Turkey shock interest hold sees lira plummet as banks suffer

Turkey’s central bank defied market expectations and held interest rates unchanged in its first monetary policy decision since President Recep Tayyip Erdogan appointed his son-in-law the country’s new economy czar, triggering a plunge in the lira and stock market.

The bank held its one-week repo rate at 17.75 per cent, a full percentage point less than the median estimate of analysts in a Bloomberg survey. The lira

plummeted and bonds fell as investors said they’d lost faith in the central bank’s credibility after its unexpected move.

The currency weakened as much as 4.2 per cent to approach a record low and the yield on the nation’s 10-year bonds jumped 132 basis points to a one-week high. Most analysts in a Bloomberg survey had forecast that the central bank would raise the repo rate by at least 100 basis points after inflation accelerated to more than three times the bank’s official target in June.

"This is a shocking decision given that inflation accelerated sharply and the lira weakened to a new record low earlier this month,” said Piotr Matys, a currency strategist at Rabobank in London.

Inan Demir, an economist at Nomura International in London, added: “This decision essentially confirms the markets’ worst fears. Unless this policy mistake is corrected by an emergency rate hike very soon, the markets’ fears will translate into further substantial lira weakness.”

Tuesday’s decision was under close scrutiny by investors who’ve been seeking an indication of where monetary and fiscal policies might be headed after Berat Albayrak, 40, was named treasury and finance minister earlier this month. Mr Albayrak has in the past written extensively in support of unorthodox economic views held by Mr Erdogan, who’s adamant that inflation will only slow if borrowing costs for companies and households are lowered.

Without directly disputing those views, Mr Albayrak used his first interview in his new role to voice generally mainstream policies on the importance of maintaining the central bank’s independence, saying that policy actions will be in line with economic realities and the requirements of the markets.

“This was a major policy mistake from the Turks and a missed opportunity to build on the credibility they gained with +500bp of policy tightening delivered during Q2,” said Paul Greer, a London-based emerging market money manager at Fidelity. His views were echoed by other analysts, including Jason Tuvey at Capital Economics, who said more than anything, the decision to leave rates on hold "provides the first evidence that President Recep Tayyip Erdogan holds increasing sway over Turkish monetary policy".

Turkey’s banks are about to reveal the extent of the damage caused by the lira’s plunge and a surge in interest rates.

As the country’s biggest lenders start reporting second-quarter results this week, investors will be scouring their balance sheets for clues into how they’re coping from a 22 per cent slide in the currency this year that is knocking the ability of companies to repay their foreign debt. They’ll also be looking for signs on whether the highest borrowing costs in almost a decade have started to cool the economy.

Bank profits are expected to show an average 5 per cent drop from the previous three months, according to data compiled by Bloomberg based on the median estimates of the six-biggest publicly traded lenders. The lira on Tuesday fell more than any other currency.

“Turkey’s weak currency, together with a 500-basis point interest-rate hike year-to-date will wreak havoc on banks’ asset quality, and raise alarm bells that flat 2018 cost-of-risk targets are increasingly unrealistic,” said Tomasz Noetzel, a European banks analyst for Bloomberg Intelligence in London. Those efforts are being further complicated by the adoption of new accounting standards that has led to higher provisions, he said.

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Akbank will report earnings on July 25, followed a day later by Turkiye Garanti Bankasi. Others lenders including Turkiye Is Bankasi, Yapi ve Kredi Bankasi, Turkiye Vakiflar Bankasi and Turkiye Halk Bankasi.

The lira is the worst-performing currency after Argentina’s peso among 24 emerging markets tracked by Bloomberg at a time when foreign borrowings have more than doubled since 2008. Foreign-exchange liabilities after accounting for offshore assets climbed to a record $221 billion at the end of April.

The currency’s decline and the interest-rate increases risk causing a spike in non-performing loan ratios and eating into capital adequacy ratios, which are still at about 3 per cent and 16 per cent, according to banking watchdog data. However, bad loans jumped more than 7 per cent in the three weeks to July 5, reaching $16bn, showing the first signs of cracks in asset quality.

Turkey’s largest companies are seeking to rearrange almost $24bn of loans, with the energy sector alone still having to repay $51bn of debt. It also comes as Mr Erdogan tries to stoke growth by encouraging lending.

“Should a significant number of Turkish corporates default on their foreign obligations, this would reverberate across the Turkish economy, cause mass consumer panic, shake the confidence of international financial markets and potentially lead to a crisis within the Turkish financial system and to a deep and prolonged economic recession,” said Fadi Hakura, Chatham House Turkey analyst.

“Erdogan is spiking the fuel to boost the speed of the sputtering mid-sized Audi-style Turkish economy to achieve superior Ferrari growth rates,” he said.

Fitch Ratings echoed some of Mr Hakura’s concerns in its assessment of the economy on July 13, when it cut Turkey’s sovereign rating into deeper junk.

“Tougher financing conditions and a weaker economy will likely hit the performance of the banking sector, heightening pressure on asset quality, capitalisation and liquidity and funding profiles,” the ratings company said.