This Turkey should not be pardoned
This is not a repeat of Turkey in 2018
International banks have historically stood by Turkey in times of distress, with syndicated loans still being signed even in the aftermath of an attempted coup in 2016. That loyalty is admirable but it needs to be rethought after Turkey’s President Recep Tayyip Erdoğan forced the central bank to cut rates last week.
The CBRT slashed its one week repo rate by 100bp to 15% on Thursday, despite inflation running at around 20% in the country. Erdogan believes that high interest rates cause inflation, rather than subscribing to the commonly held view across the world that the opposite is true. As a result, the lira has lost nearly one fifth of its value against the dollar since the start of last week.
This should give international banks lending money to the country pause for several reasons. Firstly, these banks’ own economists disagree fundamentally with Erdogan, so believe he is making a huge misstep. Secondly, even if Erdogan were right, the way he has forced Turkey’s central bank to reflect his views in its policy decisions means the CBRT has lost any veneer of independence.
While this situation may not have the drama of a coup d’etat, it is arguably more concerning for the country’s finances and long term stability. And a weakening currency in a heavily dollarized economy such as Turkey’s will be felt immediately by the entire population.
Some analysts are suggesting that the discontent may become so strong as to force Erdogan out of office in 2023. They go further, saying that this would actually be beneficial for the country, as Erdogan is increasingly seen as a source of volatility. But this analysis leans heavily on the assumption that free and fair elections will take place.
In 2018, when the rumblings of the battle over Erdogan's unorthodox economic views on inflation were first heard, the lira tumbled. In response, the CBRT raised rates, much to the relief of international investors. The disaster was averted.
But this time, banks need to accept that the disaster is not being squared up to. Erdogan asserted again on Tuesday that he was fighting an "economic war of independence". It seems unlikely there will be any winners in this fight anytime soon.
Syndicated lending is an important source of funding for Turkish issuers, such as the country's banks. But the lenders extending the loans are playing a dangerous game. At a minimum, pricing needs to widen. Some risk and compliance departments may be considering whether lending should be withdrawn altogether.
There is little sign of this so far. More than three dozen banks recently participated in a roughly €725m equivalent sustainability-linked term loan for İşbank, Turkey's largest private bank. But that deal was signed before last week's interest rate cut.
As Erdogan made his move, the risks of investing in Turkey rocketed. Though banks are hesitant to pull back from these borrowers because of the potential for more profitable dealings, banks lending to Turkey, its corporations and financial institutions, need to take a hard new look at how the situation this week affects their appetite for this business.