Mark Bentley
Dec 14 2017

Turkey rates move sets up battle with investors

President Recep Tayyip Erdoğan, embroiled in a political spat with the United States, now appears to be challenging foreign investors in Turkey’s financial markets after the central bank raised interest rates less than expected.

The bank in Ankara, under political pressure to help stimulate economic growth, raised rates by 50 basis points to 12.75 percent on Thursday. The increase was one-tenth of what some bankers had said was necessary. It meant borrowing costs remained below the inflation rate of 13 percent, the highest among G20 economies.

Erdoğan, used to getting his way domestically, has been in defiant mood internationally of late. Intent on both placing Turkey in the centre of global politics and retaining his seat in the presidential palace – elections are due in 2019 at the latest – Erdoğan is picking fights with Washington on Middle East policy and stonewalling the EU’s efforts to curb Turkey’s apparent journey into authoritarianism.

And this week’s decision by the central bank is perhaps the clearest indication yet that Erdoğan will not back down on the economy either. The president, a former salesman and Istanbul mayor, maintains that higher interest rates cause inflation and has vilified those who disagree with his unorthodox thesis, depicting them as part of a Western conspiracy to bring Turkey to its knees.

Erdogan
Turkish President Erdoğan speaks in Ankara on Dec. 14 (Source: Anadolu Agency)

Speaking in Ankara after the central bank’s decision, Erdoğan called on business leaders to support his government’s economic growth programme by employing more people. Those who failed to topple the government in a military coup last year, he said, were now attempting to use the economy as a weapon.

Perhaps summing up convictions at the presidential palace, Erdoğan senior adviser Cemil Ertem, writing in the Milliyet newspaper this week, asserted that the central bank would continue to support the government’s growth policies. Inflation, he said, would start to slow in the first quarter, allowing the government to free up more lending by banks and intensify support for employment and exports. The Treasury would also encourage a decline in interest rates by limiting its borrowing in the first months of 2018, he said.

Turkey had to deliver a massive rate hike in January 2014 to defend its embattled currency. The central bank raised rates in successive meetings early this year after the lira slumped against the dollar.

While praising Erdoğan’s commitment to employment, Tim Ash of London-based hedge fund BlueBay Asset Management, a veteran observer of Turkey, warned the central bank that springtime was a long way off with this kind of monetary policymaking.

“They obviously have RTE’s rose-tinted specs on,” he said. “A simply shocking move.”

 

The lira fell 1.9 percent to 3.88 per dollar on Thursday, taking losses since September to more than 12 percent. Three-month forward rates, an indicator of a currency's future value, rose to almost 4 lira per dollar.

Durmuş Yılmaz, chief of the central bank between 2006 and 2011, and now an adviser to the opposition Iyi Party, said this week that economic growth in Turkey is unsustainable without tackling inflation. Price increases and the weakening lira were encouraging dollarisation, a pattern that resembled the months leading up to a financial crisis in 2001, he said.

Inflation in Turkey is more than triple the average of similar emerging markets. The country is a major outlying economy along with Argentina (22.9 percent) and the Ukraine (13.6 percent). Concern that the economy might be overheating intensified this week when the government said annual growth surged to 11.1 percent in the third quarter.

Durmus Yilmaz
Former Central Bank Governor Durmus Yilmaz

On Thursday, the central bank in troubled Ukraine met in Kiev and wielded its independence by hiking rates to 14.5 percent from 13.5 percent, warning that inflation, which peaked at 16.4 percent in September, had not slowed as fast as expected. It was the second hike by policymakers in as many meetings.

With its “passive stance”, Turkey’s central bank is provoking higher borrowing costs rather than reducing them, Murat Gulkan, CEO of Ünlü Portfolio Management in Istanbul, said on Thursday.

“The acceleration in inflation raises concern that the end of the rope will slip away completely,” he said. “And then when the dollar gains against the lira, it creates a vicious circle.”

Concerns about inflation are prompting some Turks to cash in their lira savings for foreign currency.

Foreign exchange deposits held by Turkish residents, excluding interest-earning accounts, increased by $2.2 billion last week, according to central bank data.

Hatice Karahan, another senior adviser to Erdoğan, has been doing the rounds with foreign analysts and the media over the past few weeks. A new face at the palace, Karahan, who earned a PhD at Syracuse University in Washington State in 2006, has attempted to convince investors that Erdoğan, while focused on growth and employment, is well aware of the risks posed by inflation and will take any measures needed to keep it in check.

Friendly faces such as Karahan, and Deputy Prime Minister Mehmet Şimşek, an ex-Merrill Lynch economist who heads the cabinet’s economy team, talk the talk. But it appears that, for the time being, power over economic policy-making lies elsewhere, and Erdoğan is determined to use it.