Turkey’s Erdogan Undoes Hard Work (4 min read)

All the hard work of the past year will be put to waste if, as we fear, Turkish President Recep Tayyip Erdogan pushes the recently appointed central bank governor Murat Uysa to cut rates at the next monetary policy meeting on 25 July.  It’s not the actual rate cuts that should spook markets, though, several other emerging market countries have recently done the same, but rather it is the fact that it is Erdogan calling the shots on monetary policy – especially when his underlying motive is to claw back the lost political ground that twice cost him the Istanbul Mayoral elections.


Battle with central bank

We can trace the battle against monetary policy orthodoxy even further back than the elections. During a Bloomberg interview in May 2018, the President asserted that ‘the lower the interest rates, the lower the inflation. Once we lower interest rates, all cost expenses will go down.’ Since then, Erdogan has been fighting his central bank governor and the financial markets. This caused the Turkish lira to lose 80% of its value in 4 months as it weakened from USD/TRY 4.00 to USD/TRY 7.00 between May and August of last year.

For a while, Erdogan accepted high interest rates, as then central bank governor Murat Çetinkaya convinced him they were the only ‘medicine’ with which to adjust domestic imbalances and, more importantly, keep foreign speculators at bay.  The central bank raised rates to 24% last September and has kept them there since. This was a phenomenal achievement by the governor, firefighting the economy on the one hand and Erdogan and his son-in law, finance minister Berat Albayrak, on the other.

The adjustments worked. Inflation started to recede and will soon fall below where it was at a similar point last year (Chart One).  Furthermore, investor sentiment improved with a more stable currency, improved current account balance, and a fall in unemployment to 13% (Chart Two).  GDP Growth for Q1 was also +1.3%, the first positive after three negative quarters.

Chart 1: CPI Annual Rate of Change (%)


Source: Turkish Statistical Institute, ABP Invest

Chart 2: Unemployment Rate (%)


Source: Turkish Statistical Institute, ABP Invest

Battle with Local Politics

But politics have now intruded, and this in part drove Erdogan to replace the central bank’s governor, Çetinkaya, with the more pliable Uysa earlier this month. Erdogan’s influence may have peaked, however, with the loss of Istanbul in late June to the opposition as well as defections from loyalists in his own party. Former prime minister and AKP leader Ahmet Davutoglu, who defected in April, has a strong following among the more conservative Muslims from the AKP’s base, whilst Ali Babacan, former foreign and economy minister has strong ties with the business community. The hat-trick is expected to be former President Abdullah Gül, who has remained quiet so far but is rumoured also to be defecting.  A credible alternative for the religious vote would be highly damaging for Erdogan and the AKP.  This threat of an internal insurgency could push Erdogan even further towards more unorthodox actions in the domestic economy and even in an international arena as well.


Battle with External Politics

The external political picture has also worsened. Whether it was self-instigated, so as to give the presidency absolute powers domestically, or orchestrated through Gulenists, as Erdogan claims, the failed coup of 15 July 2016 created a new schism between Turkey and the West. The significance of the F-16 bombing of parliament in Ankara on the night of the coup was not lost on Erdogan; how might he protect himself from a recurrence? Also, during the war in Syria, NATO allies US and Turkey found themselves on opposing sides as Turkey aligned with Russia, fearing Syrian Kurdish fighters would join forces with PKK. Last but not least, the US resistance to selling Turkey the Patriot system led Erdogan instead to the S-400 missiles from Moscow.

Ankara has also been defying warnings by the EU, planning to deploy a fourth ship to continue drilling for oil and gas in the Mediterranean. Last week the EU Foreign Affairs Council decided to suspend negotiations on the Comprehensive Air Transport Agreement and agreed to refrain from holding the Association Council and further meetings of the EU-Turkey high-level dialogue for the time being. Yet, not dissimilar to the US, it is unlikely the EU will pursue aggressive sanctions or risk full on confrontation with Turkey as Erdogan holds the keys to the floodgates currently preventing refugees from disrupting domestic politics in EU.


Bottom Line

In the short term, despite the geopolitical tensions that have been building of late, the country is more at risk from possible unorthodox monetary policy mismanagement from Erdogan than threats to trade sanctions from the US and EU.  In the longer term, however, we fear that the damage between Turkey and the West is permanent, with a rebuilding of trust difficult to effect even after a change in leadership. As such, we maintain our negative outlook on the Turkish lira and find local currency 10yr bonds expensive given the potential risk to a pickup in inflation from aggressive monetary easing and a push for growth for political expediency.

Thanos Papasavvas, CFA, is the Founder and CIO at ABP Invest. He can be contacted here.


(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)

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