An interest rate hike from 8.5% to 15% would typically be seen as a shock and awe moment in most countries. However, in Turkey where annual inflation is hitting 40%, this recent rate change is perceived as only a small step in the right direction.
Despite this, Turkey’s Eurobonds remain popular with yields remaining around 9%.
This rate increase was the first public appearance of the new economic dream team, created after President Recep Erdogan’s re-election in May. Finance Minister, Mehmet Simsek, returned to his post of respected economist with a Bank of America background. Alongside him, Hafize Erkan, with a decade of experience working at Goldman Sachs, took over as the head of the central bank.
Yet despite this promising team, they face a tough challenge. The Turkish government deficit is now almost 8% of the total GDP following extensive pre-election spending. On top of this, current account deficits are running at approximately 4% of GDP. Net foreign reserves indicate deep negative territory, with cash balances lowering due to loan swaps between other central banks.
According to Senior Currency Analyst, Edward Al-Hussainy, they will “need interest rates three times where they just moved them and much smaller deficits on the fiscal side,” if they want to achieve economic balance.
Can Erdogan Pull Turkey out of Its Economic Crisis?
Turkey’s economy is facing a significant crisis, with the lira plummeting and inflation soaring. Erdogan, who just secured five more years in power, could oversee a growth shock that could last years. However, investors doubt whether he will implement the necessary measures to turn around the country’s economy.
A Painful Transition
The cost of implementing the necessary therapy would be high, likely lasting for years and possibly without International Monetary Fund assistance, which Erdogan has ruled out on national pride grounds. The question remains whether Erdogan would be willing to oversee such a painful transition.
Undermining Monetary Tightening
Fiscal policy appears to be actively undermining monetary tightening at present. The government recently hiked the minimum wage by a third. Half the country’s employees are indexed to that move, and pension requirements have been relaxed, entitling two million Turks to earlier retirement at state expense. These moves may prove damaging to Turkey’s already fragile economy.
Lack of Allies
Simsek and Erkan have yet to install allies below them at the central bank and state banks, which have been responsible for Turkey’s uncontrolled credit. Erkan’s lieutenants on the monetary policy committee remain holdovers from her hapless predecessor, while Kavcioglu has moved over to head banking regulator BRSA, which is unlikely to instill confidence.
Extreme Gradualism
The underwhelming rate hike signals a policy of “extreme gradualism,” says a leading economist. Simsek pitched Erdogan on increases that would reach 25% over 18 months, but there has been no indication that such measures will be implemented.
Despite the challenges, Turkey’s resilience is undeniable. The country has survived numerous crises in the past and will likely weather this storm as well. Nevertheless, time is running out for Erdogan to implement much-needed reforms to prevent further damage to Turkey’s already struggling economy.
Turkey’s Economic Challenges Call for Urgent Action
According to financial experts, the Turkish government’s gradualist approach to its economic challenges is not enough to prevent a crisis. Despite peaking at 85% last October, inflation is expected to reaccelerate later this year due to winter fuel costs and the shrinking lira. While Turkey’s government and banks have been creative in their financial transactions, including engaging in swap agreements with various countries, they still face considerable financial risks.
Despite the risks, default on Ankara’s hard-currency bonds is unlikely in the near future, with experts citing attractive compensation for the slight risk. Nevertheless, Turkey’s leader, Erdogan, cannot rely solely on his geopolitical presence and must take urgent action to address the country’s economic issues.
