Turkey’s risks are not mysteriously vanquished

The new-found enthusiasm for Turkish assets since the former finance minister Naci Ağbal took over the stewardship of the chief monetary authority barely five months ago quickly evaporated when he was suddenly removed after raising the central bank’s policy interest rate to address high inflation.

Naturally, the markets took this to be another hit at  institutional independence, resulting in a tumultuous week for Turkish equities – notably banks with Turkish exposures – and for a rollercoaster currency succumbing to another major sell-off, which is now aggravating an already deeply concerning inflation outlook.

Yet none of this was entirely surprising to risk analysts, who have seen a conveyor belt of Central Bank of Turkey governors ousted since 2019 and were still warning of the considerable risks to investors.

Turkey’s score in Euromoney’s risk survey continued to fall in 2020, extending a trend decline that has seen the country nosedive in the global risk rankings to 94th out of 174 countries.

That has put it firmly into tier four (of five), a very high risk category, wedged between Azerbaijan and Lesotho, no fewer than 35 places down on its rating in 2015:

Naturally, the Covid hit to the economy weighed on the relevant risk factors for GDP growth, unemployment and fiscal balance in 2020. Capital access worsened along with capital repatriation risk.

Lira depreciation also sparked another downgrade to the score for currency stability, in spite of Ağbal’s appointment and the enthusiasm for what was interpreted as a welcome return to a more orthodox monetary policy approach.

His sacking has now put Turkey back in the mire, undermining monetary policy credibility and raising concerns both financially and economically for one of the world’s leading emerging markets. Scores for institutional risk are likely to take another battering.

And yet those with knowledge of Turkey’s internal workings were not surprised.

Take Euromoney survey expert and professor of Economics at Ankara’s Hacettepe University, Timur Han Gur. His deep understanding of Turkish politics make him very wary of the situation.

With rising interest rates upsetting exporters and sectors that were borrowing or in need of credit, Ağbal’s ousting was no surprise, and it only highlighted the political risk dimension of Turkey’s investor profile.

An approach of expansionary monetary policy, increased spending and the desire to have positive economic growth at the expense of causing even higher inflation seems to be the new roadmap 

- Timur Han Gur, Hacettepe University

“The government and Erdogan, with their popularity declining, will want to go back to the old system with low interest rates, almost negative in a real sense, that focuses more on economic growth and employment to regain their strength and popularity,” Han Gur tells Euromoney.

“An approach of expansionary monetary policy, increased spending and the desire to have positive economic growth at the expense of causing even higher inflation seems to be the new roadmap.

“This might end up having colossal and irreparable costs.”

Other contributors got in touch to say that these developments were very disappointing, but not unexpected, and that investor confidence will take time to build.

Emre Deliveli, an economics columnist at Hürriyet Daily News, says that some analysts are even speaking of capital controls.

“While I don't think that capital controls are likely, the fact that it gets mentioned shows that risk perceptions have risen,” he says.

Much will depend on the government’s plans, but it is hard to find any analysts interpreting these events as positive for Turkey, and there are many who are trying to persuade Erdoğan of the merits of an alternative path.

What Turkey should do

Steve Hanke, a professor of applied economics at the Johns Hopkins University in Baltimore and a senior fellow and director of the Troubled Currencies Project at the Cato Institute, is one of those experts.

He explains the recent change as being rooted in president Erdogan’s embracing of Islamic finance, with its eschewing of interest, noting that the new central bank governor is an Islamist, Şahap Kavcıoğlu.

Unfortunately, higher interest rates (tighter monetary policy) is what Turkey desperately requires, according to Hanke, who also calculates his own inflation measures to give a more accurate picture of price changes in various countries – which in Turkey’s case is clearly worrying.

“Inflation in Turkey is soaring at 29.14% by my measure," says Hanke.

“My measurement, which employs high-frequency data and the use of purchasing power parity theory, is nearly double Turkey’s official annual inflation rate of 15.61% per year.”

The question is whether Turkey – read Erdoğan – is listening 

Hanke says that Erdogan’s frequent changing of the guard at the central bank will not change the course of the lira, or rein in surging inflation.

“To save the lira and Turkey’s economy, Erdogan must make a change to Turkey’s exchange-rate regime, not its bureaucratic personnel," he says.

“All Erdogan has to do is follow the instructions for establishing a gold-backed currency board." A currency board with the lira tied to gold at a fixed exchange rate and fully backed by gold reserves is laid out in Hanke and Kurt Schuler’s book Gelişmekte Olan Ülkeler İçin Para Kurullari, which was published in Ankara in December 2019.

It is a plan he believes cannot fail. There have been more than 70 currency boards over 170 years, he says, and none has failed.

The question is whether Turkey – read Erdoğan – is listening. At present that seems extremely unlikely.