The latest figures out of the Turkish treasury ministry are nothing short of eye-watering. The consumer price index or CPI, which measures inflation at the consumer level, was higher by 6.3 percent in the last month and over 24 percent in the last year. As for the producers' price index, or PPI, those figures were higher by 46 percent year-over-year and over 10 percent in the last month.
The recent rate hike last month to 24 percent means that investors in Turkish bonds would just break even earning a real rate of zero percent. Surprisingly, however, the Turkish lira was weaker by less than half a percentage point late Wednesday, meaning currency markets weren't much surprised.
What do these numbers mean for the broader economy and the investability of Turkey?
The recent hike in interest rates was in response to the volatile swings in the Turkish lira and the rate hike appears to have calmed down jittery currency markets with the lira resting near the 6 liras to a dollar handle. The current inflation report we see now is reflecting the massive moves in prices in the month of August just passing through the economy and to the consumer. The incredible jump in producer prices reflects the dollar dependency of producers especially as they relate to energy. Oil trading at 4.5 year highs is doing the Turkish economy no favors and similarly emerging markets across the board are beginning to feel the pinch of higher energy prices coupled with aggressive Fed tightening.
The Federal Reserve's latest rate hike and predictions for a near doubling of interest rates within the next two years means that an investor in U.S. government bonds will be able to easily get returns of over 5 percent at the peak of current interest rate hike predictions. This would mean emerging markets such as Turkey would need to offer real rates above those figures to fund government operations and corporations. Will the Turkish Central Bank hike rates in an attempt to offer investors real returns on par with U.S. government bonds? The short answer is maybe. In the near term I doubt the Fed will be able to stick to its current plan to hike at the predicted rate. Continued increases in oil prices will simultaneously push prices higher and will ultimately lead to a slowdown in the U.S. economy, necessitating a pause in rate hikes.
The Turkish central bank may hike rates if the upcoming inflation reports echo Wednesday's numbers but this will almost certainly not be the case according to Treasury Minister Berat Albayrak. If the inflation pressures due to the excess volatility in the currency markets has indeed passed through the economy, this will mean far lower inflation data next month. Also next week, a Turkish court is expected to release pastor Andrew Brunson from house arrest, allowing him to return to the United States. Markets have mostly priced in this event although an immediate warming of U.S.-Turkey relations following the release may help the lira regain some footing. If that does happen, dollar denominated energy will be cheaper for Turkish producers and inflation will very quickly retreat.
Turkish firms are struggling to finance their debts as the central bank's rate hikes have forced them to scramble to roll over existing debt at much higher rates. My fear is that such refinancing will be unsustainable and that many firms won't make it out of this upcoming economic recession leaving hundreds of thousands of workers unemployed. The central bank has a very delicate balancing act it needs to pull off here. Should interest show signs of abating, immediately inform markets without having to further hike rates. If they don't however, policy makers need to come up with new plans to curb inflation in the near term, lest the economy enter an irrecoverable tail spin.