Turkey’s Economic Turbulence
September 27, 2018
President Recep Tayyip Erdogan came to New York on September 23 for a visit dominated by diplomacy. The centerpiece of the trip was his speech to the United Nations General Assembly (UNGA) on September 25 in which he endeavored once again to emphasize Turkey’s global profile while pushing his ideas on the restructuring of the world body. However, while in New York, he also made a point of underlining his continuing attention to the troubled Turkish economy by encouraging investment at the Turkey-U.S. Business Council meeting on September 26. His attendance at the high-level business conference followed his meeting on September 19 in Ankara with the representatives of U.S. companies operating in Turkey. On his way home, Erdogan is spending two days in Germany during which he will be seeking to mend relations and to expand on Treasury and Finance Minister Berat Albayrak’s recent discussions with his German counterparts in fostering closer economic links.
Erdogan’s overseas trip took place after two important moves in Turkey’s ongoing endeavor to calm turbulent markets. On September 13, there was a significant rate hike by the Central Bank of Turkey (CBRT) to try to stabilize the Turkish Lira (TRY), which has plunged by almost 40 percent in 2018 against the U.S. dollar (USD). A week later, Albayrak unveiled the 14th Medium Term Program of the governing Justice and Development Party (AKP) since 2005. Designed to cover the period 2019-2021, it bore the ‘New Economic Program’ (NEP) label in conformity with AKP claims relating to the creation of a “New Turkey.”
The twin initiatives reflected the government’s keen desire to demonstrate its awareness of the seriousness of the financial and economic problems confronting the country and confidence in its ability to address them primarily through its own actions, along with its willingness to tackle them to foreign investors. However, the message they conveyed has also been accompanied by constant assurances to the domestic audience that there was, in fact, no crisis and that the economic situation would stabilize in the near future.
Raising the Interest Rate…Again
The CBRT raised the policy rate again by a higher than predicted 625 basis points to 24 percent, its biggest hike during the nearly 16 years of AKP rule. It is worth noting that it stood at 8 percent as recently as the beginning of the year. The rise was widely expected following the statement of the CBRT on September 3, which sought to reassure markets that it would “take the necessary actions to support price stability.” Explaining its decision, the CBRT cited the “inflation outlook pointing to significant risks to price stability,” pledged to maintain “a tight stance in monetary policy until inflation outlook displays a significant improvement” and promised to deliver further monetary tightening if necessary.
The move, which foreign investors have been demanding for some time, was clearly motivated primarily by the need to stabilize the TRY, which would almost certainly have fallen further in the absence of a sizeable rate hike. Having dipped below 7 against the USD on August 10, the TRY had strengthened during the week before the CBRT decision from 6.67 to 6.34. While the action had the effect of pushing the rate to just above 6 against the USD, the currency then fell again steadily to around 6.40 after failing to cross that psychologically important threshold before hovering between 6.20 and 6.30.
The hike was also designed to curb consumer inflation, which has now officially reached 17.9 percent—its highest level since 2004—and to make the country attractive again to short-term investors abroad with the world’s second-highest interest rates. An additional motive was to shore up the credibility of the CBRT, which has been seriously undermined by Erdogan’s comments. During his visit to London on May 15, for example, he had said, “When the people fall into difficulties because of monetary policies, who are they going to hold accountable? They’ll hold the president accountable. Since they’ll ask the president about it, we have to give the image of a president who is influential on monetary policies.”
The CBRT decision came just hours after Erdogan repeated his well-known opposition to high interest rates. In a speech to a Turkish business federation, Erdogan declared that there had been “no change” in his “sensitivities on the issue of interest rates.” After repeating the unorthodox view that “the interest rate is the cause, inflation is the result,” he continued, “If you say inflation is the cause and interest rates are the result, you do not know this business…You may determine interest rates, but inflation is a result of the wrong steps you have taken. And who pays the price? The people.” Erdogan added, “The CBRT publishes year-end estimates for inflation, I have never seen them get it right.” Targeting the high interest being charged on commercial loans even before the CBRT move, he complained, “How will the real sector invest? Many private banks already do not open new credit lines easily, and the interest rates are close to 50 percent…Who among you here earns 50 percent? This only happens with marijuana and heroin dealers.”
Despite Erdogan’s typically harsh comments, there was a general recognition in Turkey as well as outside the country that the CBRT could not have moved without his implicit permission, particularly as he had taken control over the Sovereign Wealth Fund the previous day while installing Albayrak as his deputy, thus demonstrating his domination of economic management. The Financial Times reported that Albayrak had used his special connection to play a key role behind the scenes to persuade his father in law on raising the interest rate. However, notwithstanding his alleged acquiescence, Erdogan chose to resume his diatribe against the CBRT on September 14, by saying, “They say independence…now we will see the result of independence. Right now, personally I am at the limit of my patience…because we can’t say okay to a lever of exploitation.”
