Turkey could be on the cusp of another currency crisis after President Recep Tayyip Erdogan abruptly fired the head of the country’s central bank, putting the lira on track for its worst single day decline against the US dollar in nearly three years. The move will knock investor confidence at a fragile moment for Turkey’s economy and drive rising inflation even higher, say analysts, which could force the government to resort to capital controls or emergency rate hikes. The lira tumbled as much as 15% to hit 8.39 per US dollar on Monday, nearing an all-time low. The last time the currency suffered such a sharp correction in a single day was during Turkey’s 2018 currency crisis, which caused it to lose almost half its value against the dollar. The lira’s collapse came after Erdogan dismissed Turkish central bank governor Naci Agbal on Saturday, just two days after Agbal hiked interest rates to counter a sharp rise in inflation. Agbal had served less than five months on the job and becomes the third central bank governor ousted by Erdogan since mid 2019.The shock dismissal also rattled equity markets, causing the Istanbul Stock Exchange to briefly suspend trading on Monday after its main index fell by nearly 9%. It also hit European banks with exposure to Turkey, including Spain’s BBVA (BBAR) and Dutch lender ING (ING).With his removal, “Turkey loses one of its last remaining anchors of institutional credibility,” Phoenix Kalen, an emerging markets strategist at Société Générale, wrote in a research note on Sunday. Agbal was replaced by Sahap Kavcioglu, a banking professor and former parliamentarian for Erdogan’s ruling Justice and Development Party, known as AKP. “The shock firing of central bank chief Agbal over the weekend may deal a fatal blow to investor confidence in Turkey,” wrote Win Thin, global head of markets strategy at Brown Brothers Harriman, in a Sunday research note. Agbal defended the central bank’s economic reforms and independence during his brief tenure, steps that bolstered local and foreign investors’ confidence in Turkish assets. Two days before he was fired, he hiked interest rates by 200 basis points to 19%, higher than expected, after inflation reached nearly 15% in February.
The third large rate hike since his appointment in November “was very well received by the market,” increasing the lira’s attractiveness due to Agbal’s commitment to “keep inflation on track to fall in the second half of the year,” according to Rabobank strategists. “However, this bullish scenario for the lira was left in tatters,” they wrote in a note to clients on Monday. “We are seriously concerned about the outlook for inflation and economic activity. “Win said that the fallout could even push the lira to 8.58 per US dollar, the all-time high, and may “even surpass it.”
Erdogan believes in an unorthodox approach to monetary policy based on keeping interest rates low to avoid inflation. Kavcioglu, the newly appointed head of the central bank, has defended similar approaches. He was a member of parliament in AKP from 2015 until 2018, and wrote columns for the pro-government Yeni Safak newspaper. “At this point, it doesn’t matter who Agbal’s replacement is or what they say, as it’s clear that Erdogan is running the show,” Win said.