Erdogan calls on Turks to support the lira, investors fear currency crisis

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Turkish President Tayyip Erdogan attends a Republic Day ceremony at the Presidential Palace in Ankara, Turkey on October 29, 2020.

Presidential Press Office | Reuters

Inflation, currency decline and rapid depletion of foreign exchange reserves: these are some of the risks emerging market investors and economists warn following Turkish President Recep Tayyip Erdogan’s dismissal of his hawkish former central bank chief this week-end.

The move, which represented the third such dismissal in two years, sent the value of the Turkish lira plunging But Erdogan maintains the economy is doing very well, telling his ruling AK Party members in a speech Wednesday that this week’s market volatility does not reflect Turkey’s economic reality, according to a Reuters translation.

In the same speech, however, he urged the Turks to sell their currency assets and gold and buy pound-based financial instruments, with the aim of stabilizing the besieged currency which has lost 10% of its value since Friday. .

“The return of volatility,” could be read Monday in the headline of an analyst note from Barclays. “The risk of a currency crisis is increasing,” wrote London-based Capital Economics. He described how former central bank governor Naci Agbal, who set out to tackle Turkey’s double-digit inflation by raising its key interest rate by 875 basis points since taking office in November , had instilled confidence in investors.

But Erdogan has long been of the unorthodox view that higher interest rates cause inflation and are “bad.” Analysts say it was only a matter of time before Agbal was replaced by someone more malleable in Erdogan’s views, stoking investor fears over the central bank’s lack of autonomy and an upcoming inflationary and monetary crisis.

Agbal’s replacement, Sahap Kavcioglu, according to many Turkish experts, lacks experience in the field and is used to criticizing interest rate hikes, raising concerns about runaway inflation.

“It looks like the central bank’s efforts to tackle the country’s inflation problem may come to an end, and a messy balance of payments crisis has become (once again) a real possibility,” Tuvey wrote, Senior Emerging Markets Economist at Capital Economics. . Inflation in Turkey is 15%, youth unemployment is 25% and the dollar has risen more than 10% against the lira since the layoff.

“Agbal’s summary dismissal is among the most counterproductive government actions in Turkish recent history,” Erik Meyersson, senior economist at Handelsbanken Macro Research in Stockholm, told CNBC. “This will instantly erode any credibility accumulated during Agbal, increase the risk premium on Turkish financial assets and force the remaining policymakers to walk an even harder tightrope in the future.”

The Turkish presidential office did not respond to a request for comment from CNBC.

Impact on other markets?

When the pound fell sharply amid similar fears about Turkey’s monetary policy in May 2018, the impact rocked many Spanish and French banks, which were heavily exposed to Turkish assets. Now that’s less of a problem, said Can Selcuki, managing director of Istanbul Economics Research.

“I doubt this will lead to non-performing loans that could pose a risk to foreign banks,” Selcuki told CNBC. “The level of the lira is not unprecedented, so the company is used to it,” and those who became insolvent did so during the currency’s previous decline, he added.

The Spanish banking sector leads in terms of exposure to the Turkish public sector with $ 14.7 billion in Turkish assets, including government bonds, up from $ 20.82 billion in spring 2018, followed by the France with $ 6.4 billion, against $ 7.1 billion in 2018, according to S&P. Global.

And for emerging markets, analysts also see limited overflow risk.

“You may see limited risk reduction, but I don’t think it will be contagion,” Standard Chartered’s Divya Devesh said Monday, adding that there may be risk reduction on the part of investors from retail holding of the Turkish lira, particularly in Japan.

“I don’t think this has the potential to lead to wider market contagion – over the past couple of years I think markets have come to view Turkey as a case of very idiosyncratic emerging market risk (emerging markets )”, did he declare.

Running out of reserves

So the rest of the world may be safer than it used to be, but Turkey is poised to take a difficult path, especially if the new central bank chief maintains his dovish outlook.

“The pressure on the TRY (Turkish Lira) is likely to intensify,” Goldman Sachs analysts wrote in a note Monday. The Turkish central bank’s previous strategy to prop up the lira was to buy more currency with dollars, thus burning its foreign exchange reserves.

“A restart of currency intervention similar to 2020 may be the initial response, but the buffers are relatively weak,” Goldman warned. He estimates Turkey’s gross foreign exchange reserves at $ 35.7 billion – “not large enough to support continued interventions, in our opinion.”

The central bank’s Erdogan move could be the last straw for many, said Tim Ash, senior emerging markets strategist at Bluebay Asset Management.

“It’s hard to see these people come back one day, which is very damaging to Turkey’s reputation with investors,” he wrote in an email on Tuesday. “Those who really trusted Agbal and the history of Turkey are penalized.”

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