The Presidential Government System, adopted by the April 16, 2017 referendum has been in effect since July 9, 2018 in Turkey. The President has become the head of the executive in this system. Critical issues are now regulated by presidential decree. Decisions are taken faster than the old system. In fact, during the referendum process, this feature of the system was frequently emphasized by the representatives of the AKP government. The main claim of this form of government is that stability and positive development will be maintained. This study will examine whether the presidential system creates a stable economy as claimed. In doing so, the developments of the past four years will be evaluated and the impact of these developments on economic and financial indicators will be discussed.
First Cabinet of the New System
Recep Tayyip Erdoğan announced the first cabinet of the presidential government system on July 9, 2018. Erdoğan’s son-in-law Berat Albayrak, who was the Minister of Energy in the previous cabinet, was appointed as the Minister of Treasury and Finance in this new cabinet. In the 28 months until his resignation on November 8, 2020, Albayrak had absolute control over the institutions under his administration. He appointed names close to him to head these institutions. Those with whom Albayrak had disagreements were dismissed. For example, Central Bank Director Murat Çetinkaya, who conflicts with Albayrak over monetary policy implementation, was dismissed by presidential decree. Çetinkaya was against the policy of reducing interest rates early.
It is known that under Albayrak rule, large amounts of Central Bank reserves were sold to support the low interest rate policy. Reserves are held to show lenders that a country is able to pay its debt. In addition, during extreme periods such as pandemics, reserves are used as a kind of nuclear option. The purpose of the reserve sales, which were mainly made through state-owned banks, was to eliminate the upward pressure on exchange rates caused by artificially low interest rates. Albayrak has gathered all the authority in his hands to carry out this policy decisively.
Due to the Pastor Brunson crisis with the USA, a currency crisis occurred in Turkey in August 2018. The USD/TL parity rose 53% in ten days. Reserve sales began slowly at that time. The TCMB, being late a little, increased the policy rate to 24% in September 2018. After a quiet period, interest rate cuts started in June 2019. At the end of this interest rates decreasing process in May 2020, the interest was 8.25%. It was during this period that large amount of the Central Bank reserves began to be sold.
Currency swap is the process of exchanging its own currency for a certain period of time with another currency by the Central Banks. At the end of the swap deal, the two central banks return the money they received from each other, adding the interest calculated for that period. The foreign currency obtained in this way is not the ownership but the obligation (debt) of the Central Bank. The addition of these foreign currencies to the reserves is always a matter of debate. Excluding the foreign exchange and gold borrowed by the Central Bank through swap transactions, it is observed that its net reserves have melted after 2018. By comparison, the Central Bank’s net reserves excluding swaps at the end of 2018 were $28 billion. At the end of 2019, it was $18.5 billion. Net reserve excluding swaps, which was -$49.5 billion at the end of 2020, dropped to -$56 billion at the end of 2021.
Debates created by the dramatic fall in the reserves have eroded Berat Albayrak’s reputation. On November 7, 2020, Naci Ağbal became the President of the TCMB with the decision of the President. Albayrak then resigned on 8 November 2020. Lütfi Elvan was appointed as the new Minister of Treasury and Finance on 10 November 2020. Ağbal’s short term at the Central Bank is interesting in every respect. Ağbal worked in harmony with Lütfi Elvan. It increased the policy rate by 875 basis points to control inflation. The USD/TL parity, which was 8.50 on November 9, 2020, the first business day of Ağbal, dropped to 6.90 on February 16, 2021. In three months, there was an inflow of nearly 20 billion dollars to Turkey. A significant improvement was observed in inflation expectations.
On March 18, 2021, when the TCMB increased the interest rate by 200 basis points, more than expected, Ağbal began to be harshly criticized by media organs close to the AKP. On March 19, 2021, Yeni Şafak newspaper ran the headline “For whom did you make this operation” and Ağbal was dismissed the next day. Şahap Kavcıoğlu became the new TCMB Governor. The Minister of Treasury and Finance, Elvan, who was disturbed by the events, did not appear in public in the next period. Elvan resigned from his post on December 2, 2021. He was replaced by Nureddin Nebati, who served as Deputy Minister of Treasury and Finance during Albayrak’s term. After Nebati took office, the USD/TL parity, which was already in a strong uptrend, rose to 18.30. On December 20, 2021, there was a complete panic in the financial markets. After the cabinet meeting held that day, President Erdoğan announced the Currency Protected Deposit (KKM) instrument.
Currency Protected Deposit (KKM) Account
Before detailing the KKM instrument, it is useful to remember what happened in the September-December 2021 period. The Central Bank, headed by Kavcıoğlu, started interest rate cuts in September 2021, despite global risks such as energy prices that started to rise rapidly in Europe and Asia, the Fed’s statement that it would end monetary expansion, and high inflation in Turkish economy. In the September-December period, interest rates were cut by 500 basis points. The USD/TL rate, which was 8.20 in September 2021, rose to 18.30 on 20 December, 2021. After the announcement of the Currency Protected Deposit instrument by President Erdogan, there was a sharp pullback in the exchange rates in the first place. In the following months, exchange rates started to rise again with the continuing demand for dollar.
