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The cost of borrowing money in Turkey is surging, a sign that President Recep Tayyip Erdogan’s policy of driving down interest rates is starting to backfire.
Since the central bank began slashing rates in September, the yield on 10-year government bonds has climbed more than 7 percentage points, touching an all-time high of 24.9% on Wednesday. It stands at more than 10 percentage points above the bank’s benchmark repo, the biggest premium on record.
The surge in bond yields comes as investors worry that monetary policy will remain far too loose to contain inflation that is nearing the highest in a decade and eroding the value of their local currency holdings.
It also underscores the challenges Erdogan faces in putting his unconventional economic theory into practice. He believes low rates curb consumer prices and has strong-armed policymakers into cutting rates by 500 basis points over the past four months to 14%, saying easier policy will stoke growth. But even his latest measures to shore up the lira have done little to rein in yields.
“Turkey has given up on using its interest rate weapon and the central bank has lost control over inflation,” said Ogeday Topcular, a money manager at RAM Capital. The increase in borrowing costs in the market is a “natural outcome”, he said.
With inflation already running at more than 21% households and businesses are bracing for the fallout of more stimulus. Depositors are demanding higher rates on their saving accounts and investors are pricing in a higher risk premium, all of which risks undermining any benefits of loose central bank policy.
Some bank loan rates, meanwhile, have jumped to as high as 35%, Rifat Hisarciklioglu, the president of the Union of Chambers and Commodity Exchanges, told Dunya newspaper this week. That compares with a weighted average of about 21% before the start of the easing cycle, according to central bank data.
The lira has lost close to a third of its value this quarter as investors rushed to buy dollars to shield their savings. The depreciation has pushed up the cost of imports, which only threatens to stoke further price gains. The median estimate in a Bloomberg survey sees consumer inflation rising six percentage points to an annual 27.3% in December.
To help stem the run on the currency, Erdogan announced a set of extraordinary measures, including a new type of lira bank account, whereby the government makes up for any currency losses that exceed the interest rate on the deposit. The central bank and state lenders have also intervened in the currency market in December by selling dollars.
While the measures have offered respite for the currency, analysts say they risk weighing on the budget and fuelling more inflation.
“Instead of raising interest rates, the government introduced FX-linked deposits — this is a trial-and-error method,” Topcular said. “The cost of trial and error may be too expensive.”
The currency weakened for a fourth day on Thursday. It fell as much 5.8% to 13.4262 per dollar, trimming a rally that pushed it from a record low of 18.3633 on December 20 to a high of 10.2512 last week. The yield on 10-year government bonds fell 28 basis points to 24.5%.
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Published by Arena Holdings and distributed with the Financial Mail on the last Thursday of every month except December and January.