Erdogan calls on the Turks to support the lira and investors fear a financial crisis

Erdogan calls on the Turks to support the lira and investors fear a financial crisis

Turkish President Recep Tayyip Erdogan attends the Republic Day celebration at the Presidential Palace in Ankara, Turkey, October 29, 2020.

Presidential Press Office | Reuters

Inflation, a falling currency, and rapidly depleting foreign exchange reserves: These are among the risks that investors and emerging market economists are warning about after Turkish President Recep Tayyip Erdogan sacked his hard-line former central bank chief at the weekend.

The move, which represented the third dismissal of its kind in two years, led to the devaluation of the Turkish lira But Erdogan maintains that the economy is doing well, telling members of the ruling Justice and Development Party (AKP) in a speech on Wednesday that the market volatility this week does not reflect Turkey’s economic reality, according to a Reuters translation.

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

“Volatility is back,” read the title of an analyst’s note from Barclays Bank on Monday. “The risks of a currency crisis are increasing,” London-based Capital Economics wrote. He described how the former central bank governor, Nasi Aghbal, who had set out to tackle double-digit inflation in Turkey by raising the key interest rate by 875 basis points since taking office in November, had instilled confidence in investors.

But Erdogan has long espoused the unorthodox view that high interest rates cause inflation and are “evil”. Analysts say it is only a matter of time before Aghbal is replaced by someone more flexible with Erdogan’s views, raising investor concerns about the central bank’s lack of independence, the inflation crisis and the upcoming currency.

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Many Turkish experts say that Sahab Kafcioglu, the alternative to Aghbal, lacks experience in this field and has a history of criticizing interest rate hikes, which raised fears of uncontrolled inflation.

Jason Tuvey, chief economist for emerging markets at Capital Economics, wrote: “It looks like the central bank’s efforts to fight the country’s inflation problem may end, and the messy balance of payments crisis (again) has become a real possibility.” Turkey’s inflation rate is 15%, youth unemployment 25%, and the dollar has appreciated more than 10% on the lira since the dismissal.

“The immediate separation of mountains is one of the most counterproductive government measures in Turkey’s modern history,” Eric Myerson, chief economist at Handelsbanken Macro Research in Stockholm, told CNBC. “This will instantly erode any credibility built up during Agbal, increase the risk premium on Turkish financial assets, and force the remaining policymakers to tread a much more difficult tightrope going forward.”

The Turkish Presidency Office did not respond to CNBC’s request for comment.

Impact on other markets?

When the lira fell sharply due to similar concerns over Turkey’s monetary policy in May 2018, the impact bothered many Spanish and French banks, which had significant exposure to Turkish assets. Now that’s less of a problem, says Kan Selcuk, managing director of Istanbul Economic Research.

“I doubt that this will lead to bad loans that may pose a risk to foreign banks,” he told CNBC. “The level of the lira is not unprecedented, so businesses are used to it,” he added, and those who became insolvent did so during the previous currency’s depreciation.

The Spanish 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 Spring 2018, followed by France with $ 6.4 billion, down from $ 7.1 billion in 2018. According to Standard & Poor’s. my world.

For emerging markets, analysts see limited indirect risks as well.

“You might see a limited amount of risk free, but I don’t think it will be an infection,” Standard Chartered’s Divya Devaish said Monday, adding that there could be some risk on the part of retail investors who own the Turkish lira, particularly in Japan.

“I don’t think this would lead to a wider contagion in the market – I think in the past two years markets have come to view Turkey as a very particular risk situation in emerging markets,” he said.

Reserves run out

Therefore, the rest of the world may be safer than it was, but Turkey appears ready for a bumpy path ahead, especially if the new central bank chief maintains his pessimistic outlook.

“The pressure on the Turkish lira is likely to increase,” analysts at Goldman Sachs wrote in a note on Monday. The previous strategy of the Turkish Central Bank to support the lira was to buy more currency in dollars, thus burning foreign exchange reserves.

Goldman cautioned that “restarting foreign exchange interventions similar to 2020 may be the initial response, but buffers are relatively low”. Turkey’s total foreign exchange reserves are estimated at $ 35.7 billion – “not large enough to continue interventions, in our view.”

Tim Ashe, chief emerging market analyst at Bluebay Asset Management, says Erdogan’s central bank move may be the last straw for many.

“It’s hard to see these people ever coming back – damaging Turkey’s reputation among investors,” he wrote in an email on Tuesday. “Those who have already trusted Iqbal and the story of Turkey are being punished.”

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