Lira slide becomes headache for Turkey's embattled Erdogan
* Erdogan's reputation built on economic success
* Lira's slide risks hitting Turks' pockets
* Central bank buring through fx reserves
* Government opposed to interest rate hikes
By Nevzat Devranoglu and Nick Tattersall
ISTANBUL, Jan 24 (Reuters) - Turkey's lira tumbled to new lows on Friday and investors doubted central bank ability to stem the rout as Prime Minister Tayyip Erdogan seeks to defuse a corruption scandal and stem a challenge to his power.
The lira tumbled beyond 2.33 to the dollar, meaning Turks now need more than twice as many lira to buy dollars as they did at the currency's peak six years ago, a costly decline in a nation heavily dependent on imports.
Erdogan has overseen a tripling of Turks' nominal wealth since coming to power in 2002, a record which has formed the basis for his ruling AK Party's growing margin of victory in three successive elections.
Any threat to that record could cost him at local and presidential elections this year, further tarnishing a reputation under threat from a corruption investigation which has led to the resignation of three ministers and the detention of close business allies.
He says the investigation and accusations have been engineered by a secretive U.S-based islamic cleric, Fethullah Gulen, who has strong influence in the police and judiciary. He suspects Gulen of wanting to unseat him, which Gulen denies.
Erdogan has cast the investigation also as a foreign-backed plot to undermine Turkey's standing, contrived in part by what he sees as an "interest rate lobby" of speculators bent on profiting from high rates to the detriment of Turkey's growth.
His vociferous opposition to interest rate hikes has left the central bank hamstrung, struggling to defend the lira by burning through its forex reserves and trying to squeeze up borrowing costs on the margins - a battle it seems to be losing.
Bankers said the central bank had sold around $3 billion on Thursday in its first direct intervention in the forex market for two years, but the move did little to calm markets.
"The central bank has to cast off the shackles of government control and interference and prove its independence by hiking rates in a meaningful way ... otherwise things could get much worse," said Timothy Ash, head of emerging markets research at Standard Bank.
The bank's net forex reserves stand at around $34 billion, economists estimate, meaning it can sustain dollar sales at Thursday's levels for weeks rather than months, although the bank has said all its reserves, including those held with it by commercial lenders, could be tapped if needed.
Its gross reserves stood at $107 billion as of last Friday.
"The Turkish central bank is in a difficult position," said Reinhard Cluse, an economist at UBS.
"Hiking official interest rates would have been the simplest and most powerful way to defend the lira and rein in the current account deficit. Yet, recent months have made it increasingly clear that there is strong political resistance."
TURKEY'S OWN MAKING
The cost of insuring Turkish debt against default hit fresh 18-month highs, while its new 2024 dollar bond, a $2.5 billion issue lapped up by foreign investors this week, fell below its launch price.
The selloff in Turkish assets was part of a wider emerging markets rout, fuelled by expectations that the U.S. Fed will make deeper cuts in its monetary stimulus and by turbulence in Thailand and Ukraine as well as Turkey.
But much of the pressure on Turkey is of its own making.
Erdogan has overseen strong economic growth since coming to power in 2002, transforming Turkey's reputation after a series of unstable coalition governments in the 1990s ran into repeated balance of payments problems and economic crises.
But his increasingly authoritarian style, from a heavy-handed police crackdown on street protests last summer to his reaction to the corruption investigation in recent weeks, has started to unnerve investors.
Government efforts to tighten control over the judiciary since the corruption scandal erupted with the detention of businessmen close to Erdogan and three ministers' sons on Dec. 17 have drawn sharp criticism from the EU, which Turkey has been seeking to join for decades.
He vowed on Friday that his party would not withdraw its plans to increase the government's say in the naming of judges and prosecutors - seen by the opposition as a ploy to thwart the graft investigation - although, in an apparent nod to EU concerns, he said elements of the draft bill would be shelved.
Concern about his authoritarianism have stretched to monetary policy, the central bank's reluctance to raise rates despite rising inflation and the tumbling lira seen by many as a direct consequence of Erdogan's opposition to any such move.
The bank kept its main interest rates on hold again this week, but said it would fund the market at 9 percent on "additional tightening" days, when it cancels repos and sells dollars at auction, in what amounted to a covert rate hike.
That did little to ease market nerves, leaving investors wondering how frequently those "additional tightening" days would be and whether even direct intervention would be enough.
"Past experience shows that burning forex reserves to ease the depreciation pressures proves sufficient only when it is supported with decisive interest rate tightening," said Gökçe Çelik, an economist at Finansbank in Istanbul.