If you had any doubts as to whether Recep Tayyip Erdogan’s extraordinarily ill-advised (if wholly predictable) decision to fire central bank governor Murat Cetinkaya earlier this month presaged rate cuts and a return to Erdogan-o-mics, you can put them to bed.
“We aim to reduce inflation to one digit by the end of this year”, Erdogan said Sunday in Istanbul. “As we achieve this, we will achieve our year-end interest rate target as well”.
With all due respect to his excellency, no, “we” likely won’t. Depending on the external environment, it’s possible Erdogan will be proven correct, but it wouldn’t be because his unorthodox views on the relationship between rates, FX and inflation were borne out. Rather, it would be a happy coincidence attributable to, for instance, the avoidance of another diplomatic row with Washington and a favorable backdrop for emerging market currencies in general, perhaps due to a dovish Fed in the US.
At this point, Erdogan’s penchant for insisting that lower rates are consistent with lower inflation is a bad joke. It’s been going on for so long that it would scarcely bear mentioning were it not for the fact that an outright crisis in Turkey has the potential to roil the EM complex more broadly, not to mention spill over into a fragile Europe.
Turkey was downgraded by Fitch on Friday afternoon thanks in no small part to Erdogan’s latest broadside against CBT, which the agency says “risks damaging already weak domestic confidence, jeopardizing the inflow of foreign capital needed to meet Turkey’s large external financing requirement and worsening economic outcomes.” The move came a month (nearly to the day) after the Moody’s downgrade.
As we and plenty of others have emphasized, Erdogan’s latest assault on the central bank comes at a particularly inopportune time. For one, firing Cetinkaya was a slap in the face to everyone who thought the results of the Istanbul re-run might presage a more conciliatory stance from the Turkish autocrat on other issues. For another, it heightens the risk that US sanctions associated with the S-400 dispute will catalyze another bout of severe currency depreciation.
Late last week, Turkey took delivery of the first parts from the Russian missile systems, putting Washington in a bind, and prompting a 2.3% selloff in Turkish stocks – the week was pretty much a wash prior to Friday’s losses, which was saying something considering it could have been much worse given the CBT news.
Trump’s overtures in Osaka suggested the administration is loath to hit Erdogan with sanctions that could cripple the Turkish economy, but not responding would risk emboldening Ankara further. Turkey will surely have to be expelled from the F-35 program – for good. Parking the jets anywhere near the Russian systems would presumably represent a serious security risk for NATO.
“Both the State and Defense departments support imposing the harshest sanctions on Turkey, which could include cutting Ankara off from the US financial system, but Trump, whose personal relationship with Erdogan has made for some unexpected policy shifts, could choose to delay implementation of the sanctions—or try to waive them altogether”, Foreign Policy writes, before noting that the US president’s revisionist history about Erdogan and the Patriot systems isn’t entirely accurate (imagine that). “Turkey actually passed over the Patriot twice before the most recent offer, which included better terms both on pricing and on coproduction [and] both times, the deals fell apart because Ankara insisted on a transfer of the missile technology, something US officials declined to do”.
The State Department and the Pentagon continue to insist that America’s position hasn’t changed, but clearly it has – or at least if you define “America” as “Trump”, who, according to Erdogan’s account of the Osaka bilateral, gave Turkey his word that sanctions “would not happen”.
According to Bloomberg, the US has decided on a sanctions package to punish Turkey, but the announcement was delayed to avoid coinciding with the anniversary of the 2016 coup attempt, which Erdogan’s allies variously blame the US for playing a role in orchestrating. “The administration chose one of three sets of actions devised to inflict varying degrees of pain under the Countering America’s Adversaries Through Sanctions Act”, Bloomberg said Saturday, adding that “by law, Trump needed to pick at least five out of 12 different sanctions — ranging from mild to harsh — under the sanctions act, once delivery was certified”.
Suffice to say Sunday’s rhetoric from Erdogan on rate cuts isn’t going to do Turkish assets any favors at a delicate juncture, as it just underscores the fact that, to quote an opinion piece by Bobby Ghosh, “you can’t keep a good autocrat down”.
For those interested, there’s a long Twitter thread from MEE’s Ragıp Soylu that’s perhaps worth reading – you can start with these:
No genuine effort shown by both sides to resolve the S-400 crisis. Both thought the other was bluffing.
• US was wrong to underestimate Turkey’s resolve. Failed to understand Turkey’s security concerns
• Turkey needed to see that S-400 is a genuine threat to F-35
— Ragıp Soylu (@ragipsoylu) July 12, 2019