When banks and investment funds sent senior representatives to dine with Recep Tayyip Erdogan, they probably expected the Turkish president to deliver a reassuring message about investing in his country.
But by the end of Monday’s lunch at Bloomberg’s London office, they were left wondering whether there was any longer an argument for risking their money in his country’s currency, stocks and government bonds.
The message was uncompromising. The Turkish president, seeking re-election next month, made clear that not only was he steadfastly opposed to raising rates, he was intent on taking control of monetary policy.
Investors had for months given the president some leeway, prepared to overlook a rising current account deficit and high inflation because of Turkey’s strong banking system and fiscal discipline.
Their assumption was that despite the president’s repeated aversion to raising rates, the central bank would end up “doing the right thing”.
Market reaction was blunt after the president told investors to their face what he thinks of monetary policy
The Turkish lira plumbed a new record low, while the country’s dollar-denominated 10-year yield rose more than 40 basis points to 7.08 per cent. The lira has lost 15 per cent of its value in the past three months, while the 10-year yield is up from a low of 5.27 per cent in January.
As Moody’s warned about Turkey’s “overheating economy”, the consequences for international investors are plain. “How can you invest in a country when the guy doesn’t believe in basic interest rate theory?” said one person with knowledge of the discussion. “Turkey almost looks uninvestible.”
Turkey would beg to differ. A headline on one pro-government newspaper described the lunch as an “18 trillion dollar meeting”. Turkish media reported that the president urged those present to take advantage of special investment schemes for foreign investors, with new ones being prepared, and assured them there were no discrimination between foreign and Turkish investors.
But the conditions for investing are far from benign. EM assets already look too much of a risk as the US dollar gains lustre from Treasury yields rising to multiyear highs. With the exception of Argentina, nowhere in EM looks as vulnerable as Turkey.
“Coming at a time when Turkey already had pretty acute vulnerabilities, Erdogan has thrown petrol on the flames,” said Paul Greer, portfolio manager for EM fixed income at Fidelity International in London.
Analysts were similarly dismayed by what were described as “astonishing” remarks by Mr Erdogan on interest rates at a private meeting at Chatham House, the international relations think-tank, earlier in the day, where he reportedly asked those present to “please learn” that low interest rates deliver low inflation.
“When you hear things like that, you really start to wonder,” said one of those present.
“There’s no hope now,” said another. “It sounds like he doesn’t listen to anyone any more.”
The lira has fallen steeply since the middle of April, when the US dollar began to strengthen after depreciating for two years. The combination of a strengthening dollar, rising US interest rates and rising oil prices has been particularly damaging for Turkey, with its large foreign currency debts and its current account deficit equal to about 6 per cent of GDP, largely a result of its dependency on imported oil.
In lira terms, Mr Greer noted, the price of oil has risen 40 per cent in the past two months. This, he warned, would have an immediate impact on inflation, currently running at 10.8 per cent a year.
“We think inflation is heading for 15 per cent pretty quickly,” he said. “But they’ve got a central bank with an effective policy rate of 13.5 per cent, which is woefully inadequate. They need to act quickly, but they are really messing things up for themselves.”
Futures markets show that investors have “priced in” 350 basis points of interest rate rises in the next six months, taking the policy rate to 17 per cent a year. If that is not delivered, the lira will be even more vulnerable to selling pressure.
Yet as Mr Erdogan made clear in London, should he win the country’s presidential election on June 24, further interest rate rises can almost certainly be counted out.
Analysts see only one direction for the lira. “We could be at the beginning of a fascinating battle between President Erdogan — a proponent of unorthodox measures — and market participants who believe that monetary policy is too loose,” says Piotr Matys, EM strategist at Rabobank.
Additional reporting by Steve Johnson