Turkey’s central bank faces test of independence
Inflation has hit nearly 18 per cent and the lira has reached a series of all-time lows, but since Recep Tayyip Erdogan won re-election in June, Turkey’s central bank has sat on its hands.
The reticence of Ankara’s monetary policymakers to increase interest rates in the face of the lira’s 40 per cent slide against the dollar this year has heightened criticisms that Mr Erdogan, who has long railed against high interest rates, has tightened his grip around what was once one of the developing world’s more respected central banks.
Turkey’s central bankers last week signalled they were at long last prepared to act, saying their monetary stance would be “adjusted” at Thursday’s meeting.
But investors are wary that, given Mr Erdogan’s growing push to dominate all institutions of Turkish political life, the central bank will be too cowed to raise rates enough to stem capital flight.
Their suspicions were borne out just hours before the central bank decision when the president said high interest rates were a “tool of exploitation”, in comments that drove the lira 3 per cent lower.
Turkey’s decision will have ramifications far beyond its own borders. Indeed, on a day that the European Central Bank and the Bank of England are also due to announce their own policy decisions, Ankara is the focus of markets’ attention.
“It’s a watershed moment,” said Michael Metcalfe, head of macro strategy at State Street Global Markets.
For the past month, much of the emerging market sell-off has been confined to two countries with deep political or fiscal challenges: Turkey and Argentina, which has been forced to request a speeding up of $50bn in IMF bailout funding to meet a budget shortfall.
But investors have begun to show a proclivity to drag down other developing economies in their wake. South Africa, which last week reported its back-to-back quarterly contractions since 2009, suffered a sharp sell-off in the rand; Indonesian equities have slid as nervousness takes hold over the US-China trade war.
“How many idiosyncratic events do we have to have for it to be a more systemic issue across emerging markets?” said Mr Metcalfe. “If all the major trees in your forests fall down, there may be something wrong with the soil.”
Goldman Sachs Asset Management said Turkey’s central bank should undertake “a sizeable rate hike” to restore its credibility. Market consensus is that the bank will raise rates by about 300 basis points — but several investors think it needs to go further.
“More will probably be needed to sustain a reversal of the lira’s course,” said Adrien Pichoud, chief economist at SYZ Asset Management.
Argentina has already gone down that road, raising rates to 60 per cent— though that has thus far failed to win back investors. Analysts have also argued that Mr Erdogan should ape Argentina’s President Mauricio Macri by committing to fiscal discipline and, if necessary, seek IMF support.
If Turkey’s central bankers undershoot, some analysts believe currencies across the emerging markets could be hit. “At some stage, investors will start to differentiate between various emerging markets, but it’s too early to expect that,” said Piotr Matys, emerging market strategist at Rabobank.
Investors have given the lira some breathing space in the past few weeks, leaving it to trade between TL6 and TL6.50 against the US dollar as the market takes stock of one of the most tumultuous trading periods of the year and assesses whether Turkey can recover.
Sergei Strigo, co-head of emerging market debt at Amundi Asset Management, believes it can. “It’s a deteriorating story on the macroeconomic side, but it’s not a disaster,” Mr Strigo said. “Government debt is very manageable. We don’t see a crisis scenario on the sovereign side, although corporate debt has to be monitored.”
Turkey and other emerging markets remain vulnerable to forces outside their control, particularly the strengthening American economy that has pushed up the US dollar and given the Federal Reserve a freer hand to raise rates — which has elevated the dollar even further. Trade tensions between the US and China have also put pressure on countries reliant on Chinese supply chains for economic growth.
While none of these factors are showing any signs of ebbing, decisive action in Turkey, Argentina and other vulnerable countries could have a positive effect among investors who, according to Mr Metcalfe, see developing world assets as cheap.
“The question we keep getting is, ‘When should we be going back [into emerging markets]?’,” he said. “The environment is difficult, but it’s far from impossible.”
“If we do see some stabilisation or marked improvement in Turkey and Argentina, it should be supportive of the EM debt market overall,” Mr Strigo said.
The problem, Mr Strigo added, is that so long as Turkey continued to struggle with its domestic political issues, the emerging markets would be firmly bearish. “We need to break this negative sentiment circle,” he said.