Announced on September 20 by Albayrak under a prominent sign, which read “Balance-Discipline-Transformation,” each slogan a theme for the three years covered by the program, the NEP identified its main goals as ensuring “price and financial stability…economic balancing, budgetary discipline, and medium-term sustainable growth.” It blamed “the speculative rise in exchange rates for the rise in costs, inflation and, consequently, higher market interest rates” as well as for “the slowing down of consumption and investment expenditures and overall growth and the reduction in the ability of the private sector to access internal and external financing.”
Acknowledging “the increase in the number of companies experiencing disruptions in their cash flows and the tightening of banks’ credit terms,” the NEP laid out a series of steps to deal with these problems from the beginning of 2019. It promised to impose fiscal discipline by reducing spending and suspending public projects, which have been tendered but not yet initiated while extending the construction phase of ongoing projects. It also posited a reduction in the current account deficit from 6.1 percent to 2.6 percent of the GDP by 2021 by “reducing dependence on imports.”
The NEP also sought to explain the failure to undertake necessary structural reforms with reference to what it termed “a series of grave threats” faced by the government, beginning with the Gezi protests in 2013 and culminating with the July 2016 coup attempt, along with serious geopolitical risks emanating from the Syrian crisis and terrorist acts, which had forced priority to be given to security. The document argued that the political stability assured for the next five years under the new presidential system, with its “fast and effective decision-making process and coordinated economic management,” provided “a window of opportunity to achieve economic targets.”
Albayrak went on live TV within hours of the NEP’s announcement to reassure the Turkish public that their main concern, the surge in prices—which many ordinary people have been complaining is considerably higher than official figures—would soon come to an end. Having conceded in the NEP, contrary to earlier optimistic projections, that the inflation rate would climb to 20.8 percent by the end of 2018, Albayrak claimed that the rate would then fall below double digits again by the end of 2020 in accordance with the “Total Struggle Against Inflation” campaign promised in the NEP. He also stated that while the NEP conceded that the much-vaunted growth rate would fall to 3.8 percent in 2018 and to 2.3 in 2019—again at variance with previously declared expectations—it would rebound to 5 percent in 2021.
To be sure, the NEP is a more realistic program than its predecessors with respect to growth and inflation projections. It is worth noting that Erdogan had repeatedly promised to lower interest rates and inflation while pushing his 2023 Vision in which Turkey would become one of the 10 biggest economies in the world through high growth during his successful election campaign this spring. Consequently, the NEP is much less ambitious in scope than Erdogan’s grand vision and unshakeable confidence in the health of the Turkish economy would normally have warranted. In fact, according to Reuters, because of this, there was “a debate among top government officials about the extent of the growth revisions” right up to the unveiling of the NEP.
Although it is an important statement of intent on the part of the government to do things differently from the past, question marks persist over the extent to which it will be implemented given its previous record. This was confirmed by the limited immediate impact of the NED on the TRY/USD rate. Concern has also been expressed that it may still be too optimistic in its targets and inadequate with respect to the measures it incorporates in view of the severity of the headwinds facing the Turkish economy. One area of particular worry is the lack of specificity to confront the growing risk Turkish corporations and banks are facing because of their foreign-exchange liabilities and increasing non-performing loans.
While the two moves were clearly prompted by worsening macroeconomic indicators, which could not be ignored, Erdogan has persisted in imploring his supporters not to believe that there was a crisis. In a speech on September 14, for example, he declared, " We don’t have such a thing. These are all a manipulation.
We are growing stronger as march into the future.” On September 26, he reiterated this message in an interview with Reuters in New York in which he said, “The current economic challenges have been exaggerated more than necessary.” Although he was due to meet U.S. investors the following day, he also confidently asserted that “Turkey will overcome these challenges with its own resources.” As the overwhelmingly pro-government media looked for positive factors to emphasize while downplaying negative economic news, Erdogan encouraged them to continue in this mode by saying on September 13 that just as he had predicted during the global 2008 crisis, there would only be “a glancing blow” to Turkey.
At the same time, Erdogan took aim at those he accused of taking advantage of the temporary economic turmoil by saying, "Hoarders have also increased in number these days. The Interior Ministry and the Treasury and Finance Ministry will give the necessary answer to them. The ones who engage in stockpiling will pay a price. We will conduct raids on them…These are the times when we pinpoint those who push the limits and continue to produce, invest, and create employment, as well as those, who, in an act of opportunism, betray their own country and nation.” On the same day, the Trade Ministry announced that action would be taken against 131 firms identified as hoarders and would be fined in the range of the equivalent of $1,000 to $10,000 with the possibility of the fines being increased by 10 times.
In his comments on September 13, Erdogan had tied the downturn in the Turkish economy to “external manipulative attack,” a claim, as polls indicate, that has traction with the Turkish public. The following day, he proceeded to identify the U.S.—which he had previously blamed for a range of issues such as its failure to extradite Fethullah Gulen and support for the Syrian Kurds as well as for imposing sanctions on two Turkish ministers because of the continued detention of Pastor Andrew Brunson—as the financial aggressor. He declared, “There was no political instability, war, disaster or any other extraordinary situation in Turkey in August. The emergence of the current situation, because we have not fulfilled the U.S. administration’s demands which are a blatant disrespect for our country’s sovereign rights, indicates that this is totally a political issue…The issue has already gone beyond the limits of the economy and reached the proportions of punishing Turkey altogether.”
