Turkey could stop its currency collapsing in value by hiking interest rates by as much as 10 percentage points, according to multiple analysts.
Unfortunately, that looks unlikely given that President Recip Tayyip Erdogan is exerting influence over the country's central bank and has publicly attacked interest rates as "evil."
The Turkish lira fell 25% against the dollar last week and is down another 1% on Monday morning, having fallen as much as 10% in earlier trade. The currency has been hit by tariffs levied by the US, a widening current account deficit, and fears over what Erdogan's growing influence over the Turkish central bank could mean for monetary policy.
Analysts agree that the easiest way for Turkey to soothe its currency crisis would be to raise interest rates. Inflation is currently running at a 14-year high in Turkey, close to 16%. The benchmark interest rate, meanwhile, is 17.75%. It means there is little incentive for investors or savers to leave their money with Turkish banks, and that is exacerbating capital flight.
"Looking at different measures of real rates (using current CPI, or different forward-looking measures) we think a rate hike of 350-400bps to 21.25%-21.75% from 17.75% looks consistent with real rate levels that in the past helped to stabilize the currency," Gyorgy Kovacs, UBS' chief economist for emerging EMEA markets, said in a note on Friday.
Other analysts believe a rate hike as high as 10 percentage points could be necessary. Exotix Capital, a specialist emerging market investment bank, said in an email on Monday: "International investors would like to see the same actions taken in Argentina recently: much higher interest rates (e.g. a more than 10 percentage point hike), a commitment to address inflation and improve fiscal performance, and engagement with multilateral lenders such as the IMF."
For context, a routine interest rate change in a large economy with a stable currency would be 0.25%.
JPMorgan's John Normand wrote in a note on Friday: "Our EM colleagues’ view is that a sufficient policy response to the negative spiral in TRY would be (a) 5-10% in policy rate hikes, (b) a fiscal package to backstop banks, (c) targeted fiscal support for distressed sectors, and (d) a policy framework that signals acceptance of the need for deleveraging and possibility of recession."
Unfortunately, Turkey is unlikely to get the rate hike that analysts agree it needs. President Erdogan earlier this year said: "Interest rates are the mother and father of all evil," and he has recently been exerting ever greater influence over Turkey's central bank. In 2017, he argued that high interest rates actually cause inflation (they do not).
"The fresh negative round of news started when the central bank decided not to hike the interest rates at its monetary policy meeting on 24 July," Nordea analysts Morten Lund and Tuuli Koivu said in a note to clients on Friday. "The market reaction has been strong partly because the central bank decision was probably affected by President Erdogan and the independence of the Turkish central bank is under question."
Nomura analyst Craig Chan and his team agree, writing in a note on Friday: "TRY is likely to remain under pressure until the TCMB [Turkey's central bank]’s credibility is restored.
"The way to build credibility, we believe, is still relatively straightforward: no pause in the tightening cycle as long as inflation keeps accelerating."
Erdogan's solution so far has been to try and put political pressure on the US by accusing it of waging economic "war" and urging Turkish citizens to sell gold and US dollars in favour of the lira.
Analysts believe that if Erdogan continues to rule out an interest rate hike, Turkey may be forced to implement capital controls to stop money from leaving the country at its current rate.
The Turkish central bank pledged to maintain stability in the financial system in a statement issued early Monday morning.
"The Central Bank will closely monitor the market depth and price formations, and take all necessary measures to maintain financial stability if deemed necessary," the TCMB said.
The fallout from Turkey's lira crisis spread to Asian and European markets on Monday, amid fears of possible contagion for banking sectors exposed to the economy.
Konstantinos Anthis, head of research at ADSS, said in an email on Monday: "Ergodan's unwillingness to raise interest rates suggests that the situation might not be defused, soon extending the risk-off sentiment seen across all markets.
More on the Turkish meltdown and its impact:
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