Mark Bentley
Oct 27 2017

Why Erdogan’s rates call is more than rhetoric

Thanks to Turkish President Recep Tayyip Erdoğan's tightening grip over economic decision-making, everything seems possible in Turkish economic and monetary policy these days, aside from a prudent move to increase interest rates.

In Turkey, it would be easy to regard yet another decision this week by the Central Bank to leave its key one-week interest rate at 8 percent as a non-event. After all, not one analyst or investor would have predicted any other outcome, despite the weakening lira and rising U.S. bond yields.

One might be just as flippant about a summit of bankers called by Erdoğan at the Presidential Palace in Ankara on Oct. 25, where he espoused his unconventional, much-repeated theory that high interest rates cause inflation. He also called on bankers to cut borrowing costs, an all-too-familiar refrain.

It would be easy to dismiss the president’s call to lower borrowing costs as harmless frustration or mere in-character play-acting . He has done it countless times before and the script is straightforward; set yourself up as the victim, blame others and score political points.

And that is not just when it comes to the economy, but in relations with the European Union -- most recently an ugly spat with Germany -- and in the visa crisis with the United States. The list goes on.

The devil, however, is in the detail, and many investors, particularly in Turkey, look complacent.

Erdoğan, the political “dragon-slayer” that he is, is becoming increasingly assertive in matters of economy, propping up growth with policies that have caused disquiet among investors and ratings agencies. And after setting about the military, the Gülen movement blamed for last year’s coup and Kurds for threatening his political omnipotence, there are few enemies left.

Erdoğan clearly sees high interest rates as the major obstacle to his acquiring full, untrammelled control of the country in presidential elections, due in 2019 and perhaps much earlier. Opinion polls look shaky and financial stimulus is becoming more difficult.

TOO TEMPTING?

The president is no doubt aware that the economic data promoted by his ministers – chiefly the current 5.1 percent growth rate and the promise of double-digit expansion in the third quarter, fail to reflect hardships on the ground, in Istanbul, central Anatolia and elsewhere. Consumer confidence is down, unemployment up, and businesses are worried about the future.

 

Turkey consumer confidence falls
Turkey consumer confidence falls

There is an increasingly unfavourable global economic backdrop for emerging markets such as Turkey. Despite that, cutting rates in an effort to boost prosperity and stave off a possible downturn, though reckless, may prove too much to resist for a relentless leader used to getting his own way.

A constellation of other factors could also precipitate what could be a very risky decision.

Tens of billions of dollars the government used to stimulate the economy and help industries such as the struggling tourism sector have now dried up. Analysts estimate the programme contributed 2 percent to the country’s GDP this year. Attempts to borrow through a controversial wealth fund, initially an egotistical foray to match the wealthy, energy-rich states of Qatar and Saudi Arabia, are in their infancy. Despite higher budgetary spending, the taps just are not flowing as fast as Erdogan would like.

Aside from ordinary voters, who are also feeling the aftershocks of the lira’s precipitous downward path in the past year, Erdogan’s business allies in construction and infrastructure, some of whom are saddled with increasingly expensive foreign debt, also need feeding. The financial machine of these important economic actors must keep churning.

To help Erdoğan’s cause, the Central Bank of Turkey, once an independent actor of responsibility and prudence, is at best feeling under serious political pressure or, at worst, now fully under his control (a penny for the thoughts of Governor Murat Çetinkaya as he sat alongside Erdoğan at a meeting with senior bankers this week). One only has to look at the most recent slide shows of Çetinkaya’s presentations to foreign investors – a barrage of glitzy numbers showing off Turkey’s successes and in stark contrast to the prudent monetary assessments of his predecessors, Erdem Başcı and Durmuş Yılmaz, for clues to his approach. Erdoğan would be deeply proud, even though Çetinkaya may be just towing the line.

As pointed out by Moody's in its April decision to cut Turkey’s debt outlook to negative, the Central Bank has been holding its key interest rate at negative in real terms in the face of rising inflationary pressure, primarily to avoid increasing financing pressures on domestic firms. There are no concrete signs of that policy being abandoned.

PARADIGM SHIFT

Yet as Erdogan and Çetinkaya are no doubt aware, emerging markets are on the cusp of another paradigm shift. Yields on U.S. 10-year Treasuries, which have surged to an eight-month high this week, provide the latest signal that yet another period of easy money is coming to an end. The European Central Bank cut back its bond-buying programme this week and the U.S. Federal reserve is expected to increase interest rates at least three times in the next year.

The lira, dropping more than 7 percent this month and underperforming most other major emerging markets by some distance, jolted downward after this week’s rates decision. These price changes should all be warning signs to Erdogan. As should the core inflation rate, which is now at a 13-year high, partly due to the pass-thru effect of the lira’s depreciation.

Turkey core inflation

Expectations for future inflation rates – the latest Central Bank survey shows the market expects inflation of 8.5 percent in 12 months, are at the widest deviation from the Central Bank’s medium-term goal of 5 percent since 2008.

Then there is the burgeoning foreign debt of Turkish corporates. Any shock to the lira, caused by irresponsible economic policy, would mean more Turkish firms struggling to refinance some $200 billion to creditors next year.

The above factors would almost certainly mean that, should the Central Bank succumb to political pressure and cut rates next year, the reduction would be short-lived. With more and more cash being drawn to U.S. and European assets, emerging markets must work harder to attract capital to their debt markets and economies, not less, and the government would surely learn that lesson rather quickly. Structural economic reforms to areas such as the labour market are long overdue.

Still, Erdogan may be ready to take the risk. If any attempt to slash borrowing costs failed, he could swiftly switch back to victim mode and blame his favourite whipping boys – the big foreign banks and ratings agencies that are apparently hell-bent on bringing Turkey to its knees. 

Hopes that any such plans will be shelved were raised by the Central Bank in its statement on interest rates on Oct. 26. The Monetary Policy Committee emphasised that economic activity was “strong” and that it will “decisively’’ maintain tight monetary policy until the inflation outlook “becomes consistent with the targets’.’ Let us hope it sticks to its word, or raises interest rates further.

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