Central Bank’s rate decision week with Erdogan looming large

On Jan, 21, this week on Thursday, the new governor Naci Agbal appointed in November to reverse the fate of the Turkish lira, will lead the Turkish central bank’s routine Monetary Policy Committee (MPC) meeting.  In the past two meeting, Agbal has raised borrowing costs by a cumulative 675 basis points to 17.0% versus 15% CPI inflation in Turkey.  Added the talk of reform by the Presidentforeign portfolio inflows gained TL some 10% of value over the same period.

At the first meeting of 2021, the bank was anticipated to elevate the policy rate by another 100 basis points as Agbal said he was sincerely targeting 5% CPI inflation.    

Yet, during his televised comments on Friday addressing a group of Turkish businessmen, the President resorted to his unorthodox belief that higher borrowing costs are responsible for inflation. Criticizing the current level of the rates and its impact on the real sector that can lead to a a wave of bankruptcies in the real sector, Erdogan said “whether they listen or not, I’ll continue my struggle… there is one thing I believe in: we can’t achieve anything with high interest rates.”  The President also emphasized that price stability was a top priority for 2021. 

1.7% TL weakness versus the US dollar followed his remarks.

His remarks right ahead of this week’s MPC meeting now turns attention to Agbal’s next move.  As he had promised a transparent, credible, orthodox monetary policy to investors, a decision to keep the policy rate flat at 17.0% could be costly on TL.  If he is to hike the policy rate further as expected, the move would help with the central bank credibility and obviously attract further portfolio flows.  Yet, such a move could turn the curtailed criticism from Erdogan more direct, threatening another central bank governor replacement that would have dire effects on the Turkish economy.

In terms of lowering Turkey’s very high inflation rate, monetary policy should remain tight throughout 2021 and should be lowered gradually along with the expected drop in the inflation rate.  End of year CPI inflation is expected at around 11%.  In the meantime, the AKP government should deliver on the reform front, economically and politically.  The President’s relations with the incoming Biden government in the US, his choices on the S-400s will have profound effects on the Turkish economy.