Who runs Turkey’s central bank?

At the first gathering for economists since central bank governor Naci Ağbal was sacked and replaced by Şahap Kavcıoğlu, the new governor’s speech seemed little different to the one likely to have been given by his predecessor.  

Those who only knew Kavcıoğlu from his column for Yeni Şafak newspaper, and therefore thought he believed interest rates should be lowered to reduce inflation, an unorthodox economic theory also promoted by President Recep Tayyip Erdoğan, were left even more puzzled about what to expect from the new era.  

Kavcıoğlu began his speech with the need for tight monetary policy, echoing remarks he had made two days earlier to the central bank’s ordinary general assembly that the policy rate would be kept above inflation. He further emphasised that expectations of an immediate interest rate cut were misplaced, again repeating the stance he had set out at his last meeting with economists and investors, where he insisted that both the current and expected rate of inflation would be taken into account in determining policy.

When Kavcıoğlu said a continuation of the central bank’s institutional stance was essential, he meant Ağbal’s monetary policy, which partially extinguished the fire engulfing the Turkish lira, without referring to his predecessor by name.

The new governor said interest rate decisions would be made based on data from the central bank’s technical team, and that tight monetary policy would not be abandoned without a permanent decrease in inflation. Emphasising an adherence to the medium-term 5 percent inflation target, he said international developments would also be taken into account, referring to rising U.S. bond yields and commodity prices.

Following Kavcıoğlu’s speech, the central bank's technical team made an inflation-focused presentation. Highlights from the impressive address included analysis that showed domestic demand had remained strong in the first quarter of 2021, as reflected in bank loan data after COVID-19 restrictions were eased at the beginning of March. Stronger domestic demand had also driven imports, the team said.  

Continued growth in domestic demand, however, is not compatible with the central bank’s medium- and long-term inflation target. This situation, combined with the 13 percent devaluation in the lira following Ağbal’s dismissal, will likely carry consumer price index (CPI) inflation to worrying new heights in April-May.

Similarly, the central bank’s "institutional" approach means continuing a tight monetary policy to balance the value of the lira. But this is likely to lose power after creating an inflationary wave. Another fact to come out of the meeting was that the central bank’s next inflation report, due at the end of April, may include an upward revision to its year-end expectation of 9.4 percent CPI inflation following the increase in global commodity prices.

After his focus on institutionalisation, it was interesting to hear Kavcıoğlu reply to a question by emphasising that his conduct would be based on continuity as central bank governor, rather than the position he set out in previous articles for Yeni Şafak. "Please do not look back” he said.  He also refrained from directly answering another question on whether he would deliver more interest rate hikes if needed, leaving the door was open to the move.

The lira’s positive movements following the meeting show the market is united in not expecting an early interest rate cut, at least not before the central bank’s next policy meeting on April 15. However, many questions remain unanswered.

With CPI inflation likely to accelerate to 20 percent in April-May, will Kavcıoğlu be able to raise interest rates at that point? If not, how will he control the lira when the market starts pushing for more rate hikes?

Kavcıoğlu was criticising Ağbal for raising interest rates two weeks ago in his newspaper column. How much will the markets believe his opinion has changed 180 degrees now that he is governor?

After foreign investors fled market uncertainty in Turkey incurring significant losses, how will Kavcıoğlu convince them that he is sincere in his commitment to tight, transparent monetary policy?

How will the governor convince foreign investors that he is not just saying what investors want to hear, that he will resist an early rate cut even if President Erdoğan instructs him to do so?

Will he be able to explain whether public banks have intervened in the currency markets in order to counter the heavy lira sales over the last two weeks?

Will he be able to make a reasonable response to the reported undisclosed sale of 128 billion dollars in central bank reserves under former Finance and Treasury Minister Berat Albayrak amid new stories Ağbal was fired for planning an investigation into the issue?

And the most important questions: Since Kavcioğlu is determined to continue the monetary policy of the Ağbal period, is he aware of the reasons for his own appointment by Erdoğan and how long he is likely to hold the position?

Or will the Turkish economy have to face another ‘shock’ central bank governor change in the not too distant future?