The Turkish central bank is facing growing pressure to decisively hike interest rates at a meeting Thursday to defend an ailing currency and rein in double-digit inflation.  But concerns remain over President Recep Tayyip Erdogan’s grip on monetary policy.

The Turkish lira has fallen more than 40 percent, much of it in the past few weeks, fueling rampant inflation.  

”Just to keep up with the acceleration of inflation the central bank needs to hike by more than 400 basis points,” said chief economist Inan Demir of Nomura International, “This is only to keep up with the acceleration in inflation, since last formal hike.  If we consider the prospect of a further acceleration inflation outlook, perhaps more is needed [interest rate hikes],” he added.

Demir says what has accelerated heavy lira falls are investor concerns the central bank can’t act decisively because of Erdogan, who has sweeping executive powers.  He has repeatedly voiced opposition to high-interest rates, which he claims “enslaves poor people.”

In a statement, this month the central bank declared it was ready to alter monetary policy to rein in inflation.  Financial markets interpreted the comment as the bank preparing to hike rates aggressively.  “The statement suggests we will see some action,” Demir said, “but I am not very confident the policy response will be as large as the markets need.”

This week, Finance Minister Berat Albayrak sought to talk up the Turkish economy, claiming the financial system was already “correcting itself.”  

Albayrak is the president’s son in law and widely seen as having the inside track with  Erdogan.  Some analysts suggest Albayrak’s positive statements may be seeking to play down the need for a significant increase in interest rate.

Misjudging international investors expectations could be costly.  “There will be massive sell off to the point of a panic if they don’t raise rates enough,” said political analyst Atilla Yesilada of Global Source Partners, “the sky’s limit, there is no way to make a rational forecast on the exchange rate, because we really don’t know when it stops,” he added.

Analysts warn a further decline in the lira risks undermining the Turkish public’s faith in the currency will lead them to convert their savings into dollars, adding pressure to the currency and risking the economy falling into a vicious cycle.

“Lira weakness feeds into inflation,” Demir said, “insufficient action by the central bank leads to deposit dollarization, which feeds into lira weakness, and that feeds into inflation again.”


“Past experiences in Turkey show, a sharp slow down of the economy followed after sharp depreciation,” Demir said, “the GDP [Gross Domestic Product – the size of the economy] growth rate [has] dropped off by 11 to 13 percent, that is the big risk we are looking at for Turkey.”

International banks are forecasting the Turkish economy heading into recession next year.  The timing for Erdogan could not be worse.  In March, Turkey holds critical local elections for the country’s biggest cities, one of the few places where opposition parties still have the opportunity to exercise power.  Erdogan has made it a priority to win the March polls.

Erdogan is likely to be aware, with many of Turkey’s big companies heavily indebted, a further hike in interest rates also risks driving the economy further into recession.


But interest rate hikes on their own may not be enough to address investor concerns and restore stability to the currency.  “A package of reforms is needed,” Demir said.

The World Bank has warned Turkey to rein in massive state building projects it says are overheating the economy and stoking inflation. Investors are also calling for the central bank to be independent and free of political interference.  Analysts say Ankara will also need to repair relations with Washington.

August’s crash in the lira was triggered by the imposition of Turkish sanctions by U.S. President Donald Trump over the detention of American Pastor Andrew Brunson, who is on trial for terrorism charges that Washington claims are politically motivated.

“To stop inflation they [Turkish central bank] will need at least 500 basis points or possibly like Argentina 1,000 basis points interest rate hike,” analyst Yesilada said.

“But is the problem [currency weakness] lack of confidence in running the economy or Father Brunson,” he added.  “If it’s Brunson then raising rates will hurt the economy, but not do much to stabilize the currency.  So maybe it’s better to wait until Mr. Erdogan decides to end this crisis with the United States.”

For now, Erdogan appears to be ready to tough it out, insisting Brunson should stand trial and that lira weakness is part of an international conspiracy against Turkey.

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