Turkey - is Simsek the answer?

The market is awash with speculation that former finance minister, Mehmet Simsek, is about to return in some similar or even enhanced role as economic supremo in the next Erdogan administration.

Reports suggest that the cabinet line up will be unveiled on Friday, and Simsek will be on the list. Turkish credit markets have already bought into the news, with Turkey 5Y CDS rallying back by 100bps to around 600bps from the highs after the market shock from the first round Erdogan win in the presidential elections on May 14 - he then secured a slam dunk second round run off win on May 28. 

Simsek is a respected economist, having served a long stint as Treasury and then finance minister, and prior to that working as an economist at the US embassy in Ankara and later at ML, as it then was. His views are orthodox, and the market remembers his time under the CBRT governorship of Murat Cetinkaya of heading to the presidential palace to request permission for policy rate hikes. He has the battle scars. 

And that’s kind of the problem, what is clear is that to address a looming and near perennial balance of payments problem, Turkey has to slow the economy by hiking policy rates, but will Simsek have to return to the MO of the Cetinkaya period of having to ask the boss, Erdogan, when and by how much to raise policy rates? If that is the case, I don’t think this relationship (Erdogan - Simsek, and then Erdogan/Simsek with the market) is going to work. The market wants an independent central bank, with the ability to do whatever is needed to address head on the looming balance of payments crisis.

How much freedom will Erdogan give Simsek on the economic policy front to do whatever it takes to rebalance the economy, and particularly, the foreign accounts? And unfortunately for the market, the recent past experience is not that encouraging, as was proven with the short tenure as CBRT governor of Naci Agbal, and then former finance minister, Lufti Elvan, who were both removed ultimately as Erdogan did not appreciate their more orthodox economic policy views. What assurance is there for the market that even if Simsek is hired, and tightens policy, that Erdogan will not soon remove him, unwilling to stomach the invitable impact of policy tightening which will be lower growth, higher unemployment, albeit likely bringing a benefit of a stable lira, lower inflation and only later higher growth? 

Remember herein also that Erdogan ran the election campaign on a clearly unorthodox economic agenda - he banged the line that his unorthodox low interest rate policies will inevitably do the trick in driving inflation lower. And Erdogan has that huge political capital from winning the election against the odds. Why should he listen to anyone and change course now? Likely he thinks his policies are winning, at least politically. 

What assurances can Simsek secure from Erdogan that this time will be different? 

We hope here that the team now around Erdogan have helped convince him that the current macro mix is indeed toxic. A huge current account deficit with a weight of short term debt falling due, making a total of $230bn plus of gross financing needs, set against gross CBRT reserves of just over $100bn, and net reserves which are now significantly negative. The CBRT was able to scrape together reserves to defend the lira somewhat before the election, but post the election the cupboard is bare, and the risk now is of a seismic move lower in the lira which might have systemic risks for the economy, particularly the banking sector. Erdogan has limited choices now, among them a maxi devaluation which will boost inflation even further, capital controls which will hurt business and much of his own constituency, borrow funds from Russia or the Gulf which will likely come at a huge geopolitical and economic cost (Saudi Arabia will demand economic orthodoxy anyway, as it has with Egypt and Pakistan) or slow the economy moderately thru a combination of monetary and fiscal tightening. Perhaps the more rational and orthodox advisers around Erdogan have finally won the day and this is now playing out likely with Simsek’s appointment.

Simsek may be able to secure assurance by pitching for the creation of a new reform team, extending to a new orthodox central bank governor, and new treasury minister. Perhaps then, hopefully then there will be safety in numbers - surely Erdogan would never sack the lot of them. But the market I think will be cautious herein, after rallying initially on a Simsek appointment - they will adopt a seeing is believing approach, on how much pain, via monetary and fiscal tightening Simsek is able to deliver, and Erdogan live with politically and perhaps personally. Simsek can, and likely will stabilise the situation, but for how long will depend on the length of his own tenure in office and really how much economic policy freedom he is given. There are clear exits routes out of the current difficult economic mix, and Simsek can deliver Turkey through these challenges (he has the tool kit, knowledge and experience), and the market trusts him, but he needs to be given the freedom to do whatever it takes.