The Turkish lira faced heavy selling pressure on Monday, sinking by up to 15 per cent against the dollar at one stage, following President Recep Tayyip Erdogan’s abrupt weekend decision to remove the central bank governor and replace him with a party member who is more aligned to the president’s dislike of high interest rates.
The currency later made a slight recovery but was still 8.2 per cent below Friday’s close at 7.8618 to the US dollar by 2.20pm. The Turkish government’s bonds also faced a sell-off, with 10-year US dollar bonds trading almost 11 per cent lower.
“For veterans on Turkey, this looks very much like a story they have seen several times before. Almost as soon as policy credibility is re-established, it is lost,” Hasnain Malik, strategy and head of equity research at Tellimer Research, wrote in a research note.
“The March 20 dismissal of the central bank governor signals that growth has again taken precedence over inflation control, FX [foreign exchange] reserve stabilisation and FX rate stability, even though the next general election is not due until mid-2023.”
Naci Agbal’s sacking on Friday came a day after the bank hiked rates by 200 basis points to 19 per cent on March 18, which brought cumulative rate hikes to 875bps since he was appointed in November 2020. He had hiked rates in a bid to strengthen the lira and tame inflation, which is currently running at over 15 per cent.
The lira had rebounded more than 15 per cent during Mr Agbal’s five-month tenure.
“Monday is likely to be a bloodbath for the Turkish lira as markets express their clear and strong dissatisfaction with Mr Agbal’s removal and begin to reverse the 18 per cent currency appreciation and $4.7 billion of domestic government debt and equity inflows that followed his appointment,” Patrick Curran, senior economist at Tellimer Research, wrote in the note.
The central bank has now seen four governors in less than two years, underlining the lack of independence and policy interference at the Turkish banking regulator.
The latest incumbent, Sahap Kavcioglu, is a former banker and a member of Mr Erdogan’s Justice and Development party. He said in a statement on Sunday that the central bank will continue to use the monetary policy tools to achieve “a permanent fall in inflation” and it would follow the previous schedule for rate-setting meetings.
He had written a column in the Yeni Safak newspaper last month that “interest rate increases will indirectly lead to an increase in inflation” – an unorthodox economic view also espoused by Mr Erdogan, a vocal critic of high rates.
Almost as soon as policy credibility is re-established, it is lost
Hasnain Malik, strategy and head of equity research at Tellimer Research
“Mr Agbal’s central bank adopted a more orthodox monetary policy,” Stephen Innes, chief global market strategist at Axi, said, adding that the former governor had enhanced its inflation-fighting credibility during his “very short” tenure.
The loss of the figurehead who implemented that orthodox economic policy correction punctures the investment case for foreign investors in the local currency, equities and bonds, Mr Curran said.
Turkey’s stock market also witnessed a sell-off, with the Borsa Istanbul 100 index of shares trading 9.2 per cent lower.
A sustained depreciation in the lira could push inflation higher in the second half of 2020, adding to the risk that the lira could enter into a tailspin, Scott Livermore, chief economist at Oxford Economics Middle East, told The National.
If Mr Kavcioglu does begin to implement interest rate cuts, it could create a negative feedback loop of lower real interest rates, rising inflation and further currency depreciation, analysts say.
It could also weaken Turkey’s already fragile dollar reserves.
“Turkey is among a group of vulnerable emerging markets and has little ammunition to defend the lira, with reserves covering below three months of imports and could quickly fall in stressed territory,” Mr Livermore said.