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Turkey's Central Bank Hikes Interest Rates

  • Dorian Jones

Turkey's Central Bank Governor Erdem Basci speaks during a press conference in Ankara, Turkey, Tuesday, Jan. 28, 2014.
In a bid to rescue the tumbling Turkish lira, the country’s central bank has substantially hiked all its key interest rates.

In a dramatic meeting midnight local time on Tuesday, Turkey's central bank took the financial markets by surprise by ordering a massive across-the-board hike in interest rates, which meant that a key interest rate was more than doubled, to 10 percent.

Atilla Yesilada of Global Source Partners, an Istanbul-based financial consulting firm, says the aggressive move was unavoidable.

"Had it not been for this interest rate hike, the exchange rate would have become a bottomless pit, dragging half of Turkey’s wealth and most important corporations down with it. It was a move that was forced by the necessity," he said.

The Turkish lira has plummeted ever since a series of investigations into alleged government corruption was launched last month, reaching new record lows on a nearly weekly basis. Following Tuesday's rate hike, the lira initially recovered some of its losses, but it again started to fall.

Inan Demir, chief economist at Istanbul-based Finans bank, says many Turkish companies heavily indebted in foreign currency are seeing this as an opportunity to buy foreign currency.

"The corporations are probably seeing these levels as an opportunity to buy dollars for their upcoming redemption or import bills, so this is going to be one source of foreign currency demand. "

Demir warns that despite the interest rate hikes, international investors remain nervous about Turkey, which has one of the largest current account deficits in the world. Adding to that concern, the U.S. Federal Reserve Bank is expected to continue to phase out its policy of injecting large amounts of money into financial markets.

That policy has helped sustain the Turkish economy, according to economist Demir. He warns that further interest rate hikes maybe needed.

"What you have is a current account deficit county, with significant domestic political risks. Against that backdrop, international investors will still anticipate further increases in the level of that single policy rate," he said.

Economists and analysts say the political and economic uncertainty surrounding Turkey since anti-government protests erupted last summer has resulted in a marked downturn in long-term international investment. Analyst Yesilada warns that with the real Turkish economy facing difficult times, new investment is unlikely .

"Already, January business and consumer confidence indexes revealed a very sharp decline in numbers. Sort of a confidence crisis largely caused by the fight in Ankara. Now we have, on top of that, we have a massive interest shock -- roughly 300 basis points. The inescapable conclusion is Turkey will suffer a relatively deep recession," said Yesilada.

A booming Turkish economy is one of Turkish Prime Minister Recep Tayyip Erdogan's main achievements and is widely cited one of the main factors behind his more than a decade of electoral success. The current economic woes come at a bad time for the prime minister, with key local elections set for March.

Erdogan has strongly opposed any interest rate hikes, accusing those calling for them of being part of an international conspiracy against his government. Observers warn such statements will likely make international investors even more nervous about Turkey and put further pressure on its currency.