Turkey’s economic problems began in 2018, when the Turkish economic growth model collapsed. The model involved maintaining high levels of investment financed by ever-increasing foreign debt. Relevant reforms were not introduced despite a temporary improvement in the economic situation in 2019 due to favourable global trends and the Central Bank of the Republic of Turkey (CBRT) significantly increasing the interest rate.
Turkish President Recep Erdoğan, on the other hand, pushed a lax monetary policy, and the central bank became heavily dependent on him. The problems resurfaced in early 2020, when Turkey’s total foreign debt reached almost $440 billion. Turkey was also affected by congestions in global supply chains and the associated price hike. The problems intensified in 2021, and by December the Turkish economy was on the brink of collapse. Inflation reached 36%, and the rising prices are accompanied by a currency crisis. The weakening Turkish lira (TRY) poses a threat to the stability of the domestic banking system, which is indebted in dollars. The Turkish President is fighting the growing problems with a rather unusual economic policy.
Origin of Turkey’s economic problems
Turkey’s economic problems are linked to the policies pursued by Recep Erdoğan. To illustrate the causes of the country’s current economic situation, let us take a look at the policy pursued by the Justice and Development Party (AKP) since it came to power.
When the AKP took power in Turkey in November 2002, the Turkish economy was recovering from the severe financial crisis of 2000-2001, which caused the country’s worst recession since World War II. In 2001, Minister of Economic Affairs and the Treasury of Turkey Kemal Derviş, who had previously worked in senior positions at the World Bank, began implementing reforms based on support from the International Monetary Fund (IMF). The reforms proved successful, but did not prevent the government of Bülent Ecevit from losing the election. This was how AKP came to power. The party was initially led by interim Prime Minister Abdullah Gül and then, from 2003, by Recep Erdoğan. The new government continued to implement the reforms initiated by its predecessors. The reforms brought great success and empowered the position of AKP. In fact, they appeared to be a remedy for the banking system and contributed to the increase in foreign direct investments.
Since the very beginning of his term, Erdoğan has employed aggressive, pro-growth strategies with excellent results. At that time, among other things, he initiated the implementation of expensive infrastructure projects, courted foreign investors and encouraged businesses and consumers to incur debt. Those circumstances made the Turkish economy grow rapidly in the first decade of Erdoğan’s rule, and Turkey was deemed an “economic miracle”. Poverty was reduced, and Turkish society grew richer. Turkey also coped relatively well with the global financial crisis of 2007-2009. A slowdown in the GDP growth in 2008 to 0.6 per cent and a recession of -4.8 per cent in 2009 were followed by strong growth of 8.4 per cent in 2010 and 11.2 per cent in 2011.
However, Turkey’s economic success was based on a negative current account balance. It was the import of capital that made the key impetus for the development of the Turkish economy. Moreover, Turkey was dependent on the import of energy resources and, simultaneously, it did not manage to generate a foreign trade surplus. It was already in 2010 that some voices pointed out that Turkey should move towards sustainable development, as its economy was on the verge of “overheating”.
The Justice and Development Party was re-elected in 2011. Then, they began the process of consolidating the power and creating a system in which the economic policy is subordinated to the party’s interests. It was also the period when the dynamic economic growth slowed down. In 2013, Turkey struggled with serious internal problems. A revolt in Istanbul’s Gezi Park that led to massive nationwide protests against the governance of Erdoğan took place at that time. And among the elites, there was a conflict between AKP and its allies, which led to the gradual marginalisation of the Gülen Movement. The real turning point came in 2016, after the failed coup d’état, with mass arrests and purges in the state institutions. Those internal tensions strengthened the power of AKP and enhanced Erdoğan’s position. Simultaneously, they significantly affected the economy. While after 2002 the Turkish government allowed some flexibility in economic matters and adjusted its economic policy to external conditions, this flexibility decreased since 2016. The government began to subordinate the economy to its political objectives and to strengthen its supervision over the key economic areas. The business initiatives were more and more controlled, and the governmental power became increasingly centralised.
The expansionary monetary policy allowed Turkey to maintain a relatively high rate of economic growth. However, it was the inflow of foreign capital which posed the stimulus for development, and it led to an increase of the Turkish companies’ and banks’ indebtedness. The expansion resulted in foreign exchange imbalance, rising inflation and the weakening of the Turkish currency. Turkey’s external debt reached $450 billion at the end of 2017, while the central bank’s foreign reserves amounted to $85 billion. In addition, many of the indebted businesses stood on the verge of bankruptcy. To stimulate the rapid growth, the Turkish government decreased taxes, introduced subsidies for businesses and loan guarantees for the private sector. Meanwhile, the S&P credit rating agency downgraded Turkey’s rating from BB/B to BB-/B and warned of an “overheating” of economy. In mid-2018, Turkey invested nearly $18 billion in foreign bonds and stocks, deepening the financial meltdown. The situation was exacerbated by Erdoğan’s statements that he had the right to influence the central bank policy.