The KKM account is a foreign currency-indexed deposit product that guarantees investors 17% interest in TL, while ensuring that they do not miss the possible rise in exchange rates. Banks pay 17% interest to those who transfer from TL deposits to KKM. If the change in the exchange rate is against TL, the difference is paid by the Treasury in addition to the interest. This creates a heavy burden on the budget. Those who change their foreign currency account and open a KKM account are paid with the same system. However, this payment is made by the Central Bank, not the Treasury. Although there is no up-to-date data on the payments made by the Treasury from the beginning of 2022 until the end of August, the figure is thought to be over 80 billion TL. The public is not informed about the KKM transactions made by the Central Bank.
Although the KKM account set out to convert foreign currency deposits into TL deposits, it evolved into a different structure by allowing TL accounts to be converted into currency protected deposits. In this way, TL deposits are fixed to foreign currency in a way. The KKM instrument, which is offered to reduce foreign currency deposits, on the contrary, increases foreign currency deposits. According to the calculation made based on the data published by the Banking Regulation and Supervision Agency, it is seen that the dollarization (double currency system) in Turkey has increased to 72%.
Turkey’s current economic model is built on KKM. The policy rate is deliberately kept well below official inflation. Negative real interest rate is roughly -67%. Investors who wanted to be protected from high inflation turned to stocks, real estate and automobiles in this period. Many bought and stocked various goods. For this reason, the prices of goods and services in Turkey have risen to abnormal levels. The Central Bank’s reserve sales continue in order to mitigate the impact of the very high negative real interest rate on exchange rates. In short, the policy that started in August 2018 continues. Exporters make the repayment of the rediscount credits they receive from the Central Bank in foreign currency. Again, exporters transfer 40% of the foreign currency they bring to the country to the Central Bank. Tourism revenues also contribute to the reserves. The reserves that are tried to be increased in this way are used to intervene in exchange rates.
Independence of State Institutions in the New System
Today, when the expression “independence of the Central Bank” is used, it is understood that the Central Bank makes a policy-independent decision and implements it on the use of monetary policy instruments such as open market operations (APİ) and required reserves. This independency means the free choice and use of monetary policy instruments by the Central Bank, without the interference of the political authority, in order to achieve the goals set by the law. The most important monetary policy instrument is the interest policy. In the new system, the Central Bank has no independence. Moreover, the interest policy has not been used as a policy tool for the past year.
In the new system, the role of the “Central Bank that supports development” was deemed appropriate for the TCMB. The TCMB is demanded to support government’s priorities such as growth, employment and increasing investments. The TCMB website states, “The main purpose of the Central Bank is to ensure price stability”. However, the fight against the current high inflation in Turkey is not carried out through the most critical tool, interest policy. In fact, the TCMB openly says, “We do not use interest rates as a policy tool”. The fight against inflation is carried out through macro-prudential measures. Micromanagement is also done. However, these regulations are not enough to reduce inflation.
After the transition to the presidential system, one of the most discussed institutions was the Turkish Statistical Institute (TÜİK). The data published by TÜİK is criticized by all parties in Turkey and abroad. Like the TCMB, the capacity of this institution to make independent decisions is being questioned. There is no other country in the world where the managers of an institution whose job is only to produce and announce data are discussed so much. TÜİK President Erhan Çetinkaya is the sixth president in the new system. In the last year, when inflation rose from 19% to 80%, the president of TÜİK changed three times. Frequent changes in the management level of this institution naturally cause data security to be questioned.
Turkey Wealth Fund was established on December 26, 2016, to which valuable public enterprises and public goods were transferred. In this way, public enterprises were gathered under one roof. The portfolio of the Turkey Wealth Fund consists of 28 companies operating in seven sectors, 2 licenses and 46 real estates. In the world, sovereign wealth funds invest in various financial assets by considering the risk-return balance. Commodity-rich countries have the largest sovereign wealth funds. The revenues of these funds consist of the budget surplus. Turkey is neither a country with a budget surplus nor a commodity-rich country. One of the critical points regarding the Turkey Wealth Fund is that the expenditures of the fund are not subject to the audit of the Turkish Court of Accounts. In response to this critisizm, the fund management said, “There is a three-stage audit process, these stages are; the independent audit process, the audit process of the State Supervisory Board and the Planning and Budget Committee of the Turkish Grand National Assembly.” In the last audit report of the Turkey Wealth Fund, presented in the Turkish Grand National Assembly in November 2021, it was stated that the debts of the fund were folded and companies could not be audited.
