So the “rate cut” calls begin: Erdogan playing with fire

Foreign portfolio investors have been piling up TL assets over the past two months following last year’s epic monetary policy mistakes that had ended with the sacking of the central bank governor, the treasury and finance minister’s resignation and the interest rate hike to 17.00% from 10.25%.  So that the severe meltdown in the value of the TL had stopped and positive real rates even resulted with 10% appreciation.

Yet, the bewildering debate on interest rate-inflation dynamics has resurfaced again.  What started as a call from the largest business group in Turkey (TOBB) for banks to lower the loan rates yesterday, continued with President Erdogan’s perplexing statements today.

Going back to his old rhetoric that had brought the Turkish economy to the verge of collapse last year, President Erdogan reiterated his stanch belief that “it is important to cut the high interest rates to reduce inflation since interest rates are directly correlated with inflation”.

Erdogan’s pro-growth motivation have resulted with currency attacks twice in the past two years as he fails to grasp one basic fact that overheating in the absence of enough resources creates significant economic imbalances.

In fact, the previous central bank governor was appointed for the sake of monetary easing to fuel a credit boom based growth which went to extremes as the pandemic hit by the end of first quarter of 2020.  The president himself was forced to sack the central bank governor given the catastrophic turn of events in the Turkish lira and the economy; hence Erdogan appointed the former finance minister Agbal last November.  A credible name for the investors and a close friend of Erdogan, Agbal had delivered what the market has been waiting for so long: rationality and orthodoxy along with efforts to get more direct and transparent in monetary policy.

In fact, while foreign investors loved Naci Agbal’s approach to monetary policy and appeared attracted to TL yields through easy carry trade, the locals kept piling up hard currency to their fx deposits not even bothering to give “any benefit of doubt” for Agbal.  The locals remained sceptic about Erdogan being himself sooner rather than later and reengage in directing the monetary policy as he does with all else.  Today’s comments from Erdogan just proved the locals right.

During the two and a half months of Agbal’s appointment, the foreigners had bet on a form of gentlemen’s agreement between the two and had raised hopes for Erdogan staying at the sidelines; letting Agbal do the job.

Today, when Erdogan was complaining about the high interest rates he also said “I need investment, I need employment, I need production, I need exports. If I don’t have these four things, then there is nothing.”

The President also said the focus of his government’s economic policy this year would be price stability, economic and legal reforms.  He added his party had been working on the reforms and they would soon be announced. He also said the lira had gained against the dollar and euro, and that USD15 billion of foreign capital had entered Turkish markets in the past few months.

What Erdogan had failed to acknowledge was the fact that the rate hikes were the only reason for TL gaining strength, Turkey attracting USD 15 billion and not his unreliable talk of reform.

With Erdogan’s urge for easy monetary policy resurfacing perhaps along with his government’s fast deteriorating public support, the President also fails to grasp that he severely wounded the central bank’s new governor Naci Agbal’s sincere efforts to regain the long lost credibility.

Erdogan’s comments today once again proved how any form of institutional autonomy is non-existent under Turkey’s authoritarian presidential system. The ailing support for the Erdogan-Bahceli partnership along with the deteriorated economic conditions has long opened the Pandra’s Box for Erdogan. A switch back to a balanced parliamentarian system is no doubt going to be the main agenda item of the upcoming 2023 elections.