Turkey’s Economic Struggles
Turkey is a country with deep divisions, both geographically and culturally. The coastal regions are home to a secular elite, while the interior is predominantly conservative and religious. This divide has significant implications for the country’s economy and politics.
A History of Credit Booms
To maintain power, President Erdogan has relied on a strategy of creating credit booms to stimulate economic growth. This approach has lifted Turkey’s per capita GDP above that of its emerging market peers. However, it is inherently destabilizing, as it boosts consumption, increases imports, and widens the current account deficit to unsustainable levels. The inevitable result has been repeated currency crises, making the Turkish Lira the weakest currency in real effective terms across all emerging markets.
The Impact of COVID-19
The COVID-19 pandemic presented a significant challenge to Turkey’s economy. In response, Erdogan unleashed an unprecedented credit boom to keep the economy afloat. This move widened the current account deficit, causing the Turkish Lira to depreciate sharply. In an attempt to stabilize the currency, Erdogan appointed a hawkish central bank governor, Naci Ağbal, who raised interest rates in November 2020. However, Ağbal’s tenure was short-lived, and his firing in March 2021 marked the beginning of a series of rate cuts that sent the Lira into free fall.
Consequences of Rate Cuts
The rate cuts had two devastating consequences. Firstly, they eradicated any semblance of central bank independence, as the government’s influence over monetary policy became overt. Secondly, the cuts occurred at a time when other countries were raising interest rates, resulting in a significant divergence in rate differentials that worked against the Lira. The irony is that the Turkish central bank was eventually forced to hike rates far higher than they would have been had Ağbal’s policies been allowed to continue.
Turkey’s Real Exchange Rate
A comparison of real effective exchange rates across advanced and emerging markets reveals that Turkey’s currency is the weakest among 34 countries. The real exchange rate takes into account Turkey’s high inflation rate relative to its trading partners, making the Lira’s weakness all the more remarkable. This is a stark indictment of the country’s past policy mistakes and its continued reliance on credit stimulus to drive growth.
Lessons Learned
Turkey’s fundamental problem is Erdogan’s desire to maintain power, which drives the government’s focus on boosting growth through credit expansion. As long as Erdogan remains in power, there is little prospect of an end to credit booms and the resulting depreciation pressure on the Lira. Furthermore, central bank independence is an illusion in such an environment, as truly restrictive monetary policy is incompatible with the credit expansion required by Erdogan. The Turkish Lira has lost its anchor, and the country’s economic stability remains precarious.
Conclusion
In conclusion, Turkey’s economic struggles are deeply rooted in its political landscape and the government’s prioritization of growth over stability. The country’s history of credit booms, the impact of COVID-19, and the consequences of rate cuts have all contributed to the Lira’s weakness. Until there is a change in the country’s economic policy and a commitment to central bank independence, Turkey’s economic future remains uncertain.
