Turkey may have made a long overdue move to raise interest rates in an attempt to rescue its plummeting national currency, but investors are still in doubt over the independence of its central bank ahead of national elections in June.
On Friday, aiming to allay market fears over its monetary policy and rising inflation, Turkish Deputy Prime Minister Mehmet Simsek announced that the country would not step back from a rules-based economy and that its central bank would “deliver additional reaction if needed,” hinting at further rate hikes.
The central bank on Wednesday convened an extraordinary meeting to hike rates by 300 basis points to 16.5 percent, amid a currency rout and double-digit inflation. Analysts have called it the “bare minimum,” however — and the biggest casualty of this damaged credibility may continue to be the Turkish lira.
Turkey’s currency was in free-fall as the central bank, under pressure from President Recep Erdogan — who has called interest rates “the mother of all evil” — wouldn’t lift rates to curb the country’s ballooning inflation, which in April stood at 10.85 percent. UBS in a note Friday described the hike as having been delivered belatedly, “but should help in stabilizing the lira in the short term.”
“Looks like Erdogan got the message — Simsek been told to go out and do whatever it takes to stabilize the market,” said Timothy Ash, senior emerging markets sovereign strategist at Bluebay Asset Management. But asked if this changed his mind on the central bank’s independence, he said, “Not really.”
He described the last rate hike as being “for some, too little, too late,” adding that “they never seem to learn… until it is too late.”
Before the rate rise, the lira was at a record low of 4.929 to the dollar, down 20 percent against the greenback since the start of this year, according to Reuters. The bank’s move pulled the lira back up by 2 percent on the day to 4.565, but it’s slipped back down to 4.741 as of 12:38 a.m. Friday, Istanbul time (5:38 a.m. ET).
The central bank has been under pressure to keep rates down in favor of fueling its growth rate, which led the G20 at more than 7 percent in 2017. The president’s interventionist tendencies have damaged the government’s credibility when it comes to monetary policy and given investors little reason to believe in the independence of its central bank, even after Wednesday’s rate hike.
‘An urgent problem’
“It’s really an urgent problem about the central bank credibility and… the president steps in and casts further doubt on that,” said James McCormack, global head of sovereigns rating at Fitch ratings. “We’ve had issues with the central bank and their policy credibility over the past couple of years.”
Turkey also suffers from a widening current account deficit (CAD), which by March had hit $4.8 billion, a $1.7 billion increase on the previous year.
Erdogan said this week that Turkey would bring in “new and serious” measures to battle inflation and lower the CAD after the upcoming June election, which he mandated as an early vote instead of the original election date scheduled for November 2019.
The move was widely seen as a power grab and an attempt to secure reelection before the economy got any worse. If victorious, Erdogan will be able to eliminate the role of prime minister and heavily consolidate executive power.
Contradicting policy promises
Observers, meanwhile, aren’t entirely convinced by Erdogan’s economic pledges.
“Some of the things the president has said, it’s not quite clear how those are going to be delivered,” McCormack said. “He’s talked about lowering inflation, but doesn’t want to hike interest rates; talked about bringing the current account deficit in, but also talking about fiscal expansion. Those two things go in opposite directions.”
Turkey’s high inflation has been a longstanding problem that’s focused markets on its external financing needs, which McCormack says are around $200 billion a year — more than twice what its foreign reserves are.
It’s thanks to Turkey’s international financing needs that the lira’s battering stands out among emerging market currencies, many of which are being squeezed on the back of a strengthening dollar and rising U.S. Treasury yields.
In the meantime, more action will be required from Turkey’s policy leaders in order to convince markets that the central bank’s rate turnaround wasn’t just political show.
“Electoral necessity won the day, and I don’t think Erdogan’s underlying views on interest rates changed,” Ash said of Wednesday’s move. “It still leaves a bad taste over how economic policy will be made under the new executive presidency and Erdogan with a lack of real checks and balances.”