The Turkish currency is in free fall and inflation is picking up pace. President Erdogan sees dark forces at work and announces that he will fight against high interest rates. That doesn’t mean anything good for his country.
Recep Tayyip Erdogan has declared the “economic war of independence” – his opponent is interest. The Turkish President’s struggle “against the mother of all evils” has plunged his country into a deep currency crisis, while inflation threatens to spiral out of control.
Expressed in numbers: The currency lira has lost almost half of its value against the dollar this year, in November alone the exchange rate collapsed by almost 30 percent. In October inflation was 20 percent.
This is mainly due to the fact that the – formally independent – central bank, at Erdogan’s behest, does not increase interest rates, but actually lowers them, despite the weak lira and high inflation. The president had fired several central bank chiefs within two years because they were too unruly for him. In the spring, Erdogan installed Sahap Kavcioglu, who is happy to fulfill the wish of the head of state – since September the central bank has reduced the key interest rate from 19 to 15 percent. There is little doubt that things will continue to decline. Erdogan announced last week: “The key interest rate will fall. We will not allow high interest rates to wear down our people and our farmers.”
At the moment, however, it looks more as if the decline in the lira and high inflation will affect many Turks. They can buy less and less for their money, while vital imports such as energy and raw materials become even more expensive.
“Cries of the black painters”
Erdogan is therefore taking a risky bet. He wants to stimulate the economy with low interest rates and a weak lira. Because Turkish products are cheaper on the world market and holidays in Turkey are cheaper for foreign tourists. In addition, it will be more attractive to take out loans – with 20 percent inflation and 15 percent interest, the real interest rate is negative. In fact, the Turkish economy grew 7.4 percent in the third quarter. The International Monetary Fund assumes that the gross domestic product will increase by 9 percent this year – that would be one of the strongest rates in the world.
The head of state hopes that inflation will soon pass and that the current problems are only collateral damage. Erdogan says his government is relying on economic growth in order to increase investment, production, exports and employment. He does not pay attention to “the screams of the black painters”.
Economists oppose this: a lira in a deep intoxication and high inflation rates would very likely destroy this plan. The entire economy could be affected and the Turkish financial system would be in danger.
But Erdogan absolutely needs growth. Presidential elections are due in Turkey in a year and a half at the latest, and the incumbent head of state wants to be re-elected. His popularity is falling, and currently polls look like Erdogan will lose to the most likely challengers.
Unorthodox interest rate theory
When Erdogan came to power almost 20 years ago, it was also because he promised growth and steadily increasing incomes. He had kept this promise for many years. He was initially helped by an IMF program that had been agreed upon before his presidency. Economic growth was later fueled by an enormous loan-financed construction boom, which has now come to an end. Even through the Corona crisis, Turkey came off comparatively well through a debt-financed upswing.
However, this is not sustainable. But until the presidential elections, the self-proclaimed “interest enemy” is unlikely to change course. It is fitting that Erdogan, contrary to economic doctrine, is of the opinion that high interest rates lead to high inflation and low interest rates lead to low inflation. He studied economics and knows his way around, says the head of state.
A different logic is used in economics. Accordingly, higher interest rates tend to dampen prices because they make loans more expensive. In addition, saving is more worthwhile. That means: companies invest less, consumers consume less. This reduces the demand for products and makes it more difficult to push through price increases.
Erdogan meanwhile consistently blames forces such as an ominous “interest rate lobby” for inflation and currency collapse, which want to enrich themselves at the expense of Turkey. The president rages that he will not give in to demands from “opportunists” and “global interest rate acrobats”.
Money flows from Turkey
But the forces of the financial market and economic laws are increasingly becoming a problem for Erdogan. The situation is made worse because almost every central bank – except the Turkish one – has tightened monetary policy or is preparing such a step. Above all, the interest rate turnaround initiated by the US Fed is affecting the currencies of emerging countries such as the lira. Because this makes the dollar area more attractive for investors.
In recent years, Turkey has benefited enormously from the fact that a lot of money has flowed into the country from abroad. That was in large part due to the ultra-loose monetary policy in the US and the euro zone. Because that pushed interest rates down there, investors looked for returns elsewhere and found them in Turkey, for example. Now the development is turning around. Turkey is also particularly suffering from this because the country is becoming less attractive for investors due to persistently high inflation. Because investors can count on a rapid devaluation of their money. A vicious circle: inflation contributes to the fact that money flows out and thus the currency falls. And the falling currency is fueling inflation.
The consequences of the currency crisis and inflation can already be seen in Turkey. Turks are also allowed to hold their bank balances in foreign currency. In the face of high inflation, many convert their savings into euros or dollars. According to the “Financial Times” (FT), foreign currencies now make up 55 percent of deposits in the banking sector.
This threatens another vicious circle: the more lira are exchanged for another currency, the more pressure the rate will come under. This increases the pressure to part with one’s own lira. There is a rush for iPhones in Turkey because the smartphones and other electronic products are viewed as a store of value. A great danger is that the population will lose confidence in the banks and try to vacate their accounts. Such a bank run occurred in 2001.
In addition, Turkey imports energy and raw materials. A depreciating currency quickly leads to rising prices that consumers and companies feel.
Debt in dollars, repayment in lira
But that’s not all: Turkey has borrowed heavily in foreign currency in recent years. According to the “FT”, 60 percent of the state’s liabilities are not in lira. Companies have also taken out loans in foreign currencies. In September, the private sector abroad stood in the chalk with nearly 172 billion dollars – a large part of which has to be repaid within the next twelve months. This is a problem because debt servicing and the repayment of dollar or euro liabilities, for example, have to be earned in increasingly worthless lira.
November inflation data will be released in Turkey on Friday. And on December 16, the central bank will decide on the next rate cut.