Beginning of the economic crisis in Turkey
The Turkish model of economic growth collapsed in 2018, which involved high levels of investment financed by rising foreign debt, and Turkey faced an economic crisis. Inflation reached 25 per cent in November, and the value of the Turkish lira was significantly eroded. In August 2018, U.S. President Donald Trump doubled the customs tariffs for Turkish steel and aluminium imports, leading to a rapid fall in the value of the Turkish lira, which tanked by 20% a few days after the U.S. decision. In response to the high inflation, the Central Bank of the Republic of Turkey boosted the interest rate, which first rose from 13.5 per cent to 16.5 per cent in May and then up to 24 per cent in September. The increase was strongly opposed by the Turkish President, whose position was that a high interest rate hampers economic growth and causes inflation. Erdoğan attempted to exert pressure on CBRT governor Murat Cetinkaya to reduce the interest rate. However, Cetinkaya did not do so, and Erdoğan forced him to resign from the position of the central bank’s governor in July 2019. Keeping the interest rate high at 24 per cent has had a positive impact on the Turkish economy and has helped to alleviate the economic problems. Murat Uysal became a new CBRT governor in 2019, and he served his duty for over a year. Over the last few years, the governors of the Turkish central bank have been changed several times, which only shows the level of the bank’s politicisation. The institution should be, however, independent from the government.
Erdoğan’s monetary policy
The President of Turkey advocates low interest rates of central banks to stimulate the economy. At the same time, he strongly opposes high interest rates, arguing that they slow down the economic growth and fuel inflation. Are these theses true? The first of his claims – yes, it is. When the central bank raises the interest rate, commercial banks have less ability to borrow for maintaining their minimum reserve, so they grant loans at the increased interest rate. This implies more expensive credits for companies, so fewer businesses borrow. Investment is declining, causing a slowdown in the economic growth. However, Erdoğan’s other argument, i.e. a claim that high interest rates increase inflation, goes against conventional economic theories. In fact, the interest rate hike causes a fall in borrowing and consumer spending, leading to a fall in prices.
The monetary policy promoted by the President of Turkey is unusual and has been criticised by most economists. According to the “Washington Post” analysis, Erdoğan’s approach to high interest rates may be rooted in his experience as a food industry businessman, which he was before he started his political career. This is because a lot of Turkish companies finance their operating costs by contracting loans. According to Erdoğan, increased interest rates make the loans more expensive for them, so they pass the costs on to consumers by increasing the prices of the products they sell. However, many economists challenge the view that an interest rate is a significant part of the businesses’ expenditure and that manufacturers’ pricing power is sufficient to impose their will on consumers.
Deterioration of the economic crisis
In 2019, Turkey temporarily recovered from the recession, and its tourism revenue was $34 billion. In turn, decreased oil prices have resulted in lower transport costs. The situation has stabilised thanks to favourable global trends, such as the expansionary monetary policy in the USA and lower commodity prices. The Turkish economy was also positively affected by the high CBRT interest rate, which was increased to 24 per cent in September 2018, thus reducing inflation. In the second half of the following year, however, the CBRT began to gradually lower the interest rate, which was below 10 per cent in the first half of 2020.
Despite the improvement in the economic situation, proper reforms have not been introduced, and at the same time the strategy of stimulating the investments generating increasing foreign debt of the economy was quickly revived. As of late 2019 and early 2020, Turkey’s total external debt stood at nearly $440 billion, while the reserves amounted to around $80 billion. In the first months of 2020, the situation deteriorated again. The CBRT, on the other hand, introduced gradual interest rate cuts to drive the economic growth rate by keeping consumption and investment high, which led to higher inflation. The Turkish economy was also negatively affected by the COVID-19 pandemic, although Turkey achieved the economic growth of 1.8 per cent in 2020. To avoid having to declare insolvency, the government took many measures to protect the Turkish lira. However, these proved ineffective, and what saved Turkey was the help of expanding foreign exchange with Qatar and China.
Turkey’s economic crisis escalated significantly in 2021 as a result of the deteriorating global economy and the CBRT’s controversial monetary policy. Turkey has been also affected by the congestions in global supply chains and the associated price hike. Despite the persistently high inflation, the CBRT, without prior announcement, began to cut the interest rate even more, reducing it from 19 per cent to 14 per cent between September and December. It resulted in a rapid GDP growth, drastic increase in inflation and weakened the Turkish lira.
Inflation in Turkey rose to 36.08 per cent in December 2021, compared to 21.31 per cent in the preceding month. This is the highest level since September 2002. The main price increases occurred in relation to food and non-alcoholic beverages (43.80 per cent), transport (53.66 per cent), housing and utilities (28.57 per cent), household furnishing and equipment (40.95 per cent), hotels, cafes and restaurants (40.85 per cent) and clothing and footwear (20.13 per cent).
