All is not well in the Turkish economy. At a time when global financial markets are jittery, Turkey is witnessing a rapid depreciation of the lira and accelerating inflation, driven largely by the political interference of President Recep Tayyip Erdogan in the Turkish central bank.
Despite repeated entreaties by central bank governor Erdem Basci to support the lira after it declined by 20 per cent against the US dollar in 2015, Erdogan has steadfastly hampered his efforts. Basci had plans to transition from an opaque monetary policy – in which interest rates are allowed to move within a ‘corridor’ between the borrowing and lending rate – to a conventional single interest rate strategy, but these were abandoned under pressure from Erdogan.
Erdogan has branded Basci a ‘traitor’ for not cutting rates more assertively last year to boost growth and has claimed that an illusive ‘interest rate lobby’ seeks to wreak havoc in the Turkish economy. Despite economic orthodoxy to the contrary, he equates higher rates with higher inflation and does not recognize that Turkey’s economy is stuck in long-term stagnation known as the ‘middle income trap’.
Turkey can ill-afford any actions damaging to the credibility of the nominally independent central bank. Once the confidence of foreign investors is lost, the prospects for economic turmoil, if not a severe recession, rise significantly. Diminishing confidence has already encouraged $10 billion of foreign capital to exit holdings in Turkish stocks and bonds in 2015 while foreign currency deposits in Turkish banks have grown by nearly 50 per cent over the past year as some savers abandon the lira.
Credibility risks will probably increase with the departure of Basci in April, when his term as governor comes to an end. Most of the Monetary Policy Committee are expected to follow by the end of the year. It is likely that they will be replaced with figures more pliant to Erdogan’s objectives. Given that the central bank’s depleting net foreign exchange reserves – excluding the holdings of commercial banks – are below $30 billion, it has relatively little firepower to defend the lira. A sliding lira, after all, is particularly painful to the private sector burdened by dollar-denominated debts amounting to nearly a quarter of Turkey’s GDP, making Turkey one of the most leveraged economies among emerging markets.
Foreign policy hurts the economy
Erdogan’s ideological and uncompromising approach to foreign policy is equally damaging to the economy, which saw annual exports plunge 8.7 per cent in 2015. His decision to shoot down a Russian Sukhoi SU-24 fighter jet, last November for, according to the Turkish account, entering Turkish airspace from Syria for 17 seconds contributed to the loss of between $9-12 billion of trade with Russia.
Similarly, Turkey’s withering commercial ties with neighbouring Iran have their roots in the government’s foreign policy. Even though a preferential trade agreement to cut tariffs on 140 products from Turkey and 125 products from Iran took effect on 1 January 2015, bilateral trade volumes have fallen from $21.89 billion in 2012 to $9.7 billion in 2015. It seems that Turkey will barely benefit from the lifting of US and EU sanctions against Iran in January. Quite tellingly, the paucity of once-frequent reciprocal visits by senior government ministers between both countries in recent months testifies to the frosty economic relations.
Erdogan dismisses the antagonism with Russia and Iran as a by-product of their conflicting stances on Syria. His unwavering endorsement of regime change is matched by the latter two countries’ fierce resistance to it. Yet, trade is also plummeting with the Gulf Arab states who share a nearly identical regime-change agenda towards Syria due to Turkey’s growing isolation in the Middle East. Turkish exports to those states fell from $12.8 billion in 2013 to $9.1 billion in 2014 and, below $9 billion in 2015. That much of the decline occurred prior to the collapse in oil and gas prices in 2015 indicates that the blame cannot be ascribed to developments in commodity markets.
Current policies are exposing the Turkish economy, unnecessarily, to greater political and economic uncertainty, magnified significantly by the fragility of the international economic climate. Turkey needs an autonomous central bank and a more balanced foreign policy if it is to achieve monetary and currency stability, and increased trade and investment with Russia, Eurasia and the Middle East.
Fadi Hakura, Associate Fellow, Europe Programme (Chatham House).