Turkey’s president Recep Tayyip Erdogan and Sahap Kavcioglu
Turkey’s president Recep Tayyip Erdogan, left, has handed the nation’s central bank reins to Sahap Kavcioglu, a little-known professor of banking and a former lawmaker from the ruling Justice and Development party © FT montage

President Recep Tayyip Erdogan has triggered a slide in Turkey’s financial markets by sacking the central bank chief who had been regarded as a crucial force in pulling the lira from historic lows.

The currency plummeted as much as 14 per cent in frenetic trading on Monday, while the stock market shed almost a tenth of its value and investors rushed out of the country’s local and foreign currency debt.

The dismissal of Naci Agbal, announced in the early hours of Saturday, shocked many local and foreign investors who had applauded the official’s decisions to move Turkey towards a more orthodox monetary policy.

“With Naci Agbal’s removal from the central bank, Turkey loses one of its last remaining anchors of institutional credibility,” said Société Générale strategist Phoenix Kalen, adding: “Turkey may soon be headed toward another currency crisis.”

Line chart of Lira per US dollar showing Turkish lira sinks after Erdogan replaces central bank chief

Agbal’s appointment in November as part of a broader economic leadership shake-up helped spark a sharp rally in the lira, which was at one point the best performing emerging-market currency of 2021 having previously dropped to a historic low.

The lira had recovered almost a fifth from its trough of about 8.58 to the US dollar on November 6 before Agbal’s removal. It had gained last Thursday after Agbal increased interest rates by 2 percentage points, double what economists expected, on top of a 6.75 percentage point increase he oversaw last year.

Investors had long called for tighter monetary policy in Turkey to tame inflation that is running at more than 15 per cent and to quell strong outflows from foreign investors.

Ehsan Khoman, head of emerging markets research at MUFG Bank in Dubai, said that Agbal’s leadership and the central bank’s prudent measures had played a “pivotal role” in restoring confidence in the lira and Turkish assets.

Traders and analysts are concerned that Erdogan’s decision to install Sahap Kavcioglu to the role could rapidly erode the gains made during Agbal’s short tenure. Kavcioglu wrote in his column at the pro-government newspaper Yeni Safak last month that “interest rate increases will indirectly lead to an increase in inflation” — a view that runs counter to most modern macroeconomic theories, but is also espoused by Erdogan, a vocal opponent of high rates.

Robin Brooks, chief economist at the Institute of International Finance think-tank, said Turkey was at risk of “large” investor outflows, which would place pressure on the lira.

The lira traded as low as 8.4 against the US dollar on Monday, 14 per cent weaker than Friday’s closing level, before recovering to some extent to trade at around TL7.95. The fall on Monday was one of the most acute since the revaluation of the currency in 2005.

Line chart of Year-on-year change in CPI (%) showing Turkish inflation remains elevated

The selling also bled on Monday into the fixed income market. Turkey’s dollar-denominated bond maturing in June 2031 tumbled in price to about 89 cents to the dollar, from 99.87 cents on Friday, pushing the yield up to 7.45 per cent. The country’s lira-denominated bonds also fell sharply, sending the yield on the benchmark 10-year to 16.2 per cent from 13.6 per cent at the end of last week.

Meanwhile, the cost to protect against a default on Turkish debt shot higher. The spread on the country’s five-year credit default swaps jumped 155 basis points — the most on record — to 460 bps.

Lutfi Elvan, Turkey’s finance minister, pledged on Monday to adhere to price stability and free-market principles.

“The macro policy framework that we are implementing and which ‘prioritises lowering inflation’ will continue until a permanent reduction in inflation is achieved,” Elvan said on Twitter. “We give extreme importance to the effective and healthy operation of markets,” he said.

Elvan’s statement came after Kavcioglu said on Sunday that 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 sudden change in Turkey’s monetary policy leadership came during a fraught moment for emerging markets, which have been under pressure as borrowing costs in the US and other developing markets have climbed higher. Last week, Russia and Brazil joined Turkey in increasing interest rates as they sought to keep a lid on inflation.

Line chart of Cents on the US dollar  showing Turkey's foreign currency bonds under pressure

Additional reporting by Katie Martin and Hudson Lockett in Hong Kong

This article has been amended since first publication to clarify the description of the newspaper Yeni Safak

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