The sell-off in Turkish assets and the currency following the decision of President Tayyip Erdogan to remove the central bank governor is set to continue over the coming weeks, but the contagion to other emerging markets is likely to be moderate, John Higgins, an economist at Capital Economics, said.

Erdogan appointed Sahap Kavcioglu as new governor over the weekend, replacing Naci Agbal, who was at the helm of the central bank only for four months.

The surprise announcement came after the central bank resorted to a larger-than-expected 200 basis point rate hike on Thursday. During Agbal’s tenure, the key one-week repo rate was raised by 875 basis points.

The new governor Kavcioglu has expressed sympathy for Erdogan’s unusual view that high interest rates lead to high inflation.

In a statement, Kavcioglu said the central bank will continue to use the monetary policy tools effectively in line with its main objective of achieving a permanent fall in inflation.

The decline in inflation will foster macroeconomic stability through the fall in country risk premiums and a permanent improvement in financing costs, and will contribute to the development of conditions essential for sustainable growth that will enhance investment, production, exports and employment, Kavcioglu added.

Capital Economics had forecast the lira to strengthen in 2021 and Turkish assets to gain ground assuming a shift in Turkey’s policymaking towards more aggressive inflation fighting – of which the appointment of Agbal was an integral part. Events over the weekend have made clear that this would not be the case, the economist noted.

The lira and Turkish assets are set to fall further this year as monetary policy will probably be looser and inflation higher than previously expected, which would directly hurt the lira and local-currency government bonds, said Higgins.

The economist said the fall-out in other EMs from turmoil in Turkey’s financial markets has been limited mainly due to two reasons.

Higgins said Turkey’s difficulties are clearly idiosyncratic in nature. Moreover, most other major EMs have reduced their external vulnerabilities during the coronavirus crisis.

Second, foreign investors reduced their exposure to Turkey following the 2018 currency crisis, so it seems unlikely that sharp drops in the prices of Turkish assets will force them to sell other EM assets to cover their losses, the economist observed.

The material has been provided by InstaForex Company – www.instaforex.com

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