Turkey - Nebati says don’t expect rate hikes

Turkey’s finance minister is on the wires this morning arguing that anyone expecting rate hikes will be disappointed.

It’s not rocket science - whoever wins the elections will face the challenge of closing a large external financing gap, high inflation, and, I would argue, an overvalued lira.

The choices are:

a) Let the lira adjust weaker;

b) Hike policy rates to slow domestic demand and cut import demand, and hence the current account deficit;

c) Impose capital controls to artificially limit demand for FX;

d) Go on an IMF programme, but likely they would demand a) + b) anyway.

E) Call a friend to gain access to more FX reserves to defend the lira. Friends could be Russia or the Gulf. Problem is that once Erdogan wins the election, Putin will have no interest in giving Erdogan a get out of jail card, he would want him to remain weak and dependent economically. Putin also needs his own $$ for his own survival. And the Gulf? Well we have seen in the broader region that the likes of Saudi, et al give $$ but now demand orthodox policy responses to preserve their own investments. We are now seeing this play out in Egypt - so the Gulf guys would demand Erdogan sets the lira at a cheap level and hikes policy rates.

So, if Erdogan wins, I think we see a) + c) initially, and if that fails he will have to do b), eventually. Question is how long it takes him to come to that realisation and how much damage is done in the interim.

If the opposition wins, then I think we see a) and b) soon after taking office, and maybe even d). That response will be painful in the short term, crimping growth, but will pay off with lower inflation and higher and more sustainable growth over the longer term.

It all feels a bit like a police interrogation, we can do this the nice or the painful way. But ultimately you are going to have to deliver policy rate hikes.