Critical week for Turkish economy

Critical week for Turkish economy

At first look, the domestic economic agenda looks light this week, with purchasing managers’ indices, preliminary exports and inflation being the main data releases. However, it may end up being the make-or-break week for Turkish assets, and eventually for the economy.

To understand why, it is useful to look at global markets. While they still ended up lagging behind their developed country counterparts, emerging market (EM) equities began to pick up over the past month. Turkish equities, however, have underperformed their peers. Borsa Istanbul fell 6.2 percent in February.

Other Turkish assets have fared similarly. Despite rate cuts during the last two rate-setting meetings, government bond yields have significantly risen. After having hit a nearly two-year low of 6.7 percent at the end of January, on Central Bank Governor Erdem Başçı’s emergency rate cut announcement, the two-year benchmark is now at 8.7 percent.

All this could surprise an economist who has not been following Turkish news. After all, the country was poised to be one of the main EM beneficiaries of lower oil prices and the European Central Bank’s quantitative easing. Maybe the rout in the Turkish markets would have been much larger without these two events.

As any Turk would tell you, Turkish assets are responding to President Recep Tayyip Erdoğan’s attacks on the Central Bank and Başçı. After implying they were controlled by external forces on Feb. 25, Erdoğan hardened his rhetoric even further on Feb. 27 by accusing the Bank of treason for keeping interest rates high.

A high February inflation would make it even harder for the Central Bank to justify further cuts at its next rate-setting meeting on Mar. 23. Annual inflation will increase if monthly prices rise more than 0.42 percent. All but two of the 24 economists surveyed by business channel CNBC-e expect a higher outturn. A hold on Mar. 23 would literally drive Erdoğan and his cronies mad with rage.

The deciding factor will be the exchange rate, which affects ordinary people and companies much more than stock or bond prices. Global factors could cause further depreciation of the Turkish Lira, which would tie the Central Bank’s hands. For example, markets still expect the Fed to delay rate hikes. A strong U.S. nonfarm payrolls figure on Mar. 6 could wake them up and lead to a correction.

The lira would test new highs then. Having already weakened 7.8 percent against the dollar so far this year, it is the third-most depreciated major EM currency, after the Russian ruble and the Brazilian real. Russia is suffering from lower oil prices and the conflict in Ukraine. The Financial Times recently listed 10 reasons why the new Brazilian government would go soon.

On the contrary, support for Erdoğan is very strong. Not only your average John Doe, but many Anatolian businessmen as well, still believe that he is fighting for lower rates for them. The negative impact of a weakening lira on the Turkish economy could lead them to reconsider this view, with their dissatisfaction eventually even spilling out into the streets.

That’s when the new security bill and fresh supplies of tear gas, which have started to arrive from South Korea, would be useful. To repeat the question from my last column: Would consumers spend or businesses invest in such an environment, no matter how low the interest rates?