On Thursday, September 13th, the market was pleasantly surprised when the Turkish Central Bank (CBRT) boosted the benchmark rate for the lira by 625 basis points. Although given the market conditions in the country at the time, a significant tightening of policy would have been expected, there was a growing consensus that the central bank was losing its independence to the country’s President, Recep Erdogan.
Just hours before the release of the CBRT’s policy decision, Erdogan had reiterated his stance that interest rates were too high. The drastic move by the CBRT was both in line with what analysts wanted and showed that the bank still maintained independence. The move helped restore some confidence in the Turkish economy.
How did we get here?
Many analysts have been concerned for months about what is seen as a consolidation of power in the figure of the Presidency, under Erdogan. He was recently elected with a mandate to reform significant portions of the government, with many detractors pointing to authoritarian policies.
Erdogan has been critical of the role of the Central Bank for years, and many saw his reelection as an opportunity for him to chip away at, if not eliminate, the independence of the central bank. The lack of independence of the financial regulatory institutions would provide significant uncertainty in the market, and make potential foreign investors more nervous.
At the first meeting following Erdogan’s reelection, the CBRT did not raise rates as much as expected by analysts, which was broadly interpreted as a sign that the bank had lost its independence. It led to a significant sell-off of the lira, reaching record lows before recovering slightly.
Turkey and the United States
In parallel, in terms of foreign policy, Turkey was seen moving away from its NATO allies, and in particular, having increased friction with the US. Tensions flared up following the 2016 attempted coup in Turkey, which Erdogan loyalists blamed on an opposition cleric, Gulen, who resides in the US. The US refused to extradite him, and earlier this year, Turkish authorities arrested an American pastor, Brunson – largely seen as a move by the Erdogan government to pressure the US into extradition Gulen. However, the Trump administration applied steel and aluminum tariffs on Turkish exports instead, putting additional pressure on the already shaky Turkish economy.
The combination of these factors has led to a loss in business confidence in Turkey, with a corresponding impact on businesses exposed to the financial situation (among them, for example, major Spanish bank BBVA), and the worry of contagion in the periphery.
Although the move by the CBRT has returned some confidence in the independence of the central bank, Erdogan has stepped up his rhetoric against financial institutions, calling the decline in the lira an “economic assassination attempt”. Tensions still remain with the US, not just over extradition, but US support to Kurdish rebels, as well as Turkish policy in Syria, among other concerns. Additionally, Turkey continues to apply regulations to the forex market, and push firms to keep their cash in lira instead of foreign currency.
While many might see the CBRT’s move as a relief over mounting fears, there remain many other factors at play that could keep investors worried. While the bank has vowed to keep monetary policy tight, some analysts expect further measures are needed to bring inflation under control – measures that will likely be contrary to Erdogan’s wishes, and just today he said his “patience is to a point”. What that means, we’ve yet to see.