Economic Reason Returning to Turkey?
The surprisingly strong interest rate hike in Turkey makes a recession even more likely.
September 13, 2018
Today, Turkey’s central bank raised the country’s repo rate by 625 basis points, from 17.75% to 24%.
This was a surprise, because the country’s omnipotent president Recep Tayyip Erdogan has basically taken control over the central bank since his re-election in June. Erdogan has always spoken out loudly in opposition of higher interest rates.
The rate hike should lead to a surge in the Turkish lira (after the announcement, the lira appreciated by 5%) and some recovery in Turkish equity markets (Turkish markets rose up to 1% after the announcement with bank stocks being particularly strong).
The very aggressive central bank action against the apparent wishes of the president might be the result of conversations between bank officials and the president explaining to him the tradeoffs involved. This includes pointing out to Erdogan that the markets are running even faster away from Turkey without an increase vis-à-vis a lira recovery after an aggressive move.
The rate hike makes a recession in Turkey even more likely. However, Turkey’s current account should continue to stabilize.
A surging lira will be offset by a greater slowdown in the economy, leaving imports depressed.
Borrowing costs in Turkish lira for Turkish corporations will rise as well. Yet, that will be at least in part be offset by falling costs to repay dollar-denominated debt (and possibly greater access to international markets.
It’s a confidence game
In the end, it’s a confidence game. Markets may find that Turkey’s central bank is more independent than previously thought.
Yet, Erdogan needs to stay out of the headlines. Otherwise, he will implicitly — and very unwisely — raise the “political risk premium” that will ultimately decide the fate of Turkey’s economy.
In that regard, it did not help that President Erdogan took control of the country’s sovereign wealth fund, worth an estimated $200 billion, two days ago. He removed the board and installed himself as Chairman and his son-in-law as his Deputy. That makes it look one more time as if he treats Turkey as a family business.
Markets will carefully watch these kinds of steps.
Takeaways
Today, Turkey’s central bank raised the country’s repo rate by 625 basis points, from 17.75% to 24%.
The aggressive central bank action against the apparent wishes of Erdogan might be the result of conversations between bank officials and the president explaining to him the tradeoffs involved.
Erdogan needs to stay out of the headlines. Otherwise, he will implicitly -- and very unwisely -- raise the “political risk premium” that will ultimately decide the fate of Turkey’s economy.
The rate hike makes a recession in Turkey even more likely. However, Turkey’s current account should continue to stabilize.