Desperate measures are in the air in Turkey: Trading rooms are awash with talk of a bailout by the International Monetary Fund and potential capital controls. But there’s a vacuum at the core of economic policy making.
The central bank and government have remained largely silent as the currency plummeted to record lows and the U.S. imposed sanctions and threatened more. The lira rebounded after falling by the most in a decade on Monday, getting a lift from news that Turkish officials were headed to Washington for talks. The yield on 10-year bonds surged above 20 percent to an all-time high.
Capital controls are now “more than a tail-risk scenario now as the authorities show no signs of reverting to more orthodox policies,” said Shamaila Khan, AllianceBernstein’s director of emerging-market debt in New York. What the lira really needs is “independence of the central bank, tighter fiscal policies and an IMF program,” she said.
Late Tuesday, the IMF put out a statement saying it has “received no indication from the Turkish authorities that they are contemplating a request for financial assistance.” Meanwhile, U.S. State Department spokeswoman Heather Nauert said that Secretary of State Mike Pompeo’s call with Turkish Foreign Minister Mevlut Cavusoglu yesterday was, generally speaking, a "good sign."
Yet the radio silence from Ankara is deafening. President Recep Tayyip Erdogan, who won almost absolute power in June elections, is a staunch critic of higher interest rates and investors worry that he may be standing in the way of the central bank.
“It is very difficult to foresee an about-face by the authorities,” said Per Hammarlund, chief emerging-market strategist at SEB in Stockholm. “The moment when Turkey will be forced to go to the IMF for support is drawing closer.”
The lira is buckling under the weight of one of the widest current-account deficits in emerging markets and inflation is spiraling ever higher. As of July it was running at more than three times the central bank’s target, driving the real policy rate to below 2 percent, the lowest since December.
The lira was 1.4 percent stronger at 5.2539 per dollar as of 4:35 p.m. in New York, after tumbling more than 4.5 percent on Monday. Ten-year yields fell 19 basis points after earlier surging as much 42 basis points to a record 20.09 percent; the benchmark stock index was up more than 2 percent.
Although investors are pushing for a significant rate increase from the central bank, there is growing consensus it is going to take more than monetary policy to reverse the tide.
“It’s going to be a shock of one type or another: either a policy shock or a macro shock or some combination of the two,” said Christopher Granville, managing director for EMEA and global political research at TS Lombard in London. “But the way to sugar that pill,” he said, would be a “political accommodation with the West. That would make the pain much less."
Turkey’s deputy foreign minister Sedat Onal was leading a delegation with officials from the finance, justice and foreign ministries to the U.S., the foreign ministry in Ankara said in a statement, fueling speculation that a deal to patch up relations — strained by Turkey’s detention of an American pastor — may be in the works.
The U.S. remains a solid friend and ally of Turkey, the U.S. embassy in Turkey said in a Twitter post, as it denied news in Turkish media that a U.S. official predicted the lira would weaken to 7 per dollar.
On Monday, the central bank boosted banks’ access to dollar liquidity by $2.2 billion, an effort to take some pressure off the lira. The currency trimmed its losses briefly, only to plunge to successive record lows through the night as investors saw the move as evidence that the bank’s hands were tied.
|What Our Economists Say…|
|“It’s often claimed that the Central Bank of the Republic of Turkey cares less about the level of the lira and more about its speed of decline. It’s got reasons to worry about both now: the currency has tumbled to a historic low and at a record speed. With no monetary policy meeting scheduled until September 13, an emergency rate hike is a real possibility.”
–Ziad Daoud, Bloomberg Economics
For more, see our Turkey Insight