Turkish voters return to the polls this weekend to choose a president. The run-off vote is uncharted territory for Turkey, which moved in 2017 to an executive presidency from a parliamentary democracy. Before the first round of the election on the 14th of May polls suggested that voters
Were evenly divided between the two biggest parties, however, Erdogan’s unexpectedly strong first round (where he failed to secure an outright majority but scored a much bigger share of the vote than his rival) has put pressure on the Turkish lira and knocked other Turkish assets ahead of this weekend’s runoff vote.
Turkish assets fell in value as investors began reversing the bets they had placed that new leadership might bring Turkey back to a conventional economic policy and away from Erdogan’s idea that low-interest rates can cure inflation. The official annual inflation rate in Turkey was 43.7% as of April.
This is actually down from the 80% inflation rate that Turkey saw the prior year. There is no guarantee that this slowdown will persist. There is in fact widespread suspicion that the official numbers understate an inflation rate that according to independent experts is actually closer to 100 percent.
Exacerbating the economic stress in Turkey is the vast damage caused by the powerful earthquakes that destroyed large parts of southern Turkey in February. In March, a government assessment put the damage at $103 billion dollars, or about 9 percent of this year’s GDP.
The economy will be a significant challenge for whoever wins the presidency on Sunday as the high inflation along with government largess and efforts to prop up the currency are threatening economic growth and could push the country into a deep recession. Another term for President Erdoğan would likely imply a continuation of the current
Policies with a heightened risk of persistent very high inflation and severe currency pressures,” according to Moody’s, the credit rating agency. Erdogan’s government has deployed a range of unconventional measures in recent years to stabilize Turkey’s economy, including tight controls of companies’ transfers of
Foreign currency and the 2021 launch of special savings accounts to protect depositors from lira fluctuations which I discussed on this channel at the time. These tools have helped slow the lira’s fall, but the currency is still trading near a record low against the dollar.
Brad Setser from The Council on Foreign Relations argues that “The relatively strong economy of the past several quarters has been the product of unsustainable policies, so there will most likely be a contraction or recession,” “Working Turks will feel poorer when the lira falls in value,” he said of the local currency.
“People will find it harder to find a job and harder to get a salary that covers the cost of living.” Net foreign assets, a proxy for the size of Turkey’s foreign currency holdings, have declined to minus $13 billion dollars from $1.4 billion dollars a year ago, according to central bank data.
Those figures include billions of dollars in funds borrowed from the domestic banking system through swaps. Pressure on international reserves has been “significant in recent weeks” as the government made efforts to prop up the economy ahead of Sunday’s elections. Turkey’s foreign currency and gold reserves tumbled $17 billion dollars in the six weeks
Leading up to the first round of the election according to the FT, a decline of 15 percent. Now, before we dig further into the economic problems in Turkey and the possible solutions, let me tell you about today’s video sponsor GrammarlyGO.
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Sign up for premium the link will give you 20 percent off the price of a subscription. So, Turkey had a painful experience of high and chronic inflation from 1975 through to 2004 caused by political instability, poor institutions, high public sector budget deficits
And depreciation of the Turkish Lira which culminated in a severe financial crisis in 2000-2001. The establishment of an independent central bank in 2001, which focused mainly on fighting inflation along with tight fiscal policies implemented at the same time brought inflation under control.
An economic boom during Erdogan’s first 10 years in power transformed Turkish cities and lifted millions of people out of poverty. Turkey transformed from a low-income country into an upper middle-income nation, The poverty rate collapsed between 2002 and 2014 and while still classified as an Emerging Market, Turkey
Was seen as one of the most developed developing countries in the world. According to the IMF, in 2020 it was the twentieth largest economy in the world by GDP. But some of those gains have eroded in recent years as the national currency lost 94 percent
Of its value against the dollar since 2008 and inflation has been extremely high. So, what is causing these problems? Well, as you might expect, there are a number of things causing inflation in Turkey and putting pressure on the Turkish lira.
For example, as an importer of energy and intermediate goods, Turkey is exposed to inflationary pressures caused by the rise in energy prices and the supply chain disruptions that were seen all around the world over the last few years. Next up, most emerging market currencies performed badly against the US dollar once the Federal
Reserve began hiking interest rates. Higher US interest rates means that capital that was chasing higher returns in developing countries is now being brought back to the United States. This has led to an appreciation of the dollar against most emerging market currencies.
While these issues might explain some of the problem in Turkey, the bulk of the problem is being caused by President Erdogan’s unorthodox economic policy of cutting interest rates during a period of high inflation, with the belief that this policy will boost Turkey’s economic growth and export potential.
Erdogan’s unconventional economic theory is rooted in Islamic economics, and he has invoked Islamic precepts against usury and referred to interest on loans as the “mother and father of all evil” to justify his actions. He mostly blames foreign interference for rising prices and claims that lower interest rates lead to lower levels of inflation.
This is the opposite of what most economists believe to be true. Erdogan argues that if the lira loses value against the dollar, Turkey’s exports will simply become cheaper and foreign consumers will want to buy even more of them.
While this idea does contain some truth, these export gains come at a very heavy price for Turkish people. The Turkish economy is heavily dependent on imports, and as the lira falls in value, imported products become more expensive. Erdogan has cited China’s economic transformation as evidence that a low interest rate model
Would work, and while it is true that China devalued its currency in the 1980s and 1990s, this devaluation was combined with a clearly defined industrial policy. It is not clear what industries Turkey is trying to promote with a currency devaluation.
