Erdoğanomics (Part Two): Fallout
Despite Turkey’s inflation rate dropping to its lowest point in over a year, and the central bank cutting rates, just 3 days later, Erdogan dismissed central bank governor Murat Cetinkaya, causing the lira to fall a further 1.6% in one day. While no official reason was given for the sacking, there were vast reports of disagreements over cutting interest rates, specifically the pace and depth of such cuts. Investor sentiment was damaged further as they were concerned about the central bank’s independence and how political interference would affect monetary policy. The June inflation figure that seemingly represented hope contrasting to the pain of the currency crisis, did little to counteract Erdogan’s authoritarian approach to economic policy. Though this marked the last set back in Erdogan’s implementation of his own ideas. Soon after the appointment of Mr Uysal as the new chief of the central bank, rates were slashed twice within a few months towards winter. Benchmark rates found themselves as low as 16.5%, a far cry from the rates in the height of the crisis.  Erdogan was driving forward with his wishes of lower rates as he repeatedly stated ambitions of single-digit rates in the near future. All is well, provided Erdogan realises the desire to stimulate growth must be balanced with the need to remain attractive to foreign financing that is critical in keeping the economy afloat. Slashing rates too abruptly could eventually deter investment – especially if inflation begins to rise once again. An ambitious growth target for 2020 ended the year, with 5% laid on the table. The months leading up to the years end provided Turkey their lowest inflation in over 3 years, coming in at 8.6%. Erdogan used this opportunity to further cut rates so that by 2020 the benchmark had seen a drop from the highs of 24%, right down to 12%. 
Rates were cut for a 5th time in a row in mid-January, despite inflation rising back into double digits (11.9%). However, the reduction by 75 basis points brought real interest rates close to zero once inflation is accounted for, therefore reducing the premium for investors in Turkish assets. Erdogan has vowed to bring the benchmark rate to single digits this year and believes lower interest rates will rein in inflation, contrary to conventional economic theory. The aggressive easing strategies are viewed as ensuring a “reasonable” rate of return by the Turkish central bank’s Uysal, though rate cuts could make Turkish assets less attractive to foreign investors and cool investor inflows. In February, rates were cut for a 6th time in a row, leaving a 10.75% borrowing cost, despite growing currency volatility and geopolitical issues that required intervention in late January – namely, new caps on the fees that could be charged by banks in order to try and limit currency speculation by foreign traders.  The issue is, without doubt, a new wave of credit-fuelled growth risks stoking inflation, reviving its fatal current account deficit and putting fresh pressure on the Lira. In turn, this tests the Turkish authorities’ effort to control the lira – something that we’ve learned from this seemingly never-ending, cyclical process. They’ll do what it takes, and more. The question is: when will this end?
The answer: not yet. This month, following the Friday-Monday public holiday closure of the Turkish markets, the lira’s forward-implied overnight yield in the offshore market jumped from 30% to 280%, then well over 1000%. The implied lira shortage follows heavy selloffs in foreign reserves by state banks, draining lira liquidity as the trades settle. An initial strengthening of the lira was short-lived, falling to 6.93 against the US dollar, below the 6.85 managed float target. The credit boom aimed at tackling the Covid-19 pandemic forced the hand of the Turkish economy, as this was already on the cards to stimulate growth. This alongside the interventions to prevent lira speculation has wounded the lira market both in Turkey and abroad. The ambitious growth at the cost of higher inflation and the current account deficit is all the making for another currency crisis if this is to continue. And the reluctance of raising the 8.25% rate at all costs makes for a daunting outlook. The efforts to limit foreign selling of the lira, the low real rates, ongoing dollarisation, credit boom, high inflation, rising current account deficit and panic attacks in the lira market do not bode well with the Turkish economy’s near future. While an imminent August 2018 like the crash of the lira is not today’s concern, a bumpier ride with lots of volatile days appears on the horizon for the Turkish lira.
Whilst the lira has been protected by the economic policies set in place by Erdoğan, the country’s foreign reserves have been burned through, amounting upwards of $65 billion. On August 6th, however, the Turkish central bank allowed the lira to float, seemingly running out of options to save the lira, in turn, sending the currency tumbling to the floor. A repeat of the currency crisis is firmly on the cards and one could see the need to impose the towering interest rates of 2018 once again. Amid depleted foreign-currency asset reserves and the authoritarian styled overwatch of Erdogan on the bank’s operations, the benchmark policy rate that sits at 8.25% alongside inflation at nearly 12% imposes one of the lowest real rates among emerging economies. This paired with the lira’s shedding of a fifth of its value this year to date creates problems and introduces possibilities of failing to win back credibility with investors. In light of all this, the central bank without a doubt requires freedom to raise the main rate, but the inconsistencies in Turkey’s policies and Erdogan’s unparalleled control makes that a far cry from reality. Only last week Erdogan displayed his ignorance by calling for further rate cuts: “God willing, they will go down further.” With similarities in power akin to God, Erdogan’s imminent control on economic policy for sure had an influence on the latest monetary-policy board meeting today. And whilst this remains a feature of the Turkish economy, the same factors playing into the cyclical maze that drives the lira to the ground will be prominent. More devaluation is on the horizon, as the decision to not hike rates and keep them steady was announced. The lost tourism income, dried-out capital flows, rising current account deficit, double-digit inflation, dollarisation, and the rapidly widening fiscal gap, stand strong as factors that will keep weighing on the Turkish lira. Thus, given the absence of the central bank and the president’s desires to keep the interest rates under pressure, we can safely assume a continuation of the lira’s value loss towards 8.0-8.5 versus the US dollar.