Erdogan Economy U-Turn Sparks Market Euphoria — and Some Doubts

(Bloomberg) -- After more than two years of confrontation, President Recep Tayyip Erdogan signaled a cease-fire with international investors, pledging to support his new economic managers with market-friendly policies.

Erdogan on Wednesday followed the ouster of the central bank chief and the departure of his son-in-law as economy czar in recent days with a commitment to contain inflation while putting Turkey on a sustainable growth path. Turkish assets soared, as investors saw a possible green light for interest-rate increases to stabilize a currency that has lost almost half its value against the dollar since May 2018.

“Evidence has been rapidly accumulating that Turkey is eager to execute a dramatic shift in policy making back toward a more orthodox framework,” said Phoenix Kalen, a strategist at Societe Generale SA in London. “We believe that the central bank will implement a substantial interest-rate hike” next week, possibly as much as 4 percentage points to 14.25%.

The currency gained 4.6% against the dollar on Wednesday. It’s headed for its biggest weekly gain in more than a decade even after retreating 0.6% on Thursday. The Borsa Istanbul 100 Index extended its winning streak to a ninth day, led by a surge in banking shares, which helped push Turkey’s benchmark gauge to an all-time high.

Erdogan’s remarks mark a dramatic U-turn from an approach that has hammered Turkish markets the past two years. Shortly before he was sworn in under a new constitution with near-total authority in 2018, Erdogan promised to take full control of monetary policy to implement his unorthodox view that lower interest rates promote slower inflation.

It didn’t work out, especially under the weight of the global recession spawned by the coronavirus pandemic.

Currency Interventions

To support the sinking lira, Turkish banks sold more than $100 billion this year alone, according to Goldman Sachs estimates. The effort saw net foreign-exchange reserves fall by more than half to $18.4 billion while money borrowed from banks under short-term swaps reached tens of billions of dollars. The lira touched consecutive record lows last week, extending 2020 losses to over 30%.

The remarks by the 66-year-old president who has led the country since 2003 reflected those pressures. “Like everywhere else around the world, in our country it is the central bank’s job to determine and implement policies needed to curb inflation,” he told lawmakers from his AK Party.

Erdogan’s comments capped a tumultuous stretch that began when he ousted central bank Governor Murat Uysal early Saturday after a series of interest-rate increases failed to stem the lira’s decline. On Sunday evening, Berat Albayrak announced his resignation as treasury and finance minister on Instagram, citing health reasons.

Still, there were doubts about Erdogan’s change of heart and how long it will take before his electoral priorities might cause yet another policy reversal.

“Can a leopard really change its spots?” said Nigel Rendell, a senior analyst at Medley Global Advisors. “There will be a significant degree of skepticism about what Erdogan has said, which will temper some enthusiasm.”

Market Confrontation

Erdogan’s battle with markets began in earnest in 2018, a year when he was sworn in with additional powers and appointed Albayrak to the top economy position. The appointment was soon followed by a diplomatic row with U.S. over accusations against an American pastorin Turkey. The president blamed a shadowy “interest-rate lobby” for speculative attacks against the currency as the lira plunged.

Erdogan wasn’t completely unaware of the transactions involving Turkey’s foreign reserves, but the crunch came after he sought an explanation from the central bank for its September decision to raise the benchmark one-week repo rate to 10.25%, according to officials familiar with the matter.

Ensuing conversations with former Governor Uysal and other top officials including Agbal allowed Erdogan to get a fuller picture of the FX liabilities and how they compared to net reserves, they said, asking not to be identified due to the sensitivity of the matter.

Litmus Test

The president’s support is critical for new central bank Governor Naci Agbal, who will face a credibility test at his first Monetary Policy Committee meeting on Nov. 19, and new Treasury and Finance Minister Lutfi Elvan. With Erdogan saying he won’t interfere, optimism has grown that Turkey will allow interest rates to rise to offer a sufficient inflation-adjusted return.

Agbal has begun meeting top banking executives to tell them he was appointed with a mandate to lower the inflation rate, which is just under 12%, people familiar with the meetings said, asking not to be identified due to the sensitivity of the matter.

Even before Erdogan’s speech, Agbal and Elvan have been doing the rounds to convey market-friendly messages to Turkish businesses while they prepare for the rates decision.

To be sure, Erdogan’s career saw previous attempts to appease investors, which proved short-lived. Even in Wednesday’s speech, he repeated his widely discredited view that lowering interest rates will also lead to lower inflation.

“Erdogan’s priority is to consolidate support and maintain the popularity of his party,” Nihat Ali Ozcan, a strategist at the Economic Policy Research Foundation in Ankara, said by phone on Wednesday. “He is a pragmatic leader and the economy management appointed by the president are unlikely to act independently. His arguments are aimed at preventing the economy, which is badly hurt by the pandemic, from deteriorating further.”

©2020 Bloomberg L.P.