The long-awaited Turkish presidential and parliamentary elections finally came and went in May 2023. Ever since the previous elections held in June 2018, the government led by President Recep Tayyip Erdoğan and his Justice and Development Party always had one eye on the new elections in five years’ time. Above all else, it was determined to keep its base support happy and retain power. In that the president and his party were re-elected in May 2023, their policies proved to be very successful. But at what cost?
For the Turkish president, it was all about ensuring continued growth. Even at the height of Turkey’s economic woes in 2022, Turkey’s GDP achieved 5.6%, out-performing nearly all other emerging and developed countries. However, this high growth rate did not reflect the fundamental shortcomings behind the Turkish economy. The official annual inflation rate was 64.27%, and the unofficial ENAG annual inflation rate was 137.55% as of December 2022. The Turkish lira devalued against the US Dollar by 40.3% in 2022. This would have been much higher if not for the government’s constant sale of its f/x reserves to prop up the Turkish lira in the second half of 2022. Turkey’s reserves were more than USD 50 billion in the red after accounting for swap agreements. The foreign trade deficit was USD 109.5 billion in 2022, 137% up on the previous year. The current account deficit for 2022 was USD 48.4 billion, compared with a USD 7.2 billion deficit in 2021. The only redeeming indicators were income from tourism of USD 46.3 billion, up 53.4% on 2021, and exports which were 12.9% up on 2021 at USD 254.2 billion.
The Turkish government had managed to bring about a high GDP figure in 2022 by encouraging cheap loans enabled by its negative real net interest monetary policy. The Turkish Central Bank’s policy interest rate was 9% at the 2022 yearend, compared with the official inflation rate of 64.27%. In order to help keep inflation under control despite its inflationary economic and monetary policies, the government used all the means available to it to prevent the Turkish lira from devaluing against foreign currencies. Through cash loan infusions and swap agreements obtained from Saudi Arabia, UAE, Qatar and Russia, capital controls over F/X generated and held by corporations, close monitoring and control over bank F/X operations, and continued effective implementation of the Treasury’s F/X-protected TL deposit accounts instrument, the government avoided a run on the Turkish lira which ended at TL 19.58 to the US dollar just before the first round of the presidential election on May 14th, 2023. This represented only a devaluation of 25.7% in the year leading up to the election, well below even the official inflation rate.
As a result of the overvalued Turkish lira at 2022 yearend, many of Turkey’s statistics given in US dollars were bloated. For example, the income per head of population for 2022 was recorded at USD 10,655, whereas the correct figure was undoubtedly below the 2021 figure of USD 9,539. The overvalued Turkish lira was a major factor in a boost in imports and a deteriorating foreign trade deficit. Many imbalances were now evident in the Turkish economy. Economic and monetary policy decisions have been taken on a daily basis to fight problems as they arose. Planning, savings and investment were highly-valued concepts which were no longer being addressed. An economy model which went against all generally accepted economic norms had been generated.
In the Economist weekly magazine, Turkey’s unique economic model was addressed in an article titled “Stuffed like Turkey. Erdoganomics across the world, threatening trouble”. Interestingly, the article notes that increases in the central banks’ policy rates in emerging markets do not have the same deflationary effect as in developed countries. According to the Economist, the reason for this is that “Unlike in advanced economies, banks do not pass the rate change on to government and household borrowers”. The Economist goes on to say that “Emerging-market financial institutions struggle to find funds at home, since few households save and there are not many big firms. Instead, they turn to international markets”. It adds that “Poor countries are also home to big informal sectors, where firms do not borrow from banks” and refers to the conclusion that “emerging economies take longer to feel the pinch of higher rates”. It is debatable whether the above emerging market examples apply fully to Turkey. However, it is clear that President Erdoğan was clearly frustrated by the failure to bring down inflation despite higher interest rates. His desperate need to encourage growth to keep his political base happy made him lose patience with the orthodox economic model, and he just turned the model upside-down by claiming that higher interest rates brings higher inflation.
Despite the significant deterioration in economic indicators, the Turkish government somehow managed to keep the economy afloat until the May 2023 elections. President Erdoğan’s gamble had paid off. However, once the elections were over, it was time to count the cost.
One re-elected President Erdoğan had somehow realised that his unorthodox economic policies had failed and he reluctantly accepted a return to realistic policies to try and salvage the desperate situation and prevent the Turkish economy from collapsing into bankruptcy. Erdoğan’s first step was to bring in a new economic team headed by Mehmet Şimşek who was appointed the Economy Minister and Head of Treasury and Gaye Erkan who was appointed the Governor of the Turkish Central Bank. Mehmet Şimşek was appointed in the knowledge that he desired a return to orthodox economic policies. The first move of this new economic team was to stop foreign currency sales and allow the Turkish lira to fall to a more realistic level. The result was that the Turkish lira had devalued to TL 25.84 by the end of June, and TL 26.96 by the end of July, at which point it had devalued 50.5% over the previous year and 44.1% since 2022 yearend. The first to give a sigh of relief at this development were Turkish exporters who were facing a serious loss of competitiveness in foreign markets.
