(Bloomberg) -- Turkish government bonds tumbled and the lira hit a new record low after a 49% minimum wage hike, that threatens to fuel inflation and puts investors on alert for pre-election populist measures from President Recep Tayyip Erdogan.

The government raised the net minimum wage for 2023 to 17,002 liras ($578), a level which Goldman Sachs Group Inc. and Morgan Stanley had suggested would force the central bank to further tighten monetary policy. 

The minimum wage is the base salary of more than a third of Turkey’s workforce and serves as a reference for other pay deals. The decision was closely watched by credit rating agencies and investors, who are anxious for authorities to stick to the orthodox policies adopted after a May election returned Erdogan to power. 

That swing back to orthodoxy — particularly the aggressive interest-rate rises deployed in recent months to rein in inflation — has been luring foreign investors back to Turkey.  

However, the lira has slid this week and on Thursday approached 30 per dollar. The yield on Turkey’s two-year government bonds jumped 120 basis points, and 10-year borrowing costs rose 23 basis points, a stark contrast with year-end rallies across most other emerging markets.  

Turkey’s 49% Minimum Wage Hike Balances Between Unions, Markets

“There is the potential for very strong returns from Turkish assets in 2024, as long as they stick to credible economic policy,” said Daniel Wood, a portfolio manager at William Blair International. 

“Investors will see the upcoming local elections in March as critical to negotiate in order to add further credibility and reassurance that Turkey will not U-turn on policy this time around.”

Having quintupled Turkey’s main interest rate since June to 42.5%, the central bank expects inflation to end this year at 65%, before peaking above 70% in May. Governor Hafize Gaye Erkan has also said the central bank took into consideration potential minimum wage hikes when compiling the inflation outlook. 

If inflation slows per Erkan’s forecast, Turkish bonds could prove a winning investment for 2024, many fund managers reckon. But they also remain wary of a pre-election shift from Erdogan, who has in the past ousted several central bank chiefs for their efforts to tame inflation. Senior officials say the president is fully supportive this time. 

On Thursday, authorities extended a withholding tax cut on lira bank deposits to April, state-run Anadolu Agency reported, citing a presidential decree published in the official gazette. The move shows the government intends to continue encouraging citizens and businesses to shift into liras from hard currency.

The Turkish currency is wrapping up the year as the second-worst performing EM currency tracked by Bloomberg, after the Argentine peso. Its latest losses bring the year-to-date slide against the dollar to about 36.5%. 

Onur Ilgen, head of Treasury at MUFG Bank Turkey AS, reported extra dollar demand from corporates before year-end, as well some appetite to hedge lira exposure.

“The higher-than-expected increase in the minimum wage will also create partial inflationary pressure,” Ilgen added.  

 

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