So the 'rate cut' calls begin: Erdoğan is playing with fire

Foreign portfolio investors have been piling up Turkish lira assets over the past two months following last year’s epic monetary policy mistakes that ultimately ended with the sacking of the central bank governor, the resignation of the treasury and finance minister, and an interest rate hike from 10.22 to 17.00 percent. The severe meltdown in the value of the lira stopped and positive real rates even resulted in a 10 percent appreciation.

Yet, the bewildering debate on interest rate-inflation dynamics has resurfaced again. What started yesterday as a call from the largest business group in Turkey, the Union of Chambers and Commodity Exchanges (TOBB), for banks to lower loan rates, continued with President Recep Tayyip Erdoğan’s perplexing statements today.

Going back to his old rhetoric that brought the Turkish economy to the verge of collapse last year, Erdoğan reiterated his staunch belief that “it is important to cut high interest rates to reduce inflation since interest rates are directly correlated with inflation”.

Erdoğan’s pro-growth motivation has resulted with currency attacks twice in the past two years, as he fails to grasp one basic fact: overheating in the absence of enough resources creates significant economic imbalances.

In fact, the previous central bank governor was appointed for the sake of monetary easing to fuel credit boom based growth, which went to extremes as the pandemic hit at the end of the first quarter of 2020. The president himself was forced to sack the central bank governor given the catastrophic turn of events in the Turkish lira and the economy; hence Erdoğan appointed the former finance minister Naci Ağbal last November. A credible name for the investors and a close friend of Erdoğan, Agbal delivered what the market has been waiting for so long: rationality and orthodoxy, along with efforts to get more direct and transparent in monetary policy.

In fact, while foreign investors loved Ağbal’s approach to monetary policy and appeared attracted to lira yields through easy carry trade, locals kept piling up hard currency in their foreign exchange deposits without even bothering to give “any benefit of the doubt” to Ağbal. Locals remained sceptical, believing Erdoğan would return to being himself sooner rather than later and reengage in directing the monetary policy as he does with all else.  Today’s comments from Erdoğan just proved the locals right.

During the two and a half months since Ağbal’s appointment, foreigners had bet on a form of a gentlemen’s agreement between the two, and with raised hopes that Erdoğan would stay at the sidelines and let Ağbal do the job.

Today, when Erdoğan was complaining about the high interest rates, he also said: “I need investment, I need employment, I need production, I need exports. If I don’t have these four things, then there is nothing.”

The president also said the focus of his government’s economic policy this year would be price stability, economic and legal reforms. He added his party had been working on the reforms and they would soon be announced. He also said the lira had gained against the dollar and euro, and that $15 billion of foreign capital had entered Turkish markets in the past few months.

What Erdoğan failed to acknowledge was that the rate hikes were the only reason for the lira’s gaining strength and Turkey attracting $15 billion, not his unreliable talk of reform.

With Erdoğan’s urge for easy monetary policy resurfacing perhaps along with his government’s fast deteriorating public support, the president also fails to grasp that he severely wounded the new central bank governor’s sincere efforts to regain long lost credibility.

Erdoğan’s comments once again proved that any form of institutional autonomy is non-existent under Turkey’s authoritarian presidential system. The ailing support for the Erdoğan-Bahçeli partnership along with the deteriorating economic conditions has long opened the pandora’s box for Erdoğan. A switch back to a balanced parliamentarian system is no doubt going to be the main agenda item of the upcoming 2023 elections.

(A previous version of this article was originally published here and reproduced with permission)

The opinions expressed in this column are those of the author and do not necessarily reflect those of Ahval.