(Bloomberg) — President Recep Tayyip Erdogan’s pledge to stay committed to free markets after replacing the country’s top economic officials signals a major policy shift after two years of currency turmoil though it remains to be seen whether the Turkish leader has fully relinquished his long-held preference for lower interest rates at any cost.
In his first speech on the economy since replacing his son-in-law as the nation’s treasury and finance minister and firing the central bank chief, Erdogan said the government was not giving up its dedication to free-market rules or to economic growth led by the private sector, which he’s sought in the past to stimulate with lower borrowing costs.
“We are putting up a historic fight against those who want to condemn Turkey to modern capitulations through the shackles of interest rates, inflation and exchange rates,” he said in Ankara on Tuesday.
As mixed as the message is, coupled with the change of guard, it could mean a return to more standard monetary and fiscal policies — and potentially higher interest rates to stabilize the lira and curb inflation — at least until election time.
The immediate challenge the newly appointed officials face is how to “convince investors that the central bank and the administration will pursue market-friendly orthodox policies,” said Piotr Matys, a London-based strategist at Rabobank. “Perhaps the biggest challenge will come ahead of the next general elections when they may have to resist the preference of President Erdogan for a rapid growth stimulated at all costs.”.
Erdogan’s statement comes as former Deputy Prime Minister Lutfi Elvan prepares to take over as treasury and finance minister following the abrupt resignation of Berat Albayrak on Sunday. A day earlier, Erdogan had fired central bank Governor Murat Uysal and replaced him with Naci Agbal, a former finance minister.
Photographer: Simon Dawson/Bloomberg
The Turkish leader’s view that cutting rates reduces inflation flies in the face of mainstream economic theory and continues to cast a long shadow over the economy, as it remains unclear how much Agbal and Elvan will be able to do differently.
Under their predecessors, the president mostly got his way, as rates were slashed by 15.75 percentage points since last summer to levels trailing inflation. The central bank and other state bodies then tried to defend the lira with market interventions but were unable to halt a steep decline in its value, double-digit increases in prices and massive outflows of foreign capital. The approach also led to a rapid decline in the country’s foreign-exchange reserves, leaving it more vulnerable to external shocks while further eroding confidence in the lira.
Goldman Sachs Group Inc. economists estimate the interventions exceeded $100 billion this year while the Turkish lira lost more than 30% of its value in the last 12 months, making it the worst performer among major world currencies tracked by Bloomberg.
The currency rallied on Albayrak’s departure to close 5.5% higher against the dollar Monday, its biggest daily gain since 2018. The lira was trading 2% lower as of 2:49 p.m. local time.
Read: Economic A-Team Down to Last Man as Erdogan Exerts His Power
There are already signs that a broader economic and political overhaul is in the works. The decision to fire Uysal as central bank chief was driven by Erdogan’s anger that tens of billions of dollars in reserves were depleted in the failed effort to defend the currency, according to numerous officials familiar with the matter.
The new central bank chief, Agbal, has already begun work to replace Monetary Policy Committee members who were close to Albayrak, people familiar with the matter told Bloomberg, asking not to be named because of the sensitivity of the matter.
On Sunday, Erdogan met with Agbal and another former deputy prime minister, Nurettin Canikli, to discuss monetary policy, people familiar with the meeting said, also asking not to be named.
Recep Tayyip Erdogan
Photographer: Simon Dawson/Bloomberg
Elvan is believed to have a strong working relationship with the new central bank chief. The 58-year-old was development minister until 2018, when Turkey changed its political system to an executive presidency and Albayrak was appointed as the nation’s top economic official.
He hails from a now-defunct central development agency, which planned and oversaw large-scale projects such as dams and highways for around five decades until it was folded into the ministry of development in 2011. He has served as cabinet minister under three ruling AK Party premiers and previously chaired a parliamentary committee that scrutinizes legislation on the economy and central government budgets.
Elvan will officially assume his post after taking an oath in parliament, without a traditional handover ceremony with Albayrak, 42, who stepped down due to unspecified health problems, according to two people familiar with the matter.
“It is crucial that the CBRT and the finance ministry work in tandem as even a proper rate hike without substantial progress on structural reforms will not prove sufficient to stabilize the lira for an extended period of time,” said Matys. “It is therefore encouraging that reportedly Agbal and Elvan have a good professional relationship as there is a chance that their combined efforts may gradually restore confidence.”
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