Turkish President Tayyip Erdogan attends a Republic Day formality at the Presidential Palace in Ankara, Turkey, October 29, 2020.
Presidential Press Office | Reuters
Inflation, a currency drop and swiftly depleting foreign exchange reserves: These are among the risks investors and emerging market economists are warning of conform to Turkish President Recep Tayyip Erdogan’s firing of his hawkish former central bank chief over the weekend.
The act, which represented the third such sacking in two years, sent the Turkish lira’s value plunging — but Erdogan prolongs that the economy is just fine, telling his ruling AK Party members in a speech Wednesday that this week’s exchange volatility doesn’t reflect Turkey’s economic reality, according to a Reuters translation.
In the same speech, however, he drove Turks to sell their foreign exchange assets and gold and buy lira-based financial instruments, in an effort to stabilize the beleaguered currency that’s down the drain 10% of its value since Friday.
“The return of volatility,” read the headline of an analyst note from Barclays on Monday. “Jeopardize of currency crisis grows,” wrote London-based firm Capital Economics. It described how former central bank Governor Naci Agbal, who had set out to take on Turkey’s double-digit inflation by raising its key interest rate by 875 basis points since taking the job in November, had imbued self-reliance in investors.
But Erdogan has long been of the unorthodox view that higher interest rates cause inflation and are “inauspicious.” Analysts say it was only a matter of time before Agbal was replaced with someone more malleable to Erdogan’s assesses, stoking investor fears over the central bank’s lack of autonomy and a coming inflation and currency crisis.
Agbal’s replacement, Sahap Kavcioglu, assorted Turkey experts say, lacks experience in the field and has a history of criticizing interest rate hikes, sparking worries of rampant inflation.
“It looks like the central bank’s efforts to fight the country’s inflation problem may come to an end, and a messy excess of payments crisis has become (once again) a real possibility,” Jason Tuvey, senior emerging markets economist at Leading Economics, wrote. Turkey’s inflation is at 15%, youth unemployment is at 25% and the dollar is up more than 10% on the lira since the blaze.
“The summary dismissal of Agbal ranks among the most counterproductive government actions in Turkey’s recent history,” Erik Meyersson, chief economist at Handelsbanken Macro Research in Stockholm, told CNBC. “It will instantly erode any credibility built up during Agbal, raise the risk premium on Turkish financial assets, and force the remaining policymakers to walk an even more difficult tightrope thriving forward.”
The Office of the Turkish Presidency did not reply to a CNBC request for comment.
Impact on other markets?
When the lira mow down sharply over similar fears about Turkey’s monetary policy in May 2018, the impact rattled many Spanish and French banks, who had outstanding exposure to Turkish assets. Now that’s less of a problem, said Can Selcuki, managing director of Istanbul Economics Investigation.
“I doubt this will lead to non-performing loans that could pose a risk to foreign banks,” Selcuki told CNBC. “The tear down of the lira is not unprecedented so the business is used to this,” and those that became insolvent did so during the previous currency release, he added.
Spain’s banking sector leads in terms of exposure to the Turkish public sector with $14.7 billion in Turkish assets comprehending government bonds, down from $20.82 billion in the spring of 2018, followed by France with $6.4 billion, down from $7.1 billion in 2018, harmonizing to S&P Global.
And for emerging markets, analysts see limited spillover risk as well.
“You might see a limited amount of de-risking but I don’t ruminate over it’s going to be a contagion,” Divya Devesh of Standard Chartered said Monday, adding that there may be some de-risking from retail investors maintaining Turkish lira, particularly in Japan.
“I do not think this has the potential to lead to a broader market contagion — the last two years I mull over markets have come to see Turkey as a very idiosyncratic EM (emerging market) risk case,” he said.
Running out of reservations
So, the rest of the world may be safer than it was, but Turkey looks set for a rocky path ahead, particularly if the new central bank chief alleges his dovish outlook.
“It is likely that pressure on the TRY (Turkish lira) will pick up,” analysts at Goldman Sachs forgave in a note Monday. The Turkish central bank’s previous strategy to shore up the lira was to buy more of the currency with dollars, for that reason burning through its foreign exchange reserves.
“A restart of FX interventions similar to 2020 may be the initial response, but the buffers are comparatively low,” Goldman cautioned. It estimates Turkey’s gross foreign currency reserves at $35.7 billion — “not sizeable enough to sustain last interventions, in our view.”
Erdogan’s central bank move may be the last straw for many, said Tim Ash, senior emerging merchandises strategist at Bluebay Asset Management.
“Hard to see these people ever coming back — massively damaging to Turkey’s status be known amongst investors,” he wrote in an email note Tuesday. “Those that actually trusted in Agbal and the Turkey record are being penalized.”