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Reshuffling economy posts won't solve Turkey's troubles, says Erdogan's ex-ally

* Former Erdogan ally Babacan has formed breakaway party

* Says government lacks coherent plan to rebuild economy

* Comments come after cbank chief, finance minister quit

* Lira has hit record lows, cenbank faces test next week

ANKARA, Nov 11 (Reuters) - Turkey’s economic troubles cannot be solved by shuffling the central bank chief and finance minister because institutions have lost independence and credibility under President Tayyip Erdogan’s authoritarian drift, a top former ally said.

Ali Babacan, a founding member of Erdogan’s ruling AK Party who served as economy minister when Turkey was emerging from a 2001 slump and as deputy prime minister until 2015, formed a breakaway party in March, calling for major reforms.

He told Reuters the government lacked a coherent strategy to tackle a slump in the lira and an alarming fall in foreign exchange reserves, and Turkey had no good options unless it restores confidence and attracts investment.

Erdogan sacked the central bank governor at the weekend and accepted the resignation of his son-in-law and finance minister on Monday, after the lira hit record lows following the bank’s decision last month not to raise its policy rate.

“Given the current political framework it will be very, very difficult for the government to fix things just by changing a couple of people in the economy management...,” Babacan said.

Turkey has burnt through $100 billion this year trying to curb the fall in the lira while eschewing a tighter monetary policy.

Analysts say the central bank must hike its main interest rate - now at 10.25%, below inflation of around 12% - at its next policy meeting on Nov. 19. But Babacan said this would need the blessing of Erdogan, who - contrary to orthodox economic doctrine - blames high interest rates for pushing up inflation. He sacked the bank governor last year for not cutting rates.

“President Erdogan will have to choose between two options: deteriorating his political capital (with a rate hike), or deteriorating Turkey’s economic and financial system,” said Babacan.

A rate hike risks further choking an economy battered by the global COVID-19 pandemic, but analysts say newly appointed governor Naci Agbal has no choice if Turkey is to avoid further turmoil in the currency market.

In a speech on Wednesday Erdogan promised a new growth strategy financed by international investment, stressing the need to raise reserves. But he repeated his assertion that interest rates “are the cause of inflation”.

“NO CHECKS OR BALANCES”

Babacan, who leads the new Democracy and Progress Party (DEVA), is one of two prominent politicians who have broken from Erdogan to set up rival parties ahead of elections due by 2023 but which could be called earlier.

Both parties register low single-digit backing in polls, but have helped erode support for Erdogan, who relies on an alliance with nationalists to maintain his parliamentary majority.

Erdogan, modern Turkey’s longest serving leader, has centralised power under an executive presidency adopted after a failed 2016 coup which also led to a purge of tens of thousands of military personnel and state employees.

“All the checks and balances in a good democratic system evaporated quite fast,” Babacan said, leaving Turkey subject to “one person’s instincts, emotions and personal convictions”.

The government says its post-coup crackdown was a necessary response to multiple security challenges, and that institutions such as the central bank operate independently.

Turkey has also seen the share of international investment in its treasury bonds dwindle to 3% from 20%-25% three years ago.

Unless it can find fresh investment and foreign currency inflows, it will struggle to restore financial stability, Babacan said.

In the short term, investors seeking better returns than the negative rates in Europe could be tempted to return “if they see a small light” of hope in Turkish markets.

But any durable recovery would need a systemic overhaul.

“If we believed that the country would recover under Erdogan’s management, we would not have founded this party,” Babacan said. “Our strong conviction is they will not be able to fix the problems, and the problems will only grow.” (Editing by Jonathan Spicer and Gareth Jones)

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