INSIGHT: Turkey’s central bank calms markets but economic growth woes persist

Author: Jonathan Lopez


LONDON (ICIS)--Turkey’s central bank on Monday announced it would simplify its system of interest rates, effectively increasing the cost of borrowing, in a move not favoured by President Recep Tayyip Erdogan

This has brought some calm to the country’s troubled financial markets, with the Turkish lira (TL) shooting up 3% on the day, but concerns among the country’s chemical players and investors’ aversion to Turkey assets continue casting a shadow.

Some analysts have said the move by the central bank represents a return to a more conventional approach to monetary policy.

An increase in interest rates by the bank also showed the institution still guards its independence, although the sharp jump in the lira’s value on Monday had reversed some of the gains by the end of the day.

Financial concerns for the 80m-strong country run deep among corporates.

The move by the central bank on Monday had been preceded a week earlier by Erdogan’s comments to newswire  Bloomberg hinting that post-June election, was his Justice and Development Party (AKP) to win, the new government may intervene directly in monetary policy.

Anathema for financial markets, the President's remarks caused a sharp fall in the lira’s value during the week, with the currency having already accumulated a 20% loss against the dollar year to date.

Erdogan had already given himself broad powers after the failed coup d’etat in 2016, prompting a purge among civil servants, but the economy had steered along as stimulus by the government and an improvement in the European economy kept factories and services alike performing healthily.

However, hinting that he intends to intervene in monetary policy is a new step toward authoritarianism that has caused alarm among some Turkish chemical players.

Market players agree that the big chemical companies in the country are still getting materials through on a contractual basis, via contracts which were settled before the lira posted its sharp depreciation.

From an exchange rate of $1:TL3.77 at the start of the year, the Turkish currency was trading at $1:TL4.56 by Tuesday afternoon.

The consequence is that chemical players intending to purchase on the spot market are likely to face a “nightmare”, according to a chemicals trader based in the country.

“The effect on the convertors, if they haven’t contracted on an annual basis, could be the loss of 20% of sales overnight,” said the trader.

“Nobody is signing significant business now, none of the traders have been. It is not as bad as having zero business – business is there, but namely for contract holders and large companies. Others, compared to a year ago, are nearly 60% down [in business volumes],” it added.

Uncertainty among corporates causes in turn a slowdown in investment, which would ultimately affect GDP growth. The stand-off between Erdogan and the central bank will undoubtedly be  a major concern for those market players who need stable exchange rates in order to plan their business.

“The life of a trader in Turkey has been a nightmare – you don’t know what’s going to happen tomorrow,” said the trader.

Turkey’s importance as a manufacturing hub, financially, and as a growing power in the Middle East makes the country’s stability key for the stability of the whole European economy.

Soon after Erdogan made his remarks, US credit rating agency Fitch said that the President's rhetoric was threatening to heighten economic instability at a crucial moment – when central banks in the west are tightening monetary policy, which in turn affects emerging markets like Turkey as investors return to safer bonds which are starting to pay higher interests.

“Monetary policy in Turkey has long been subject to political constraints, but an explicit threat to curb the central bank's independence increases risks to the policymaking environment and to policy effectiveness, not only from political interference but from the greater pressure on the CBRT [Central Bank of the Republic of Turkey] to prove its independence,” said Fitch.

“Greater erosion of monetary policy independence would put further pressure on Turkey's sovereign credit profile, particularly if it contributed to serious external financing stresses and a deterioration in the macroeconomic environment, or undermined wider economic policymaking credibility and the country's business environment.”

Analysts see a direct link between the US tightening monetary policy and Turkey’s financial woes.

Extensive research published earlier in May by Germany’s Deutsche Bank showed the correlation between cycles of tightening monetary policy and specific emerging markets suffering as a consequence.

On this occasion, and given the internal political and now economic instability, it is Turkey’s turn.

“Absolutely. First it was Argentina, now Turkey. The country has been able to fund very high growth, in the face of large external imbalances, by tapping the easy money created by QE [quantitative easing, by the US Fed or the eurozone’s ECB, among others]. As markets begin to look ahead to an exit from QE, funding conditions are getting systemically tougher for Turkish banks, just as they are for other Ems [emerging markets],” Marcus Chenevix, a financial analyst for Turkey at London-based TS Lombard, told ICIS.

“It does not matter that nothing real has happened yet. Sentiment has changed, and Turkey is on the wrong side of this change. Turkey has its own idiosyncratic problems, and they are very severe, but the country probably had another six months for as long as international conditions were benign.”

Chenevix said that some “real economy” sectors in Turkey are clearly slowing down, like construction, but others like exporters, tourism and household consumption were still holding up.

The potential economic slowdown was widely seen as the ultimate reason for Erdogan to call an early election in order to secure another mandate.

“However, this is not a crisis of the real economy, this is a corporate debt problem – the growth is going well, but the risk stems from how it has been funded. Whichever policy decision Erdogan imposes on the central bank post-election will drive a sharp slowdown,” added Chenevix.

“This is because right now the government has two choices: either they can push the economy into recession by raising interest rates by another 200bp [basis points] to 400bp, or they can choose to hold interest rates, let the lira slide, and deal with the resultant wave of corporate bankruptcies with a campaign of state bailouts. This second probably also results in a recession.”

While there is some expectations that Monday’s move by the central bank represented the victory of the orthodox monetary policy, the stand-off between the institution and Erdogan is likely to persist.

If the incumbent is victorious in the June election and goes ahead with its plan to intervene more in monetary policy, then financial turmoil will be the only certainty.

A victory for Erdogan is an outcome everyone takes for granted.

The Turkish trader said that Erdogan will win the election “one way or another” and showed concerns that other powers within the country like the military may come into the picture after the poll.

“That’s what everybody is afraid of. If it happened in 2016 [the failed coup], it could happen again in 2018.”

Pictured: Erdogan supporters celebrate his victory in the 2017 referendum which gave him broader powers
Source: Depo Photos/Depo Photos via ZUMA Wire/REX/Shutterstock

By Jonathan Lopez