EPFR)

5

Capital flows: challenges



Capital flows may have important benefits, but they pose big challenges for macroeconomic policy as well:



Sudden reversals (stops) can have very large adverse effects on real and/or financial sector.



Procyclical flows amplify macro-financial fluctuations, rather than dampening them.

6

Capital Flows and GDP Growth in Turkey 10 8 6 4 2 0 -2

-4 -6

Net Capital Flows/GDP

GDP Growth Rate 2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

-8

Source: CBRT

7

Capital flows: why bother now?

Historically the main source of volatility in Turkey has been cross border capital flows, why bother now? 

Size and volatility of capital flows have increased even more during the post-crisis period



More importantly, it is mainly driven by global factors. •

Less related to domestic fundemantals

•

Inefficient and distortionary

8

Emerging Market Currencies Against USD* 1.35

Collapse of Lehman Brothers

1.25

1.15

1.05

0.95

20%-80% Interval of EMs 0.85

EM Average

0911

0511

0111

0910

0510

0110

0909

0509

0109

0908

0508

0108

0907

0507

0107

0906

0506

0106

0905

0505

0105

0.75

Emerging Economies: Brazil, Chile, Colombia, Czech Republic, Hungary, Indonesia, Malaysia, Mexico, Philippines, Poland, Romania, South Africa, Korea.

9

Portfolio Flows: Turkey vs. Developing Countries (Billion US dollars)

13-week moving average

1.2 1.0

Turkey

All developing countries (right axis)

6 5

0.8

4

0.6

3

0.4

2

0.2

1

0.0

0

-0.2

-1

-0.4

-2

-0.6

-3

Source: EPFR, CBRT.

10

Capital Flows and Macro-Financial Risks: Turkish economy as of late 2010

11

Turkish Economy as of late 2010: Sharp Increase in the Current Account Deficit, Financed with Short-term Inflows Current Account Balance

Main Sources of External Financing*

(Seasonally Adjusted, Quarterly Average, Billion USD ) 2

(12-months Cumulative, Billion USD) 80 Portfolio and Short-Term*

1

FDI and Long-Term**

70

Current Account Deficit

0 60

-1

50

-2

40

-3

30 20

-4 CAB

10

-5 CAB (excluding energy)

-6

0 -10

-7

Source: TURKSTAT, CBRT.

2011:01

2010:11

2010:09

2010:07

2010:05

2010:03

2011

2010:01

1

2009:11

2010

4

2009:09

3

2009:07

2

2009:05

1

2009:03

2009

4

2009:01

3

2008:11

2

2008:09

2008

1

2008:07

4

2008:05

3

2008:03

2

2008:01

1

2007:11

4

2007:09

-20

-8

*Short-term capital movements are sum of banking and real sectors' short term net credit and deposits in banks. Long-term capital movements are sum of banking and real sectors’ long term net credit and bonds issued by banks and the Treasury. Source: CBRT.

Turkish Economy as of late-2010: Rapid Credit Growth, and Sharp Appreciation of Domestic Currency Total Loan Growth Rates

Real Exchange Rate (2003=100)

(13 Weeks Moving Average, Annualized, FX Adjusted, Percent) 135

60 130 45 125 30 120 15 115 0 110 -15 105 Jul-10

May-10

Mar-10

Jan-10

Nov-09

Sep-09

Jul-09

May-09

100 0309 0409 0509 0609 0709 0809 0909 1009 1109 1209 0110 0210 0310 0410 0510 0610 0710 0810 0910

Source: CBRT

Mar-09

Jan-09

Nov-08

-30

Searching for a new policy framework MAIN GOAL:

Design a new framework to 

correct the cyclical part of the current account deficit, by reducing overborrowing and overvaluation,



alleviate the impact of excessive volatility in capital flows on the domestic economy,



reduce the sensitivity of credit and exchange rate cycles to capital flows,



without jeopordazing price stability objective.

14

Can we do it with conventional Inflation Targeting?



When global liquidity shocks dominate, using single instrument under IT may exacerbate the trade-offs



For example, during capital inflows there are two options:



•

i↑ => further appreciation => wider CA deficit, sudden stop risks increase

•

i↓ => overheating => higher inflation

Multiple objectives, multiple instruments are needed.

15

The New Policy Framework

16

Policy Framework

Price Stability

Price Stability Financial Stability

Interest Rate Corridor Policy Rate

Reserve Options Policy Rate, etc…

17

Financial Stability: How can Monetary Policy Contribute?



