Turkish bonds are signaling investor discomfort over Recep Tayyip Erdogan’s likely attitude toward monetary policy when he assumes the presidency this month.
Far from being a ceremonial figurehead, the prime minister and leader of the Islamic-leaning Justice and Development Party plans to expand his role to one that combines head of state with running the government. Two-year yields jumped and inflation expectations rose since the Aug. 10 vote through yesterday, while the lira weakened the most among 24 emerging markets.
Erdogan, who must step down as premier when he’s sworn in Aug. 28, may keep up his criticism of the central bank over the pace of interest-rate cuts as he presses for steps to bolster growth with a new team of ministers. While a report today showed an improvement in the current-account deficit, Fitch Ratings cited Turkey’s vulnerability to a “sudden change in investor sentiment” this week in the event of a “rapid unwinding” of borrowing costs.
“We expect further weakness in Turkish assets over the coming weeks on elevated domestic political risks and the possibility of central bank policy error,” Phoenix Kalen, director of emerging-markets strategy at Societe Generale SA in London, said by e-mail yesterday. The new cabinet may erode “the country’s macro-stability backstop, undermining investor confidence in Turkey’s economic policies,” she said.
The ruling Justice and Development Party, or AKP, will probably name Foreign Minister Ahmet Davutoglu as Erdogan’s successor Aug. 27, a senior party official said earlier this week, asking not to be identified because the information isn’t public.
The current lack of clarity over whether new government ministers will advocate “a disciplined monetary policy and disciplined fiscal policies” is causing concern among investors, according to Mehmet Besimoglu, chief economist at Oyak Securities in Istanbul. AKP may decide to build a cabinet with those who back lower interest rates to gain support before parliamentary elections next year, he said.
“The pressure on the central bank to lower rates will continue,” Besimoglu said by phone Aug. 11. “There is no reason to expect an end to politicians pushing for lower rates and higher growth. The administration will not want to go to elections with a weak economic performance.”
While Turkey’s economy tripled to more than $830 billion during Erdogan’s time as prime minister, growth has slowed during the second part of his 11-year tenure to less than half the 6.8 percent average of the first period. The economy will probably expand 3.2 percent this year, down from 4 percent in 2013, according to a Bloomberg survey of analysts.
The central bank more than doubled the benchmark one-week repurchased rate to 10 percent in January to stop the lira’s depreciation. Since then, the bank’s monetary policy committee has lowered the rate by 1.75 percentage points to 8.25 percent. Governor Erdem Basci said on July 24 that the market was pricing in another half point cut in the repo rate over the next three months. Policy makers are scheduled to meet on Aug. 27.
The lira strengthened 0.2 percent to 2.1528 per dollar at 6:15 p.m. in Istanbul, trimming this week’s decline to 0.4 percent. Two-year yields rose nine basis points after Erdogan was elected Aug. 10 to 9.45 percent yesterday, before falling 20 basis points today. Two-year break-even rates, a measure of investor inflation expectations, also rose nine basis points in the three days following the vote before dropping 20 basis points today. Currencies in emerging Europe gained today amid speculation the conflict between Russia and Ukraine may ease.
“Market resilience following the expected outcome of Erdogan’s presidential victory will likely prove short-lived,” SocGen’s Kalen said by e-mail yesterday.
Consumer prices rose 9.3 percent in July from a year earlier, more than economists anticipated, a report showed on Aug. 4.
The current-account deficit narrowed to $4.1 billion in June, from a gap of $4.8 billion a year earlier, according to the central bank. The median estimate in a Bloomberg survey of 13 analysts was that the gap would narrow to $3.7 billion.
Increased government pressure for looser monetary policy may hinder the capital inflows the economy needs, William Jackson, an economist at Capital Economics Ltd., said in an e-mailed note yesterday.
Foreign investors sold a net $1.48 billion of Turkish bonds in the week to Aug. 8, according to the latest central bank data published today.
“There are already early signs that the markets are losing confidence in Turkish monetary policy,” Jackson said. “The uncertainty alone about the composition of the new government is likely to make it more difficult for Turkey to attract foreign investment.”