Turkish lira may pay the price as Moody’s warns of negative rates impact

Turkey’s lira may be faced with renewed weakness after the central bank lowered interest rates to below the annual inflation rate.

Ratings agency Moody’s warned on Monday that negative real interest rates in Turkey make investing in the lira less attractive than in other emerging markets where real rates are positive.

The rate cuts will also “likely affect central bank credibility, which risks negatively affecting investor confidence,” Moody’s said in a report.

Turkey’s central bank has slashed the benchmark interest rate by more than half to 11.25 percent in January from 24 percent in July, when President Recep Tayyip Erdoğan sacked and replaced the bank’s governor for failing to back his government’s pro-economic growth policies. Meanwhile, annual consumer price inflation in Turkey accelerated to 11.8 percent in December from 10.6 percent the previous month.

The lira fell by 0.3 percent to 5.93 per dollar at 11:13 a.m. in Istanbul on Tuesday, adding to losses of 0.7 percent on Monday.

The rapid reduction in interest rates following Erdoğan’s July decision underlines market concerns about the erosion of monetary policy independence in Turkey, Moody’s said.

“Negative real interest rates expose Turkish banks to occasional “risk-off” episodes, in which interest rates no longer compensate for the multiple risks of investing in Turkey and its banks,” Moody’s said. “This scenario can make capital market access extremely challenging, which happened during the 2018 currency crisis.”

The Turkish lira lost 28 percent of its value in 2018 after a currency crisis ripped through financial markets in August of that year, sparking a severe economic downturn. The lira fell an additional 12 percent last year.

The central bank's Monetary Policy Committee next meets on Feb. 19. Some economists expect another rate cut at the meeting. 

Treasury and Finance Minister Berat Albayrak said on Monday that he wanted to see a “more competitive lira”. His comments suggest that the government may allow the currency to trade weaker in order to boost exports, a main driver of economic growth in the country. State-run banks have helped support the currency in recent months.

Exports from Turkey are now failing to keep pace with an increase in imports, raising the spectre of a widening in Turkey’s current account deficit, which reached 6.5 percent of GDP just before the currency crisis struck.

Albayrak also said on Monday that the central bank would tinker with banks’ reserve requirements in order to encourage lending to specific areas of the economy. Monetary policymakers began taking the unorthodox steps late last year, rewarding banks who increased loan volume with lower reserve requirements, while punishing those who did not.