OPINION:  Turkish Central Bank rescues TL, sinks Erdogan

The Central Bank of Turkey (CBRT) Shocked Economists by Raising Interest Rates last Thursday

Since that day, just as I expected, it has significantly tightened monetary policy by funding the market close to the  simple overnight rate of 49%, effectively tightneing monetary policy to the max. Why did the CBRT take this decision? Please, don’t give me copy/paste answers from the Monetary Policy Committee (MPC) statement like “it saw signs of deterioration in inflation behavior” or “domestic demand slowdown wasn’t on a path to meet inflation targets.” If we find the real reason, we can also get a sense of when the CBRT might cut rates.

Summary of the article is simple: CBRT pulled the Turkish lira back from the cliff at the expenses of keeping rate at the current level for a long time—but dealt a blow to Erdoğan.

The CBRT didn’t just raise rates out of concern for eroding foreign currency reserves. It also feared new political shocks and global crisis risks.

Technically speaking, due to the TL liquidity shortage in the market, the TLREF will be around 49%, meaning a significant dose of de facto monetary tightening. In this scenario, the average deposit rate will align with the TLREF or will exceed it by a 3-5 point margin, while the loan rate will be even higher than both. This equates to very serious monetary tightening and will significantly suppress domestic demand through both credit and psychological channels.

After the MPC decision, we must rethink the interest rate path.

The negative impact of the mini-devaluation on pricing behavior during the İmamoğlu crisis won’t quickly fade. In addition, Erdoğan may ignore Bahçeli’s warnings and attempt to appoint trustees (kayyum) to the CHP after schools go on summer break. A social media post by a prominent AKP troll, Rasim Ozan Kütahyalı—claiming that trustees will be appointed to CHP—led to a panic in the stock market. If Erdoğan restarts attacks on the CHP—even during the summer when tourism revenues help CBRT reserves—it could once again trigger capital flight and locals converting to foreign currencies.

In other words, expecting a rate cut at the next meeting is no longer reasonable.

We can’t ignore the possibility that the CBRT might keep policy rates unchanged until the global storm and domestic political turmoil subside.

Now let’s talk about the psychological impact of the MPC decision.

First and foremost, it quickly erases the expectation that the monetary easing—which most economists believe started too early—was carried out under Erdoğan’s orders and put on autopilot. Like Trump, it’s impossible to predict what Erdoğan will do tomorrow, but it’s now highly likely that he prefers a stable lira over low interest rates and is willing to pay the price for it.

Speculatively, Erdoğan may have shaped his political roadmap in his own mind and convinced himself of a solution path where he won’t have to deal with elections for at least two years. During this period, he could instruct Şimşek to prepare a comprehensive Tax Reform plan to establish the missing leg of the fight against inflation: fiscal discipline.

Back to the markets: IF there are no major political shocks, I’m sure depositors will return to the lira. The cost of staying in foreign currency—especially on the eve of a tourism season that will make it easy for the CBRT to control the exchange rate—is too high to bear. Money Market Funds will suddenly become popular.

If geopolitical risk consisted only of Trump’s ever-changing tariff policies, I’d argue that Turkey is the safest haven among Emerging Markets (EM) in this global storm. Let me list my reasons:

In the İmamoğlu crisis, the CBRT declared its independence and proved its competence by skillfully managing the exchange rate. Foreign investors must now see that the CBRT will respond to political storms caused by Erdoğan with additional tightening.

The strong TL policy will continue until fiscal policy is brought under discipline to support disinflation, and—according to our base scenario—will gain even more meaning once locals return to the TL and CBRT reserves swell.

There’s now a possibility that inflation may converge toward the CBRT’s year-end target. While the Trade Wars may not affect us negatively, the decline in not only energy but also all industrial commodity prices suggests a narrowing current account deficit. Turkey is no longer vulnerable to external shocks.

Stocks and government bonds were cheap before the İmamoğlu crisis; now they’re practically free.

There are positive developments on the Turkey–U.S. front.

According to Israeli media, Trump will withdraw most of his troops from Syria. Erdoğan’s meeting with Trump in Saudi Arabia is almost certain, and a White House invitation in May is still on the agenda. Cevdet Yılmaz stated that negotiations with the Trump administration regarding Halkbank will begin. In short, in a world where Trump’s friendship is an unparalleled prize, Erdoğan is in the front row alongside Putin and Orban.

However, I’m not at all sure that hot money will return to Turkey—or any EM—in the short term. The reason is that Trump keeps coming up with increasingly crazy ideas like a spoiled child acting out for attention. I examined this in my last article. Let me offer a short paragraph:

Just like in our country, Trump believes that if the dollar loses value, the trade deficit will shrink and American companies will gain a competitive edge in export markets. This is not true. As long as the U.S. maintains a low savings rate and its currency remains the global reserve, the trade deficit cannot close.

But even the mere occurrence of the meeting I mentioned could create a crisis in the FX markets. Who wants to hold the currency of a country whose leader insists on devaluing it? People would sell dollars, no one would buy U.S. stocks or government bonds. Rising yields on U.S. Treasuries could trigger a global debt repayment (default) crisis.

CBRT’s surprise decision, combined with the perception of heightened political uncertainty triggered by post-İmamoğlu protests, is likely to cause a decline in private sector fixed capital investments, housing, and auto sales. In other words, domestic demand will slow and inflation will be somewhat curbed.

But as always, the price of gains against inflation is sacrificing growth. So the urban legend that “the people will pay for Erdoğan’s political mistake” is not true.

In fact, by raising interest rates, the CBRT dealt a heavy blow to Erdoğan’s approval ratings. Surveys conducted at the end of April indicated that the public’s number-one complaint, the cost of living, had somewhat eased. After rising interest rates, cost-of-living concerns will be replaced by unemployment or lower disposable income. Voters will hold Erdoğan—not the CBRT—accountable.

According to the latest TEAMS poll, Erdoğan is now trailing İmamoğlu by 10 points in the presidential race. In all seven surveys conducted in April, the AKP is losing ground to the CHP.

By Atilla Yesilada