MADRID. Historically, one of the key factors that has intensified the volatility of the lira has been Turkey’s unorthodox monetary policy stance, which has accentuated the country’s dubious image among investors. Your inflation it is known to be permanently high and has been in double digits since the beginning of 2020. On the other hand, the central bank has largely refrained from tightening monetary policy and has been particularly reluctant to raise its main interest rate. This policy of keeping rates low and sustaining the lira has proven to be unsustainable, and a change is needed to avoid another currency crisis (like the one in 2018, which wreaked havoc on the Turkish economy).
Measures to curb the depreciation of the lira included a interest rate hike of 200 basis points in September, which brought the one-week benchmark repo rate to 10.25%. This was insufficient and the CBRT (Central Bank of the Republic of Turkey) did not satisfy investors when it left rates unchanged in October. In November, Turkey signaled to the international community that it was taking seriously the possibility of normalizing its monetary policy through changes in direction. Turkish President Erdogan removed the head of the central bank, Murat Uysal, and shortly after, the finance minister and Erdogan’s son-in-law, Berat Albayrak, resigned.
Under the direction of the next governor, Naci Ağbal, the central bank was proactive with raising interest rates, surprising investors on several occasions with movements in interest rates higher than expected. Shortly thereafter, in March, when the CBRT raised the one-week benchmark repo rate by 200 basis points to 19% (Chart 5) Ağbal was ousted by Erdogan and replaced by Şahap Kavcıoğlu, who has echoed criticism of the president to high interest rates.
Despite The lira depreciated 15% against the dollar following the removal of Ağbal – which we believe has already started to have an impact on higher inflation – rate hikes appear to be ruled out at this time. The key question now is when are we going to see cuts and how big will they be?
Figure 5: Turkey’s One-Week Benchmark Repo vs. Inflation Rate (2015 – 2021)
Source: Refinitiv Datastream Date: 04/29/2021
Real rates remain positive, but with inflation rising in March to 16.2% we are likely to see a pullback into negative territory in the coming months., especially considering that the CBRT seems that it will enter another cycle of easing. The expected reduction in rates is likely to reduce the attractiveness of the currency to foreign investors, especially when compared to other emerging markets that have already begun to tighten their policies.
Although we think that the improvement of the pandemic globally should be positive for risk assets, we believe that the lira will be one of the currencies that will continue its downtrend against the dollar. We believe that the change in the direction of the CBRT will cause Turkey to enter a cycle of easing earlier than expected, probably at the end of the second quarter.
This, added to the significant internal imbalances, means that we continue to anticipate declines in the currency. Due to a shift in expectations towards CBRT policy and the market reaction to the removal of Ağbal, we have revised up our forecast of the dollar / lira cross and we expect the currency to end this year at historic lows and continue to depreciate in 2022.
Enrique Díaz-Álvarez is Director of Risks at Ebury