Appointed prior to the current government’s installation, Serdengecti had a frosty relationship with the ruling Justice and Development (AK) Party, precluding the possibility of his re-appointment. Instead, Prime Minister Recep Tayyip Erdogan appointed then vice-governor of the CBRT, Erdem Basci, as interim governor as his government searched for a permanent successor. The search for a replacement has dragged on now for more than two weeks, including a presidential veto of the first official candidate proposed by the government last week. As uncertainty surrounding the appointment has lingered, financial and exchange rate markets have grown unsteady, although a collapse has neither happened nor is imminent. The Istanbul stock exchange lost 3.1% last week, while the lira depreciated against the U.S. dollar by more than 2% in the first three weeks of March, after appreciating by 2.7% in the first two months of 2006 (although some of this weakness owes to expectations of an interest rate hike in the United States).

The first replacement formally offered by the government was Adnan Buyukdeniz. Buyukdeniz is an executive officer of the Islamic, interest-eschewing finance group, AlBaraka Turk. President Ahmet Necdet Sezer–a staunch secularist–vetoed the nomination, claiming Buyukdeniz was an “inappropriate” choice. Sezer has long been an outspoken guardian of Turkey’s secular model, which strictly limits Islamic influence in policy-making. It was the likelihood of Sezer’s veto of any Islamic-leaning candidate that probably prevented Erdogan from officially submitting Basci as a permanent replacement, as Basci’s wife wears a headscarf.

The position of CBRT governor is an important one, given the bank’s political independence and its dual role for both guiding monetary policy and overseeing the commercial bank sector. Financial markets and the IMF regarded Serdengecti highly, as he had great success over his tenure in guiding the country through the 2001 financial crisis to its current, stable state. Average annual inflation plunged from 54.4% in 2001 to just 8.2% in 2005. The drop of consumer price growth into single digits (actually occurring first in 2004) was an important turning point, since it signaled the end of more than 30 years of annual inflation rates that easily topped 20%. The victory over inflation culminated in the re-denomination of the Turkish lira at the beginning of 2006, with the removal of six zeros from the currency. Strict monetary policy under Serdengecti firmed international investor confidence in Turkey, with high real interest rates attracting significant inflows of foreign capital. In the four full years since Serdengecti was leading the CBRT, net flows of portfolio investment turned around from an outflow of US$593 million in 2002 to a record inflow of US$13.7 billion in 2005. Net inflows of foreign direct investment has also surged in recent years—although that owes as much to the government’s acceleration of the privatization program as it does to the stabilization of the economy under Serdengecti. The CBRT’s oversight of the banking sector has provided much of the groundwork for increased inflows of FDI, however. The sector’s stabilization was a key factor behind the European Union’s decision to finally being accession negotiations with Turkey. Again, credit for the cleaning up of the banking sector does not lie solely with the CBRT, but also with the government and parliament for enacting more-effective controls of the sector.

Not all have been so forthright in their praise of Serdengecti, however. As mentioned previously, the governor had relatively cool relations with the government, primarily over his reluctance to loosen monetary policy as inflation began to ease significantly. Domestic producers and exporters decried what they believed to be overly restrictive monetary policy. High interest rates were a primary reason for the explosion of net inflows of portfolio investment in recent years, but that has simultaneously triggered the lira’s appreciation against both the U.S. dollar and the euro. Against the dollar, for example, the lira appreciated by 18.6% from the end of 2002 to the end of 2005 in nominal terms. Although this strength contributed to the stabilization of the Turkish economy, it has also undermined domestic producers’ and exporters’ international competitiveness and contributed to the explosion of the current-account deficit. In 2005, the current-account shortfall stood at an estimated 6.3% of GDP, a historical high. A lack of domestic producers’ competitiveness has slowed the creation of new jobs despite a domestic economy that is otherwise booming. As a result, unemployment remains high and is one of the country's major problems.

The next governor will be faced with significant challenges, including a potentially overvalued lira, a gaping current-account deficit, and the continuing cleanup of the financial sector. In addition, the drawn-out course of replacement will increase the initial scrutiny of the incoming governor. Markets will watch the opening moves of the new governor intently, attempting to extrapolate his approach to monetary policy, as well as the future independence of the CBRT. This scrutiny will likely ensure that monetary policy will remain tight in the short term. Any loosening could have an adverse impact on financial and currency markets, as a rate change could be blown out of proportion. Knowing this, the first meeting of the Monetary Policy Committee under interim Governor Basci held interest rates unchanged last week.

As inflation cools in the coming months, even Serdengecti likely would have reduced interest rates. Basci or a new CBRT governor may hold interest rates steady, however, to reassure markets that monetary policy has not radically changed. But in the longer term, the government will almost assuredly choose a successor that will prove to be more expansionary than was Serdengecti, although Prime Minister Erdogan has attempted to reassure markets that the CBRT will remain independent and relatively cautious. Indeed, with the European Union keeping close tabs on economic policy in Turkey, a radical break from Serdengecti’s policies is not expected. In fact, with the candidacy of Basci and Buyukdeniz effectively ruled out, the next most likely candidate—Ibrahim Canakci, current under-secretary of the Treasury—would be expected to operate monetary policy more similarly to Serdengecti than would either of the first two candidates that were considered.

Contact: Raul Dary

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raul.dary@globalinsight.com

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