A new currency crisis is looming in Turkey

When the Turkish central bank raised interest rates by 2 percent last week, more than expected, Governor Naci Agbal was widely praised by analysts and foreign investors. They saw it as confirmation that the new governor was pursuing orthodox monetary policy to stabilize the troubled Turkish lira and tame the persistently high inflation.

Two days later, Agbal was fired. He is the third central bank governor in three years to be sidelined by President Erdogan. Agbal had been appointed by the same Erdogan just four months ago with the message: “We are ready to swallow the bitter pill.” In the following months, Agbal hiked interest rates a total of 8.75 percent, increasing the value of the lira.

But Agbal’s latest interest rate hike turned out to be a bit too bitter for Erdogan. He is fiercely opposed to high interest rates. He sees this as the cause of high inflation, unlike most economists. That’s why he appointed Sahap Kavcioglu, a banking professor at Marmara University in Istanbul and a proponent of Erdogan’s economic policy, as the new central bank governor on Saturday.

The response from Monday’s financial markets was as predictable as it was dramatic. The lira fell 17 percent during morning trading, but then recouped some of the losses, possibly following central bank intervention. The Turkish stock exchange BIST 100 plummeted by 5 percent, triggering an automatic shock absorber that temporarily halted trading.

“The fall of the Turkish lira is terrible to watch”, Robin Brooks tweeted, chief economist of the International Institute of Finance (IIF), a bank think tank. “Markets are bringing the lira rate back to where it was before Agbal, which was 8.50 a dollar. This is a ‘sudden stop’ in capital flows, such as [tijdens de valutacrisis] in August 2018. The result was a deep recession at the time due to tighter financial conditions. It will be the same now. ”

The Turkish economy is highly dependent on foreign money due to the structural current account deficit. In other words, Turkey imports more than it exports. 150 billion euros in loans must also be refinanced this year, which will become more expensive due to the fall of the lira. Thanks to Agbal’s policy, foreign lenders returned, investing a total of $ 4.6 billion (3.85 billion euros) in Turkey. They are now taking their money out of the country.

Significantly, Lütfi Elvan, the finance minister appointed at the same time as Agbal, was the one who tried to calm the markets on Monday. Because he is seen as a capable bureaucrat. Elvan stated that the government will not intervene in the free market, that the floating exchange rate will be “resolutely” enforced, and that monetary policy will be supported by fiscal policies and structural reforms.

Turkey already written off

But analysts seem to have already written off Turkey. French investment bank Société Générale wrote to clients that the country is “past the point of return” and predicted that the lira would weaken to 9.70 per dollar in the second quarter. “We advise to leave Turkish assets, given the radical policy turnaround and the expected financial turmoil.”

There are doubts as to whether Kavcioglu has enough capacity and experience to lead the central bank in such turbulent times. In addition to being a professor, he is a columnist for the pro-government newspaper Yeni Safak, who last week chopped the interest rate hike on the front page because it would hurt growth and benefit “London-based owners of hot money”,

Kavcioglu wrote in February that it was “sad” to see Turkish bankers and businessmen seeking economic stability in high interest rates, while interest rates are extremely low in many other countries. “The central bank should not push for high interest rates. If interest rates are close to zero worldwide, raising interest rates will not solve our problems. On the contrary, it will deepen them. ”

These kinds of texts make the hair of economists worldwide stand out. Because Turkey does not have the scope to lower interest rates, like some Western countries. Certainly not now that the US central bank is actually raising interest rates. And the idea that high interest rates lead to high inflation sounds absurd to economists.

With Kavcioglu at the helm, many analysts expect a return to the unorthodox policies of former finance minister Berat Albayrak, Erdogan’s son-in-law. He resigned in November out of dissatisfaction with Agbal’s appointment. There is speculation about Albayrak’s return to government, possibly in his old role as Energy Minister – he remains family, after all. It was telling that the lira fell sharply with the rumors of his return.

Under Albayrak’s rule, state banks have gobbled up some $ 130 billion in foreign reserves in an effort to stabilize the lira. As a result, foreign reserves fell by three-quarters last year to a paltry $ 11 billion. If they are not replenished, or if they are used again to prevent a new lira exchange rate drop, a new currency crisis is looming, meaning that Turkey may soon be unable to finance essential imports.

Bill for Turkish citizens

Turkish citizens pay the bill. Their money is worth less and less. Inflation has risen for five months in a row and is now at 16 percent, while the end is nowhere in sight. High food prices in particular are a problem, partly due to the lack of rainfall, which means that a poor harvest is expected. In addition, the drop in the lira is felt by everyone, because products from abroad with a low lira are becoming increasingly expensive, and because Turkish companies together have hundreds of billions in debt in dollars and euros.

In a farewell email to colleagues, Agbal defended his track record, the channel reported HaberTürk. “We have done important and courageous work to ensure continued price stability. I hope our country will one day achieve financial and economic stability. ” Remarkably, Agbal thanked President Erdogan in a tweet for his resignation. This was perceived by some as a veiled criticism of the man who made his job so difficult.
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