Turkish lira collapses after Erdogan set fire to central bank chief

The unrest comes after President Recep Tayyip Erdogan unexpectedly fired Naci Agbal on Friday, the central bank governor who had repeatedly raised interest rates in an attempt to tame inflation since his appointment in November. Foreign investors say the move has raised concerns that the central bank has lost its independence from political influence, diminishing the credibility of policymakers and diminishing the appetite for Turkish assets.

New governor, Sahap Kavcioglu, tried to reassure markets on Sunday by saying that taming inflation is the bank’s main goal. He also pledged to promote economic stability by lowering borrowing costs and boosting growth. Money managers are concerned that he could allow the currency to depreciate and accept increased inflation rates to cut interest rates.

“We’re really trying to gauge the level of commitment to the lira,” said Simon Harvey, senior foreign exchange analyst at broker Monex Europe. “We know in Turkey that interest rates are politically sensitive.”

The Turkish benchmark Borsa Istanbul 100 stock index fell a whopping 9.4% on Monday, setting it on track for its sharpest sell-off since June 2013 and triggering two trading breaks. The Nasdaq-listed iShares MSCI Turkey exchange-traded fund fell 17.5% in premarket trading.

The turmoil in Turkey’s financial markets pointed to the risks of investing in emerging markets, but showed soft signs of spillover for now. The Mexican peso and the South African rand fell slightly against the dollar.

Shares of the Spanish bank BBVA fell by more than 6% in Madrid. Turkey accounts for more than 10% of BBVA’s profits through its 49.9% stake in Turkish bank Garanti BBVA

according to Jefferies.

The lira has been one of the best-performing emerging market currencies this year as investors applaud the recent rate hikes. Foreign money managers had added $ 4.6 billion net to Turkish stocks and bonds in local currency during Mr. Agbal, believing that higher interest rates would help curb inflation and stabilize the lira.

Before Mr. Agbal’s appointment to the central bank, investors sold Turkish assets for much of 2020 as low interest rates and high credit expansion pushed up imports. The currency weakened, triggering multiple rounds of intervention to stabilize the lira, even as investors speculated the currency would continue to depreciate. At one point, the central bank sold its own reserves and those it had borrowed from domestic banks, to the extent that it owed more foreign exchange reserves to the banks than it owned.

Mr Kavcioglu, the fourth chief of the Turkish central bank in less than two years, is a former MP from Mr Erdogan’s Justice and Development Party and a columnist for the pro-government newspaper Yeni Safak. He has publicly sided with Mr Erdogan’s preference for lower interest rates.

Mr Agbal’s resignation came on the heels of an interest rate hike on Thursday that exceeded expectations, pushing interest rates from 17% to 19%.

The prospect of a renewed rate cut cycle under Mr Kavcioglu is worrying about the country’s outlook.

The cost of insuring Turkey’s government debt against default rose sharply on Monday, to annual costs equal to $ 476,000 for every $ 10 million in bonds over a five-year contract. That’s up from $ 306,000 at Friday’s close, according to IHS Markit, and is the highest since early November.

“It’s as complete a surprise as I can remember in more than 20 years doing this job,” said Paul McNamara, an investment director at GAM Investments in London who manages emerging market bond funds. For the past few months, he had bet on the appreciation of the lira through forward exchange contracts, which are agreements to buy or sell a currency at a predetermined rate on a specific date.

Mr. McNamara said he expects high volatility in the lira this week as he and other investors await further clarification on Mr. Kavcioglu’s policies.

Some investors were also concerned that Turkey would limit their ability to sell local assets to stop the turmoil in the market. Lütfi Elvan, Turkish Minister of Finance and Finance, issued a statement on Monday indicating that Turkey would not impose capital controls or set a fixed exchange rate.

Any interest rate cuts may not take effect immediately. In Mr Kavcioglu’s statement on Sunday, he said that the schedule for monetary policy meetings, where reference rates are set, will remain unchanged. The next meeting will be on April 15th.

“If you stick to the meeting schedule, you won’t have a meeting this week to cut interest rates, so there is a short grace period for investors,” said Kieran Curtis, emerging markets fund manager at Aberdeen Standard Investments. had bought bonds in lira under the tenure of Mr Agbal.

“The next step will certainly fail,” added Mr. Curtis. “The question was: when will the rates go down and to what extent.”

—Joanne Chiu, Jared Malsin, and Paul J. Davies contributed to this article.

Write to Caitlin Ostroff at [email protected]