Turkey could solve its banking crisis with one simple mechanism — but Erdogan is ideologically against it

Sean Gallup/ Getty ImagesTurkish President Recep Tayyip Erdogan.
  • The Turkish lira fell 25% against the US dollar last week and is still under pressure.
  • The currency is suffering from trade tensions with the US, deteriorating current-account balances, and fears around President Recep Tayyip Erdogan’s influence over the central bank.
  • Analysts agree that an easy fix would be to raise interest rates by as much as 10%, encouraging investors to put more money in Turkish banks.
  • This is unlikely to happen, given that Erdogan has called interest rates “evil.”

LONDON – Turkey could stop its currency’s collapsing in value by hiking interest rates by as much as 10%, according to multiple analysts.

But that looks unlikely, given that President Recep Tayyip Erdogan is exerting influence over the country’s central bank and has publicly described interest rates as “evil.”

The Turkish lira fell 25% against the dollar last week and was down another 1% on Monday morning, having fallen as much as 10% in earlier trading. The currency has been hit by tariffs levied by the US, a widening current-account deficit, and fears over what Erdogan’s growing influence over the Turkish central bank could mean for monetary policy.

Analysts agree that the easiest way for Turkey to soothe its currency crisis would be to raise interest rates. Inflation is at a 14-year high in Turkey, at close to 16%. The benchmark interest rate, meanwhile, is 17.75%. It means there is little incentive for investors or savers to leave their money with Turkish banks, and that is exacerbating capital flight.

“Looking at different measures of real rates (using current CPI, or different forward-looking measures) we think a rate hike of 350-400bps to 21.25%-21.75% from 17.75% looks consistent with real rate levels that in the past helped to stabilise the currency,” Gyorgy Kovacs, UBS’s chief economist for emerging markets in Europe, the Middle East, and Africa, said in a note on Friday.

Other analysts think that a rate hike as high as 10% could be necessary. Exotix Capital, an investment bank specializing in emerging markets, said in an email on Monday: “International investors would like to see the same actions taken in Argentina recently: much higher interest rates (e.g., a more than 10 percentage point hike), a commitment to address inflation and improve fiscal performance, and engagement with multilateral lenders” such as the International Monetary Fund.

For context, a routine interest-rate change in a large economy with a stable currency would be 0.25%.

JPMorgan’s John Normand wrote in a note on Friday: “Our EM colleagues’ view is that a sufficient policy response to the negative spiral in TRY would be (a) 5-10% in policy rate hikes, (b) a fiscal package to backstop banks, (c) targeted fiscal support for distressed sectors, and (d) a policy framework that signals acceptance of the need for deleveraging and possibility of recession.”

But Turkey is unlikely to get the rate hike that analysts agree it needs. Erdogan earlier this year described interest rates as “the mother and father of all evil,” and he has recently been exerting ever greater influence over Turkey’s central bank. Last year, he argued that high interest rates actually cause inflation. (They do not.)

“The fresh negative round of news started when the central bank decided not to hike the interest rates at its monetary policy meeting on 24 July,” Morten Lund and Tuuli Koivu, analysts at Nordea, said in a note to clients on Friday. “The market reaction has been strong partly because the central bank decision was probably affected by President Erdogan and the independence of the Turkish central bank is under question.”

The Nomura analyst Craig Chan and his team agreed, writing in a note on Friday that the lira “is likely to remain under pressure until” Turkey’s central bank’s “credibility is restored.”

“The way to build credibility, we believe, is still relatively straightforward: no pause in the tightening cycle as long as inflation keeps accelerating,” they added.

Erdogan’s solution so far has been to try to put political pressure on the US by accusing it of waging economic “war” and urge Turkish citizens to sell gold and US dollars in favour of the lira.

Analysts think that if Erdogan continues to rule out an interest-rate hike, Turkey may be forced to implement capital controls to stop money from leaving the country at its current rate.

In a statement early Monday, the Turkish central bank pledged to maintain stability in the financial system.

“The Central Bank will closely monitor the market depth and price formations, and take all necessary measures to maintain financial stability, if deemed necessary,” it said.

The fallout from Turkey’s lira crisis spread to Asian and European markets on Monday amid fear of contagion for banking sectors exposed to the economy.

Konstantinos Anthis, the head of research at ADS Securities, said in an email on Monday: “Erdogan’s unwillingness to raise interest rates suggests that the situation might not be defused, soon extending the risk-off sentiment seen across all markets.”

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