The political threat for the Turkish lira

 The independence of the Central Bank in Turkey is at best questionable

Earlier in November, the Turkish Central Bank cut the one-week repo rate by 1 percentage point to 15 percent, sending the lira (TRY), the country’s currency to a freefall: a few days later the USD/TRY exchange rate hit an all-time low of 13.46 and since then hit even lower levels against the dollar.

Naci Agbal, the previous head was inclined to keep a more hawkish interest rate policy to curb the galloping inflation in the country but was eventually dismissed by Erdogan because his monetary policy approach was deemed too restrictive by the President. The current head, Sahap Kavcıoglu, has a more dovish point of view and is more willing to act according to the wishes of Mr. Erdogan. Indeed, the last cut was a third straight reduction since September.

Markets are paying a lot of attention to what happens with the senior roles in the central bank and the financial administration in Turkey because the independence of the Central Bank in Turkey is at best questionable. Senior central bankers including the head of the bank and have been dismissed a number of times in the past years. In addition, the bank also made contrary decisions regarding the Turkish policy rate, both increasing and decreasing them, eroding the market’s trust in the institution. In western democracies independence of the institution of the Central Bank is guaranteed in order to insulate it from short-term political pressures. For example, without autonomy, the central bank can be influenced by politicians into enacting an extremely expansionary monetary policy to lower unemployment or support growth in the short term. Such a measure could however destabilise the country’s currency and spur inflation thereby contradicting the primary goals of the institution.

This is exactly what is happening in Turkey. Under the management of Mr. Agbal, the market believed that the country would implement a stricter monetary policy. The interest rates, at 19%, were high enough for the lira to strengthen and inflation began to stabilise over the summer. Such a situation might have presented an opportunity for rate cuts some months or quarters down the road however Mr. Kavcıoglu’s decisions proved to be too hasty. Additionally, the increasing energy and raw material prices, as well as the strengthening dollar, were external factors that supported inflation, therefore, created a more difficult external environment to start a dovish interest rate cycle.

A very important motive behind lowering the policy rate is political in nature. The popularity of Mr. Erdogan’s party, the AKP, has been eroding and together with his political allies, is neck and neck with the main opposition parties and the election is about a year and a half away. Therefore this does not leave much time for what the President would like to achieve: he would like to be able to win votes and secure his next term by boosting GDP growth in the country. Thus he needs a low interest rate environment to be able to artificially spur economic activity in the short term. Mr. Erdogan however was playing a risky game: the market’s trust in Turkey and its institutions has been fickle and the last interest rate decrease was the straw that broke the camel’s back, generating the huge selloff in the lira.

The issue seems to be unresolved to date. The market would want higher interest rates to believe that inflation, currently around 20% levels, could be curbed however the President does not seem to have changed his mind. The lira has strengthened somewhat since it hit its record low however just this week, Erdogan affirmed his stance on interest rates that yet again weakened the lira by 4%. If the country’s currency remains at current levels, that will largely support imported inflation as goods produced abroad will cost substantially more when exchanged to TRY. This can even lead to extreme situations like Apple halting iPhone sales in the country possibly because the currency is so volatile at the moment that they cannot stably price their products. Additionally, the foreign currency reserves of the central bank are also depleted so it does not have the firepower to be able to intervene by buying lira on the open market. The central bank therefore may well be forced to revise its expansionary monetary policy and begin a rate hike cycle yet again. A move that will surely spark interest in Turkish assets which over the past months have been hammered due to political intervention rather than economic sense.


Disclaimer: This article was issued by Tamas Jozsa, Research Analyst at Calamatta Cuschieri. For more information visit, The information, view, and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.