Call Participants

ATTENDEES

Harumi Taguchi

Kristen Hallam

Shuchita Shukla

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Presentation

Kristen Hallam

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Kristen Hallam

In a previous episode of monetary policy pivots, our economists went beyond the questions of when and how much to the implications of these pivots for businesses. In this episode, we delve further into the different narratives presented by central banks that are raising rates instead of cutting or looking to cut them, particularly in Turkey, Russia and Japan.

I'm Kristen Hallam, your host for today's episode. Joining me for this discussion are Rumi Taguchi, principal economist, Asia Pacific economics; and Shuchita Shukla, senior economist, European economics. Let's dive in.

Question and Answer

Kristen Hallam

We want to talk about some different narratives now. So the emerging markets are a different scenario, a different narrative from the U.S. and from developed Europe. Let's focus now on the 2 major outliers in your region where rates are instead going up, starting with Turkey. Is the defensive monetary policy stance there working as intended?

Shuchita Shukla

Yes. That's definitely the one to watch in our region. The turnaround in Turkish monetary policy came in May of 2023 when President Erdogan brought in a new investor respected technocrat as the Finance Minister and appointed a new Central Bank governor from the western banking world. Under this new leadership, the TCMB was allowed to embark on a hawkish monetary policy cycle in order to curb runaway inflation. And the policy rate has been lifted from 8% to the current 50%, 5-0. But in April this year, the TCMB actually signaled a pause in its hiking cycle as it expects inflation to have peaked in the second quarter of the year. We think that the rates will remain on hold until the end of this year when inflation is projected to slip below the current policy rate.

Now in terms of the impact of tightening so far, the current account balance has narrowed even beyond energy and gold trade and on net portfolio capital is now flowing into Turkey. But as is the case with most policy normalizations, there are certain necessary adjustments that tend to push in the opposite direction at least temporarily. And for the TCMB, it has actually had to normalize its exchange rate policies by phasing out administrative restrictions on FX holdings and transactions. And with that dismantling support, the Lira has continued to depreciate faster than most emerging market currencies, which means that the foreign exchange reserves are still under 3 months of import coverage.

Additionally, the tightening so far has not been sufficient to rebuild long-term investor interest as, despite improving sovereign assessments for Turkey, we haven't really seen any meaningful return of foreign direct investments into the country. So the message really is that, although latest adjustments have definitely been welcome, Turkey's long-standing fundamental constraints haven't really gone away. And the primary of those is continued political influence on monetary policy, which means that any shift to greater stability is heavily dependent on continued support from President Erdogan. So the risk of a premature pivot to easing remains quite significant should he deem higher rates to be unnecessary yet again. And that could happen if capital inflows pick up sufficiently or if domestic demand contract too much. So that big caveat notwithstanding and increasing reliance on short-term swaps to maintain the FX buffers or an excessive slide of the Lira could turn up the TCMB's hawkishness in the next 12 months, but we think that a pause is more likely.

Kristen Hallam

Let's turn to the other outlier in your region, which is Russia, where the Central Bank has had to hike rates to defend the ruble. What impact has that had? And where do we go from here?

Shuchita Shukla

Yes. The other interesting one. So the CBR pivoted to monetary tightening in July last year in order to curb inflationary pressures but also to support the beleaguered Ruble and of course, if the currency aggravates imported inflation when domestic demand is resilient and that's exactly what we've seen in Russia, where state-subsidized corporate loans, pre-electoral fiscal expansion and the tightening of labor markets owing to the outflow of skilled labor since the beginning of war all added to the release of pent-up demand.

In August of 2023, the Ruble crossed the psychologically relevant mark of RUB 100 per U.S. dollar, and that was the key trigger for the CBR to abandon its previous course of monetary easing as the currency lost about 40% of its external value at the time. So to date, the CBR has raised the policy rate from 7.5% to 16% and has also tightened capital controls.

But despite those decisive monetary policy response, the Ruble has remained weak and volatile, and there are several reasons for that, most importantly, the declining energy export earnings under western sanctions has broken the currency's positive correlation with crude oil price gains. And at the same time, strong domestic demand and a speedy rerouting of supply lines away from the rest have all contributed to an import rebound, which has increased the demand for Chinese Yuan, which is the preferred currency for cross-border payments.

Lastly, the fiscal rules around oil and gas windfalls have actually limited the CBR's ability to support the Ruble by intervening in the FX market. And so this backdrop of weak Ruble and persistent pro-inflationary factors has led the CBR to signal tighter for longer monetary policy over the next 2 years. We do expect a few cuts, mostly in 2025, as we expect government spending to peak this year. But with our projections about target inflation, both this year and next year, we do -- it will remain restrictive, and we see them ending 2025 still in double digits.

Kristen Hallam

Thanks for that, Shu. And Harumi, let's go to Japan, which also is a different narrative from the U.S. and the ECB as we've been discussing. What is it that prompted Japan to start raising rates? And what is the BOJ trying to achieve there?

Harumi Taguchi

Okay. The wage growth was the key driver for the BOJ's decisions. We saw the early result of the annual wage negotiation in March, which was an average of 5.28%, and it is the biggest rise since 1991. This led the BOJ to consider the probability to achieve 2% inflation target has risen. The BOJ is trying to achieve the sustainable inflation of 2% slowed the vicious cycle between wage and prices. In other words, the bank is waiting for the sustainable inflation driven by the consumer demand supported by sufficient wage increase. The BOJ will move once it becomes more confident about the inflation outlook, which is to say if wages actually increase and outpace inflation, while less struggles in private consumption.

Kristen Hallam

Thanks, Rumi. Following the April 26 policy meeting, the Yen significantly weakened, as we've discussed. How might that influence the course of the BOJ's monetary policy decisions? What might the BOJ do to shore up the Yen?

Harumi Taguchi

The weakness of the Yen reflects the wider interest rate differentials. This is due partially to the outlook, the BOJ is to maintain the accommodative policy, but also more importantly, due to factoring the slower-than-expected anticipated policy led by U.S. Federal Reserve. But BOJ is unlikely to raise its policy rate in response to the Yen depreciation, but we think it could move that, is scheduled for the rate hike if higher import prices, if the consumer price is more than expected and then effectively it's increased.

Kristen Hallam

And one more question for you. Rumi, when will the BOJ start tapering asset purchases?

Harumi Taguchi

Okay. The BOJ has decided to stop yield the curve control and purchasing risk asset but still continue to be purchasing the government bond. The BOJ could begin to reduce purchase of the Japanese government bonds slightly in response to the market conditions, but it is unlikely to start meaningful reduction until the policy rate could come close to the neutral rate, which probably in the later 2026, or unless the bond market participant increase enough so that the Bank of Japan do not need to fight with the speculative strategies. But the Bank of Japan do not plan to use the tapering as an active instrument to raise bond yields as the short-term interest rate is now the main policy instrument.

Kristen Hallam

Thank you for that. So we've given you all a lot to think about today, and we are committed to continuing the conversation. Please look for our analysis and thematic coverage on our blog. And that is all the time we have for today. Thanks to Rumi and Shu, and thanks to you for engaging with us today.

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