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Another crunch decision for Turkey's central bank

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By Mariam Meskin
13 Apr 2021

Turkey's central bank once again faces a critical rates decision this week. Any whiff of a cut in rates would be disastrous for the volatility-stricken country and its access to capital markets.

No other emerging market country has gripped investors in the way that Turkey has so far this year. 

Their list of grievances lengthens by the day: ballooning inflation, lack of central bank credibility, poor monetary policy, market-unfriendly politicians, and so on.

It comes as no surprise, therefore, that Turkish assets have tumbled in recent weeks following president Recep Tayyip Erdoğan's shock sacking last month of central bank chief Naci Ağbal, who was respected in the markets.

But Turkey has the chance to redeem itself in the eyes of the investors when the central bank’s monetary policy committee reveals on Thursday its latest decision on the level of interest rates.

It will be the first meeting under its new governor, Şahap Kavcıoğlu, who in recent weeks has flitted between advocating for rock bottom interest rates and vowing to fight inflation with tight monetary policy.

If he holds the key policy rate where it is — at 19%, following a 200bp rate hike last month under Ağbal — it may be just enough to maintain what is left of investor confidence.

But if Kavcıoğlu sticks to his ideological guns, which he vocalised in articles just weeks ago and cuts interest rates, Turkey would find itself in a disastrous position. Its credibility would be shredded in the eyes of investors — some have even said it would be a "suicidal" move. 

New data this month showed that inflation still rising, up to 16.2% in March compared to 15.6% in February — far, far off the target of 5%. That, combined with a $6bn drop in FX reserves and a declining lira, which has dropped from TL7.21 to the dollar before the sacking to TL8.17 as of Wednesday, puts Turkey in a perilous position.

Cutting interest rates would undoubtedly exacerbate those trends while also limiting international capital market access even further.

But some investors say that “too much damage has been done” and even with a rate hold on Thursday, the concerns around the long-term direction of monetary policy would re-emerge soon enough. A way to dispel that speculation would be to do the unthinkable — at least unthinkable for Erdoğan — and raise rates. 

However, while a hike would go some way to remedying matters, as Ağbal showed, those who raise rates do not last long in the top job at the central bank. He lasted just 134 days in the post. Many believe his decision to raise rates was what got him sacked.

If that puts the best outcome — a rate hike — out of reach, anything less than a rate hold would be a colossal error. 

One thing is for certain, whatever the outcome, Turkey has a long way to go to heal the self-inflicted wounds to its financial credibility.

By Mariam Meskin
13 Apr 2021