With the haggard Turkish lira (TRY) struggling to claw back some ground on May 25, Turkey’s biggest “market friendly” economic gun, Deputy Prime Minister Mehmet Simsek, was rolled out to reassure investors that although it had been late to hike interest rates the country’s central bank remained independent and was ready to do what was necessary.
It was President Recep Tayyip Erdogan’s declaration in an interview that he was set to take an even bigger role in setting monetary policy, on top of his unconventional assertions that higher interest rates cause inflation in an economy like that of Turkey, that sent the TRY plummeting towards a startling five-to-the-dollar this week. What was seen by critics as Erdogan’s subsequent May 23 surrender to classic monetary theory—the central bank’s ‘cavalry’ finally arrived with an emergency rate hike of 300 basis points (bp)—was thus expected to deliver a more substantial recovery in the currency’s value than it actually has so far. From the all-time low of 4.9294 to the dollar recorded early on May 23 it had, by 17:10 local time on May 25, gained to 4.7224, leaving it down around 20% in the year to date.
Simsek told broadcaster NTV that the fact the central bank had made the hike showed that it was in fact independent. He claimed the impact of the rate increase was limited by developments a day later including market rumours. Turkey, he said, would not stand obstinate against the markets and the central bank would take further steps to aid the lira if required.
Krugman: Classic currency-and-debt crisis
However, warnings that the routing of the lira could presage a financial crisis in Turkey are spreading. Writing in The New York Times on May 24, Nobel Prize-winning economist Paul Krugman said: “What’s happening in Turkey is a classic currency-and-debt crisis, of a kind we’ve seen many times in Asia and Latin America. First, a nation becomes popular with international investors and runs up substantial foreign debt—in Turkey’s case, largely debt owed by domestic corporations.
“Then it starts, for whatever reason, to lose its luster: Right now, emerging markets in general are being weighed down by a rising dollar and rising U.S. interest rates. And at that point a self-reinforcing crisis becomes possible: External factors cause a loss in confidence, which causes a country’s currency to drop, but the falling currency causes the domestic value of those foreign debts to explode, worsening the economy, leading to further declines in confidence, and so on.”
In a scathing assessment of Erdogan as “Turkey’s Trump”, he added: “When big shocks do hit, the quality of leadership suddenly matters a lot. Which is what we’re seeing in Turkey now.”
“Authoritarian instincts and contempt for rule of law aren’t the only things Erdogan and Trump have in common,” according to Krugman. “Both also have contempt for expertise. In particular, both have surrounded themselves with people notable both for their ignorance and for their bizarre views.”
Lagarde: Let the central bank do its job
In St Petersburg, meanwhile, in an interview with Bloomberg TV, International Monetary Fund (IMF) managing director Christine Lagarde reminded the Turkish government of the importance of preserving the independence of its central bank.
Mixed signals about whether the central bank is free of political interference created a sense of uncertainty among investors, putting the currency under pressure, she said, adding: "In terms of monetary policy, it’s always better for all political leaders to let the central bank governors do the job that they have to do, and to preserve and secure their independence."
"Some of the comments made [by Erdogan] alerted the international community and particularly the investors to the fact that suddenly the central bank of Turkey could be under directions, instructions, or influence," Lagarde also said. "That has created a sense of uncertainty and a lack of confidence, which has found its way in the market."
In a May 25 assessment of the latest situation with the TRY, analysts Gunter Deuber and Gintaras Shlizhyus of Vienna-based RBI wrote in a note: "As we predicted, the [central bank] hiking its late liquidity window rate by 300bp did little to stop the TRY bleeding. It appears the regulator faces a ‘classical’ EM crisis dilemma in which a ‘too little too late’ action paradigm puts the bank constantly behind the curve. In this regard the market awaits more concerted actions including a steep rise of all policy rates."
They added: “Sticky inflation and the inflation pass-through from recent lira devaluation as well as the overall challenging outlook for commodity importing EMs do not give [the central bank] any breathing space in this regard too. So far more emergency policy decisions may need to be taken in the coming weeks.”
‘Flirting with the IMF’
The RBI analysts also looked at whether the IMF might be called in, observing: “We would not rule out that a discussion regarding potential IMF support for Turkey may gain traction going forward (an IMF engagement as ‘external anchor’ may help to restore the policy credibility). At some point ‘flirting with the IMF’ could even be a rational strategy for Turkish policymakers (like they did in the past without signing an IMF deal in the end). However, ahead of the elections at the end of June both a ‘flirting with the IMF’ scenario or even an actual turn to the IMF, are highly improbable options. Therefore, we would expect further volatility on Turkish markets in the days/weeks ahead."
Capital Economics commented in its May 25 note on Turkey that it looked like Erdogan had “taken the hint” where the need for interest rate hikes was concerned but, it cautioned, an abrupt slowdown could be ahead for the country.
Its note stated: “The latest activity data provide signs that economic growth is starting to slow. Admittedly, our GDP Tracker points to growth remaining strong at around 9% y/y in Q1. But the manufacturing PMI fell to a 15-month low in April, before the latest financial market turmoil. And past experience suggests that the sharp tightening of financial conditions in recent weeks is likely to precipitate an abrupt slowdown.”