A critical juncture: Erdoğan, Fed concerns crush lira despite central bank efforts

Published March 12th, 2015 - 08:07 GMT
The lira fell to as low as 2.6462 against the greenback early on Tuesday, just shy of a record low hit last Friday at 2.6475.
The lira fell to as low as 2.6462 against the greenback early on Tuesday, just shy of a record low hit last Friday at 2.6475.

Turkey's lira maintained its weak position against the US dollar on Tuesday, despite efforts by the central bank to defend the currency. 

The lira fell to as low as 2.6462 against the greenback early on Tuesday, just shy of a record low hit last Friday at 2.6475. The lira was the worst-performing emerging market currency against the greenback on Tuesday, according to Reuters data. The lira has lost nearly 12 percent of its value against the dollar so far this year on expectations that the US Federal Reserve (Fed) will raise its interest rates, reducing appetites for riskier emerging-market assets, and government officials' criticism of central bank policy after it did not rapidly cut its rates. 

Benchmark index Borsa İstanbul (BİST) fell more than 3 percent to 78,167 points, lagging behind emerging markets peers later on Tuesday. Efforts to defend the lira by the central bank did little to lift it from record lows on Tuesday, outweighed by a globally strong dollar and concern about President Recep Tayyip Erdoğan's intervention in monetary policy. 

In a complex series of steps, the bank said it would adjust its reserve requirements -- used to control the amount of dollars in the market -- to temporarily boost forex liquidity by some $1.5 billion over the coming weeks. The lira continues to remain weak partly as expectations of a US interest rate hike pushed the dollar to multi-year highs. Its falls have been exacerbated by Erdoğan's demands for sharp interest rate cuts to boost growth ahead of the June 7 election. That has tied the central bank's hands, leaving it unable to contemplate a rate hike and trying instead to defend the currency with policy adjustments on the margins. "In this environment countries don't need to give investors any excuse to sell," said Timothy Ash, head of emerging markets research at Standard Bank in London. "In Turkey's case we have an administration that thinks it is cleverer than everyone else, and the market ... Turkey needs to get back to plain vanilla policy [and] the government needs to back off from the central bank," he wrote in a note. 

There is little immediate sign of that happening. Central Bank Governor Erdem Başçı was due to meet with Prime Minister Ahmet Davutoğlu and nine cabinet ministers later on Tuesday and will brief Erdogan on the latest developments on Wednesday. Economy Minister Nihat Zeybekci, one of the cabinet's most vocal critics of the central bank, said on Tuesday it should have cut interest rates before its last meeting in late February. The cost of insuring exposure to Turkish debt rose to 11-month highs, with Turkey's 5-year credit default swaps (CDS) rising by 227 basis points, bankers said. 

The benchmark 10-year government bond yield rose to 8.36 percent from 8.28 percent on Monday, while the main İstanbul stock index was down more than 2.7 percent, again lagging behind emerging markets peers. 

Başçı tries to sidestep Erdoğan pressure 

Başçı -- a technocrat reluctantly thrust into a standoff with Erdoğan -- appears to believe he will eventually ride out the storm. 

In his shoes, many bank chiefs might have already quit. Erdogan's relentless demands for sharper interest rate cuts, his assertion that the bank is under outside influence and his equating of high rates with treason have left Basci struggling to restore investor confidence. 

Yet those close to the former professor -- who is respected in the world of finance for his command of economic theory -- say he is optimistic that Erdoğan's rhetoric is little more than populist theatre before the parliamentary election due in June. While reluctant to talk politics even in private, Basci has made it clear that he does not plan to stand down, saying last month that a public duty must be performed for the full period in which it is assigned. 

Economic growth, a pillar of the ruling AK Party's electoral strength over the past decade, is flagging. Industrial production fell more than 2 percent in January, data showed on Monday, adding weight to Erdogan's case against Başçı. "He is cornered," said Selin Sayek Boke, deputy chairwoman of the main opposition Republican People's Party (CHP), who like Başçı taught economics at Ankara's Bilkent University. "If he resigns he is going to be blamed for bringing havoc to the financial markets. If he does not resign, he will be blamed (for stalling growth)." 

When the central bank lowered its main rate in January to 7.75 percent, government ministers immediately said the 50 basis point cut was not enough to support growth. But with the lira tumbling to record lows last week and inflation stubbornly above target, Başçı will likely attempt to convince Erdoğan of the need to keep monetary policy tight. "I think Başçı is living under an illusion. He's still not resigning. He's assuming Erdogan can be persuaded and the tension can be eased after the parliamentary election," said one source familiar with thoughts being shared inside the central bank. 

Others in the institution fear Erdoğan's statements will only intensify and "spin out of control." "[Some] think this is a political maneuver by which Erdoğan aims to put the blame for the deterioration in growth and rising inflation on somebody else, and claim that the economy got worse because they didn't listen to him," the source said.

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