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Andrew Kositkun Senior FX Advisor
Turkey’s central bank governor, Naci Agbal, was removed through a surprising late-night presidential decree last Friday night. Agbal’s removal marks the third ouster of a central bank chief in less than two years. Headlines from local and international newspapers suggest that the decision might be related to the 200 bps rate hike delivered on Thursday.
During his four-and-a-half-month tenure, Agbal increased the blended funding rate by roughly 4.5% to 19%, as inflation rose by 3.72% due to lagged effects from credit-driven growth, foreign exchange depreciation and rising energy prices. In addition to rate hikes, the central bank also simplified monetary policy and increased policy transparency and communication. As a result, Turkey’s credit default spread significantly from Nov. 6 through last Friday, and the Turkish lira (TRY) appreciated against the U.S. dollar by roughly 18% during the same period.
Overall, there appears to be two main drivers of positive sentiment toward Turkish assets in the past four months: the expectations for further tightening of monetary policy and the end of unorthodox/interventionist policies. Clearly, recent events put both of these beliefs in question.
Regarding monetary policy, the new governor, Sahap Kavcioglu, did not refer to a continuation of tight monetary policy in his first communication on the central bank’s website. Kavcioglu has also expressed the opinion that high rates will not solve Turkey’s economic problems. Given this, the likely return of volatility and continued upward inflation pressures should limit the central bank’s ability to deliver a rate cut in the near term.
As for unorthodox/interventionist policies, a lot will depend on market volatility. Stable foreign exchange markets are critical for price and financial stability in Turkey. If foreign exchange volatility rises and stays at elevated levels, it is possible that authorities will revert back to the interventionist policies and the other restrictive measures seen in 2019–20, although more limited foreign currency reserves, relative to the past, could cap efforts. In the past, the most common interventionist policies included foreign exchange sales by public banks, an interest rate corridor, additional taxes on foreign exchange transactions and restrictions on swap transactions. Should Turkey return to interventionist policies, similar steps would not be a surprise.
The clear takeaway from Friday’s move is that the credibility of Turkey’s central bank has been undermined. As such, Turkish assets are expected to remain under pressure beyond a one-day sell-off. However, the idiosyncratic nature of recent events in Turkey should limit how much spillover there is.
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