Since the presidential and parliamentary elections on June 24th, 2018, it’s now suddenly all about the economy. Turkish President Recep Tayyip Erdoğan had to promote loose fiscal policies and offer sweeteners to the electorate in order to assure victory in the elections despite clear signs that the economy was overheating and on the brink of a meltdown. Under normal circumstances, the government should have started to take fiscal precautionary action well before the end of 2017. However, political considerations were paramount and the economy was taken to the precipice. With election victory under his belt, Erdoğan has now concentrated the minds of his new designated cabinet on the economy. He even started to relax the geo-political tensions he was such a master of creating in order to win over his electoral base. Relations with Germany appear to have normalised, even out of necessity for both sides, and relations with the USA have somewhat improved after the release of Pastor Brunson. Unfortunately the Brunson issue was not resolved before US President Trump waded in with sanctions against Turkey. Erdoğan’s brinkmanship failed him this time and the Turkish lira collapsed overnight in August creating all sorts of problems for an economy already under siege.
The consequence of all the fun and games over the Summer months is that Turkey now has an inflation rate of 25.24%, a central bank interest rate of 24% and a Turkish Lira over 40% lower than its value at the beginning of 2018. Of course, the inflation rate felt by the man in the street is much higher than the official inflation rate. Electricity and natural gas bills have increased by 9% at the beginning of August, September and October…. a compound increase of some 30% in just three months. A combination of persuasion and threats by the government to companies to make price sacrifices will only offer a temporary respite. The Turkish government is battling to slow the inevitable sinking into recession with every means at its disposal. This even includes the psychological indoctrination of the Turkish people that there is in fact no real recession except those problems caused by external enemies of the state. The government has the advantage of controlling nearly all the media, such that the Turkish people are not confronted with depressing news about the economy.
The games of government denial, attempts to patch up holes in the economy as they appear, and efforts to paint a positive picture in the face of all adversity will continue until the Turkish local elections of March 31st, 2019, After then, it does not really matter anymore.
President Erdoğan and the Minister of the Treasury and Finance Berat Albayrak have, since the June 24th presidential and parliamentary elections, continually stated the need to pursue tighter fiscal policies in order to deal with inflation and balance the economy. Indeed, one of the main underlying premises behind the government’s New Economy Plan, which was announced on September 20th, 2018, was the need to introduce a more disciplined fiscal policy. Foreign financial analysts and investors were prepared to give the New Economy Plan the benefit of the doubt because of such sound reasoning on which it was prepared.
However, on October 31st, 2018, much to the surprise of foreign analysts monitoring the Turkish economy, the Turkish government introduced a series of tax cuts.
The tax cuts package unveiled by the Turkish Treasury and Finance Minister Berat Albayrak was effective from November 1st, 2018 until the yearend. These cuts represent a combination of new cuts and the continuation of previous tax cuts. The six areas of tax cuts were as follows :
1) The special consumption tax on white goods will be suspended
2) The reduction in title deeds fees rate from 4% to 3% will continue
3) The reduction in VAT rate on housing sales from 18% to 8% will continue
4) The reduction in VAT rate on furniture sales from 18% to 8% will continue
5) The special consumption tax on motor vehicles with engines under 1600 cc will be reduced to 15%
6) VAT on commercial vehicles will be reduced to 1% from 18%
Albayrak said that these tax cuts were implemented with the aim of supporting economic rebalancing, employment and the fight against inflation, and of invigorating those sectors contracted by the currency impact. Albayrak believes that Turkey has entered a period of normalisation since the beginning of October and that 2019 will be a year in which the markets’ confidence in Turkey will be restored. He adds that the inflation rate in September was the worst part left behind, and that he is sure that positive developments on the inflation front in October are in the pipeline.
The Turkish Lira has certainly recovered somewhat since its collapse on August 10th, 2018, following sanctions imposed and threats of further sanctions by the USA. The Turkish Lira had at one point fallen close to TL 7.50 to the US dollar. Since the release of Pastor Brunson on October 12th, 2018, the Turkish lira has recovered to TL 5.50 to the US dollar. It would now appear that the Turkish government saw an opportunity to use this respite in the pressure on the Turkish lira to add a boost to the Turkish economy ahead of the local elections at the end of March 2019. Albayrak sees the Turkish economy as entering a “period of normalisation” during which a change in fiscal policy may be implemented.
Whatever the reasoning, these tax cuts will be judged as a serious U-turn in economic policy, The timing of their announcement was unfortunately made only just a few hours after the Turkish Central bank had revised its inflation forecast for 2018 from 13.4% to 23.5%. Foreign investors and financial institutions will now have serious doubts as to whether Turkey can be relied on to pursue a medium and long-term economic strategy based on sound fiscal policies to ensure a recovery in the Turkish economy.
Following the announcement of the tax cuts, the Turkish lira fell to TL 5.63 to the US dollar from TL 5.50, before settling back to TL 5.60. Shares in Turkey’s white goods maker Arçelik rose 5% after the announcement, while car makers Ford Otosan and Tofaş were both up 7%.
The tax cuts were introduced to temporarily support sectors which were suffering from the dramatic fall in domestic consumption. These are the automobile, furniture, construction, and white goods sectors. However, it has been argued that the benefit of tax cuts to these sectors will be limited because of current high interest rates. Purchases of cars and houses are in particular very much dependent on bank loans, and with interest rates as high as 65%, many potential buyers will be discouraged from taking out loans.
On November 5th, 2018, international credit rating agency Moody’s criticised the tax cuts in an analysis on its web site, and said that “the tax cuts are credit negative because the fiscal stimulus points toward a potentially looser fiscal stance in the future, with the risk of an eventual gradual erosion of Turkey’s fiscal strength. Furthermore, boosting domestic demand could slow Turkey’s macroeconomic re-balancing. In light of those risks, the tax cuts could revive the downward trend in the Turkish lira exchange rate, fuelling already-strong inflationary pressure rather than reducing it, the opposite of what the authorities intend.“ Moody’s added that “Besides being ineffective on the inflation front, the tax cuts will be too short-lived to provide more than a temporary boost to consumption, particularly amid very high interest rates that will curtail borrowing for expensive articles such as cars and white goods. Importantly, although we do not believe the tax cuts will have a perceptible negative effect on the government's budget because of their temporary nature, larger fiscal stimulus measures that attempt to bring the economy out of recession would be problematic.”
Moody’s also emphasised its concern about the Turkish government’s shift in fiscal policy by stating that “Any signals from the government that it will renege on its commitment to fiscal consolidation would be seen negatively in foreign-currency markets, since increased government spending would suggest that the authorities are seeking to halt economic rebalancing. Such moves would almost certainly weaken the currency again, invigorate already high inflation and end up curbing demand instead of propping it up.”
The Turkish government’s tax cuts have not inspired a great deal of confidence in its ability to apply correct and timely fiscal economic policies to the economic recession now enveloping Turkey. Considering the fact that these tax cuts will only offer a temporary respite, even if that in the light of high interest rates, it may be wondered whether these measures were really worth it in the first place. The Turkish government risks losing the support of global financial markets at a very critical time, but has nevertheless decided that stimulating the economy before the March 2019 local elections has a higher priority.