Turkey bank chief ignores Erdogan to save reeling lira

Wed Jan 29, 2014 5:32am EST

* Central bank announced rate hike at midnight

* Governor Basci torn between political and market pressures

* Former academic fond of experiments, risked credibility

* Turkish lira rallies from record lows to dollar

By Alexandra Hudson

ISTANBUL, Jan 29 (Reuters) - Torn between an angry prime minister railing against an interest rate hike and punitive markets baying for a rise, Turkish Central Bank Governor Erdem Basci opted for a bold increase in rates that has stunned investors.

On Tuesday morning, he faced a front-page headline "Stand firm, don't raise" in Yeni Safak, a paper close to the government, ahead of an emergency policy meeting, called as the lira plunged to unprecedented lows.

A few hours later, he calmly fielded questions from critical international analysts and the press, insisting the central bank had the resources and strategy to overcome the biggest bout of volatility in Turkey's markets in a decade.

And shortly after that, the 47-year-old risked Prime Minister Tayyip Erdogan's wrath, putting up interest rates dramatically in a move that spurred the lira to its biggest jump in five years and boosted investors' hope that a cycle of selling in emerging markets may have been short-circuited.

In one of the world's most unorthodox policy mixes, the bank had been battling to support the weak lira with foreign exchange auctions, liquidity adjustments and verbal intervention while avoiding outright rate hikes.

Erdogan's government has condemned rate increases as pandering to an "interest rate lobby" of foreign investors and harmful to economic growth, creating a political climate in which those calling for rate hikes are left feeling like enemies of the state.

CRISIS AVERTED

But on Wednesday, Basci, was being congratulated for bold action that also averted a domino crisis in emerging markets.

"The policy response to severe financial stability risks was punchy, aggressive and credible. An amazing job overall," said economist Benoit Anne at Societe Generale.

"The Central Bank of Turkey is now back in the game after going through a few tough weeks during which its credibility was heavily challenged by emerging market investors."

Many Turkish newspapers used pictures of Basci looking determined, his fists clenched.

"Hawkish step from Basci," said Milliyet, with a cartoon of the governor as a weight lifter. "The central bank pulled out its interest rate gun," said the daily Taraf.

But the pro-government Sabah newspaper took a more critical line, predicting that the economy would stall.

Alarmed investors have fled Turkish assets as a high-level graft case engulfed figures close to the government, hastening an exit that followed curbs in U.S. monetary stimulus.

Erdogan has launched a purge of the judiciary and police in response to the corruption probe, testing investors' faith in the independence of state institutions and adding to pressure on Basci to show that the bank does not bow to politicians.

Former academic Basci has seen his name become so synonymous with opaque, elaborate monetary policy since taking the helm in 2011 that some analysts had speculated the midnight-hour announcement might herald yet more monetary black magic.

But during a presentation of the bank's quarterly inflation report earlier on Tuesday, Basci made clear he would take decisive action to fight rising inflation and a tumbling lira.

"Actually I think this is about a return to orthodoxy for now," Murat Ucer, an analyst at Istanbul-based investment consultancy Global Source Partners, told Reuters on Tuesday.

HOT MONEY

Basci took charge as Turkey emerged from the global financial crisis and faced dizzying growth rates and a rush of speculative hot money.

Highly respected for his prodigious command of academic theory, he viewed himself as a maverick central banker experimenting with policy tools often untested by more orthodox peers, according to those who have worked closely with him.

To deter destabilising flows of speculative money into Turkey, Basci created a wide "corridor" between the rates at which the central bank borrows and lends in the overnight money market, and manipulated funding costs inside the corridor.

The result has been one of the world's most complex monetary policy mixes, often to the frustration of economists who have at times accused him of trying to do too much in too complex a way.

To general surprise, the bank has now raised its overnight lending rate to 12 percent from 7.75 percent, its one-week repo rate to 10 percent from 4.5 percent, and its overnight borrowing rate to 8 percent from 3.5 percent - all much sharper moves than economists had forecast.

Central bank insiders describe a highly centralised decision-making process around Ankara-born Basci, who is surrounded by monetary policy committee members also largely from academic backgrounds and reluctant to challenge him.

Ideologically close to Erdogan's Islamist AK party, he was a childhood friend of Deputy Prime Minister Ali Babacan, seen by international investors as one of the more trusted members of the government's economic team.

His wife wears the Islamic head scarf, possibly one of the reasons why he didn't get the governorship in 2006 when he was vetoed by Turkey's staunchly secular then-president.

Basci taught in Turkey and Britain before becoming central bank deputy governor in 2003.

In January 2013, the London-based magazine The Banker named him central bank governor of the year, saying the bank "had moved ahead of other emerging markets" in designing steps to cope with volatile international capital flows.