Recep Tayyip Erdogan is taking on financial markets again, and if history is a guide, he’s going to lose.
The Turkish president triggered a slump in lira assets this week by reviving his long-standing criticism of conventional central banking: namely, that policy makers should cut interest rates — rather than raise them — to stem soaring inflation.
That approach didn’t work in January 2014 when the central bank eventually had to more than double borrowing costs to stem a flight of foreign cash. As the lira plunges toward a record-low 4 per dollar, traders say he’ll be pushed into a corner again if he wants to avoid alienating the very investors he needs to sustain his economy.
“Nobody genuinely believes that high interest rates cause inflation, this is populist rhetoric from Erdogan. I’d be very surprised if he himself believes that,” said Paul McNamara, a London-based fund manager at GAM U.K. Ltd., which sold all of its Turkish holdings months ago. “The lira is going to keep falling until we see tighter money.”
The financial markets are one of the few areas where Erdogan has been unable to exert his will during his 15 years in power. In April, he centralized political authority in his office amid worsening ties with the west. That’s a stark contrast to the years after he took over in 2003, when Turkey’s domestic and foreign policy were oriented toward joining the European Union.
Erdogan has been cracking down on dissent since anti-government protests erupted four years ago. He’s overseen purges of police and judges he accused of being sympathizers of Fethullah Gulen, an exiled preacher based in Pennsylvania who he blames for orchestrating a coup attempt last year.
In retaliation for the failed putsch, Turkey’s leader has thrown tens of thousands of academics, journalists and judges in jail, paving the way for the April referendum that gave him near absolute authority.
That didn’t make him more popular, though. As his approval ratings dipped, Erdogan sought to win over Turks by flooding the economy with state-guaranteed credit to engineer short-term growth, helping spur inflation to a nine-year high of almost 12 percent.
After months of silence on monetary policy, Erdogan slammed the central bank on Nov. 17 for being on the “wrong path” in dealing with rising prices. Policy makers have steadily increased the weighted-average cost of the funds they lends to banks by more than three percentage points this year to 11.99 percent.
While traders are used to Erdogan’s unorthodox economic views, they received his latest remarks with alarm because they’re worried he now has more power to stomp on central bank independence. The yield on 10-year Turkish bonds soared 135 basis points this month, the most in emerging markets, to 13.18 percent — surpassing countries like Pakistan and Lebanon that are rated five steps below Turkey at Moody’s Investors Service.
“If you had the Turkish monetary policy run by the Russian central bank or the South African central bank, rates would probably be 16 percent or something,” said Paul Fage, a strategist at TD Securities in London. He’s concerned that “this is going to be the start of renewed political pressure on the central bank at a time when it probably least needs it.”
Erdogan’s offbeat view on economic policy is based on what Noah Smith, an assistant professor of finance at Stony Brook University in New York and a contributor to Bloomberg View, has dubbed a “neo-Fisherite Rebellion” after late Yale University economist Irving Fisher.
The thesis rests on the argument that the nominal interest rate includes two components: a real or inflation-adjusted interest rate demanded by investors, which is largely independent of monetary policy in the long run, plus expected inflation. When rates are elevated for a long time, according to this theory, prices rise to make up the difference.
Cemil Ertem, one of Erdogan’s chief advisers, used a column in Tuesday’s Milliyet newspaper to argue that in economies like Turkey’s, where the biggest contributor to inflation is interest charges, trying to curb price pressures with higher interest rates is “like throwing gasoline on the fire.”
Comments like these from politicians have put international investors on edge. Traders say they want to see evidence that Erdogan will back off and let the central bank do its job. They’d also like to see Turkey improve ties with the U.S.
So far, Central Bank Governor Murat Cetinkaya seems to be reading from the same playbook as his predecessor Erdem Basci, who left his post after five years in April, just as Erdogan as tightening his grip on power.
Like Basci, Cetinkaya seems intent on trying everything other than raising official interest rates to appease investors. On Tuesday, he forced lenders to pay 25 basis points extra to borrow money from the central bank, but that barely shored up the lira from a fresh record of 3.9776 per dollar.
“They have a history of tweaking the ratios with the banks and bringing in obscure, unusual instruments to tighten the policy without really hiking the rates,” said Paul Greer, a London-based senior trader of emerging-market debt at Fidelity International, who wants to see 150 basis points of tightening. “But all that has achieved is delaying the inevitable.”
One of the challenges is that Turkey doesn’t have a functioning benchmark interest rate. Its one-week repurchase rate, at 8 percent, hasn’t been used in months; no funds are offered at its overnight lending rate of 9.25 percent. The only rate being used, the late liquidity window, was 12.25 percent as of Tuesday.
“Political pressure can force unorthodox policy for some time, but something has got to give,” said Ziad Daoud, a Dubai-based analyst with Bloomberg Economics. “The current situation is unsustainable. The depreciation in the lira is hurting borrowers. Higher funding costs are hurting banks.”