The Turkish lira plunged as much as 15% against the dollar following President Recep Tayyip Erdogan’s shock decision to oust the country’s central bank chief, wiping out a large chunk of the currency’s gains under his four-month tenure.
The decline put the lira within a few percentage points of a record low reached on Nov. 6, the day before ex-governor Naci Agbal was appointed. It was trading at 7.8645 to the dollar at 10:12 a.m. in Istanbul after weakening to 8.4707 in early Asian hours, when liquidity for emerging-market currencies tends to be thinner.
The decision to fire Agbal, who had sought to restore the central bank’s credibility, raises concerns that the country will again prematurely ease interest rates. Before Agbal, investors frequently criticized Turkey’s monetary authority as being too quick to undo tightening and too slow to respond to risks, most recently in August, when the lira lost about a quarter of its value.
Agbal’s policies to raise rates to tackle soaring inflation had made the lira the best carry-trade currency this year, bringing capital into Turkish markets.
“Bulls’ optimism was based on CBRT being allowed to keep rates high for some time, and after last Thursday that looked very promising,” said Henrik Gullberg of Coex Partners Ltd., who previously saw the lira appreciating beyond 6.90 per dollar. “That’s ruined now; it will be hard to find lira bulls,” he said, adding that the currency could now head back to levels when Agbal was appointed.
Agbal’s replacement, Sahap Kavcioglu, pledged on Sunday to use monetary-policy tools effectively to deliver permanent price stability. He also said the bank’s rate-setting meetings will take place according to schedule.
Kavcioglu is a professor of banking at Marmara University in Istanbul and a columnist at the pro-government Yeni Safak newspaper. The paper criticized the monetary authority’s latest interest-rate increase on its front page on Friday, saying the decision “turned a deaf ear” to Turkey’s 83 million people, would hurt economic growth and primarily benefits “London-based owners of hot money.”
In a column published by Yeni Safak on Feb. 9, Kavcioglu said it was “saddening” to see columnists, bankers and business organizations in Turkey seeking economic stability in high interest rates at a time when other countries had negative rates. He also seconded Erdogan’s unorthodox theory on the relationship between interest rates and inflation, saying that raising interest rates would “indirectly open the way to increasing inflation.”
Most economists think the opposite is true.
A rush to sell the currency as markets reopened in Asia overwhelmed support for the lira from state banks, according to a foreign currency trader familiar with the transactions, who isn’t authorized to speak publicly and asked not to be identified.
Treasury and Finance Minister Lutfi Elvan said Turkey will continue to stick to free markets and a liberal foreign-exchange regime. The government will continue to prioritize price stability, and fiscal policies will support the monetary authority in its efforts to rein in inflation, he said on Monday.
“I expect massive state bank intervention in the short term to hold a line on the lira,” said Timothy Ash, a strategist at BlueBay Asset Management in London, adding that he’s not sure where the line will be drawn. “The new governor will be dependent on utilizing the reserve bounty that the former governor left him to smooth his entry into the job.”
Hold the Line
Last year, Turkish banks spent more than $100 billion of the nation’s foreign reserves to support the currency, according to a report by Goldman Sachs Group Inc. That prompted calls by Turkish opposition lawmakers for a judicial probe into the official reserves.
In comparison, foreign investors purchased a net $4.7 billion worth of stocks and bonds in the months following Agbal’s appointment. Overseas inflows to Turkey through swaps totaled about $14 billion during that period, Istanbul-based economist Haluk Burumcekci said.
The lira had strengthened under Agbal’s watch as he ended a complicated funding structure and pledged to ensure price stability. His abrupt removal comes on the heels of a 200 basis-point interest-rate hike on Thursday, double what was expected in a Bloomberg survey, amid accelerating inflation.
What Bloomberg Economics Says
“The hit to the central bank’s credibility and independence can’t be overstated. Erdogan has battered the institution with interventions that have repeatedly backfired. Financial markets were willing to give Agbal a chance, his successor will find it hard to build that trust again.”
–Ziad Daoud, chief emerging markets economist. For full REACT, click here
The lira’s weakness could add to inflationary pressures building in the economy and erode Turkey’s real rate, currently the highest in emerging markets after Egypt’s.
While Turkey’s high nominal rates are a lure for yield hunters, its mercurial inflation and the perception that central-bank policy has been too loose has made the lira one of the most volatile currencies in the world.
Among those who find themselves on the wrong side of the trade are Japanese retail investors. Long positions made up almost 86% of the total lira-yen positions traded on the Tokyo Financial Exchange on Friday, the most among 14 major currency pairs, based on the latest data compiled by Bloomberg.
“We will never know how successful Agbal’s approach could have been, but initial signs were positive,” said Emre Akcakmak, a portfolio adviser at East Capital in Dubai, who anticipates a reversal on some of the recent hot money inflows.
“Even when the market stabilizes after a while, investors will have little tolerance, if any, in case the new governor prematurely cuts the rates again,” Akcakmak said.
(Updates with more details on markets from the third paragraph.)
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