Not surprisingly, Erdogan’s charge was repeated in the NEP, which stated, “Beginning from the second quarter of the year…our country risk premium increased, and the TRY lost value due to our external financing need and the U.S. administration taking direct aim at the Turkish economy.” On September 26, Erdogan reiterated the accusation by saying, “The doubling of steel tariffs, sanctions, investigations and of course currency moves are steps through which the current administration is targeting our country…Its willingness to use trade issues as a tool in the pursuit of political goals is an impediment to economic cooperation.”
Erdogan pointed to Turkey’s economic difficulties as further evidence of the need for a global response to U.S. domination. In his September 13 speech, for example, he declared, “What Turkey is experiencing shows that no country in the world has political or economic security any longer. Accordingly, signs of significant annoyance have started to be seen across the world, first and foremost in the EU, China, Russia, and India. However, the attack targeting our country was staged in a much more insidious, damaging and deliberate manner than with others.” Similarly, in his speech at the UNGA on September 25, he urged member states not to remain silent at the “use of economic sanctions as weapons.” He followed up the next day with an article in Foreign Policy in which he argued that it was “time to redefine global leadership,” a process Turkey was ready to commit itself to actively, even though it was “no military or economic superpower” it had “emerged as a global leader.”
Writing in Foreign Policy earlier on September 7, Albayrak had also blamed Turkey’s economic woes on a “systematic attack…by the biggest player in the global economic system, the United States.” He stated Turkey’s determination to “rebalance the structure of the international economy so that powerful countries like the United States no longer have the power to unilaterally disrupt the economic life of others.” To that end, Albayrak called for “mutually beneficial economic and political cooperation” between countries adversely affected by U.S. sanctions and tariffs, goals, which he surely discussed recently with his counterparts in Moscow, Tehran, Beijing, Paris, Berlin, and London as well as at the G20 and BRICS conferences. On the day Albayrak’s article was published, Turkey, Russia, and Iran agreed to trade petroleum, gas, and other products in local currencies at designated exchange rates on the sidelines of their summit in Tehran, a commitment long sought by the Turkish government which needs to be confirmed in practice.
Erdogan had come to power in the aftermath of the 2001 financial crisis in Turkey with a commitment to cooperate with the U.S.-led global financial system. He had then relied on it to provide external capital during a period of favorable global financial conditions as he followed a high growth economic model based on the provision of easy credits to consumers and companies. However, he now seems set on confronting it. Further evidence of this was provided by his attacks on the three major credit rating agencies, an integral part of the international financial system. In response to their reduction of Turkey’s sovereign credit rating further into junk territory and the downgrade of Turkish banks, which have exacerbated investors’ concerns over Turkey, Erdogan branded them as “fraudsters” and “a syndicate” on August 31. However, he is also continuing to court foreign investors. On September 13, for example, he assured them that Turkey remained “in favor of a free market economy.” For good measure, he added, “We know quite well that some of the countries that face troubles similar to ours resolve them by means of methods that are not compatible with the rules of free market economy…We will never resort to such methods.”
It remains to be seen whether his current strategy to deal with the crisis, which includes constant reassurances to citizens that the government is capable of overcoming the externally-provoked difficulties as well as initiatives to attract foreign capital to maintain what might be accurately termed “the circle of prosperity,” which has worked so well since 2002, will succeed. The external financial markets’ position will be determined not only by the interest rate level, but also by their perception of the NEP as well as its implementation, the independence of the CBRT, the competence of the new economic team in place since the June 24 presidential elections and the country’s ability to deal with shifting geopolitical dynamics which have deteriorated as tensions worsened with the United States.
It is interesting to note that the biggest rally in the past two weeks on the USD/TRY front, which saw the rate move from 6.32 to 6.05 on September 24, was prompted by a Wall Street Journal story that Brunson could be released as early next month. It proceeded to fall just below 6 two days after a handshake between Erdogan and Trump at the UNGA on September 25 and Erdogan’s speech at the business council meeting the following day in which he expressed confidence that “the strategic partnership which had survived many problems would overcome even the current turmoil.” He had continued, “Our close friendship with the U.S. will help transform this period to one of opportunity... we are optimistic about the future of our political and commercial relationship.”
Erdogan is clearly facing one of the most serious challenges of his political life. Ironically, it is coming not from domestic political opponents he has repeatedly trounced over the course of 16 years, during which he has been governing the country while transforming it into a full presidential system, but from external global forces without whose help he would not have been able to strengthen his grip on power.
Bulent Aliriza is a senior associate and director of the Turkey Project at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Zeynep Yekeler is a research assistant with the CSIS Turkey Project.
Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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