With the Turkish population groaning under inflation of 80 percent, the central bank unexpectedly cuts interest rates. The measure bears the signature of President Erdogan, for whom price stability is not a priority. He has other priorities.
You can buy fewer and fewer goods in Istanbul’s markets with Turkish lira.
“Just when you think the Central Bank of Turkey can’t get any crazier, it enters a new level of madness.” What Timothy Ash, Bluebay Asset Management’s Turkey expert, rather undiplomatically to the point, now reflects a broad consensus on the financial market. For some time now, the monetary authority has been behaving contrary to all economic logic and is making Turkey’s problems even worse.
Highest inflation since 1998
The latest episode in this tragedy: On Thursday, the central bank unexpectedly lowered the key interest rate from 14 to 13 percent. The step is difficult to understand because the country is suffering from inflation of almost 80 percent, which is the highest level since 1998. In view of such high inflation, money should actually be tightened and the key interest rate increased. In Turkey, however, the opposite decision is once again taken.
The measure bears the signature of President Erdogan. He thinks little of the formal independence of the monetary authority and regularly interferes in monetary policy. Above all, however, he thinks little of economic orthodoxy. On the contrary, Erdogan is convinced that the most effective way to fight inflation is through low interest rates. The fact that this opinion is unanimously rejected by reputable economists does not bother the self-assured leader in any way.
Helpless makes you Argumentation used by the central bank to justify its action: There is talk of high global inflation, rising energy prices, but also robust Turkish economic growth in the second quarter and a relatively high number of newly created jobs. All of these arguments actually speak in favor of higher interest rates, but not in favor of additional monetary policy stimulus. Because the decline in inflation promised by the central bank is nowhere to be seen at the moment.
Growth instead of price stability
It is obvious that the key interest rate cut is not well suited to boosting confidence in the Turkish lira. After the announcement of the surprising measure, the currency lost 1 percent of its value against the dollar. The lira has already lost 26 percent of its purchasing power since the beginning of this year. Due to the currency, which has been ailing for years, the import goods of the energy-poor country, which is almost completely dependent on foreign countries for covering its energy needs, are becoming more expensive, which in turn drives up inflation.
With the modest foreign exchange reserves, the collapse of the lira can hardly be stopped. But Erdogan’s focus is not primarily on exchange rates, but rather on the overall renewal elections next June. Then Erdogan, who has been putting his political stamp on the country for two decades, wants to be confirmed as president. And he hopes his AKP will do well in the parliamentary elections. What he needs for this is a booming economy, but not monetary tightening and credit becoming more expensive. Erdogan speaks of a “new economic model”. Economic growth is far more important than price stability.
However, this is a risky bet. In terms of foreign trade, Turkey is extremely vulnerable. It is struggling with a stubbornly high current account deficit and is therefore dependent on a constant influx of foreign capital. The high level of corporate debt in foreign currencies and the low level of foreign exchange reserves are also a cause for concern. A worsening of the currency crisis can only be prevented if foreign lenders can be kept reasonably happy and the value of the lira can be kept stable. With a constant cheapening of money, this is unlikely to succeed.