Monetary policy can contribute to financial stability by reducing the probability of a sudden stop,



and by dampening the amplification mechanisms triggered by capital flows. •

smoothing credit and exchange rate cycles

18

Transmission Mechanism REFERENCE INDICATORS

INSTRUMENTS Reserve Requirement Reserve Options

Policy Rate

Interest Rate Corridor Funding Strategy

Macro prudential Policy

Interest Rate Policy

Liquidity Policy

Credit Growth Exchange Rate

OBJECTIVES

Price Stability

Financial Stability

19

The link between credit, exchange rate, and final objectives

Smoothing credit and exchange rate cycles  supports financial stability by dampening the leverage cycles and lowering the probability of a sudden stop,  helps price stability through lower inflation volatility, given the high exchange rate pass-through in Turkey,  and implies a more balanced growth path.

20

Have new instruments weakened the impact of capital flows to domestic macroeconomic variables?

21

Current Account and Capital Flows Current Account Deficit and Net Capital Inflows (12 Month Cumulative, Billion USD) 90

CAD

80

Net Capital Inflows

70 60 50 40 30 20 10 0

Source: CBRT.

01/13

11/12

09/12

07/12

05/12

03/12

01/12

11/11

09/11

07/11

05/11

03/11

01/11

11/10

09/10

07/10

05/10

03/10

01/10

11/09

09/09

07/09

05/09

03/09

01/09

11/08

09/08

07/08

05/08

03/08

01/08

11/07

09/07

07/07

05/07

03/07

01/07

-10

Last Observation: February 2013.

22

Volatility of the Turkish lira and other EM currencies against USD (30 days moving average) New Policy Instruments

1.9 1.7

Other EM Currencies

1.5

Turkish lira

1.3 1.1 0.9 0.7 0.5 0.3 0113

1112

0912

0712

0512

0312

0112

1111

0911

0711

0511

0311

0111

1110

0910

0710

0.1

* Countries with current account deficits are Brazil, Chile, Columbia, Czech Republic, Hungary, Indonesia, Mexico, Poland, Romania, South Africa, and Turkey. 23

Source: CBRT. Last Observation: May 2013.

24

04/13

01/13

10/12

07/12

04/12

01/12

10/11

07/11

04/11

01/11

10/10

07/10

04/10

9

01/10

10

10/09

07/09

04/09

01/09

10/08

07/08

04/08

01/08

10/07

07/07

04/07

01/07

10/06

07/06

04/06

Inflation Expectations

Adoption of New Policy Framework

8 12 months

7

6 24 months

5

4

3

2

Macroeconomic Outcomes of the New Monetary Policy Framework

25

Economic Activity Gross Domestic Product and Private Final Domestic Demand (Seasonally Adjusted, 2003=100) 170 160

GDP

Private Final Domestic Demand

150 140 130 120

Source: TURKSTAT, CBRT.

03-13

09-12

03-12

09-11

03-11

09-10

03-10

09-09

03-09

09-08

03-08

09-07

03-07

09-06

03-06

09-05

03-05

110

Last Observation: 2013Q1

26

Real Exchange Rate CPI Based REER (Base year: 2003) 140

QE2

Policy Reaction - I

130

120

110

100

REER

2 percent

1.5 percent

EZ Policy Crisis Reaction - II

90

80

Source: CBRT.

27

Change in Credit Stock /GDP Policy Reaction 14

Turkey

12

EM Average**

10

8 6 4

2

2012*

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

0

* Forecast for 2012. ** Emerging market countries included in the average are: Argentina, Bolivia, Brazil, Chile, China, Colombia, India, Indonesia, Malaysia, Mexico, Paraguay, Peru, Philippines, Poland, Russian Federation, Slovenia, South Africa, Thailand, Turkey and Uruguay. Source: World Bank..

28

Credit and Current Account Net Credit Use and Current Account Deficit (annual, percent of GDP)

18

18

Net Credit Use / GDP (%)

16

16

Current Account Deficit / GDP (%)

Source: CBRT.

2012Q4

2012Q3

2012Q2

2012Q1

2011Q4

0 2011Q3

0 2011Q2

2

2011Q1

2

2010Q4

4

2010Q3

4

2010Q2

6

2010Q1

6

2009Q4

8

2009Q3

8

2009Q2

10

2009Q1

10

2008Q4

12

2008Q3

12

2008Q2

14

2008Q1

14

Net credit use is annual change in total credit stock. Current account is in annual terms.

29

Conclusion 

Heightened volatility in cross-border flows have prompted Central Bank of Turkey (CBT) to change its policy framework by incorporating financial stability into the inflation targeting regime.



The new policy set-up and the tools developed by the CBT have eased the trade-offs posed by cross border capital flows.



New policy framework has been effective in reducing macro financial risks in Turkey without hampering inflation objective.

30

Capital Flows, Financial Stability, and Monetary Policy S. Tolga Tiryaki Central Bank of Turkey National Seminar on Developing a Programme for the Implementation of the 2008 SNA and Supporting Statistics in Turkey 10 September 2013 Ankara, Turkey