Turkish President Tayyip Erdogan attends a Republic Day ceremony at the Presidential Palace in Ankara, Turkey, October 29, 2020.
Presidential Press Office | Reuters
Inflation, a currency drop and rapidly depleting foreign exchange reserves: These are among the risks investors and emerging market economists are warning of following the Turkish President Recep Tayyip Erdogan’s firing of his hawkish former central bank chief over the weekend.
The move, which represented the third such sacking in two years, sent the Turkish lira’s value plunging — but Erdogan maintains that the economy is just fine, telling his ruling AK Party members in a speech Wednesday that this week’s market volatility doesn’t 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 beleaguered currency that’s lost 10% of its value since Friday.
“The return of volatility,” read the headline of an analyst note from Barclays on Monday. “Risk of currency crisis grows,” wrote London-based firm Capital Economics. It 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 the job in November, had imbued confidence in investors.
But Erdogan has long been of the unorthodox view that higher interest rates cause inflation and are “evil.” Analysts say it was only a matter of time before Agbal was replaced with someone more malleable to Erdogan’s views, stoking investor fears over the central bank’s lack of autonomy and a coming inflation and currency crisis.
Agbal’s replacement Sahap Kavcioglu, many Turkey experts say, lacks experience in the field and has a history of criticizing interest rate hikes, sparking worries of uncontrolled inflation.
“It looks like the central bank’s efforts to fight the country’s inflation problem may come to an end, and a messy balance of payments crisis has become (once again) a real possibility,” Capital Economics’ Senior Emerging Markets Economist Jason Tuvey 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 firing.
“The summary dismissal of Agbal ranks among the most counterproductive government actions in Turkey’s recent history,” Erik Meyersson, senior economist at Handelsbanken Macro Research in Stockholm, told CNBC. “It will instantly erode any credibility built up during Agbal, increase the risk premium on Turkish financial assets, and force the remaining policymakers to walk an even more difficult tightrope going forward.”
The Office of the Turkish Presidency did not reply to a CNBC request for comment.
When the lira fell sharply over similar fears about Turkey’s monetary policy in May of 2018, the impact rattled many Spanish and French banks, who had significant exposure to Turkish assets. Now that’s less of a problem, says Can Selcuki, managing director of Istanbul Economics Research.
“I doubt this will lead to non-performing loans that could pose a risk to foreign banks,” he told CNBC. “The level of the lira is not unprecedented so the business is used to this,” and those that became insolvent did so during the previous currency drop, he added.
Spain’s banking sector leads in terms of exposure to the Turkish public sector with $14.7 billion in Turkish assets including 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, according 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 think 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 holding 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 think markets have come to see Turkey as a very idiosyncratic EM (emerging market) risk case,” he said.
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 maintains his dovish outlook.
“It is likely that pressure on the TRY (Turkish lira) will pick up,” analysts at Goldman Sachs wrote 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, therefore 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 warned. It estimates Turkey’s gross foreign currency reserves at $35.7 billion — “not sizeable enough to sustain continued interventions, in our view.”
Erdogan’s central bank move may be the last straw for many, says Tim Ash, senior emerging markets strategist at Bluebay Asset Management.
“Hard to see these people ever coming back — massively damaging to Turkey’s reputation amongst investors,” he wrote in an email note Tuesday. “Those that actually trusted in Agbal and the Turkey story are being penalized.”