The Central Bank of the Republic of Türkiye recently declared a decision regarding a decrease in the interest rate paid on foreign currency free accounts by 25 basis points, which took it from 4.75% to 4.50%.
Foreign currency free accounts are accounts that allow one to hold currencies other than the domestic currency of the country in which the account is held. They are also known as multicurrency accounts. They typically allow a person to hold and manage several different currencies under one account. Through this, they help to reduce currency exchange fees and simplify international transactions. The gap between the average deposited amounts and the amounts that should be deposited are subject to interest payments in Turkish Lira under this particular system.
The Central Bank sets the interest rates mainly to influence markets. The reduction of the interest rate mainly aims to encourage the citizens’ investments as well as to boost consumer spending. By lowering the interest rate, the Central Bank hopes to incentivize the citizens and businesses to borrow more money in order to increase economic activity available in the country. Moreover, the goal of the decrease is to direct investments from foreign currencies to Turkish Lira, which once again aims to increase the overall economic activity. A growth in economic activity can stimulate the growth of several other key sectors, such as communication and clothing, as well, creating more jobs and decreasing the unemployment rate.
The cut came after the European Central Bank (ECB) declared that it is decreasing its three key interest rates by 25 basis points, from an all time high of %4 to %3.75, based on an assessment of the inflation outlook. Ever since the Governing Council of the ECB came together in September 2023, the inflation rate has decreased more than 2.5%. As a result, the price pressures have weakened. With this policy, the inflation has been affected in a good way, and this kept the inflation expectations well anchored.
However, while the reduction in the interest rates may have positive effects on the
economy, there are also some potential downsides. Primarily, lower interest rates may lead to increased inflation. Raising the interest rate is usually used as a mechanism while dealing with high inflation, and a lowered rate can stimulate an increased consumer activity faster than the supply rate, and when the demand increases faster than the supply, the difference between them is creates inflation. Other than this, the reduction in the interest rates may lead to higher prices in line with a higher inflation, putting low-income individuals and families into huge economical stress. Also, a potential increase in the inflation rate may result in exacerbating an already rising discontent among the citizens regarding the economic status of Türkiye. Furthermore, this reduction might affect investors and savers who rely on the interest income from their foreign currency accounts, making them take their savings from these accounts to other platforms such as crypto currencies while resulting in changes for foreign investors as well. Lower interest rates may reduce the attractiveness of holding assets in Turkish Lira when compared to other currencies. This might lead to a higher volatility, which is not something that is wanted in an economy.
To sum up, the Central Bank’s decision is a move aimed to boost economic growth and stability. While there are potential risks to consider, it is hoped that the benefits will outweigh the negative sides.