The Turkish president fired his country’s central bank governor just two days after the latter delivered an above-expectations increase in interest rates (200 bps to 19%). Having been in the job for only five months, Governor Naci Agbal was instrumental in restoring investor confidence in Turkey and the central bank’s credibility. His replacement, Sahap Kavcioglu, is little known by most market participants and most recently worked as a university professor and columnist for a pro-government newspaper. The move demonstrates the unpredictable nature of policy in Turkey and that reforms are needed to reduce external vulnerabilities and high inflation.
Agbal’s sudden removal sparked a sell-off in Turkish assets Monday, on concerns around a return to unorthodox monetary policies, with the new governor having expressed policy views like those of Erdogan, including an antipathy toward high interest rates. The lira market opened down as much as 16% before settling 9% weaker at the London open, while local bonds yields rose 500 bps. U.S. dollar and hard currency 10-year sovereign spreads widened roughly 130 bps. On the corporates side, short-dated bonds were down from one to three percentage points on average, while longer dated bonds were down three to five points.
We read the developments as a fundamental turn away from the policy shift in November. State banks and local institutions are likely to intervene in the short term to support markets, especially ahead of the AK Party congress coming on Wednesday. However, Turkey enters this period of stress in a substantially weaker position, with negative net FX reserves, a current account deficit (driven by oil imports and low tourism revenues), and large FX debt financing requirements. Therefore, a U-turn in policy in the coming weeks is unlikely, but the erosion of central bank credibility, likely earlier-than-expected monetary policy easing and renewed pressures on the currency could leave risk premia higher in Turkey for some time. On the positive side, the country’s still relatively low public debt burden and robust growth fundamentals will likely mitigate these risks.
Investor positioning has generally been significantly reduced across emerging market assets over the past two months and, given the idiosyncratic and self-inflicted nature of the event, we believe that there will be limited spill-over impact on other emerging markets.