Head Research Analyst at Bovell Global Macro.

Has the CBRT Regained Its Independence?

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The Turkish lira has seen strong gains over the past two weeks but remains in a heavy loss for the year. The lira has been struggling for around two years, with the rout worsening last year when the central bank governor was fired. President Erdogan has now allowed the central bank to hike rates for the first time in two year to tackle inflation, but how much can the CBRT manoeuvre with rates?


CBRT Hikes Rates By 475 bps


The Turkish central bank moved rates higher for the first time in two years yesterday, with a hike of 475bps. The move was largely expected by the markets, following the appointment of a new central bank governor two weeks ago. In 2019, President Erdogan fired the central bank chief after a disagreement on interest rates. Erdogan made the bizarre claim that higher rates lead to inflation. Most economists and analysts would tell you that higher rates curb inflation.


The move from Erdogan led to fears about the central bank’s independence and the path of the Turkish economy. Since then, rates have moved lower whilst inflation has moved into double-digits. The lira has also weakened significantly, which has led to cost-push inflation. In the past two weeks, some level of normality has been restored for the central bank. Replacing the central bank governor sent somewhat of a signal to the markets that Erdogan realised he was wrong and policy direction needed to change.


This week’s rate hike has given investors hope that a change in economic and central bank policies will aid the Turkish economy in the coming months. However, Erdogan has poured some cold water on this sentiment by stating this week that he still believes higher rates lead to inflation. Although the central bank hiked rates yesterday, this now begs the question as to how much higher can rates go. The comments also indicate that the central bank have not regained full independence and will need support from Erdogan if they are to tighten monetary policy further.


Why Is Central Bank Independence Important?


When it comes to investment decisions, one of the criteria that many individual and institutions will look for is central bank independence. This will give investors more confidence about the stability of an economy. In most countries although the central banks are set up by governments, and central bankers report to the government, there is usually limited involvement from the government in policy decisions.


Central bank independence removes political agendas out of decision-making and means that central bankers should make the correct decisions for the economy. Central banks have historically made policy mistakes leading to recessions but on the whole, they tend to do a good job of supporting the economy.


Governments control fiscal policy and when it comes to less developed nations in particular, the decisions made by the government on the economy can quite often be incorrect. This is where an independent central bank can sometimes step in and counter decisions (to an extent) by adjusting monetary policy. However, if the government takes control of both fiscal and monetary policy, it is normally a recipe for disaster. Furthermore, for a country like Turkey, a lack of central bank independence and incorrect policy decisions could result in significant downgrades by ratings agencies. This type of a scenario leads to outflows from these economies and further deepens any crisis.


How Much Further Can the Lira Go?


Although the CBRT have not yet gained full independence, and may never do so under Erdogan, recent developments have been positive. The lira has weakened substantially this year, hitting historic-lows on multiple occasions. As such, I see plenty of room for the lira to strengthen further in the short-term.


From a global perspective, the recent vaccine developments have also been positive, which should keep the global recovery broadly on track. This will likely provide a boost to emerging market currencies like the lira, particularly against the US dollar. In the medium-term, President Erdogan remains the main obstacle for the Turkish lira. If Erdogan prevents further tightening of policy, or forces loosening too soon, then we would see downside in the lira.


It is also worth noting that long lira positions should pay a positive swap, which is a great incentive to continue holding the trade provided that the current fundamental picture remains intact.

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