Turkey Promises New Era of Tight Policy, Higher Reserves

Turkey’s central bank chief promised to go all in to curb inflation and build up national reserves, a continuation of the orthodox policy guidance he has built since taking over last month.

Turkey will tighten monetary policy when warranted by price developments, and increase its holdings of foreign assets without derailing the lira, Governor Naci Agbal said in a video conference on Wednesday.

Agbal’s comments underscore Turkey’s shift to the monetary policy mainstream following a year of rapid interest rate cuts by his predecessor that resulted in rapid credit growth and a weak currency. The governor already increased borrowing costs at the first central bank rates meeting he led in November, and simplified the bank’s funding channels by providing cash to lenders mostly through the one-week repo mechanism. But inflation remains high, fueling calls for another policy step at the Dec. 24 meeting.

“A set of hawkish comments from Governor Agbal most likely will raise market expectations that the central bank may end an eventful year with a rate hike” next week, said Piotr Matys, a London-based strategist at Rabobank. “The risk is that if Governor Agbal boosts expectations for a rate hike and fails to deliver, this will dent his credibility, which he cannot afford to do at this very early stage of being in charge of the central bank.”

Skeptics Everywhere

Agbal faces a daunting task in convincing markets of his orthodox credentials after years of policy missteps by his predecessors and a failure by the bank to hit the official inflation target since it was set at 5% in 2012.

Investors have put much of the blame on political pressure for cheaper borrowing by President Recep Tayyip Erdogan, who believes higher interest rates push up inflation. Most economists and central bankers around the world believe the opposite to be true.

The president sacked two bank governors in as many years, at least one of them over a failure to comply with his wishes for lower borrowing costs.

In response to repeated questions on whether he is free to do whatever it takes to curb inflation, the governor tried to tread a fine line to appease the investor community without personally taking on the president.

“It’s been my principle to act in a rational, right and realistic way in every office I held,” said Agbal, a finance minister until July 2018. “I’m also a person who believes that if I set an objective, I need to walk my path with a view to convincing everyone of that objective and taking everyone on board.”

Reserves Policy

A key element of next year’s policy mix will be to amass foreign reserves without destabilizing the lira, Agbal said. The bank will be on the lookout for a change in the dollarization trend in bank deposits as well as stable capital flows into Turkey’s economy before direct FX purchases can be considered.

A detailed plan on how and when reserves can be rebuilt will be unveiled later, Agbal said. Wall Street banks including the likes of Goldman Sachs Group Inc. estimate the central bank has spent tens of billion of dollars to defend the lira over the past year, thinning foreign reserves.

“This is going to be very difficult as rebuilding reserves means weakening the lira, all the rest being equal,” said Cristian Maggio, head of emerging markets strategy at TD Securities in London. “And the lira seems to have reached a point where it struggles to appreciate further.”

The lira is this year’s second-worst performing emerging market currency tracked by Bloomberg even though it trimmed some of its losses after Agbal’s appointment and Berat Albayrak resignation as treasury and finance minister.

The currency appreciated on the governor’s comments Wednesday and was trading 0.6% stronger at 7.7912 per dollar at 1:07 p.m. in Istanbul.

©2020 Bloomberg L.P.

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