The Turkish central bank has “bowed” to the unorthodox monetary policy of President Recep Tayyip Erdogan, Capital Economics concluded on July 24.

As the markets digested the stunning decision of the regulator’s monetary policy committee (MPC) to leave rates on hold despite the collapse of the Turkish lira (TRY) and the burden of annual inflation at a 14-year high of 15.39%, Jason Tuvey, senior emerging markets economist at the macroeconomic research company, said in a note to investors: “The Turkish central bank’s decision to leave its one-week repo rate unchanged at 17.75%, when most had expected at least a 100bp hike, suggests that President Erdogan is already using his strengthened position [as Turkey’s first ever executive president] to influence monetary policy. The lira has sold off following the decision and another emergency rate hike now appears to be on the cards.”

He added: “Today’s decision to leave the benchmark one-week repo rate unchanged at 17.75% was a huge surprise. All but four of the 23 analysts, including ourselves, polled by Bloomberg ahead of the decision had expected the central bank to hike interest rates. The consensus was for a 100bp increase in the one-week repo to 18.75%.”

Bloomberg, meanwhile, quoted Inan Demir, an economist at Nomura International in London, as saying: “This decision essentially confirms the markets’ worst fears about the central bank’s independence and the future course of economic policies in Turkey.”

Those experts who believe Turkey under ‘Erdoganomics’ is on course for an economic meltdown point out that foreign lenders, essential to the country’s import-driven economy, are increasingly anxious about the $337bn of non-lira debt held by domestic companies. A weaker TRY makes it more challenging for those companies to meet their obligations and discourages banks from lending, creating a “vicious cycle,” Demir reportedly said.

In the wake of the rates decision, the TRY weakened as far as 4.9384 against the USD. By around 19:15 Istanbul time, it was trading at 4.8803, a depreciation of towards 3.5% on the day. At the market close, the Istanbul stock exchange’s benchmark BIST-100 index was down 3.33% at 92,134. The yield on Turkey’s 10-year lira bonds rose to 18.67%, set for the highest close since the country began issuing them less than a decade ago. Turkish dollar-denominated government bonds, meanwhile, fell sharply. Reuters reported selling across the whole range of bond maturities. The 2030 issue fell as much as 2 cents, while 2034-2043 issues dropped between 1.6 and 1.9 cents.

Economic populist
Economic populist Erdogan sent the already fast depreciating TRY into an even faster descent in the run-up to the June 24 elections when he told an interviewer that he planned, as executive president, to exercise greater control over monetary policy. After triumphing in the polls—with a victory that triggered constitutional changes giving him sweeping new powers—Erdogan announced a cabinet reshuffle that did away with ministers seen as market-friendly and named his son-in-law, the inexperienced Berat Albayrak, as economy czar. A former energy minister, Albayrak has written extensively in support of Erdogan’s unconventional economic views, including the contention that cheaper credit in Turkey would lead to slower inflation.

Turkish inflation jumped 3.3pp in June as the effects of traders dumping the lira filtered through. It stands at more than three times the central bank’s 5% target. Capital expects it to rise a little further over the coming months.

“It seems that unanchored inflation expectations mean that falls in the lira are feeding through into higher inflation more quickly and to a greater extent than in the past,” said Tuvey.

He added: “More than anything, though, the decision to leave rates on hold provides the first evidence that President Recep Tayyip Erdogan holds increasing sway over Turkish monetary policy. Mr Erdogan has been a strong proponent of lower interest rates. Following last month’s elections, he moved quickly to tighten his grip on economic policymaking, including granting himself sweeping powers over the central bank… But as we’ve argued numerous times, pursuing looser economic policy will simply exacerbate the vulnerabilities in Turkey’s economy and, ironically, increase the market pressure on the Turkish central bank to take emergency action.”

Tuvey pointed to the experience from 2014, when the central bank left rates unchanged due to government pressure despite expectations in the market for a hike. That showed that the TRY is likely to fall further, he said, adding: “That time around, the MPC was forced to hold an emergency meeting within a few days and interest rates were hiked aggressively. A repeat of this appears increasingly likely.”

Explaining its decision to hold rates, the central bank pinned its decision on signs that economic growth is slowing. While May’s industrial production figures released last week beat expectations and suggested that the economy has weathered the recent financial market turmoil, the survey evidence and other low-profile figures point to an abrupt economic slowdown, according to Capital. It expects a quarter or two of negative growth this year and has put out GDP forecasts for Turkey well below the consensus.