The price of meddling with Turkish monetary policy gets dearer

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The firing of Turkey’s Central Bank Governor on Saturday takes place in a relatively positive economic context for emerging economies. Still, the heavy-handed interference by President, Recep Tayyip Erdogan in monetary policy appears to be stripping Turkey of economic opportunity, driving prominent members of his political movement to jump ship.

As the US Federal Reserve and the Bank of England lower interest rates and the European Central Bank braces for the second wave of quantitative easing, institutional investors are once again turning to emerging economies for yield. Carry trade has returned as investors borrow in low yielding western jurisdictions to invest in Brazil, Argentina, Mexico, Indonesia, Malaysia, Colombia, and Turkey.

Exactly a week ago, Turkey announced plans to sell $1bn dollar-denominated five-year bonds in the fourth bond action of its kind this year. This looked like a good investment, as Turkish dollar-denominated bonds are expected to yield 6.65%, that is, a spread of around 4.9% higher than US Treasuries, which is extremely attractive in a zero or negative yield environment.

The risk appeared low. Turkey’s inflation rate saw its biggest drop in months in June. Consumer prices increased by “merely” 15.7% in June, year on year, compared with 18.7% in May and 25% in September 2018. But firing the Governor of the Bank of Turkey changes the political calculation.

Anyone betting on the appreciation of the Turkish Lira lost 2% on Monday and the message is clear: the risk is an erratic politics as much as deteriorating macroeconomic fundamentals. This political risk is weighing more heavily on the image of the government, especially following the resignation of former Economy Minister Ali Babacan from the ranks of the ruling Justice and Development Party (AKP) on Monday.

The 52-year-old Babacan is a founding member of AKP and made no secret that the firing of the Central Bank Governor was the trigger of this decision. Babacan was the chief negotiator in EU accession talks in the 2000s, the architect of Turkey’s fast-paced economic growth at the time, and well-liked by international investors. He is only the latest in a long stream of high-profile defections, which include former prime minister Ahmet Davutoglu and former President Abdullah Gul, who have taken a back seat in politics. The difference is that Mr Babacan may not be leaving but planning to remain as a political challenger.



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