* Part I here
* Part II
* Part IV
* Part V

Our Outlook 2019 Turkey report observed: “Early December [2018] brought news that Turkey’s annual consumer price inflation rate had fallen for the first time since March—and sharply. November saw it fall 3.62 percentage points from October's 15-year high of 25.24% to 21.62%... Despite the pain, the central bank appears to have been making the right noises as regards sticking to difficult-to-swallow monetary medicine, but the political pressure for generosity from the Erdogan administration ahead of the local elections in three months’ time could, fear some analysts, prompt premature easing from the central bank…

“Jason Tuvey of Capital Economics said in an early December [2018] research note entitled 'Fall in inflation could bring rate cuts further'…: 'Against the backdrop of a stronger lira, falling inflation and weak economy activity, further interest rate hikes are now completely off the table. Instead, with political pressure on the central bank to loosen policy likely to mount, there’s a growing risk that policymakers decide to loosen policy even earlier, and more aggressively, than we currently anticipate. For now, though, we are keeping our forecast for the benchmark one-week repo rate to be lowered from 24.00% at present to 20.00% by the end of next year.'

“It was comments from [President Recep Tayyip] Erdogan six weeks prior to the June 2018 parliamentary and presidential elections that once he became executive president he would tighten his grip on the economy and assume a greater role in setting monetary policy that played a big part in sending the lira into a nosedive. As the currency crisis went from bad to worse, the president, who pushes the curious view that high interest rates help to drive inflation, backed off and in mid-September the rate-setters brought in a 625 basis point hike, helping to pull the lira out of its tailspin.

“However, as executive president Erdogan now single-handedly appoints the central bank governor and all the monetary policy committee members, there is still tangible market anxiety that he may once again dabble in monetary affairs he should steer clear of.”

As things turned out, the benchmark rate was slashed to 12% by the end of 2019 as the Erdogan administration pointed to a precipitous fall in headline inflation. The starting point for that sharp descent, which began in November 2018, can be seen in the firing of the Turkish Statistical Institute (TUIK) deputy general manager responsible for the inflation data. Since then, official inflation has always handily come in just a little below the market expectation each month, converging with the government target. An eye-catching aspect of this is how Erdogan and his son-in-law finance minister always reliably 'release' the headline inflation data earlier than the TUIK, a perfect help for data forecasters, improving their cooperation with the government as they always hit the bull’s eye.

For the commencement of sharp rate cuts, Erdogan held on until after the Istanbul ‘revote’ in June was out of the way, after which his impatience became all too clear as he moved to fire the central bank governor for not pursuing an acceptable monetary policy.

For those with an unerring trust in the foresight of Erdogan, or a jaundiced eye that detects an unhealthy relationship between the powers that be and purportedly purely technocratic state statisticians and central bank regulators, it is clear that policy rates along with inflation will be presented as having fallen into the single digits in the near future and will remain there in 2020.

End-2019 inflation will come in just below the central bank and government forecast of 12% (the inflation announcement is scheduled for January 3) and it seems likely the monetary easing cycle is not yet over. In its last meeting of the year, in mid-December, the central bank went for a 200 bp cut, taking the benchmark rate to 12% against inflation recorded at 10.56% in November, following October’s 8.55%, which enjoyed a strong base effect.

According to the central bank’s monetary and exchange rate policy text for 2020, released on December 5, the authority will sustain unorthodox practices. It is to use required reserves “in an effective and flexible way” in 2020 and it will back banks’ liquidity management via gold transactions against lira and forex (read this as more swaps).

Currently, the central bank pays zero interest for the required reserves of lenders who fall short of its complicated and continuously amended loan growth targets.

Moreover, the authority is increasing its open market operations portfolio to 5% of its balance sheet.

The central bank had TRY18.4bn worth of government bonds as of December 3 and its total assets stood at TRY627bn, 5% of which suggests TRY31.4bn, Ibrahim Aksoy of HSBC Portfoy told Reuters.

The national lender will be able to help the Treasury redeem its TRY287bn of debt repayments scheduled for 2020, Aksoy also said.

Almost idle

The domestic borrowing market remains almost idle since a series of huge mistakes starting from last year while the external borrowing channels are also not promising.

The year of 2020 could be a troubling year for government financing.

Erdogan has so far had the power to order local private lenders and pension funds to finance the government and the central bank reserves but a crowding-out next year already seems inevitable.

The budget deficit is soaring despite transfers from the central bank, with the borrowing plan for 2020 up 50% y/y.

It is raining tax and price hikes and there are fresh plans to transfer more money from the central bank. A decline in the central bank’s valuation account has prompted worries that the national lender may transfer funds to the government.

While official inflation and interest rates have nosedived, the lira—also subject to plenty of behind-the-scenes engineering by officials throughout 2019—has remained relatively stable. But with geopolitical and economic concerns mounting in December, the currency suffered a bout of weakness taking its losses in the year against the dollar to nearly 9% by the end of December 30. It stood at 5.95.

The policy text disclosed that the central bank will increase the number of its monetary policy committee (MPC) meetings to 12 next year from the eight meetings in 2019.

Concerns are still there over whether there will be an overshoot of monetary policy and a renewed depreciation in the currency.

However, public lenders have so far managed to defend the local currency at the cost of burning through huge amounts of central bank reserves while the equity market is under an unofficial suspension with the short-selling ban introduced on the most liquid banking stocks.

The squeeze on offshore lira liquidity in London is introduced whenever required.

In the event that the government loses control of the lira, essential monetary tightening will no doubt be delayed by Erdogan until the last moment, as happened in August 2018 when the USD/TRY rate hit an historical high of 7.24.