In late November, Turkey dropped the word “independence” from its central bank mandate.
Although a few analysts and strategists attempted to downplay the omission by advising the market to “focus on the meaning rather than individual words” and despite assurances from Deputy Prime Minister Mehmet Simsek, who said “speculation over wording on central bank independence in the new government program doesn’t reflect the truth,” there’s reason to be concerned.
President Recep Tayyip Erdogan has repeatedly called for lower interest rates in Turkey and what Erdogan wants, Erdogan usually gets.
"In Turkey, the interest rates are high. Our rates are not those in the West, where they are low. First you have to reduce the cost of money. As long as the cost of money is on the rise, you can neither find young businessmen nor young businesswomen,” he said at the the G20 summit in Antalya, where central bank governor Erdem Basci was forced to look on as Erdogan the rates strategist lectured everyone, including Christine Lagarde, on monetary policy.
Put simply, some fear Erdogan may be moving to effectively hijack monetary policy at a time when the CBT desperately needs to move towards normalization.
This situation is complicated by the fact that 5 out of 7 of MPC members including the governor will be appointed between April and November. “We continue to see the appointment process as a major source of uncertainty, with the potential to generate significant market volatility,” Goldman wrote, earlier this month, adding that “the cluster of appointments coming due within the next 3-5 months means that the entire leadership of the CBRT can, and probably will, be overhauled.”
Right. And that’s bad news in the current environment. “This could have potentially far-reaching consequences for the conduct and direction of monetary policy, and thus condition Turkey's short- and medium-term macroeconomic outlook in important ways,” Goldman continues.
Remember, the lira came under heavy pressure last year in the wake of the general EM FX rout and amid a long list of idiosyncratic domestic concerns including political turmoil and what amounts to a civil war with the Kurds in the southeast.
Even as the currency plunged, the CBT did nothing to arrest the slide. Well, nothing other than announce an uninspiring “roadmap” for how the central bank planned to cope with DM normalization.
In short: Turkey needs to start hiking before the lagged pass through effects of persistent TRY weakness blow the roof off the CBT’s inflation target.
Inflation is already running well above target, as the following graphic from Morgan Stanley clearly shows:
Meanwhile, expectations are running disturbingly high:
And simply "normalizing" won't be enough because as you can see, real rates are actually quite low:
Ultimately, the takeaway is that if Erdogan gets his way and Turkey moves in the opposite direction that it should (i.e. if the newly constituted MPC eases rather than tightens), the following "vicious cycle" will continue to turn, vaporizing Turks' purchasing power faster than a Kurdish militant on a bad day in Cizre.