The end of the year also saw a sharp depreciation of the national currency. In January, TRY 6.7 were exchanged for $1, and this rate increased to TRY 18.6 in mid-December. The Turkish lira depreciated by almost 40 per cent against the US dollar in 2021. Over the last five years, the Turkish lira has lost almost 72% of its value against the US dollar, and over the whole decade, the depreciation reached 86%. The depreciating Turkish lira poses a threat to the stability of the domestic banking system, which is heavily indebted in the American currency. Moreover, it increases the burden on some parts of the industry, as they have to import components that are more costly for Turkish manufacturers when the currency is weak. The negative consequences of Turkish lira depreciation also include fuelling inflation in consumer goods and reducing the prosperity of the society, as reflected, for example, in rising food prices. Another problem is the dependence of the Turkish economy on expensive imports of basic products such as meat, fertilisers or metals.
Response to the crisis
In response to the worsening economic situation, the government presented the “New Economic Model” (NEM) on 30 November 2021. The initiative is aimed at creating a surplus in foreign exchange and at stabilising the economy. According to the plan, a low central bank’s interest rate and weak Turkish lira are supposed to make exports based on domestic resources more competitive. The CBRT reserves, on the other hand, should be boosted by export earnings, allowing further interventions. However, the planned measures do not involve fighting inflation in any way, and they even will exacerbate it.
The government is also taking some ad hoc steps to temporarily stabilise the economic situation, such as CBRT interventions in defence of the Turkish lira, loans from its own banking sector and other central banks, in particular of China and Qatar. Furthermore, to limit the sharp decline in the population’s purchasing power, the government has increased the minimum wage. In late December 2021, Erdoğan also announced the introduction of a profit guarantee scheme for bank deposits in the Turkish lira, aimed o compensate for its potential depreciation against the dollar, which indeed strengthened the Turkish currency. After the guarantee was announced, the exchange rate in Turkey is TRY 12 per USD 1 (previously it was TRY 17.8).
The government’s proposal to address the crisis is not a detailed agenda of reforms, and what the government hopes to achieve is to placate and reassure the investors. Erdoğan’s actions are aimed mainly at avoiding a collapse and improving the economic situation before the upcoming presidential election in 2023, which may be held sooner than expected. The present activity of Turkey is mainly oriented toward short-term effects. AKP seeks to maintain its dominant position in the state and to defend its own order. Erdoğan wants to wait out the adverse economic circumstances and open Turkey up to additional sources of financing through cooperation with Qatar and China.
However, the actions undertaken by Turkey are not going to solve the structural problems of the economy, particularly, the issue of rising inflation. Simultaneously, they will increase the burden on the banking system. The measures are also taken with scepticism by the Turks and by large business groups who fear a loss of their manufacturing capacity. With all those issues, President Erdoğan’s popularity is eroding.
The economic crisis in Turkey will deteriorate in the coming months. Ad hoc measures to stabilise the currency and increase the purchasing power of the society are not going to solve Turkey’s problems in the long run. Turkey will also be adversely affected by the actions of the NEM, which assumes only short-term improvement and aims to make Erdoğan’s government survive. Export gains due to a weak Turkish lira may improve the foreign exchange balance, but at the same time, they will lead to significant capital outflows and currency fluctuations. High inflation is another serious problem Turkey will face, one fuelled by the CBRT keeping interest rates low.
Institutions deciding on Turkey’s capital inflows (e.g. the IMF) expect broad economic reforms aimed, among other things, at changing the financing model for economic growth from the lax monetary policy and fiscal expansion into increased productivity and higher savings rates. Achieving this would involve the rebuilding of the banking system and reducing the share of public investment in total growth, so AKP will not agree to do so.
If the NEM fails to deliver the expected results, the political and social situation in the country could deteriorate and there may be mass protests against the governance of Erdoğan. The potential meltdown poses a threat to the survival of the AKP power. The consequences of Turkey’s economic collapse will entail serious international repercussions. Turkey’s main creditors are the European banks, so a collapse of the Turkish economy will affect the Eurozone. We can also expect an international crisis connected with the Turkey-EU relations, in the context of, among other things, cooperation in terms of migration affairs. A breakdown in the balance in the Middle East is also possible, as Turkey plays an active role there.
Mikołaj Rogalewicz – senior analyst at the Demagog Association, a fact-checking organization. Author of numerous articles and analyses devoted to international relations, fact-checking, and disinformation. Participant of Kremlin Watchers Movement project, in which he deals with Russian disinformation. At various conferences, he presented papers on disinformation, cyberterrorism, Russian-Ukrainian conflict, and efforts to solve it, as well as actions of the EU aimed at combating terrorism. He is a mentor of the Akademia Fact-Checkingu (Fact-Checking Academy), he organized several workshops and training events on fact-checking and fighting disinformation, including for the volunteers of the European Parliament and Facebook. Additionally, he conducted workshops on climate-related fact-checking during the Open Climate Change event in Zagreb. Graduate of international relations at the University of Warsaw.
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