CBRT rate cut sowing the seeds of next currency crisis
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CBRT rate cut sowing the seeds of next currency crisis

Turkey’s central bank stepped up its fight against economic orthodoxy by cutting its one-week repo rate by 100bp, to 13.00%, despite the backdrop of inflation at 80% and an extremely poor external position. This latest move could prove to be the trigger for yet another currency crisis.
  • Turkey’s central bank stepped up its fight against economic orthodoxy by cutting its one-week repo rate by 100bp, to 13.00%, despite the backdrop of inflation at 80% and an extremely poor external position. This latest move could prove to be the trigger for yet another currency crisis.
  • The decision was completely unexpected, with all of the analysts polled by Bloomberg anticipating that the CBRT would keep rates on hold for an eighth consecutive meeting. The accompanying statement said that the monetary policy committee expects the “disinflation process to start” and that there are signs of a “loss of momentum in economic activity”.
  • More than anything, it is clear that the CBRT is taking its instructions from President Erdogan, whose unorthodox views form the basis of the government’s “new economic model” of low real interest rates. After all, headline inflation stood at 79.6% y/y in July, the highest since 1998. (See Chart 1.) And Turkey’s external position remains extremely poor.
  • Concerns about the health of the global economy have increased this year but the fall in long-term US Treasury yields in recent months has supported an improvement in global risk appetite and probably made policymakers feel that they had sufficient cover to take action today.
  • That said, the move further increases the risk of yet another currency crisis. Prior to today’s decision, the authorities had tried to keep a tight grip on the lira at around 18/$. Turkey has been in similar situations in the past and we’ve always argued that such defences are, ultimately, futile. After all, Turkey is running a wide current account deficit (more than 5% of GDP in seasonally-adjusted terms in June), short-term external debts are large ($183bn) and foreign exchange reserves perilously low – net international reserves stand at just $15.7bn. In short, the CBRT is in no position to provide sustained support for the lira.
  • Admittedly, recent reports have suggested that Saudi Arabia may be about to deposit as much as $10bn in Turkey, possibly rising to as much as $20bn. But that support, if forthcoming, will merely act as a sticking plaster over a gaping wound. Even if the authorities managed to stage a defence of the lira in the near-term, without efforts to tackle high inflation that would simply lead to real exchange rate appreciation that erodes Turkey’s external competitiveness and causes external imbalances to mount.
  • The lira dropped 0.9% against the dollar following today’s decision, leaving it down by 26% year-to-date, and we think that it will fall a lot further to 24/$ (from 18.07/$ now) by the end of this year. (See Chart 2.) The risks are clearly skewed towards larger and more disorderly falls, which will become even more pertinent if the CBRT pursues further rate cuts. Indeed, we wouldn’t be surprised if the CBRT lowers interest rates further towards 10.00% by year-end.
  • Sharp falls in the lira pose a key threat to Turkey’s financial system given corporates’ large FX debts and banks’ high short-term external debts. What’s more, measures introduced at the height of last year’s currency crisis, including an the FX-linked deposit scheme, have started to intertwine currency, banking and sovereign risks. The upshot is that, if the CBRT is to pursue further rate cuts, we suspect that it will eventually have to resort to more restrictive capital controls.

Chart 1: Consumer Prices & One-week Repo Rate

Chart 2: Turkish Lira (vs. $, Inverted)

Sources: Refintiv, CEIC, Capital Economics

Sources: Refinitiv, CEIC, Capital Economics

Jason Tuvey, Senior Emerging Markets Economist, +44 (0)20 7808 4065, jason.tuvey@capitaleconomics.com

Jason Tuvey Senior Emerging Markets Economist
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