In Turkey, An Autocrat Goes All-In

After years spent living in denial, emerging market watchers finally came around to the reality that Recep Tayyip Erdogan is an incorrigible autocrat.

Market participants accepted that characterization in the geopolitical context, but habitually failed to extrapolate what it meant for domestic economic policy and, by extension, the lira.

Too often, we lament Erdogan’s “unorthodox” views in terms that suggest we believe his pursuit of self-evidently dangerous policies is motivated by a steadfast belief in heterodox economics. But whether Erdogan actually believes lower rates are the cure for a weaker currency and inflation is largely irrelevant. What matters is political expediency. And in autocracies, heads of state aren’t obliged to observe decorum in pursuit of their agenda.

Over the last three months, Erdogan went all-in, forcing CBT governor Sahap Kavcioglu to deliver a trio of consecutive rate cuts despite surging inflation, culminating in a series of new record lows for the currency.

Read more: Lira Collapses As Erdogan Flirts With Outright Calamity

The situation crescendoed on Wednesday, when CBT intervened in the market for the first time since 2014 citing “unhealthy price formations.”

The surprise move helped. For a few minutes. But it wasn’t long before the lira was back near the lows. Just hours later, Erdogan removed finance minister Lutfi Elvan in favor of Nureddin Nebati, a deputy minister close to Berat Albayrak, Erdogan’s son-in-law.

Albayrak presided over the economy from mid-2018 until November 2020, when he stepped down as part of the shift that brought in Naci Agbal as CBT governor, a rare moment of sanity which temporarily stanched the lira’s bleeding and restored faith in the currency. Agbal was replaced by Kavcioglu in March, opening the door to the current debacle (figure below).

At the risk of stating the obvious, the situation is dire.

But not according to Erdogan, or new Treasury and finance minister Nebati, who on Thursday said Turkey has “entered a new path.” The country, Nebati said, is targeting economic independence and will ensure policy is consistent with Erdogan’s novel approach to economics and exchange rates.

Sometimes, it’s difficult to communicate how tragically comedic this is. Most readers aren’t intimately familiar with Erdogan’s history of pushing his agenda on the central bank in a single-minded pursuit of growth, but suffice to say markets are currently witnessing one man’s vision taken to its illogical extreme. This was always the end game, it just took years to get here.

Earlier this week, Erdogan explicitly abandoned any pretense to caring what markets “say” about his policies. On Tuesday, in a truly hilarious interview with TRT, he promised to break the “vicious cycle” of hot money flows. “There’s no turning back from here,” he declared, adding that rates will fall “markedly” until the next elections.

Inflation will slow as rates fall, Erdogan went on to muse. Spoiler alert: No, it won’t. Price pressures in Turkey are unrelenting (figure below) and the lira’s historic slump is making the situation worse by the week.

Even if Erdogan were somehow right about the interplay between rates and inflation (he’s not, in part because, unlike advanced nations which issue reserve currencies, economic orthodoxy does apply to emerging markets like Turkey), FX pass-through is a killer.

Erdogan is probably right to assert that it’s not ideal for lira strength to be solely predicated on hot money. But the notion that Turkey can simply declare itself economically independent and only welcoming of foreign capital if it intends to stick around for a while, is an extremely perilous gambit.

Although he claims the central bank can intervene when needed, that’s not necessarily true. Its reserves are finite, all gimmickry aside. Colloquially speaking, what you see in the first visual (above) simply isn’t sustainable. And at some point, it’s going to be a problem for the broader market.

Currently, traders and investors have more pressing concerns, but do note that one of those concerns (the prospect of a more hawkish Fed) has implications for the lira. In 2018, when Erdogan consolidated power and tempted fate by encroaching further on central bank independence while simultaneously irritating Donald Trump, Jerome Powell was busy hiking rates. That hawkish bent exacerbated pressure on emerging market assets.

Although US monetary policy is much looser now than it was then, the combination of a faster taper, a shorter road to Fed liftoff and Erdogan’s reckless abandon could easily escalate into a crisis.

This isn’t something most “regular” market participants fret over, but it’s worth keeping yourself at least loosely apprised.

“Headline CPI will likely close in on 30% YoY over the coming months, while money moves out of the Turkish banking system,” SocGen’s Phoenix Kalen said, late last month.

“The pain threshold is now much higher… given Erdogan’s entrenched opposition to raising rates and — in our opinion — his greater sway over the direction of monetary policy,” she went on to write, before suggesting that eventually, “it’s possible that some soft forms of capital controls” will be necessary.