August 11

The Erdogan Way: High Inflation? Cut Rates

Recep Tayyip Erdogan has been elected to a ten year term as Turkey’s first President. The office has existed in prior forms as a ceremonial title, but now Mr.Erdogan will be called President after already serving since 2003 as prime minister. Critics see his AK party as likely to consolidate power with a plan to re write the constitution to transfer more powers to his executive branch.  The ongoing political turmoil over the last year has been of great concern to global investors as Turkey carries a large current account deficit that requires external funding in order for the economy to remain stable. The January Turkish Lira crisis was caused in part by speculation of government corruption among Erdogan’s cabinet members, most of which have since been replaced. The crisis was ended by a massive one time rate hike from the Central bank of the Republic of Turkey(CBRT), raising its policy rate from 4.5% to 10%.

CBRT 7 Day Repo (Policy Rate)


As 2014 has worn on and emerging markets rallied off their lows from the January EM selloff, The CBRT has backslid on its emergency policy under relentless pressure from Erdogan’s administration to cut interest rates going into the election. So far 175 basis points of cuts  spread over the last three meetings has taken the overnight policy rate down to 8.25%. This has occurred in tandem with a sharp turn higher in inflation and a fall in manufacturing sentiment indicators(HSBC PMI to 63 month low). Turkey is also becoming surrounded by conflicts with Ukraine to the North, violence in Gaza to the south, and American airstrikes bombing ISIS rebels in Iraq to the southeast.


Logistical challenges due to conflicts are likely to pressure prices higher, but the effect of this is immeasurable at the moment. What is clear is that Erdogan want his central bank to cut interest rates to boost growth so that his party can win elections. In his personal logic, high interest rates produce higher inflation, not the other way around. Many analysts have stated that Turkey is the main emerging market that will come under pressure as the Fed moves to tighten policy. Turkey’s federal government rating is already barely investment grade as just last week there was rampant speculation that Moody’s may cut their credit rating to junk status.


Whatever happens next, it is clear that Erdogan will consolidate his power with minimal opposition. He is supported by around 55% of Turkey and is seen by the West as a source of stability in the region, albeit his regime is becoming more and more autocratic. President Erdogan will continue his paranoid rants against the ‘rude’ opposition, the “jealous” ones that shed light on alleged cabinet corruption and most importantly to us his much hated ‘interest rate lobby’. The CBRT is expected to continue rate cuts, with 50 bps likely coming in the late August meeting.  Independence for the central bank is slipping away as they continue with illogical policy easing that could eventually produce another Lira crisis.