It was encouraging this week to hear President Erdogan argue that tight monetary policy would be used to bring down inflation. This appeared to be a 180 on his prior policy impulses and seemingly suggested backing for the Simsek led reform team.
Indeed, I think the market really appreciates the technical qualities, credibility of the new team – Simsek, Erkan, Cevdet Akcay, Hatice Karahan, et al. These are top notch technocrats. The market wants them to succeed, and they have begun to make the right steps, including the 750bps rate hike, against expectations, last month.
But there are two problems:
First, is the obvious question as to whether Erdogan will continue to back the team, tightening policy, slowing growth this side of important local elections. Or will Erdogan simply do an Agbal and fire them all before going back to unorthodoxy? I tend to think not this time around as I think there is a different political mix now around Erdogan, including the Bayraktar team, who get the economic challenges and have some political capital to deploy in support of Simsek et al.
Second, the question whether the economic challenges are now just too difficult even for the A team above to resolve.
One increasingly hears about banks not willing to lend given heavily negative real interest rates, companies starved of working capital, unable to borrow and access FX to transact overseas. Exports are struggling with the European growth slowdown, and the lira which is again looking expensive.
And then there is the KKM, the protected FX deposit scheme. Increasingly this looks like an unexploded hand grenade placed in Simsek’s pocket by the outgoing team just as he took the job.
The problem is that the lira needs to be allowed to adjust weaker given high inflation, but each move weaker costs the CBRT in compensation paid to depositors. These payouts increase monetary emission, further fuelling inflation and then real appreciation of the lira, requiring another devaluation, another round of payouts on KKMs and it’s a case of rinse, repeat.
The solution has to be to encourage KKM holders back into lira deposits but therein with negative real interest rates why would they? They either want to roll these, creating a perennial problem as above, or will dollarise, putting yet more pressure on the lira and depleted CBRT FX reserves.
Much higher policy rates, taking them positive in real terms would be the solution as this might well anchor the lira, but it might also need the confidence shock of an external anchor – an IMF programme. The Simsek team seem to hope this anchor will be provided by Gulf money, but it needs to come soon.
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