Tough talking in Turkey
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Emerging Markets

Tough talking in Turkey

Turkey’s central bank governor Durmus Yilmaz sticks to his guns as markets gear up for the remainder of a turbulent election year

Durmus Yilmaz, governor of Turkey’s central bank (CBRT), has good reason to be nervous. Weeks after he took office in 2006 – after a fraught selection process in which the first nominee was ignominiously dumped – Turkish markets hit a bout of volatility that caused the lira to depreciate by more than 20%. This drove up the cost of imports and inflationary expectations, and prompted the central bank to hike its overnight borrowing rate by a cumulative 425 basis points, to 17.5%. Now, Yilmaz is contemplating the heady atmosphere ahead of the parliamentary election that has been brought forward to July, from November 2007.

It is hard to forget that, in the lead-up to Turkey’s last parliamentary election five years ago, the lira lost 30% of its value at one stage. Has his baptism of fire in 2006 prepared Yilmaz to face this challenge, and can Turkish markets ride out this election campaign?

The 60-year-old central banker is quick to point out that his experience at the CBRT stretches back almost three decades, and has witnessed periods of financial chaos that made 2006 look like a very calm year by comparison. He also disputes the contention that Turkey’s high current account deficit ($2.9 billion in March 2007) renders the lira particularly vulnerable.

“Eastern European deficits are [relatively] higher, although those countries have the EU anchor. What happened in 2006 was not the result of a new risk in Turkey, but a repricing of risk centring on global growth. Investors were not very reasonable,” Yilmaz tells Emerging Markets.

Stronger

He is confident that the Turkish economy is more resilient than in 2002, when interest rates started at an eye-watering 59%, with greater foreign exchange liquidity in the market today. “Of course, there might be more volatility. But since 2001, there have been eight tremors. The first in 2001 lasted about 160 days, the most recent in February 2007 only nine days. The market has always returned at least to its previous level, and each oscillation was shorter than the one before.”

The signs so far support his contention. The lira lost around 2% of its value during the tensions surrounding the ruling AKP’s failed attempt to elect foreign minister Abdullah Gul as president, but has since partially recovered, while volatility options on the exchange rate have not increased in value, and one-year lira interest rate swaps have tightened by around 80 basis points year-to-date, suggesting growing investor confidence that the CBRT may not have to hike rates to stabilize the lira this time around.

The key element that helped the market recover from the brief uptick in volatility during the dispute over the presidency was the ruling AKP’s decision to bring elections forward. This provides the party with the opportunity to seek a firm democratic mandate, potentially strengthening its hand in the awkward relationship with the country’s staunchly secular military, which had made thinly-veiled hints that it was ready to intervene politically if the AKP moved too far on its Islamist agenda. Gul also withdrew his candidacy for the presidency, opening the possibility of a less controversial candidate, and warned that the AKP should avoid polarizing the country by confronting the military.

However, the election outcome is still a key source of uncertainty, following a Sonar opinion poll on May 7 which suggested at least five parties will cross the 10% threshold required to win seats in parliament, compared with just two in 2002. This opens the possibility of “a fractured parliament susceptible to ideological horse-trading to make up workable numbers” to form a majority government, says Cem Akyurek, the director of economic research at Global Securities in Istanbul. The outlook for continuing the economic reforms that have strengthened the resilience of Turkish markets under the AKP is therefore clouded. Leading members of the main opposition party, the CHP, have criticized bank privatizations, high interest rates and resulting “hot money” inflows [see facing page]. This serves as a reminder that the role of central bank governor in Turkey has not been made easier over the years by the constant commentary from politicians, epitomized by the disputes that preceded Yilmaz’s own nomination.

Independent stance

Yilmaz is unmoved by this. “Had I been the first person put up for approval by the president, even then, the markets would have tested me,” he tells Emerging Markets. He is determined to keep distance between the CBRT and ongoing political debates. “[Political] parties run the country, but the central bank was made independent because of the time inconsistency in economic management. That independence is written in law, but that is not enough. It must also be in the mind of the governor.”

Against this backdrop, he is wary of easing interest rates too early, even in the current climate of relative market stability. “We are an inflation-targeting central bank. Our mandate is to achieve price stability, and everything else is secondary,” he says. He focuses on the “substantial” rise in end-year inflation expectations, which have gone from less than 7.0% at the start of 2007 to almost 7.8% in May, according to CBRT surveys (compared with actual inflation of 10.72% year-on-year for April 2007).

Given the relatively weak picture for consumer demand, however, Yilmaz believes the persistence of high expectations is partly the result of pre-election uncertainty, in addition to the strength of global energy prices. He remains confident that both inflation and expectations will enter a downtrend in the second quarter of 2007, as the impact of the 2006 lira depreciation begins to drop out of the index.

Of course, the emergence of a stable government from the July elections would steady the nerves and assist the central bank’s cause, but Yilmaz expects no favours from any quarter. “Credibility is not given; it is gained.” If the CBRT steers its way through an election year successfully, his own credibility may well be enhanced.

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