The Turkish president’s war on interest

By bne IntelliNews March 5, 2015

David O'Byrne in Istanbul -


President Tayyip Erdogan has never been one to mince words – and his recent attacks on Turkey's central bank have been typically forthright. These perversely have helped worsen Turkey’s economic problems with the lira on March 5 falling to yet another all-time low against the dollar.

Speaking to reporters on a trip to Saudi Arabia on March 1, Erdogan restated his oft-repeated belief that "interest rates cause inflation" and warned that both the central bank, which sets Turkey's interest rates, and Deputy Prime Minister Ali Babacan – to whom central bank chief Erdem Basci reports should "get their act together".

The central bank, he went on, should make decisions aimed at fostering growth and stability. "They should not act according to the wishes of Western powers and the instructions of the interest rate lobby," he warned darkly.

Such intemperate comments from Erdogan are nothing new. The February 24 decision by the central bank to cut the top end of its interest rate corridor by only half a point and the lower end and the benchmark rate by just a quarter point was roundly condemned by Erdogan, who in repeating his belief that the cuts should have been greater also accused the bank of "treason" and issued a thinly veiled accusation that Governor Basci was working to the orders of an unnamed external influence.

The "influence" referred to is widely assumed to be that of Fetullah Gulen, the US-based Islamic cleric whose shady Hizmet organisation Erdogan blames for the police's corruption probes that rocked his administration a little over a year ago and whose influence he increasingly sees behind every move by anyone deemed to be in opposition to his regime.

Behind this though is a longer term and more deeply held objection of Erdogan to "interest rates" per se, which most observers ascribe to his staunch Islamic religious beliefs. These first surfaced in the wake of the 2013 "Gezi Protests" that Erdogan, despite evidence they were in direct response to his increasingly uncompromising policies, chose to blame on a nebulous and previously unknown entity he dubbed "the interest rate lobby".

More serious than Erdogan playing to the gallery was the announcement on February 28 by Economy Minister Nihat Zeybekci signalling that the government could change the central bank's remit from targeting price inflation to one that also encompasses growth, employment and trade. This would effectively end its position as the sole official body not directly under government control, as the switch would oblige it to cut interest rates to encourage growth at the expense of price stability. This could have serious implications for the long-term health of the Turkish economy.

TRYing times

What is clear is that the recent attacks on the central bank have already had an effect as investors worry the mounting political pressure on the central bank will force policymakers to cut interest rates too far, too fast. On March 5, the lira depreciated past TRY2.5920 against the dollar, which Tim Ash of Standard Bank called “an emerging Turkish lira crisis – made at home”.

“Reminds me very much of 2006 in Turkey, where self-inflicted policy errors/personnel changes created a market sell-off and ended up with the [central bank] having to hike policy rates to stabilise the situation,” Ash wrote in a note to investors.

While most emerging market equities rose during February, Turkey's fell by over 6% and government bond yields rose over the same period. The Turkish markets' performance is worse than that experienced by most other emerging markets and comes despite Turkey being highly dependent on imports oil and gas and so one of the markets most expected to benefit most from tumbling energy prices.

Indeed such has been the effect of the recent criticism of the central bank that some analysts have concluded the combined results of lower interest rates and a weaker lira might actually be the government’s aim – in order to give a short-term boost to exports and exporters without harming consumer confidence ahead of Turkey's June general election in June.

The most noticeable effect of a weak lira against the dollar would normally be rising energy prices. But with oil and gas prices falling, that effect has been cancelled out; Turkish Energy Minister Taner Yildiz already announced that falling gas prices will not be reflected in consumer bills, citing the need to pay of debts accrued by state gas importer Botas.

Similarly, Turkey's energy regulator EPDK has blamed petroleum distributors for failing to pass on falling oil prices top consumers, going to the extent of introducing a mandatory retail price ceiling that analysts suggest is aimed less at forcing distributors to pass on the effects of falling oil prices and more at covering up the fact that the benefits of those falling oil prices have been largely swallowed up by the falling lira. Certainly, the falling crude price helped reduce Turkey's trade deficit, which in January was $4.3bn, down from $6.9bn a year earlier.


But many are warning that a strategy of lowering interest rates and weakening the lira will eventually backfire. "Even in the unlikely scenario that consumption surges in response to lower rates, Turkey’s economic vulnerabilities would be rekindled: imports would rise, and the dependence on capital inflows would continue," warns Emre Deliveli, economic columnist on the English language daily Hurriyet Daily News. "Turkish exporters have to import a lot in order to be able to export and many have FX debts.”

The question though seems to be exactly when the strategy will be seen to backfire, with analysts concurring that the aim of Erdogan's current strategy doesn't go much further than polling day and that his war on "interest" is at least in part a war "of self interest". "Everything he is doing is in order to get enough votes to change the constitution to a presidential system," argues Deliveli.

Passing the necessary constitutional reforms would require Erdogan's ruling Justice and Development Party to take two-thirds of the seats in parliament, or failing that to get the support of two-thirds of those deputies elected – a tough call even with a pre-election boost to the economy.

Whatever the result at the June 7 election, few are betting that Erdogan's attacks on the central bank will end until he gets what he wants, or that Governor Basci will see out the full five years of his term, which ends in 2016. “Basci is expected to remain in office until the polls, even if calls for substantive interest rates cuts by the president and his sycophantic advisers will likely increase in the weeks ahead, posing a threat to the Turkish Lira’s stability,” says Wolfango Piccoli, managing director at Teneo Intelligence. “Looking beyond 7 June, however, there is a significant risk that key economic policy-making positions will be given to individuals on the basis of their closeness and allegiance to Erdogan rather than for their competence and skills.”

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