Guldem Atabay
May 10 2018

Waiting game begins after urgent Turkish top-level economy meeting

Stanley Fischer, a former Federal Reserve vice chairman who was also number two at the International Monetary Fund (IMF), said on Wednesday that emerging markets would have to act quickly in the wake of the dollar rise, as it happened much faster than he had anticipated.

The Institute for International Finance had said Ukraine, China, Argentina, South Africa and Turkey were the top five most vulnerable to changes in risk appetite. Argentina has already been forced to go to the IMF for help this week.

With the dollar index hitting fresh highs since late 2017, Fischer said that in order to stabilise local currencies in vulnerable countries, a lot of people were required to do the right thing at the right time and the right time was pretty soon for many of them.  

The same day Fischer spoke about the urgency of the situation, Turkish President Recep Tayyip Erdogan gathered his economy officials to discuss the falling lira. The participants at the critical meeting included the Turkish central bank governors, who have been blamed for being inactive on monetary policy to rein in the lira and inflation, advisors Cemil Ertem and Yigit Bulut, who have been feeding the president with unorthodox economic policies, and Minister Mehmet Simsek, who happens to be Merrill Lynch’s former Turkey economist and the most market friendly face in the top ranks.

The same group of top economy officials have watched inflation creep into double-digits over the past two years, the current account deficit widen up to 6 percent of GDP and the lira continuously slide.  Meeting at Erdogan's opulent new palace, they attempted to find a cure for Turkey's economic ailments with critical presidential  polls on June 24 fast approaching.

The lira was at an all-time low of 4.38 to the dollar when the four-hour meeting began. The market held its breath for tangible steps as news of Argentina approaching the IMF for the first time in 17 years was making the headlines.

The statement released by the presidential palace after the meeting did not give much away. It left open the issue of a sizable rate hike and whether the central bank was given a given the green light to raise interest rates to stabilise the lira.   

So reading in between the lines becomes a crucial task to give some meaning to the possible future course of the Turkish economy before and after the snap polls.     

Tackling inflation should be number one on the government’s priorities to normalise the economy which is inseparable from a sizeable rate hike. Given the current situation, palace statement's emphasis that for the next period would still be on growth-based economic policies was not an encouraging start. It was as if Ertem and Bulut were voicing their unorthodox beliefs.

Growth, which has been pushed by the government since mid-2016 at the cost of high inflation and a wider current account deficit, is to be pursued again, though it seems the central bank may be free to hike its policy rate by perhaps 100 to 200 basis points more.

Thus, ahead of the polls, a relatively more stable lira could help the government, but after snap elections it is hard to predict the course of monetary policy. Needless to say, with the benchmark bond yield at 15.7 percent, any rate hike below 300-400 basis points will hardly be effective in rooting out Turkey’s inflation problem. Of course there was no mention in the statement about any simplification of the usage of multiple interest rates to drive the average cost of funding for the market.  That by itself is a sign after the polls, the government’s reasoning that high rates lead to high inflation – the Erdoğan/Ertem/Bulut policy – will dominate monetary policy.

While a mild rate hike may seem pragmatic for Erdoğan ahead of the polls, the statement echoes the Erdoğan/Ertem/Bulut reasoning, saying government policy is “to reduce interest and exchange rate pressures and to combat inflation more effectively”. That is truly puzzling.

Nevertheless, it would be safe to assume a rate hike to a tune of 100-200 basis points is now on the horizon. That could be enough to keep USD/TRY at around 4.20; but a significant reversal in the value of lira does not look achievable.  

The markets will now look for an announcement from the central bank in the coming days. If it doe not come, the lira’s free fall will continue. If however the central bank surprises markets with a 300-400 basis point rate hike, its positive effect on the lira will be profound.

The statement also makes a note on the fiscal side that looks set to deteriorate due to the government’s pre-election populist spending spree.  The statement promises to take counter measures to offset higher spending yet makes no note of whether they will be in the form of permanent tax hikes or one-off privatisation gains that cannot be repeated, like the recent sale of Turkey’s sugar factories. Moreover, the statement declares that public resources will be used to support growth, while the failure to mention a shift to a more orthodox fiscal policy is feeding existing worries about Turkey’s fiscal accounts.

Related to the government’s fixation on strong growth and the employment of fiscal resources to secure it, the statement also renewed the government’s most recent populist measure of cheap housing credit from the state banks. It is no secret that Turkey’s construction sector is in trouble, with unsold houses piling up. Cheap mortgage loans from state banks should help the many construction firms close to the government. This is another reason to remain sceptical about the future course of the fiscal deficit, which is set to double from last year’s 1.5 percent of GDP.

Erdoğan and his comrades pledged to remain dedicated to the free floating currency regime and keep foreign exchange deposit accounts untouched, perhaps in reaction to recent speculations that in the worst-case scenario the government would freeze hard currency deposits.

But it is not encouraging that the statement said the government would “increase efforts for effective use of existing foreign exchange and gold assets” and “be expanding the Wealth Amnesty scheme” to include international and domestic savings. It shows how the aforementioned trio remains delusional on macroeconomics.

To sum up, even if a mild interest rate hike is now anticipated, the summit declaration reflects that fact that the economic management team remains far from fully grasping the changing economic realities.

The fact that Erdoğan is anxious to give priority to growth when higher rates, the higher dollar index and lessening liquidity in world markets escalates the cost of growth in terms of inflation and current account deficit, means steps will be taken in order to stabilise the lira in the short term for the sake of success at the polls. Yet, worries about whether the government can engage in a new and a realistic economic policy vision in accordance with the changing macroeconomic dynamics are likely to persist.

Further ahead, not switching to orthodox policy measures when a perfect storm appears to be brewing could mean further elections may be held if the polls do not confirm Erdoğan as president with a strong majority in parliament.