Erdoğan’s hand-picked bank chief may cut Turkey rates too far

Turkey’s new central bank chief Murat Uysal sounded like President Recep Tayyip Erdoğan last Wednesday when he said he would take so-called “real interest rates” in other countries as a benchmark for setting monetary policy.

Erdoğan, who claims higher interest rates are inflationary, has pointed to the negative real rates offered by central banks in Europe and elsewhere since the global financial crisis. Why were borrowing costs in Turkey so high when other countries were benefitting from rates that sat well below inflation, he frequently complained.

Erdoğan installed Uysal as governor in early July after sacking his predecessor Murat Çetinkaya for failing to cut the benchmark lending rate of 24 percent to help lift the economy out of a severe downturn. The slump was sparked by a currency crisis last year. On his appointment, Erdoğan labelled Uysal as “a friend in the finance sector”.

In Uysal’s first Monetary Policy Committee meeting last month, policymakers complied with Erdoğan’s demands and slashed interest rates by 425 basis points.

Uysal said on Wednesday that there was considerable room for lower interest rates considering current market prices.

Interest rates in Turkey are at 19.75 percent and annual inflation 16.7 percent, translating to a real interest rate of about 300 basis points, or 3 percent. In the Eurozone, interest rates are zero and inflation 1.3 percent, meaning real rates are negative. In Poland the situation is similar – the central bank’s benchmark rate is at a record low of 1.5 percent and inflation was 2.9 percent in July, putting real interest rates at a negative 1.4 percent.

But when compared with major emerging markets around the world, real rates in Turkey are already roughly where they should be - they stand at between 2 percent and 4 percent in South Africa, India, Argentina and Brazil.

In Mexico and Ukraine, they are higher, with the real interest rate in Ukraine hovering around 8 percent. Argentina’s is about 20 percent. The higher borrowing costs reflect the precariousness of those two countries’ economies and the willingness of policymakers to protect their currencies and keep inflation in check.

The central banks of Turkey’s emerging market peers are also following more orthodox monetary policies than Uysal and his colleagues in Ankara. And those policies are largely accepted by the politicians in those countries. This instils investor confidence.

Turkey’s central bank, if acting in an orthodox manner, would look at inflation and say its time to keep rates on hold. If, as expected, inflation dips in August, the central bank might prudently look at reduce interest rates by 100 to 200 basis points at its next monetary policy meeting on Sept. 12.

But this is Turkey. And Erdoğan is not just political leader. He frequently asserts that lower interest rates mean lower inflation, contradicting traditional economic wisdom. And thanks to a presidential decree last summer, Erdoğan has the power to hire and fire the senior managers of the central bank if they do not follow his orders.

Erdoğan and his son-in-law, Treasury and Finance Minister Berat Albayrak, frequently point out that inflation may slow to single digits in the third quarter. They talk far less about how it will most likely pick up again afterwards.

So what exactly does Uysal mean by considerable room for lower rates? Will the central bank move towards emulating the Eurozone or Poland and slash its own benchmark rate again, a la Erdoğan?

Or will any rate cuts be measured and hence confidence in the lira, which has strengthened of late, be preserved?

Inan Demir, an economist at Nomura in London, does not see negative real interest rates in Turkey. But he says there is considerable uncertainty about the central bank’s approach. Consequently, he expects the central bank to keep the real rate at anything between zero percent and a positive 4 percent. That would translate into actual interest rates of between 14 percent and 18 percent by the year-end, should the central bank’s estimate of 13.9 percent inflation by December be correct, he said in a note to clients.

“In light of the domestic political climate, we think rate cuts towards the lower end of this interval are more likely,” Demir said.

Economists may see a more measured approach by the central bank as the most likely. But the lira’s recent gains against the dollar could encourage policymakers to go too far.

The lira hit a four-month high this week, trading at below 5.5 per dollar. And foreign financial giants such as Citigroup are still recommending that clients buy the currency. Societe Generale strategist Phoenix Kalen says the lira may strengthen to 4.7 per dollar.

With the 425 basis point rate cut seemingly having little or no impact on the lira’s trajectory, a very bold move by policymakers, backed by Erdoğan, their new employer, is certainly not out of the question.


The opinions expressed in this column are those of the author and do not necessarily reflect those of Ahval.