Political and Economic Update
Turko-American relationship is on the brink. There is very strong (though not conclusive)evidence that gold trader Mr. Reza Zarrab has decided to confess to charges of violating Iran sanctions, which might implicate some Turkish banks and members of AKP elite. AKP is furious, portraying the trial as yet another conspiracy to undermine President Erdogan. In case of a guilty verdict about the remaining defendants or the prosecution charging Turkish banks and members of AKP, irreparable harm will be done to Turkey’s relations with the U.S.
More broadly, Turkey’s “splendid isolation” surfaced in full force, as Ankara clashed with NATO and the EU Parliament recommended a cut in pre-accession aid to protest deviations from Copenhagen Criteria. Erdogan could not convince Putin to grant permission to Turkish Army to move in on Afrin, while Turkey remains shunned in most of Sunni Arab world. At a time of rising external economic challenges and regional threats, this isolation significantly jeopardizespolitical stability.
It has been a bad week for Turkey’s banking system, as Anti-Trust Board initiated legal action against seven global banks for forming a cartel, while Erdogan wowed to fight the infamous High Interest Lobby, criticizing the CBRT for failing to deal with inflation. His promise of action could further destabilize the money market.
Recent data releases confirm the strength in economic activity through the third quarter, with the current account deficit widening, unemployment rate sharply falling, import taxes surging, inflation expectations deteriorating further, and so on.
As we were about to send our Weekly Update, the CBRT announced a new hedging instrument (the “TL-settled forward foreign exchange sale auctions”), the details of which were explained in a blog by the CBRT staff. According to the scheme, the CBRT will be on the losing side in the event of excessive lira weakness, which the Bank staff rationalizes by arguing that “[w]ith this instrument, it will be as if the CBRT fixes the profit of a respective amount equal to the auction sum”, since the Bank is currently long in F/X. We read this essentially as a subsidy -- provided by the CBRT to the corporate sector -- by way of diverting some of its profits from the government to the corporate sector. Even though the magnitudes are not too large for now, this is a tricky area for a central bank to be dragged into. What is worse -- and much more important in our context, the scheme could be seen as a way of avoiding or substituting for rate hikes, contributing to, rather than relieving, the current unease in the F/X market.
The Cosmic Man throws up His hands, claiming that Turkey entered a world of true Knightian Uncertainty. What Reza Zarrab tells the prosecutors and how Erdogan intends to fight high interest rates will determine the fate of markets. He is not sticking around to see how these events might unfold.
Now read on...
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