Turkey: Where From Here?
In September, the Turkish Central Bank decided to cut its key interest rate by 100 basis points to 12%. This policy may come as a surprise to some though, as Turkey’s headline measure of inflation rose for the fifteenth consecutive month to 80.2%. Many central banks have increased interest rates in recent times in order to combat the high inflation figures within their respective domestic economies. However, Turkey’s central bank have pursued a different strategy. They have been cutting interest rates, a highly unconventional policy move that has not worked in stemming inflationary pressures. This policy misalignment is due to the political influence of President Recep Tayyip Erdoğan, who is a strong believer that high interest rates are morally incorrect and are the cause of rampant inflation, not the cure. Since 2018, Turkey has been dealing with high inflation rates, a weak Lira and a weak economy due to the policies enacted by Erdoğan, who has taken more control of monetary policy mainly in the form of interest rates.
Under this macroeconomic strategy, the Turkish Lira has significantly depreciated against the dollar. At the beginning of 2018, the US dollar exchange rate traded at just under four liras per dollar, but it now trades at around eighteen and a half against the dollar. Currency depreciation can help make exports become relatively cheaper in international markets, but the severe depreciation has offset any of the export growth benefits due to significant economic instability in Turkey. GDP per capita has declined in Turkey since 2013, falling from $12,600 to $9,600 in 2021. This fall in prosperity is a direct result of the lack of foreign investment in the emerging economy. Turkey has traditionally had a low saving rate, making private-sector funding reliant on international investment.
In June, Erdoğan made policy attempts to reduce Turkey’s stubbornly high bond yields, which had made borrowing costs extremely expensive for the government. Lenders in the nation were required to hold a certain amount of Turkish government bonds as collateral for its currency deposits. This led to a sharp fall in bond yields helping to reduce borrowing costs for the government but seriously exposed domestic banks to inflationary risk. The increase in demand for bonds was essentially driven by domestic compliance, not an uptake in foreign investment. In August, the central bank enacted new rules to try and reduce the interest rates offered to customers by domestic lenders. The higher the interest rate charged by the lender, the more Turkish government bonds the lender would have to hold, incurring more risk on the lender. This policy led to a further reduction in yields, with the 10-year yield falling to around 11%. The 10-year yield was above 20% prior to the original policy change in June.
Although inflation stands at over 80% year-on-year, the rate of growth of inflation has begun to cool, which has led to the Turkish government signalling that inflation will begin to decline. The reduction in inflation growth has been challenged by opposition parties and other economists, however. The reduction in inflation growth contradicts the data released by the Istanbul Chamber of Commerce (ICOC), an independent economic research group in Turkey. Although ICOC use a different methodology to calculate the inflation rate than TURKStat, the official statistics organisation in Turkey, their rate has closely tracked the official CPI rate over the last few years.
Erdoğan’s political influence on government agencies is extremely powerful in Turkey. He has sacked three central bank governors since 2019, a tendency that eliminates the political independence of Turkey’s central bank. In June of this year, Bloomberg reported that the Head of Consumer Pricing at Turkstat, Mustafa Teke, had stepped down from his role with no explanation as to why. This followed from the replacement of TURKStat’s president in January, whose tenure did not last a year. Statistical tampering by a government is not a novel situation. Greece falsified their GDP deficits in 2010 to calm bond markets prior to the European Debt crisis. Andreas Georgiou, the president of their statistical agency at the time, leaked the correct GDP forecasts to Eurostat in a rogue move that subsequently upset Greek authorities. In 2017, he was sentenced to two years in prison for a ‘breach of duty’ and remains in exile in the US today.
The Turkish general election is due to take place in May next year, which makes cooling rampant inflation a key objective for the incumbent Erdoğan to hold power. Although official figures show inflation beginning to cool, many investors may doubt the legitimacy of the figures and any major recovery in the Turkish economy in 2023. The various policies of Erdoğan have not managed economic success thus far but may remain, as the authoritarian leader’s AKP party remain ahead in opinion polls. It is hard to see where the light at the end of the tunnel is for one of the world’s largest emerging economies.