We downgraded Turkey (B/Negative) in late 2020 (with foreign-currency ratings lowered one notch to B). The Turkish central bank’s policies are likely only to deepen Turkey’s economic difficulties and increases likelihood of full balance of payment crisis. In addition, rate cuts raise the possibility of another sudden reversal of monetary policy if the lira continues to decline in value.
We have seen that in the past, as in 2018 and late 2020: if a lira crisis gets “bad enough”, rates are raised in the end. The question is how much further lira would need to fall before we reach such a watershed moment. The currency has lost nearly half its value since February.
Upcoming elections may require the continuation of current policy settings
However, high political stakes involved in Turkey’s interest-rate setting next year ahead of elections due in 2023 makes such a short-run pivot of monetary policy harder to foresee. Turkish President Recep Tayyip Erdoğan and his AKP have fallen behind in opinion polling over the run of 2021. As for prospects that higher growth helped by lowered rates might engineer Erdoğan’s sought electoral comeback, recent evidence suggests there is less correlation between growth and the president’s political fortunes than might meet the eye.
WATCH: Turkey Heading for Early Elections | Real Turkey
More rate cuts damaging to economic outlook
We estimate growth of a very high 10.8% over 2021 (before moderating sharply to 2.3% in 2022 and 2.4% in 2023), yet voters appear preoccupied with more pressing economic crises such as loss of purchasing power and rising poverty. The government’s attention on raising economic growth via easing rates, including possibility of further rate cuts, is damaging the country and economic stability – impairing the ratings outlook.
Can Central Bank defend TL?
As lira devalues, it is crucial entering 2022 to monitor the degree to which government falls back on tightening of capital controls, engaging in swap arrangements and using FX reserves in defence of the currency – to allow loose monetary policy while slowing down losses of the exchange rate. The problem with this policy combination is its cost: of over USD 100bn of reserves during 2018-20: net reserves ex-swaps stood at negative USD 42.3bn as of October.
TURKEY: The Aftermath of Currency Collapse: Sudden Stop Syndrome
Should Erdoğan refuse to change course ahead of the elections and faces defeat, 2022 and 2023 may prove flash-point years for Turkey in the case the president seeks alternative avenues to remain in power, with an opposition otherwise in pole position to oust him.
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