International credit ratings agency Fitch said that it could downgrade Turkey’s ‘BB-‘ rating after President Recep Tayyip Erdoğan dismissed the governor of the central bank at the weekend.
Fitch said the decision has damaged monetary policy credibility and the prospects of reducing annual inflation of 15.6 percent. It also said external financing pressures had been heightened due to a sharp fall in the lira.
“Fitch has long viewed monetary policy credibility as a rating weakness relative to peers and we deduct one notch for it from our model implied rating,” the agency said in a report on Tuesday.
Erdoğan sacked central bank governor Naci Ağbal in a shock move on Friday night, bringing in Sahap Kavcıoğlu, a former banker, columnist and deputy for the governing Justice and Development Party (AKP). Ağbal lost his job after he raised interest rates to 19 percent from 17 percent on Thursday, in the third hike since his appointment in early November.
“To assess the impact of Mr Ağbal’s replacement, we will consider the policy direction under the new central bank governor and the evolution of the external position,” Fitch said.
The lira slumped by as much as 15 percent against the dollar on Monday as foreign investors and local deposit holders exited the currency. It lost further ground on Tuesday and was trading down 0.5 percent at 7.98 per dollar on Wednesday morning. It hit a record low of 8.58 per dollar on Nov. 6.
Fitch had upgraded the outlook for Turkey’s credit rating to ‘stable’ from ‘negative’ in February, citing improved monetary policy and financial conditions.
Kavcıoğlu’s previously stated views on interest rates – he has advocated cuts in borrowing costs – cast doubts on his credentials to fight inflation, Fitch said.
“We considered rebuilding economic policy credibility a challenging task even for the experienced Mr Ağbal, a former finance minister. Mr Kavcıoğlu, the fourth central bank governor in the past two years, does not have a comparable record,” it said.
Fitch said the central bank has been known for using a so-called interest rate corridor to set a more flexible monetary policy and for encouraging credit growth. It did both last year to help the government engineer a borrowing boom.
“Resuming these policies would be a negative signal as they have previously seen adverse consequences and contributed to a widening of external imbalances, put pressure on the lira and ultimately underpinned the necessity for policy rate hikes,” the ratings agency said.
Fitch said it will monitor the central bank’s response to the sharp fall in the lira since Ağbal’s departure.
“In the first half of 2020 foreign exchange reserves were drawn down in an unsuccessful attempt to support the currency, casting doubts over the long-standing commitment to a floating exchange rate, which is a supportive factor for the rating,” it said.
“Reserves are low relative to Turkey’s large external financing requirement and renewed foreign investor outflows and dollarisation would add to balance of payments pressures at a time when global financing conditions have worsened.”