Turkey’s President Recep Tayyip Erdogan and central bank sent markets on a rollercoaster ride on September 13 culminating in an announcement from the regulator that it was bringing in a major interest hike of 625 basis points, twice the expectations of analysts.

The increase—actually a de facto 475 bp rise as the central bank has lately been using the top-band 19.25% of its interest rate corridor as Turkey’s effective cost of funding—took the benchmark one-week repo auction interest rate to 24%, boosting the crisis-stricken Turkish lira (TRY). It had gained 4.1% to 6.0874 against the dollar by around 22:10 local time.

Shortly before the rates announcement, the TRY lost around 3% against the USD when Erdogan, in what seemed like carefully scripted political theatre, sharply criticised the Central Bank of the Republic of Turkey (CBRT) for taking “wrong steps” over the country’s rocketing inflation and repeated his unconventional “Erdonomic” opposition to high interest rates. Investors have become increasingly worried that Erdogan, who espouses the unorthodox theory that inflation is a consequence of high interest rates, has taken over monetary policy. Partly as a result of that, the TRY has recently hovered at around 40% down against the dollar in the year to date.

Who signed off?
Despite the attack on the central bankers by Erdogan, there will be a big suspicion that he signed off on the rate rise having been convinced—perhaps by the new finance minister, his son in-law Berat Albayrak—of the direness of Turkey’s financial straits. The country likely faces a painful recession, but the decision of the central bank (or of Erdogan) to ‘get real’ when it comes to tightening may give it a chance of emerging on the other side of the economic malaise that much quicker.

In his morning remarks to a traders’ confederation in Ankara, as reported by Reuters, Erdogan insisted that the central bank’s independence was intact, but added: “If you say inflation is the cause and interest rates are the result, you don’t know this business.”

Adding that he had never seen the CBRT accurately forecast inflation—now at 17.9% and rising in Turkey, with the tanking lira having pushed it to the highest rate Turkey has seen in 15 years—he also said: “We’ve been in this business for 16 years [since I came to power]. Will we not learn? You may determine interest rates, but inflation is a result of the wrong steps you [the central bank] have taken. And who pays the price? The people.”

Erdogan also said in his speech that Turkey is “on the side of the free market economy” and would not deviate from the free market framework. “Difficult times require difficult decisions to be taken and implemented,” he said. “All of our institutions, namely our economy management, are working day and night under my coordination as president.”

Erdogan also slammed private banks, saying some had hiked their interest rates to 50%. “How can the private sector invest in such high interest rates?” he asked, adding that such margins were made only by drug dealers.

Preparing the ground
Responding to the interest rate rise, Timothy Ash at BlueBay Asset Management, wrote in a note: “Great decision—made all the more difficult by the huge pressure on the CBRT from Erdogan.

“Clearly Erdogan had got the heads up from the CBRT this morning that they were hiking and his comments this morning were preparing the ground for his base constituency—putting all the blame now on the CBRT. He was saying I don't agree with this, but the CBRT is independent.”

The CBRT, added Ash, had brought in “serious tightening made all the more convincing in that the bank announced it would only finance the market at the base rate. So no more messing around with the use of interest rate corridors. This was serious tightening and simplification”.

The strategist felt that “Erdogan finally accepted the urgency of the situation—needs must, as it was a choice either to hike rates or see economic and financial collapse and end up in the clutches of the IMF”.

Ash also saw foreign banks and portfolio investors as now finding more trust and willingness to stay invested in Turkey, as well as a perhaps brutal adjustment of the current account deficit amid collapsing domestic demand amid “a hard landing—but at least collapse, capital controls and default can be avoided”.

In its statement on the rate increase, the CBRT said: “Recent developments regarding the inflation outlook point to significant risks to price stability. Price increases have shown a generalized pattern across subsectors, reflecting the movements in exchange rates. Deterioration in the pricing behaviour continues to pose upside risks on the inflation outlook, despite weaker domestic demand conditions. Accordingly, the [Monetary Policy] Committee has decided to implement a strong monetary tightening to support price stability.

“The Central Bank will continue to use all available instruments in pursuit of the price stability objective. Tight stance in monetary policy will be maintained decisively until inflation outlook displays a significant improvement. Inflation expectations, pricing behaviour, lagged impact of recent monetary policy decisions, contribution of fiscal policy to rebalancing process, and other factors affecting inflation will be closely monitored and, if needed, further monetary tightening will be delivered.”

Power bills go unpaid
On the eve of the rate-setters’ meeting the turmoil caused to Turkish companies by the currency crisis was brought home by a local chamber of commerce in Turkey which relayed reports of some of its members being unable to pay their power bills.

“We’ve been hearing that some of our member companies are not even able to pay their power bills,” Nail Ciler, head of the Gebze Chamber of Commerce, told Bloomberg. “If this goes on, and no comprehensive solution backed by government support is found, we may see mass redundancies.”

The disclosure from the chamber grouping companies in Gebze—a district on the Gulf of Izmit in Kocaeli Province, 65 kilometres southeast of Istanbul—came as analysts debated whether at this point an interest rate hike from the Turkish central bank would be to the overall benefit of debt-pressured companies in Turkey.

“The biggest problem is in companies that import goods with foreign currencies and sell products in Turkish liras,” Ciler said, remarking on the consequences of this year’s collapse of Turkey’s currency, adding: “They just can’t cope with the mismatch.”

Analysts looked at how a steep rate increase might stem the slide of the lira, but no action from the rate-setters would spare the already torrid balance sheets of companies which have already had to contend with a big increase in local borrowing costs in the past year and, looking some months ahead, could find themselves drained by a steep recession.

“Unfortunately, there is only a bad scenario and a worse scenario for the Turkish corporate sector,” Inan Demir, an emerging markets economist at Nomura International in London, told the news agency. “If the central bank delivers a convincing rate hike, the currency will stabilise. The net effect of a strong rate hike is more positive for companies.”

Pleased and confused
Assessing the big move by the CBRT, Phoenix Kalen at Societe Generale said the market was now both pleased and confused. "It almost seems like it's a game of 'good cop, bad cop' being played out between the Turkish authorities—with President Erdogan on the one hand still making statements regarding his dislike of interest rates and... a very sizeable reaction from the central bank in response to the recent inflationary and geopolitical developments."

As the dust settled on a dramatic monetary day for Turkey, more pessimistic analysts came to the fore saying an interest rate of 24% might prove far from enough and that the TRY was not out of the woods yet.

Investors were disturbed on September 12 when Erdogan banned the use of foreign currencies in all domestic contracts, with a particular emphasis on taking the dollar and euro transactions out of property purchasing and renting. The unpredictable president has also essentially taken control of a swathe of state companies, including big players in railways, telecoms and airlines, by making himself chairman of Turkey’s sovereign wealth fund, while also placing Albayrak on the board. He has also said more measures to prevent fluctuations in foreign exchange rates are on the way.

One remark from Erdogan on his contention that people should not be involved with foreign currencies unless they are either an importer or exporter has raised anxieties that individual depositors’ balances could be forcibly converted into lira.

As many analysts have now concluded, the way ahead for Turkish economic management is now not so much about monetary policy as about regaining the trust of investors.