Turkish Lira Tumbles After Erdogan Defends Rate Cuts

Turkish Lira Tumbles After Erdogan Defends Rate Cuts

13:57 - Currency falls as much as 18% after president reiterates view that higher interest rates don’t rein in inflation

Turkey’s economic crisis entered a tumultuous new phase, with its currency plunging to a fresh record low and President Recep Tayyip Erdogan preparing to meet the leader of a regional rival in search of foreign investment.

The lira slid as much as 18% Tuesday, before easing slightly, threatening to further shake the economy by undermining confidence, making it harder for businesses to pay off foreign-currency debt and increasing the cost of imported goods, especially oil. That would push the inflation rate, currently at around 20%, even higher, further hurting households, analysts say.

Mr. Erdogan sent the currency spiraling further downward when he stood by his view Monday that higher interest rates don’t rein in inflation and only damp economic growth. He said in a press conference that Turkey would reject orthodox monetary policy by fighting an “economic war of independence.”

But in a sign of the growing pressure on Mr. Erdogan, whose popularity is faltering in political polls, he is also seeking aid in unlikely places.

The United Arab Emirates’ de facto ruler, Abu Dhabi Crown Prince Mohammed bin Zayed al Nahyan, is expected to visit Mr. Erdogan on Wednesday as Ankara seeks much-needed foreign investment. The visit will be a milestone in relations between two major Middle Eastern rivals, with Ankara offering the U.A.E. potential support in a broader struggle against Iran, Abu Dhabi’s other chief adversary.

While expectations were low for a general rapprochement, said an Emirati official, investment talks were on the table. Turkish officials said that investment is on the agenda for the crown prince’s visit.

Turkey and the U.A.E. have been on opposite sides of a broader struggle for power in conflicts that emerged in the Middle East following the 2011 Arab Spring revolutions, backing opposing sides in the civil war in Libya. The Emirates also supported a military coup in Egypt in 2013 that removed an elected, Turkish-allied Islamist government in the country.

Turkey has sought to resolve conflicts with rivals including the U.A.E., Saudi Arabia, and Egypt this year as Mr. Erdogan attempts to ease his own international isolation. Turkish officials also say the rapprochement with Abu Dhabi is spurred by the Biden administration’s push to pivot away from conflicts in the Middle East.

“Now there is this sense of isolation in Turkey, and the Turkish side realized it’s not sustainable,” said Mithat Rende, a former Turkish ambassador to Qatar, referring to the efforts at rapprochement with Arab states.

Turkey, in turn, might be able to help Abu Dhabi in a broader struggle against Iran, the Emiratis’ other chief adversary, analysts say.

Mr. Erdogan has long railed against what he calls lobbyists pushing high interest rates and suggested that the lingering economic crisis Turkey has faced on and off since 2018 is of foreign design. His nationalist rhetoric has extended to geopolitics, as well, to garner support at home. Earlier this year, he threatened to expel the U.S. ambassador and several European Union envoys over their criticism of Turkey’s judicial system. He ultimately stepped back from that threat.

Signaling the likelihood of more economic pain to come, Ugur Aydemir, a parliamentarian from the ruling Justice and Development Party, or AKP, said that Turks should rein in their spending to get through a potential crisis.

“Maybe we will have to eat bread and onions for days, for weeks, but we will make no concessions on our security,” he told fellow parliamentarians.

The Turkish central bank cut its key policy rate last week despite official measures of annual inflation reaching nearly 20% in October. This move goes against conventional economic theory, which contends that looser monetary policy boosts consumer prices. In Turkey’s case, growth and investment may also suffer as foreign investors take their cash elsewhere.

In Istanbul’s covered bazaar, a centuries-old hub for trading currencies and gold, one trader said the conversion rates on an electronic board couldn’t keep up with the lira’s fall, causing confusion between buyers and sellers.

“It was a very stressful day,” said trader Ozgur Anik. “More people came along to sell dollars later in the day to take a profit on the high prices.”

The Turkish central bank Tuesday warned Turks against selling currency at current levels, which they said were unjustified and “completely detached from economic fundamentals.”

With import prices set to rise, and a possible minimum wage hike in the near future, inflation is likely set to rise even more, analysts said. The government however has been pressuring retailers to keep prices steady to limit political blowback.

Markets saw Mr. Erdogan’s Monday speech as pressuring the Turkish central bank to cut rates further, according to analysts at UniCredit. Investors were already expecting another cut at the next meeting in December, and some see the easing cycle continuing into next year.

“We must abandon this irrational experiment that has no chance to succeed as soon as possible and go back to qualified policies that will pursue Turkish people’s welfare,” said former central bank deputy governor Semih Tümen, who was removed from his position last month by Mr. Erdogan.

For now, Turkey’s banking sector looks stronger than it was in 2018 when a similar currency crisis put the sector under tremendous strain, boosting banks’ bond yields. Analysts say lenders will be able to deal with current levels of lira weakness, though a sustained fall could cause a greater run on foreign savings.

“Any signs of a flood of withdrawal requests would probably prompt a lurch towards more aggressive forms of capital controls,” noted Jason Tuvey, a senior emerging markets economist at Capital Economics, a London-based economic research consulting firm.

Tuesday’s drop in the lira, if sustained, would be its biggest since March when Mr. Erdogan fired the previous head of the central bank, who was in favor of higher rates. The size of the move is remarkable in the context of currency markets. Even the most volatile emerging-market currencies tend to move less than 1 percentage point a day against the dollar on most days—a move of 2 or 3 percentage points is considered significant.

“It’s a dangerous game the Turks are playing,” said Uday Patnaik, head of emerging-market debt at Legal & General Investment Management. “As people lose faith in the value of the currency, you could see a potential run on the banks. This would be hugely problematic, we haven’t seen that yet as far as I know.”

Both local-currency and dollar-denominated Turkish government bonds sold off Tuesday. The yield on a dollar-denominated 10-year note climbed to 7.2%, rising for a fifth straight day. The spread on a benchmark five-year credit default swap widened to just under 5 percentage points, close to the level at the height of the pandemic-induced stress in March 2020.

Turkish stocks rose. The benchmark Borsa Istanbul 100 Index advanced 1.7%.

The stock-market rise suggests that Turks are putting their money into equities as an inflation hedge rather than holding cash, said Edward Glossop, an emerging-markets economist at Aberdeen Standard Investments. This phenomenon was also seen in Argentina during a recent period of hyperinflation, he said.

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