Turkey’s central bank was pretty explicit that it rejects President Recep Tayyip Erdoğan’s unconventional theory that higher interest rates cause inflation when hiking its benchmark rate on Thursday.
The central bank said that it was acting decisively to curb inflation as it raised interest rates to 10.25 percent from 8.25 percent. Consumer price inflation in Turkey stands at a heady 11.8 percent.
“The tightening steps taken since August should be reinforced in order to contain inflation expectations and risks to the inflation outlook,” the bank’s Monetary Policy Committee said in a statement accompanying the decision.
Such is the perceived power of Erdoğan over Turkey’s politics and the economy that economists were shocked by the central bank’s seemingly defiant move. They were predicting that monetary policymakers would sidestep a conventional rate increase and continue to use other, less powerful tools to address Turkey’s economic fragilities, which also include a sharply weakening lira, to appease the president.
Unless Erdoğan gave his backing to the rate hike – he had called for lower interest rates just a few weeks ago – Governor Murat Uysal may be risking more than just the president’s frustration.
Erdoğan sacked and replaced Uysal’s predecessor last year for failing to cut interest rates and warned at the time that more heads would roll unless officials got behind his government’s quirky, growth at all costs economic agenda, which includes using low interest rates to flood the economy with cheap loans from state-run banks.
Ever since July, the common view among investors was that Uysal had the freedom to cut interest rates as much as he liked – the more, the merrier – but he could be risking his job should he try to raise them, even when the circumstances demanded it.
Those circumstances arrived this week as the lira slumped to successive record lows against the dollar. Just hours before Thursday’s decision, the lira fell to 7.72 against the U.S. currency, taking losses this year to 23 percent.
Up until now, the central bank has raised other interest rates, such as its late liquidity window rate of 11.25 percent, as part of a plan to increase average borrowing costs for banks. Those costs increased to 10.6 percent on Wednesday from as low as 7.4 percent in July.
But investors had called for tougher measures, saying such unconventional monetary tinkering would fail to arrest the lira’s decline. A plain vanilla rate hike was needed, they said.
As the lira fell, there was a distinct danger that a currency crisis that erupted in Turkey in 2018 would be repeated. A deep, painful economic recession had followed.
Capital Economics, a London-based research company, warned this week that the lira could slide to 8 per dollar this year and 9.25 in 2021. More abrupt sell-offs were possible and could force the central bank to hike interest rates substantially, just as it had belatedly done in 2018, the firm said.
Tim Ash, a senior emerging markets strategist at BlueBay Asset Management, said on Thursday that the central bank’s decision to hike the benchmark interest rate now meant that it had a chance of defending the lira.
But with the bank’s foreign currency reserves severely depleted – it has sold tens of billions of dollars this year in a failed attempt to bolster the lira’s value – raising the benchmark rate but keeping it below inflation hardly looks like a final, winning move.
With a general sell-off in emerging market currencies likely to continue due to uncertainty over COVID-19 and U.S. presidential elections, Turkey’s lira is still firmly in the woods.
The question on investors minds will now be whether Uysal is committed to raising interest rates again in a timely manner to defend the lira, even if that means losing his job, whether that be within a matter of weeks or when the dust settles. Most investors will have serious reservations.
Since acquiring vast new executive powers in 2018, Erdoğan’s increasingly authoritarian governance now stretches from his ministries and parliament to the economy and the banking world.
His son-in-law heads both the Treasury and Finance Ministry. Erdoğan personally controls the lending taps of state-run banks through his chairmanship of the country’s sovereign wealth fund, allowing him to decide who gets what and when during these troubled times.
Critical economists have disappeared from the columns of Turkey’s most popular newspapers. Scores of senior, well-qualified bureaucrats have lost their jobs via presidential decree.
Defying the president once on his ‘crackpot’ inflation theory may be ok, just. Erdogan may even have begrudgingly allowed Thursday’s hike. But doing so repeatedly could well be a different matter. Mr. Uysal, be warned.