The second move by the new economic team was to introduce a wide range of tax increases in the face of a worsening budget deficit. The value-added tax (VAT) on basic goods such as cleaning products was raised from 8% to 10%. The tax on all other products and services was raised from 18% to 20%. Fees for various administrative services, including passport, notary, and visa fees, were raised by 50%. Tax on consumer loans was increased from 10% to 15%. Proposals to increase the corporation tax rate for companies to 25% from 20%, and for banks, insurers, brokerages, pension firms and electronic payment companies to 30% from 25% were introduced.
The third move by the new economic team was for the Turkish Central Bank to increase its benchmark policy rate, the one week repo rate, from 8.5% to 17.5% on June 22nd and from 15% to 17.5% on July 20th. These hikes were far below the levels needed to correct the imbalance with the current inflation figures and had little if no effect on inflation and the value of the Turkish lira. The Governor of the Central Bank Gaye Erkan stated that it was the Bank’s policy to bring about a gradual correction, or “simplification”, of monetary variables, no doubt not to risk any over-reaction from other sensitive economic indicators. It is estimated that the Bank will continue to raise its interest rate and that this is most likely to be 250 basis points in the August monetary policy meeting.
The fourth move initiated by President Erdoğan was to obtain financial support from Arab countries to prop up the Turkish economy to buy time for the new economic team to implement its programme and to help alleviate inflationary pressures on the electorate before the up-and-coming local elections in March 2024. Despite serious political differences in the past, Erdoğan has recently been making every effort to improve relations with Arab countries. He clearly knew that the economy was likely to run into difficulties at some point in time and he had the foresight to ensure a potential source of international funding. The alternative would have meant going to the IMF with cap in hand, and this would be total anathema to Erdoğan who would never accept any conditions imposed by the IMF. On July 19th, Erdoğan, accompanied with Mehmet Şimşek and Gaye Erkan, met in Abu Dhabi with his UAE counterpart, Sheikh Mohammed bin Zayed Al Nahyan, secured agreements worth an estimated USD 50.7 billion between the two countries in addition to the trade deal first signed in March valued at USD 40 billion. The deals also covered investments, space and defence development, and energy and natural resource projects. Indeed, trade between Turkey and the UAE has expanded greatly in the last three years. Between January and May 2023, Turkey’s exports to the UAE increased by 24% from the same period last year, reaching USD 2.5 billion, while imports increased by 162% to USD 4.1 billion. In addition to the UAE, Erdoğan and his team also visited Qatar and Saufi Arabia to strengthen already developing economic ties.
Despite interest rate increases, some capital control easing by the Central Bank on the banking sector, and a guarded but positive reaction by international money markets and investors to the Turkish government’s intent to return to orthodox economic policies under a new capable economic team, pressure on the Turkish lira has continued. No doubt with some goading from President Erdoğan , the new economic team began to resume its intervention in the money markets from mid-July by selling some USD 3.7 billion in the money markets. The only difference this time from the previous economic administration was that this f/x was off-loaded directly by the Central Bank rather than through state banks as was the procedure before. The result has been that the value of the Turkish lira has remained at around TL 27 to the US dollar for the last month.
The July 2023 annual inflation rate increased to 47.83% and the Turkish Central Bank’s inflation report announced on July 27th forecast an increase in the 2023 yearend inflation rate from 22.3% to 58%. Though the official statistics and forecasts are grudgingly showing the rising inflationary pressure, they by no means reflect the devastating waves of price increases surging over the Turkish population. In the short term, there appears no way in which the government can forestall this suffocating barrage of price increases. It would appear that there is no alternative but to let the economic turbulence play out while the strategy of the new economic team gradually comes into effect.
The immediate problem of the government is clearly the need to meet its foreign and domestic debts, hence the funds acquired from Arab countries in particular. However, such are the accumulated stress levels now imposed on the Turkish economy, the situation is somewhat precarious and there is an increasing possibility that Turkey may have to default. The true state of the Turkish economy is unknown, but we do know that reserves are in the red, that foreign debt is high, and that the current account shows a large deficit. The high f/x revenue from tourism and the lower energy bills during the Summer months offer a short reprieve, but the autumn months will clearly be a make or break time for the Turkish economy.