Erdogan calls on Turks to support the lira, investors fear a monetary crisis

Inflation, a currency decline and rapidly depleting foreign exchange reserves: these are some of the risks that investors and emerging market economists are warning about following the resignation of Turkish President Recep Tayyip Erdogan over his ragged former central bank chief over the weekend.

The move, which had been fired for the third time in two years, caused the value of the Turkish lira to plummet But Erdogan insists the economy is fine and told his ruling AK party members in a speech on Wednesday that this week’s market volatility does not reflect Turkey’s economic reality, according to a Reuters translation.

In the same speech, however, he urged the Turks to sell their foreign exchange assets and gold and buy lira-based financial instruments, in an effort to stabilize the beleaguered currency that has lost 10% of its value since Friday.

“The return of volatility,” was the headline of a Barclays analyst note on Monday. “The risk of a currency crisis is increasing,” wrote London-based Capital Economics. It described how former central bank governor Naci Agbal, who had wanted to tackle Turkish double-digit inflation by raising the key interest rate by 875 basis points since taking the job in November, had boosted investor confidence.

But Erdogan has long been the unorthodox view that higher interest rates cause inflation and are “bad.” Analysts say it was only a matter of time before Agbal was replaced by someone more pliable to Erdogan’s views, sparking investor fears about the central bank’s lack of autonomy and an impending inflation and currency crisis.

Agbal’s replacement Sahap Kavcioglu, many Turkish experts say, has no experience in the field and has a history of criticizing interest rate hikes, raising concerns about uncontrolled inflation.

“It looks like the central bank’s efforts to combat the country’s inflation problem may be coming to an end, and a messy balance of payments crisis has (once again) become a real possibility,” wrote Jason Tuvey, senior emerging markets economist at Capital. Economics. Inflation in Turkey is at 15%, youth unemployment is at 25% and the dollar is up more than 10% against the lira since firing.

“The instant dismissal of Agbal is one of the most counterproductive government measures in Turkey’s recent history,” Erik Meyersson, senior economist at Handelsbanken Macro Research in Stockholm, told CNBC. “It will immediately erode any credibility built up during Agbal, increase the risk premium on Turkish financial assets and force the remaining policymakers to walk an even more difficult tightrope walk in the future.”

The Turkish Presidency office did not respond to a request from CNBC for comment.

When the lira fell sharply in May 2018 amid similar fears about Turkey’s monetary policy, its impact hit many Spanish and French banks, which had significant exposure to Turkish assets. Now that is less of a problem, says Can Selcuki, director of Istanbul Economics Research.

“I doubt this will lead to non-performing loans that could pose a risk to foreign banks,” he told CNBC. “The level of the lira is not unprecedented, so the company is used to this,” and those who became insolvent did so during the previous currency decline, he added.

According to S&P, the Spanish banking sector leads in terms of exposure to the Turkish public sector with $ 14.7 billion in Turkish assets, including government bonds, from $ 20.82 billion in the spring of 2018, followed by France with $ 6.4 billion, a decline of $ 7.1 billion in 2018, S&P said. Globally.

And for emerging markets, analysts also see limited spillover risk.

“You may see a limited amount of risk reduction, but I don’t think it will be contagion,” Standard Chartered’s Divya Devesh said Monday, adding that there may be some risk reduction from retail investors holding Turkish lira in Japan.

“I don’t think this has the potential to lead to wider market contagion – over the past two years, I think markets have come to see Turkey as a very idiosyncratic risk case of emerging markets,” he said.

So the rest of the world may be safer than it used to be, but Turkey seems to be on a tough path, especially if the new central bank chief maintains his subdued outlook.

“It is likely that the pressure on the TRY (Turkish lira) will increase,” Goldman Sachs analysts wrote in a note on Monday. The Turkish central bank’s previous strategy to keep the lira up was to buy more of the currency with dollars, thus burning its foreign exchange reserves.

“A restart of FX interventions similar to 2020 may be the first reaction, but the buffers are relatively low,” Goldman warned. It estimates Turkey’s gross foreign exchange reserves at $ 35.7 billion – “not big enough to support ongoing interventions, in our opinion.”

Erdogan’s move to the central bank may be the last straw for many, said Tim Ash, senior emerging markets strategist at Bluebay Asset Management.

“It’s hard to see these people ever come back – and that is hugely damaging to Turkey’s reputation among investors,” he wrote in an email Tuesday. “Those who truly trust Agbal and Turkey’s story will be punished.”