Three factors are driving risk perceptions among financial investors and undermining the stability of the Turkish lira (TRY):
1. Public debate over economic theory
A public disagreement between economists and political authorities over the relationship between interest rates and inflation has caused concern among investors because of uncertainty over the independence of monetary policymaking in the country.
The Central Bank of the Republic of Turkey (CBRT) cut key interest rates in February. The one-week repo rate was brought down 0.25 points, while the overnight lending and borrowing rates were decreased 0.50 points. Government reactions that found the cuts insufficient have again fueled concerns about the independence of the central bank and its ability to influence the TRY in case of steep depreciation.
CLASHING PRIORITIES ARE DRIVING A DEBATE BETWEEN THE JUSTICE AND DEVELOPMENT PARTY (AKP) & THE CENTRAL BANK (CBRT)
|Position||Do not cut interest rates too soon and/or too deeply||The interest rate needs to urgently be reduced and steeply|
|Reasoning||Weakening TRY, expectations for US FED’s interest rate increase and the still high inflation would make an interest rate cut unproductive at this time||Inflation is trending down due to lower oil prices and there is a need to stimulate growth|
|High inflation||The CBRT’s legal priority is to manage inflation; the bank argues it does that by raising interest rates and curbing demand||Most government authorities have argued that interest rates are contributing to high inflation by raising costs|
|Depreciating currency||The CBRT sees currency depreciation as potentially problematic as it increases inflation||The Minister of Economy argues that the depreciation in the TRY is beneficial for Turkey’s exports|
|Easing growth||The CBRT claims to support growth by maintaining price stability, because high inflation and deflation prevent growth||Political authorities accuse the CBRT of curtailing growth by curbing domestic consumption and investment with high interest rates|
The mere existence of such a discussion, and of intensified and direct demands by the political authorities on the central bank to cut interest rates, have eroded the public image of the independence of the central bank. As confidence in the independence of economic decision making wanes and the dollar strengthens globally, the TRY has depreciated by 6.8 percent since the beginning of 2015.
2. Regulatory predictability and fairness – controversies of the Bank Asya takeover
Political concerns are infiltrating decision making regarding not only interest rates but also the fair implementation of regulations. This poses serious concerns for businesses, especially local ones.
A case that was particularly disconcerting to investors was the government takeover of Bank Asya. The bank is strongly associated with Fethullah Gulen, accused by the ruling party of forming a parallel state within Turkey’s state institutions and attempting a coup against the AKP on December 17, 2014 by releasing wiretappings that accused AKP ministers with corruption. According to the authorities, Bank Asya failed to comply with a banking law provision and this led to the takeover by the SDIF. However, the move is also viewed as part of government efforts to attack pro-Gulen associations. After the takeover, clients deposited symbolic amounts of money to the bank, to show solidarity against what they viewed as a politically motivated move.
As part of the same effort, widely perceived as politically motivated, the government had re-allocated hundreds of police officers, claiming they were pro-Gulen and conspiring to overthrow the government. The editor-in-chief of the Gulen-associated Turkish daily Zaman was arrested and later released.
3. The upcoming elections
Parliamentary elections on June 7 are partially driving the intensity of government efforts to stimulate growth and weaken credible opposition. Companies should expect these problems to intensify ahead of the elections and to affect the exchange rate for the next several months.
However, the post-election period will also carry risks of volatility. Whether the AKP will have majority seats in the parliament, how the peace process with the Kurdish factions unfolds after the elections, and who replaces the Deputy Prime Minister responsible for the Economy Ali Babacan will determine the stability of Turkey’s post-election period. Companies should be prepared to face more disruptions and currency volatility and should consider whether some level of localization could help them mitigate these risks.