Complex Made Simple

Reluctant to hike rates, Turkey’s central bank struggles with lira slide

* Lira falls 6.8 per cent since start of 2017

* Slowing economy, insecurity, political uncertainty weighing heavy

* Central bank sees few options beyond rate hike

* Officials cast economic malaise as part of a conspiracy


For some of Turkish President Tayyip Erdogan’s aides, the mere suggestion that the central bank should raise interest rates as the lira slides through new record lows amounts to a plot against the state.


(Turkish growth: Officials cautious as political uncertainty looms)


Open to debate

“It is clear the goal is to bottleneck the country’s economy,” Erdogan’s adviser Bulent Gedikli said on Twitter on Tuesday in response to a statement from the Japan Credit Rating Agency (JCR) indicating investors might welcome a hike.

“It is open to debate how right it is to intervene in a floating-rate system, and if it is to be done, should it be just by hiking rates and destroying growth?” he said, suggesting there were other, better ways.

Less than an hour later, the central bank took the sort of step he seemed to have in mind, cutting banks’ forex reserve requirements in a move it said would inject $1.5 billion into the system in a bid to ease pressure on the lira.

The move won a “thumbs-up” emoji from Gedikli. The currency firmed briefly, but later resumed its slide, in what investors say is a sign that such steps may be unable to stem the decline without an outright rate hike.


(Turkish rate may rise, in defiance of Erdogan)


Lira falls further

The lira has fallen 6.8 percent to the dollar since the start of the year, and has now lost almost a quarter of its value since a failed coup last July. It weakened beyond 4.0 to the euro for the first time on Tuesday.

The spillover from neighbouring Syria’s civil war, bombings by Islamic State and Kurdish militants, the coup attempt, uncertainty over a planned referendum that would hand Erdogan greater powers, and the first quarterly economic contraction in seven years have all taken their toll.

Turkey’s large external borrowing requirement also makes the lira one of the currencies most vulnerable to tightening by the US Federal Reserve.

But compounding all of these is the sense that Erdogan’s aversion to high interest rates means that the central bank is unable to do the one thing that might stem the rout: hike rates sharply enough.

The bank is unlikely to be able to mount a sustained defence of the lira using its foreign currency reserves; these totalled around $92 billion at the end of last year, but analysts’ calculations suggest usable levels are around a third of that.

“To protect the lira’s resistance against the US dollar, investors’ perception that the central bank will be unable to raise interest rates must be shattered as soon as possible,” JCR Eurasia Rating head Orhan Okmen said in a statement.


(Turkish-Arab investors to spend $322m on luxury resort in Greece)


The enemy of high interest rates

Erdogan and his advisers want the central bank to reduce borrowing costs, with consumer rates above an annual 20 percent and the cost of credit for companies in double digits.

He has described himself as an “enemy” of high interest rates and railed at banks for charging them, seeing them as a bar to the economic growth he built his reputation on as prime minister from 2003-14.

With growth down to a forecast 3.2 percent last year from the high single digits of those earlier times, he and his officials have cast the lira’s slide as part of a shadowy conspiracy by outside powers to undermine Turkey.

He has even drawn parallels to the fight against Islamic State and other terror groups.

“Nobody has enough power to topple this country with economics, terror, unrest or cruelty,” he said in a speech on Friday in the southeastern city of Sanliurfa.

He has urged Turks to convert any dollars “under their pillows” into gold or lira and fervent supporters have offered free haircuts, fish and even tombstones to those who can prove they have done so.


Behind the curve

Such action has done little to inspire confidence among investors, many of whom say the bank should have acted sooner and needs to hike rates when it next meets on Jan. 24.

“The longer you wait, the more inflation expectations and confidence get contaminated and the harder the problem becomes to arrest,” said UBS strategist Manik Narain. “They will need to move at least by 50 bps and indicate more tightening is ahead.”

At its last meeting on Dec. 20, the bank kept rates on hold, with its benchmark one-week repo rate at 8 percent.

Outlining policy for 2017 at a news conference in December, Governor Murat Cetinkaya noted that the lira weakness posed a risk for inflation but argued that slowing domestic demand and weak growth could help limit the impact.

UBS said the central bank had been too reactive in its monetary policy and had fallen behind the curve.

The bank faced a similar challenge three years ago, as corruption allegations shook the government and the global impact of a cut in U.S. monetary stimulus hit the lira.

It tried to defend the currency by burning through forex reserves and seeking to squeeze up borrowing costs on the margins, a struggle it abandoned on Jan. 28, 2014 with a sharp interest rate hike at an emergency midnight meeting.

Investors may be hoping history will repeat itself.

“An outright rate hike is the only way the central bank can take action and assure markets it will not let the lira plunge,” said William Jackson of Capital Economics, adding that a hike of between 50-100 basis points was now needed.

“The longer they go without doing it, the more aggressive action will be needed.”