The Turkish economy is at risk of a hard landing and, if it has to happen, Turkish president and serial winner of 15 years Recep Tayyip Erdogan certainly won’t want it to happen in the run-up to the snap presidential and parliamentary elections he called last week.
Populist Erdogan is for ever making monetary statements that go against the conventional wisdom—Turkish markets have been crying out for a substantial interest rate cut for an extended time now, but the outspoken president persists in calling for cheaper money, even claiming that such a move would send Turkey’s sticky double-digit inflation down given the particulars of the country’s emerging economy—but most analysts have concluded that central bankers attending the crucial April 25 monetary policy committe (MPC) meeting will nevertheless go ahead and tighten.
The consensus line is that voters will want to see the battered Turkish lira (TRY) strengthen in the weeks before the June 24 election. Analysts see monetary policy makers raising the late liquidity lending rate by 50 basis points (bp) to 13.25%, according to estimates compiled by Bloomberg. The move, Nomura calculates, might cause the TRY to strengthen to about 3.92-3.94 per dollar in the election bandwagon period, something of a gain on the levels of around 4.09 that it was trading at on the afternoon of April 24.
One of the worst performing emerging market currencies in the world this year, the TRY started 2018 at around 3.79 and plummeted to an all-time low of 4.1944 on April 11. The devaluation turned into a dizzying descent as worries mounted about growing imbalances in Turkey’s surging credit-fuelled economy—which posted ‘warp-speed’ growth of 7.4% in 2018, outdoing China—and fears persisted over the possible undermining of central bank independence.
A Reuters poll issued on April 20 backed up the theory that electoral needs will give the Central Bank of the Republic of Turkey (CBRT) the leeway it requires to tighten ahead of the landmark elections—they will trigger constitutional changes that create an all-powerful executive president, scrap the position of prime minister and greatly weaken the role of parliament—with the survey showing 10 of 13 economists predicting interest rates will be lifted at the MPC meeting. A 50bp increase in its top-rate late liquidity window, currently at 12.75%, was seen as probable.
Erdogan is a self-declared "enemy of interest rates" and if the date for the elections had been kept as November 2019 he could have kept pushing for cheaper borrowing to assist investors and boost growth well into next year. As things stand, however, with the landmark elections now a matter of two months away, a rate hike is on the cards.
“The consensus seems to be for a 50-100bps hike by the CBRT this week. Erdogan has to decide which he prefers - lower IRs or a strong TRY. He cannot have both. Actually if the CBRT fails to act he might have a weaker currency and higher rates anyway,” tweeted Timothy Ash, senior emerging markets sovereign strategist at BlueBay Asset Management.
"Before the early elections were called, we were thinking the central bank would choose to manage without a rate hike," one economist, who declined to be named, was quoted as saying by Reuters. He added: "We think that the possibility of the central bank taking a noteworthy step have increased notably."
Of analysts at Turkey’s domestic banks, Erkin Isik, a strategist at Turk Ekonomi Bankasi, expects a 50bp hike from the MPC.
With Turkey’s assets also under heavy pressure from one of the world’s worst current account deficits, UniCredit put out a note on April 19 saying the central bank was likely readying a sizable interest-rate increase, if its actions in the past were a good indication of what it will do come April 25. Its London-based strategist Kiran Kowshik wrote that whenever the Turkish lira’s (TRY) implied volatility starts trading at a premium to that of its emerging-market peers, the central bank moves ahead with a strong policy response. That spread widened last week to 1.40 volatility points, a level that has triggered action from the monetary authority in the past.
Not bolted on
Not that a rate hike is a bolted-on certainty. For instance, prior to the surprise announcement of the June election and another lashing of forceful rhetoric from Erdogan, William Jackson, senior emerging markets economist at Capital Economics, on April 11 decided to pencil in a 100bp hike to be introduced by the MPC, saying in a note: “Mounting concerns about Turkey’s current account deficit as well as debt problems in the corporate sector are likely to keep the lira under pressure over the coming weeks. As a result, we now expect the central bank to respond by tightening monetary policy.” However, after the early polls were confirmed, Jackson was more circumspect, saying in an April 18 note: “… we think there are reasons for caution. For one thing, there is a risk that policy is loosened ahead of the vote in order to shore up support for the [ruling] AK Party.”
Turkey’s annual inflation rate hit a 14-year high of 12.98% last November but has since eased back to March’s 10.23%. However, the central bank's latest survey of economists' inflation expectations for the year-end, released on April 19, produced a forecast of 10.07%, from 9.49%. Analysts said that fact alone increased the odds of monetary tightening.
Murat Cetinkaya, the central bank’s governor, meanwhile, has not given any reliably strong hints of which path the MPC may take. At the weekend, he simply said that the regulator would tighten borrowing costs “if needed”.
Given the uncertain outlook, options traders remain more bearish on the lira than every other emerging-market currency except the ruble. Traders are looking to guard against more weakness. Risk reversals showed the premium on contracts to sell Russia’s ruble and Turkey’s lira versus the dollar in a month’s time over those to buy were about 3pp and 1.9pp, respectively, the highest across developing nations, according to Bloomberg data.