It is also not really settled that this is a winning long run strategy for China either. As I said in a prior video, if a country could build an export-oriented economy by simply destroying the value of its currency, Zimbabwe would be the world’s factory today. Spoiler alert… It’s not…
In order to support the lira and reduce the use of the dollar and euros in the country, Turkish authorities have made it more difficult for local consumers and businesses to purchase foreign exchange. Many have turned to gold as a way to protect their savings, but Turkey suspended gold imports
After the earthquake in February since gold imports to meet retail investor demand were driving up the countries current account deficit. The Turkish central bank has instead been drawing down its gold reserves to supply the domestic market. The Turkish general election was previously seen as a potential economic turning point
For the country, with the opposition promising a series of economic reforms. During his election campaign, Erdogan showed no intention of changing his policies, doubling down on his claims that low interest rates would help the economy grow by providing cheap credit to increase Turkish manufacturing and exports.
“You will see as the interest rates go down, so will inflation” he told supporters in Istanbul in April. “We will work relentlessly until we make Turkey one of the 10 largest economies in the world,” he said at another election rally earlier this month.
The Turkish government has been selling foreign currency reserves to prop up the price of the Lira. During one week in early May, the reserves declined by $7.6 billion dollars, the largest such decline in more than twenty years.
I discussed this strategy in my video about Egypt a few months ago, that it makes no sense to spend a countries valuable foreign exchange to pump up the value of a falling local currency, as while it might work in the very short term, you are squandering the wealth of a nation
For a temporary effect, that disappears as soon as you run out of foreign exchange, or stop buying. Exchanging something of value for something less valuable to support its price just makes no sense. Erdogan has reached agreements with countries including Qatar, Russia and Saudi Arabia to help prop up central bank reserves.
Saudi Arabia announced a $5 billion deposit in March, and Russia agreed to delay at least some of Turkey’s payment for natural gas imports until after the election. Erdoğan’s ability to get financing from “friendly countries” is really quite impressive — even countries that themselves aren’t exactly friends have lent large sums to the Turkish
Central Bank, but at some point Turkey will presumably exhaust the financial patience of its new non-market creditors. There is a very good video by Money & Macro a few months ago on this topic that I would recommend. The terms of many of these agreements with other countries have not been made public,
And paying back many of these political favors may become complex in the future, but economists are saying that they are part of a short-term strategy more focused on winning the election than on ensuring the country’s long-term financial health. With the cost-of-living crisis on many voters’ minds, Erdogan launched a range of expensive
Policies in the lead up to the election aimed at reducing the immediate impact of inflation on voters. He raised the minimum wage repeatedly, announced a free month of natural gas for consumers, reduced electricity prices increased civil servant salaries and changed government policies to allow millions of Turks to receive early government pensions.
Just days before the first round of the election He gave a 45% pay rise to 700,000 Turkish public sector workers, saying he would “not let anyone be crushed by inflation”. All of those commitments will need to be honored by whomever wins the election, meaning that
Greater government spending can be expected one way or another. In addition to honoring this spending, a new administration (no matter who wins) would need to respect Erdogan’s financial agreements with other countries used to bring in foreign exchange to the central bank. The terms of many of these deals are not clear.
Most analysts give Erdogan an edge in the election because of his strong showing in the first round and the likelihood that he will inherit significant votes from Mr. Ogan, who formally endorsed Erdogan on Monday. Erdogan’s political party and its allies also maintained their majority in Parliament,
Allowing Erdogan to argue that voters should choose him to avoid a divided government. If Erdogan sticks to his existing strategies, economists expect the currency to sink further, the government to impose restrictions on foreign-currency withdrawals and the state to soon run short of foreign currency to pay its bills.
So, how can Turkey get out of policy trap of low interest rates and high inflation. Well, Adam Tooze argues on his Podcast that Erdogan might pivot once he wins the election in the same way that XI did in China once he had won his third term and quickly ended
The zero covid policy in China. The difficulty for Erdogan’s is that pivoting from low to high interest rates will also hurt, but it will hurt a different group of people than were hurt by low rates and inflation. This might be politically difficult to do.
For a country in crisis, Turkeys problems are not that difficult to solve – it is not a total basket case economy like some other emerging markets. The country mostly just needs a sensible interest rate policy and an independent central bank.
Turkey has a lot of positives, it has a diversified economy, growth is good, it has good demographics and an educated workforce. There are of course issues with corruption in Turkey, but they are not as bad as in many emerging markets.
If the opposition came to power, they would need both short- and medium-term plans to bolster the government’s finances and restore the confidence of investors. Their ability to maneuver if elected would be restricted by Erdogan’s party and its allies who have a majority in parliament.
If the president continues to pursue a program of interest rate cuts then the lira will fall further and prices will continue to rise. In those circumstances the only way for Turks to defend their savings will be to turn to a currency outside of Erdogan’s control which is what most Turks have already been
Doing. The good news for Turkey is that it’s a dynamic economy the government itself is not heavily indebted and the economy is sound enough to sustain growth. If Erdogan wins as most analysts now expect, the question is, can Erdogan find a face saving
Way to pivot to a more sensible economic policy and does he even understand the need to change policy. If he can craft a strategy that doesn’t look like he is surrendering, he may be able to save face and improve the economic situation in Turkey in the coming years.
If you enjoyed this video, you should watch my previous video on Turkey next, or some of the great content on Money & Macro. Don’t forget to check out our sponsor Grammarly using the link in the description below. Have a great day, and see you in the next video, bye.
