Jonathan Spicer

ISTANBUL, (Reuters) – Turkey’s central bank will cut interest rates this week despite a currency collapse and soaring inflation. President Tayyip Erdogan continues to press policymakers to encourage growth in the lead up to 2023 elections.

Erdogan’s plans to prioritize exports and lending have seen the bank reduce its key rate 400 basis points to 15%. However, economists and lawmakers deem these moves reckless.

To slow down a volatile selloff, the central bank also sold four dollars this month. This has seen the Turkish Lira close to 15 to the greenback. It is at a record low of 5% and nearly half its current value as of the start 2021.

Below are five questions before the policy-setting meeting of central banks scheduled for Tuesday, February 2, at 2:00 PM (1100 GMT).

Can Rate CUTS BE CONTINUED?

Before halting in January, the bank indicated that it would cut rates again this month. Erdogan did not specify how low rates he would like, but he has repeatedly stated that rate cuts are necessary.

Reuters analysts polled expect a 100-basis-point reduction this week. Given that the rate of inflation is rising and depreciation in the lira could be aggravated by more easing, only one person predicted that they would keep rates at their current levels.

A central bank policymaker responded to a question on a conference call this month with foreign investors. He said, in part, that rates could stay at 15% in December due to market turmoil.

Most analysts still believe that Turkey’s easing will continue even though global central banks are tightening, which leaves the country with negative real rates.

Erdogan, who is also the head of the central bank’s finance ministry, replaced this year the leaders with similar-minded individuals to help pave the way. His low-rates philosophy has been adopted by all.

“The placing of pawns into important positions shows that the country will fight to maintain low interest despite market rejection,” said Ipek Ozkardeskaya, an analyst at Swissquote. Ipek Ozkardeskaya of Swissquote said, “But the market always wins this game.” (Graphic: Turkey’s ‘real’ interest rates have plunged, https://fingfx.thomsonreuters.com/gfx/mkt/myvmnaqwypr/Pasted%20image%201639480464348.png)

What are the RISKS?

Turkey’s trade imbalance has led to a chronically high level of inflation through imports.

Turkey’s export price index rose nearly 55% to November, compared with a year before. This was due to the currency’s decline. It prompted economists and analysts alike, who predicted that consumer prices will reach 30% next fiscal year, which is five times the official goal.

Businesses may also be at risk from the volatility of inflation and exchange rates.

Kemal Cakir (32), a representative of Cakirogullari Agricultural Machinery, said that there was no commerce and no money. “We anticipate bigger losses in coming years.”

An even more likely possibility is the inability of companies to pay foreign debt obligations due to China’s 12-month-long refinancing requirements exceeding $170 billion.

However, there was a $3.1 billion current account surplus in October which helped to alleviate such worries. Erdogan said it was vital that the current account balance remains in positive territory to ease inflation and make people more self-sufficient. (Graphic: Turkey private sector external maturities, https://fingfx.thomsonreuters.com/gfx/mkt/zjpqkydoopx/Turkey%20IIF%20private%20sector%20external%20maturities.PNG)

ERDOGAN’S SUPPORTERS SINKING FAITH?

According to opinion polls, Erdogan and the AK Party with Islamist roots are losing support. Erdogan would likely lose a run-off election against potential rivals.

Turkey’s 19-year-old leader is making a gamble that rate cuts will bring down unemployment. He wants to get businesses to invest and then hire more people, even as rising prices and the collapse of the lira are hurting Turks’ earnings.

Reuters received statements from some AK Party voters saying they were open to supporting other parties during the next election.

Others believe in him as a leader who is well-respected by the urban and rural working classes, and the middle class. His approval rating is near 40% according to Metropoll’s survey.

We have also been affected by the business’s dire state. “I believe that Erdogan can fix this situation,” stated a Samsun restaurant owner of 50 years old. He declined to identify himself. (Graphic: Erdogan’s job approval rating based on Metropoll, https://fingfx.thomsonreuters.com/gfx/mkt/lgpdwoqzkvo/MetroPoll.png)

HOW LONG IS THE CENTRAL BANCKET ABLE TO SUPPORT LIRA?

The central bank’s ability and willingness to keep intervening in order to correct “unhealthy” foreign currency (FX) rates is dependent on several factors. This includes how long it taps FX reserves that are already low, how lower it reduces rates and policy decisions of the U.S. Federal Reserve. It also depends upon whether Turks contribute to their record-breaking hard currency holdings totalling $231 billion.

The bank technically could access $124 billion in gross reserves, but its net reserves only amount to $22 billion. Its holdings also reflect the negative effects of swaps made with other state banks.

Bankers calculated that the bank had spent between $2 billion and $2.5 billion just Monday to buy lira, after the currency crashed briefly to record 14.99. According to them, it had sold $2.5 billion during the three initial market interventions.

GlobalSource Partners’ analyst Atilla Yesilada estimates that interventions by the bank could last as much as six months as long as the monetary policy does not change. He and other analysts believe that the bank’s sales are a waste of precious reserves during times of economic stress.

Marc Chandler is chief market strategist for Bannockburn Global Forex. “Ultimately, floating exchange rates are a confidence-game to a large extent and (the bank) has lost them.” (Graphic: Turkey’s still depleted FX reserves, https://fingfx.thomsonreuters.com/gfx/mkt/xmvjoneyapr/Turkish%20reserves.PNG)

HOW HAS LIFE EVOLVED FOR TURKS?

Many Turks are now scrambling for ways to reduce costs, as the rapid fall in the lira has strained household budgets and canceled travel plans. Istanbul has seen a surge in demand for subsidised bread. The municipality claims that Istanbul’s cost of living has gone up by half a year and that rents have increased 71%.

Inflation has risen to the point that there are now shortages of medicine. This temporarily halted cell phone sales and caused retailers to scramble last month to adjust prices. High material prices are causing delays in some construction projects, according to builders.

According to Reuters on Tuesday, the government plans to introduce an additional budget in 2022 to meet increased spending requirements and a higher minimum salary.

Because of a long-running police crackdown against civil disobedience for years, protests on the streets have only been sporadic.

“The President is most likely to be confronted with social unrest in the coming months, triggered both by rising inflation and disorderly market triggered by the continuing depreciation the lira,” stated Lawrence Brainard from TS Lombard. A consultancy in London. (Graphic: Falling rates and rising inflation, https://graphics.reuters.com/TURKEY-CENBANK/lgvdwoqbnpo/chart_eikon.jpg)