Erdogan's policies accelerate Turkish economy downfall

The Turkish lira sees a historic slump following a central bank shake-up that triggered a significant liquidity squeeze in the offshore lira swap market.

The lira was up about 1% at 7.7192 versus the dollar after falling close to its record low of 8.58, as President Tayyip Erdogan replaced the hawkish central bank governor Naci Agbal with a critic of high interest rates who has echoed the president’s unusual views that high interest rates cause rather than slow inflation.

Investor sentiment had been brightening since November when Naci Agbal was appointed head of the Turkish central bank. He had sharply raised interest rates in an attempt to slow inflation, which is running at about 15 per cent.

A 2 percentage point increase to the country’s policy rate last Thursday also helped to push back against a rise in developed market yields, which has dented the appeal of emerging market assets.

The last decline erased most of the gains for the lira since November 2020, with investors fearing a reversal of recent interest rate hikes that had revived the currency amid concerns over Turkey's falling forex reserves and high inflation levels.

"'Greed and fear' will remain the main short-term drivers for investors in Turkey," said Yerlan Syzdykov, global head of emerging markets at Amundi, Europe's largest asset manager with 1.7 trillion euro ($2 trillion) under management.

"What will determine investors' risk appetite in the long run is the assessment of the capacity of the new economic team to maintain macroeconomic stability, delivering a transparent framework for monetary and fiscal policy."

An analyst at a large international bank described Erdogan's decree as a “form of capital controls”, which would “cause even more damage to Turkey’s reputation and will not prevent the lira from weakening significantly in the coming weeks”.