The drama of Turkish monetary policy is endless. On Thursday, the central bank TCMB in Ankara cut the key interest rate again, by one percentage point to 14 percent. And this despite the fact that inflation is now galloping in the country. The rate of currency devaluation is officially 21 percent – now it should continue to rise rapidly. The investors in the foreign exchange markets had already anticipated the decision and sold large amounts of Turkish lira. On Thursday alone, the currency lost another four percent. With a dollar rate of 15.48 lira, the currency is cheaper than ever. One euro cost 17.24 lira. Since the beginning of the year, the currency has lost almost half of its value.
In fact, given the country’s economic situation, the exact opposite would have been necessary: interest rate hikes to tame inflation. The fact that the central bank has decided differently is part of the unconventional monetary policy that its President Recep Tayyip Erdoğan is imposing. In September, to the horror of almost all economists, the TCMB cut the key rate from 19 to 15 percent. Loans became cheaper, inflation accelerated, as expected, and the lira plummeted. The rating agency Fitch estimates that inflation could even reach 25 percent this month.
The problem is not only the unusual decision itself, but also the fact that Erdoğan rules directly into the central bank. Their current boss, Şahap Kavcıoğlu, supports Erdoğan’s course, but that doesn’t mean much. Kavcıoğlu is the fourth president of the monetary authority since 2019. Erdoğan dismissed all of his three predecessors because they opposed his policies. The fact that Kavcıoğlu is now obeying the head of state does not necessarily increase his reputation.
Finance Minister Lütfi Elvan also had to leave at the beginning of December, he also no longer wanted to be responsible for the head of state’s monetary policy. His successor Nureddin Nebati praises the new policy in the highest tones: “The economic situation will improve very quickly,” he said last Monday. Nebati is hardly the man to oppose the head of state’s idiosyncratic policies. “I will never do anything against Tayyip Erdoğan,” he said. “Everyone should take note of that.” Erdoğan also dismissed two state secretaries from the Ministry of Finance on Thursday. The change became known a few hours before the central bank’s interest rate decision.
Most economists consider Erdoğan’s unorthodox monetary theory to be simply adventurous. According to this theory, high key interest rates encourage inflation because interest rates are costs. In order to alleviate this “interest rate plague”, a decidedly loose monetary policy is necessary, argues Erdoğan – exactly as practiced this Thursday and in September. One must free the citizens of the interest burden, so the president: “As long as I am in office, I will always fight against interest.” Erdoğan speaks of an “economic liberation and independence war” that the country must wage.
Cheap money and the economy grows
Beyond this strange justification, the president could at least be driven by a comprehensible calculation. When the currency depreciates, it becomes cheaper to produce in Turkey. That benefits Turkish exporters and could attract more investors and tourists from abroad. In fact, despite the pandemic, the Turkish economy has grown surprisingly fast recently. In the crisis year 2020, economic output increased by two percent (the German economy contracted by 4.8 percent in the same period). According to forecasts by the International Monetary Fund (IMF), it could be six percent this year; The economists at Goldman Sachs even consider ten percent possible (it should then be 3.5 percent in 2022). The extraordinary growth is mainly due to a glut of cheap credit. The lending rates in Turkey are far below the rate of inflation. Investors are drawn to the prospect that by the time the debt has to be paid back, it will have lost a large part of its value.
Erdoğan’s course can therefore be interpreted as a kind of bet. That a glut of money can generate sufficient economic growth without inflation spiraling out of control and the currency collapsing. At least until the president has to face the electorate in the summer of 2023. However, it looks like he’s about to lose this bet.
Rents are rising much faster than incomes
The dissatisfaction in the population is growing rapidly. According to media reports, many Erdoğan’s supporters are also upset about the increased cost of living. No wonder, the consequences of politics – constantly rising prices and currency depreciation – are increasingly shaping everyday life for ordinary people. Get an impression of who is visiting Istanbul’s supermarkets. Due to inflation, some shops are already selling staple foods such as sugar, milk and cooking oil in limited quantities, reports Turkish media. Allegedly to prevent hamster purchases, but maybe only to benefit from the rapid inflation through what is actually forbidden rationing.
The low level of the Turkish currency is always present. Just take a look at the billboards at the exchange offices along the famous İstiklal shopping street. The euro is now over 17 and the dollar over 15 lira. A few months ago, nine liras were considered the magic mark for the dollar, then ten. The situation is also tough for many tenants: rents are rising much faster than incomes.
There are now repeated demonstrations against the government. According to the organizers, thousands took to the streets in the metropolis of Istanbul last Sunday. The demonstrators gathered in the Asian part of the city and held up signs that read: “Enough!” The left-wing Disk union called for the protest. To reassure his supporters, the president announced on Thursday that the minimum wage would be increased by almost 1,000 lira a month.
Concerns about Turkey continue to grow on the international financial markets. The rating agency Standard & Poor’s lowered its outlook for the creditworthiness of Turkish bonds from “stable” to “negative”. In the past few weeks, the central bank has sold dollars and euros several times to support the lira, which has only been of short-term benefit. Nor can it repeat this practice very often because its stocks of dollars and euros are dwindling. If you deduct the liabilities, Turkey’s currency reserves are already negative, economists estimate. The external debt rose within a year from 40 to 60 percent of the gross domestic product (GDP).
Taken in isolation, that would still be bearable if the financial markets had confidence in Turkish politics. But they don’t. “The problem is that the central bank has lost all credibility,” says Tatha Ghose, an analyst for Commerzbank in London. “At some point the soft lira will put such a strain on the balance of payments that the experiment fails and an interest rate hike becomes inevitable.” But even that will only ensure calm in the financial markets for a while. What is needed is a turnaround in monetary policy as a whole. In other words: Monetary policy must become orthodox again – with a central bank that is actually independent and whose policy the president can no longer rule.
Clemens Grafe, an economist at Goldman Sachs in London, sees it similarly. Turkey has no problem of over-indebtedness. “The problem is the Turks’ loss of confidence in the lira, which in extreme cases can lead to financial instability.” Since the debts in dollars, euros and other currencies are held by Turkish banks, liquidity could become scarce. The Turkish central bank can only regain trust by “keeping interest rates higher than the economic cycle would normally require” for a longer period of time. In all likelihood, however, this will then lead to a recession.
And that is also part of the picture: In view of the weak lira, investments by foreigners in the Turkish real estate market have increased. In November, more than 7,000 houses were sold to foreigners in Turkey, 48.4 percent more than in the same period last year, the statistics office in Ankara said. Compared to October the increase was 25 percent. Iranians, Iraqis and Russians invested most in the Turkish real estate market. Germans followed in fourth place.