Erdogan calls on Turks to support the lira, investors fear monetary crisis

Inflation, falling currency and rapid depletion of foreign exchange reserves: this is one of the risks that investors and emerging economists are warning of the dismissal of Turkish President Recep Tayyip Erdogan over his weekend central bank.

The move, which represented the third layoff in two years, dropped the value of the Turkish lira – but Erdogan maintains the economy is fine, and told his AK Party leaders on Wednesday in a speech that this week’s market volatility does not reflect Turkey’s economic reality, according to a Reuters translation.

In the same speech, however, he urged Turks to sell their foreign exchange assets and gold and buy lira-based financial instruments, in an effort to stabilize the besieged currency that has lost 10% of its value since Friday. .

“The return on volatility,” the headline of a Barclays analyst note said Monday. “The risk of a monetary crisis is growing,” the London-based firm Capital Economics wrote. He described how former central bank governor Naci Agbal, who had set out to tackle Turkey’s double-digit inflation by raising its key interest rate by 875 basis points since taking office in November, had been confident investor confidence.

But Erdogan has long been of the unorthodox view that higher interest rates cause inflation and are “bad.” Analysts say it was only a matter of time before Agbal was replaced by someone more malleable to Erdogan’s views, sparking fears from investors about the central bank’s lack of autonomy and the impending inflation crisis. of the currency.

According to many Turkish experts, Agbal’s replacement, Sahap Kavcioglu, lacks experience in the field and has a history of criticizing rising interest rates, raising concerns about uncontrolled inflation.

“It seems that the central bank’s efforts to combat the country’s inflation problem may end and a disorderly balance of payments crisis has become (once again) a real possibility,” the senior economist wrote. of emerging markets from Capital Economics, Jason Tuvey. Turkey’s inflation is 15%, youth unemployment is 25% and the dollar has risen more than 10% against the lira since it shot up.

“Agbal’s summary dismissal ranks among the most counterproductive government actions in Turkey’s recent history,” Erik Meyersson, a senior economist at Handelsbanken Macro Research in Stockholm, told CNBC. “It will instantly erode any credibility accumulated during Agbal, increase the risk premium on Turkish financial assets and force the remaining policymakers to walk a tightrope even harder in the future.”

The Turkish Presidency Office did not respond to a request for comment from CNBC.

When the lira fell sharply due to similar fears about Turkey’s monetary policy in May 2018, the impact shook many Spanish and French banks, which had significant exposure to Turkish assets. Now that’s less of a problem, says Can Selcuki, CEO of Istanbul Economics Research.

“I doubt this will lead to unproductive lending that could pose a risk to foreign banks,” he told CNBC. “The level of the lira is unprecedented, so the business is used to it,” and those who became insolvent did so during the fall of the previous currency, he added.

The Spanish banking sector leads in terms of exposure to the Turkish public sector with $ 14.7 billion in Turkish assets, including government bonds, below $ 20.82 million in spring 2018, followed by France with $ 6.4 billion , below $ 7.1 billion in 2018, according to S&P Global.

And for emerging markets, analysts also see a limited risk of spillage.

“You may see a limited amount of risk, but I don’t think it’s a contagion,” Standard Chartered Divya Devesh said on Monday, adding that there may be some risk on the part of retail investors holding Turkish lira, particularly in Japan.

“I don’t think this has the potential to lead to a wider market contagion; in the last two years I think markets have seen Turkey as a very idiosyncratic case of EM (emerging market) risk,” he said.

So the rest of the world may be safer than it used to be, but Turkey seems to be preparing for a rocky road ahead, especially if the new head of the central bank keeps his prospects obscure.

“Pressure on the TRY (Turkish lira) is likely to increase,” Goldman Sachs analysts wrote on Monday. The previous strategy of the Turkish central bank to strengthen the lira was to buy more currency with dollars and therefore burn through its foreign exchange reserves.

“A resumption of currency exchange interventions similar to 2020 may be the initial response, but the dampers are relatively low,” Goldman warned. He estimates Turkey’s gross foreign exchange reserves at $ 35.7 billion – “in our view,” they are not important enough to sustain continued interventions.

According to Tim Ash, Bluebay Asset Management’s chief emerging market strategist, Erdogan’s central bank move may be the last straw for many.

“It’s hard to see these people ever coming back, greatly damaging Turkey’s reputation among investors,” he wrote in an email note on Tuesday. “Those who really trusted Agbal and the history of Turkey are being penalized.”