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Rate hike brings Erdoganomics down to earth

September 13, 2018

Turkey's central bank has shown it has teeth, hiking interest rates beyond expectations to quell inflation and calm investor nerves. But as recession looms and Erdogan growls, Turkey is not quite out of the woods.

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President Erdogan
Image: picture-alliance/U. Baumgarten

Turkey's central bank's monetary policy committee said on Thursday that its one-week repo rate had been lifted to 24 percent from 17.75 percent, the first rate hike since June. The bank said further tightening will be delivered if needed.

Following the news, the Turkish lira rose 5 percent in value against the US dollar, reversing its 42-percent fall this year against the American currency.

"This was 300 basis points more than expected so we are very surprised," Win Thin, Global Head of Emerging Markets at Brown Brothers Harriman, told DW.  "This is the first time in recent memory that Turkey has delivered a hawkish surprise."

Read moreTurkish economy facing major challenges

The bank had faced a dilemma, and still does. In one direction it could hear the siren call of investors craving higher interest rates to draw a line in the inflationary sand and stop the lira's collapse. In the other direction, with the economy heading into recession, lower rates would help inject growth stimuli.

The two sides of the Turkish crisis

The president is not amused

Turkish President Recep Tayyip Erdogan has railed against interest rates as "the mother and father of all evil" and believes that high rates lead to high inflation. Economic orthodoxy suggests the opposite. And on the morning of the rate hike decision, Erdogan was busy.

"We cannot allow the use of the tool of exploitation that is interest rates," Erdogan told a meeting in Istanbul on Thursday. He added that the lira was experiencing "fake volatility," repeating his view that the currency's fall was part of a foreign plot and the result of an economic war.

Read moreOpinion: Turkey crisis a threat to Europe's economy?

Private banks also took some of Erdogan's heat. "How can the private sector invest in such high interest rates?" he asked, adding that such margins were only made by drugs dealers.

"Interest rates are the cause, inflation is the result. If you say 'inflation is cause, the rate is the result,' you do not know this business, friend."

Turkey's central banks releases plan to stabilize markets

"As of today, I have not seen the central bank fix inflation rates as they promised," Erdogan went on. "There has been no change in my sensitivities on the issue of interest rates. The central bank is independent and makes its own decisions."

The lira fell 3.5 percent against the dollar on his words, before rising 6 percent after the rate hike decision. This as inflation was up to almost 18 percent in August, its highest since September 2003 — the year Erdogan first took power as prime minister.

Read moreSPD's Andrea Nahles says Germany may give aid to Turkey

The lira hit new lows in late July after the Turkish central bank left interest rates unchanged as inflation continued to rise. The sense of doom was compounded on August 1, when the US imposed selective sanctions on Turkey over the detainment of an American pastor.

No end in sight

"Erdogan's comments clearly show that he does not support this and it becomes much more difficult, if not impossible, for the Turkish central bank to tighten enough to stabilize the lira and get inflation under control," Esther Reichelt, a forex strategist at Commerzbank in Frankfurt, told DW. 

"Against this background, the lira's reaction is still surprisingly limited in my opinion. The lira crisis seems to be far from over."

Read more:  Erdogan's son-in-law says he'll run a clean central bank

Thin from Brown Brothers Harriman agreed that it was too soon to sound the all-clear. "Let's see how this shapes up but recall that Argentina has had to tighten twice more after its initial hike to 40 percent, and that's after it did all the right things like get an IMF program," he said. "The move today should stabilize things but ... I still think there is pain ahead for Turkey despite this move today."

Read moreIs Erdogan's Turkey on the edge of a crash?

Economists predict Turkey is heading for a recession after a slowdown in the second quarter of 2018. The economy is vulnerable because of its high level of external debt. Ankara is heavily dependent on foreign capital with 70 percent of its debt denominated in dollars and euros, compared to a 35 percent average for emerging markets. The current account deficit is almost at 6 percent of GDP and is one of the largest amongst emerging market countries, which makes it vulnerable to a shock if foreign investors pull out. 

Head shot of a man (Jo Harper) with grey hair and brown eyes
Jo Harper Journalist and author specializing in Poland