Turkey’s central bank expected to stay course after leadership shake-up

Turkey’s newly appointed central bank chief Fatih Karahan is widely expected to stick with the country’s shift towards more conventional monetary policy, analysts say, after his predecessor’s abrupt exit.

Hafize Gaye Erkan, who oversaw a campaign of sharp rate rises, resigned from the top job at the central bank on Friday, blaming a smear campaign against her in domestic media.

The move brought back memories of other late-night putsches against central bank bosses who raised borrowing costs in contrast with President Recep Tayyip Erdoğan’s long-held objection to tight monetary policy.

The subsequent appointment of Karahan, deputy governor since July, has bolstered expectations that, at least for now, Turkey will stay the course with its attempts to quell its long-running inflation crisis with higher interest rates.

Who is Fatih Karahan?

Karahan, who is Erdoğan’s sixth central bank governor since 2019, is a well-known figure among the economics community in Turkey. He is seen as one of the driving forces behind a pivot towards more conventional monetary policy that began after Erkan’s appointment as the central bank’s first female governor in June.

The University of Pennsylvania-educated economist worked for nearly a decade at the New York Federal Reserve and later joined ecommerce group Amazon before his appointment at Turkey’s central bank.

Karahan’s published work and professional experience have broadly focused on macroeconomics and labour markets. His experience contrasts with Erkan, a former Goldman Sachs banker, who specialised in developing complex risk management models for banks.

“I know him as an . . . expert who is respected by the employees of the institution,” Hakan Kara, a former Turkish central bank chief economist, said of Karahan. One local banker added Karahan was a “credible” choice to lead the bank.

What is the central bank’s role in Turkey’s economic overhaul?

Erdoğan, Turkey’s leader of the past two decades, abruptly changed course on economic policy after his re-election in May. He abandoned unconventional policies that had fuelled a long-running inflation crisis and by spring 2023 ignited serious concerns that Turkey was headed for a balance of payments crisis or capital controls.

The president in June appointed Mehmet Şimşek — a former Merrill Lynch bond strategist who had served years earlier as deputy prime minister — as finance minister to lead the economic turnaround. Erkan’s appointment days later helped bolster expectations that Erdoğan was serious about the overhaul.

The central bank under Erkan’s leadership has boosted interest rates from 8.5 per cent to 45 per cent. It has also taken a series of other steps aimed at cooling rampant inflation and financing growth, while encouraging locals to hold lira rather than stashing their savings in dollars and gold.

The bank’s foreign currency war chest, which was depleted in recent years in an unsuccessful attempt to prop up the lira, was also rebuilt during Erkan’s tenure. Gross foreign currency reserves were $85bn at the end of 2023, up from $48bn in May, according to central bank data.

The central bank still faces a big challenge in taming inflation, however. A report released by Turkey’s statistics agency on Monday showed consumer prices rose almost 7 per cent in January from the previous month, a significant acceleration from 2.9 per cent in December. The annual inflation rate is nearly 65 per cent.

Economists blamed the month-on-month uptick on a 49 per cent rise this year in the minimum wage, coupled with a 3.5 per cent fall in the lira against the dollar since the end of December, which makes the cost of imported goods rise.

What does this mean for investors?

Foreign investors have been slowly warming to Turkish assets in recent months after largely abandoning the country’s markets over the past decade because of Erdoğan’s unorthodox policies.

Pimco, one of the world’s biggest bond managers, told the Financial Times last month it had started buying lira-denominated debt and that Turkey could even regain its investment-grade credit ratings in the next five years.

One of investors’ most persistent fears, however, has been the risk of another “Ağbal incident”, a reference to 2021 when Erdoğan sacked well-respected central bank governor Naci Ağbal for raising interest rates.

The initial reaction from local and foreign analysts is that Erkan’s exit is not a repeat of Ağbal’s dismissal.

A senior economic official said that Şimşek was provided the latitude to nominate a governor who shared his convictions on the restoration of conventional economic policies.

“Our president has full support and confidence in our economic team and the programme we are implementing,” Şimşek said on Friday.

Karahan added at the weekend, “We are determined to maintaining the necessary monetary tightness until inflation falls to levels consistent with our target.”

Fatih Akcelik, Turkey economist at JPMorgan, told clients that “while sudden leadership changes bring discomfort for investors, we see the new [central bank] governor as positive for disinflation and lira”.

He added that Karahan would probably be more hawkish on interest rates than Erkan had been since he was part of a trio of central bank deputy governors who were thought to have agitated strongly for large rate rises.

Akcelik added that a “dovish tilt” at last week’s central bank meeting, in which the policy-setting committee signalled it was unlikely to raise rates again, would probably be reversed.

Turkey’s benchmark Bist 100 stock index rose about 1 per cent on Monday, while the banks sub-index, which is sensitive to economic expectations, rose more than 2 per cent, according to FactSet data. The lira was little changed at TL30.5 against the US dollar.

What prompted Erkan’s exit?

Rumours have been swirling around Turkey’s economics community for several weeks, after a former employee claimed in a local news report that Erkan’s father held an unofficial role at the central bank and had sacked her.

Politicians in Turkey’s opposition political parties latched on to the drama, with one MP demanding in January that Şimşek answer questions related to the allegations. Erkan dismissed the claims as “unfounded” and “completely unacceptable”.

Erdoğan appeared to back Erkan as recently as last week, when he said unnamed assailants were seeking to “disrupt the climate of confidence and stability that we have achieved with great difficulty in the economy with unreasonable rumours”.

Erkan said she had quit for personal reasons: “A major character assassination campaign has been organised against me recently,” Erkan said, adding that she had stepped down “to prevent my family and, moreover, my sinless child . . . from being further affected by this process”.