Foreign Investors Leaving Turkey
After the exchange rate crisis in August 2018, which we mentioned above, speculations were made that the foreign currency deposits of households in banks could be confiscated and their foreign currency deposits in banks could be converted into Turkish Lira at a certain exchange rate. In fact, the discussion of switching from the floating exchange rate regime to the fixed exchange rate regime was frequently touched upon after the new system was introduced. In the fixed exchange rate regime, the external value of the domestic currency is equalized against foreign currencies at a rate determined by the Central Bank. Once the rate is determined, it remains the same until the Central Bank changes it. The fixed exchange rate regime cannot be applied in a system where capital movements are free. In order to switch to this system, first of all, it is necessary to control the capital inflows and outflows. In other words, real and legal persons cannot receive foreign currency by giving TL in their hands whenever they want. The state decides who will receive when and how much foreign currency.
Turkey’s external debt is roughly $450 billion. If the current account deficit, that is, the foreign exchange deficit, is taken into account, the amount of foreign currency that the Turkish economy needs to find almost every year is 150-200 billion dollars. While this is the case, switching to a fixed exchange rate regime stops foreign currency inflows. Since the economy’s need for foreign exchange is high, the functioning of the foreign exchange market is interrupted. A black market occurs in foreign exchange prices.
After the transition to the new system, the interest rate was reduced at every opportunity. Only after the currency crisis in September 2018, a mandatory rate rise was made. In addition, interest rates were increased during the four-month Naci Ağbal period in the TCMB. The economic policy was shaped around the idea that “Interest is the cause, inflation is the result”. Of course, the artificially low interest rate created more inflation. Since the real interest rate after adjusting for inflation was negative, savers preferred to stay in foreign currencies.
The acceleration of foreign exchange purchases in Turkey disturbed the government. In addition, it was thought that foreign investors, namely institutional investors, increased their exchange rates by taking a selling position in Turkish Lira. In order to prevent this, the Banking and Regulatory Authority (BDDK) has limited the swap (currency-TL exchange) transactions of Turkish banks with foreign financial institutions. The swap transaction limit set by the BDDK for banks was 50% of the banks’ equity. After the currency crisis in August 2018, the swap limit was reduced to 25% in September 2018, to 10% in February 2020, and to 1% in April 2020.
Foreigners receive Turkish Lira from swap transactions; they can use it to buy dollars, stocks, bonds and bills. These restrictions frightened foreigners. They have been leaving the Turkish markets for the last three years. Foreign ownership in the stock and bond markets fell. On the side of Government Domestic Debt Securities (DİBS), foreign weight decreased to 2%. Before the transition to the new system, foreign weight on DİBS was around 40%. Foreign ownership in stock exchange had risen to 72% before 2018. This rate was 66% in 2019. Foreign ownership is currently below 30% in Turkish stock exchange.
While the external financing needs of the Turkish economy are so high, foreign investors’ selling TL-denominated assets and leaving Turkey created macro imbalances. Turkey imports energy products. The foreign trade deficit formed in this way triggers the foreign exchange deficit. This deficit also needs to be financed. Portfolio entry is no longer available. Foreign direct investment, which is a long-term form of investment in which an investor controls or has a say in the management of a business in an economy, declined after 2013. It almost dried up after 2018.
Resources provided by foreign direct investment contribute to economic development when used in areas that will generate income in the future. Because Turkey’s domestic savings are insufficient, it needs foreign resources to make investments that form the basis of growth. Since 2018, exchange rates have risen due to increased risks. The rise in exchange rates fed inflation through the cost channel. As Turkey imports consumer goods, raw materials, natural gas, oil, intermediate goods and capital goods, it pays much more TL as the exchange rate increases. As a result, costs increase. In order not to make a loss, businesses naturally increase the selling prices of the goods that they produce with imported materials. This creates inflation circle. In a high inflation environment, when the interest rate should be increased, the risks increase when the interest rate is lowered. Actually, this is a vicious circle.
Trying to Lower Inflation by Lowering the Interest Rate
Turkey tried to lower the interest rate for the first time just before the 1994 crisis to reduce inflation rate. This policy of the Çiller government further increased inflation. An economic crisis broke out. The second trial took place in September 2021. Inflation, which was 19.6 that month, became 80.2% in August 2022, approximately one year later. In an economic climate where the policy rate was cut to 12%, inflation went to 80%, and banks’ deposit rates averaged 20%, savers fled from the local currency. They bought real estate, cars and physical goods. The borrowers bought foreign currency with their loans. Currency prices rose. The economy administration brought certain restrictions to prevent these purchases. In particular, measures were announced for companies. There is also great pressure on the banking sector. Government doesn’t want bank’s loans to be used for getting foreign currency. Numerous regulations have been announced for preventing this.
Indirect measures were introduced to curb the foreign exchange demand of individual investors. However, individual investors continue to buy foreign currencies when there is a drop in their prices with the thought that “a direct move may come at any moment, foreign exchange purchases may be restricted”. Such indirect and direct regulations lead to the discussion of the functioning free market economy in Turkey.
Inflation Accounting Has Become Mandatory
While high inflation reduces the purchasing power of the local currency, that is, the purchasing power of the households, it also erodes the profitability of the companies. For example, after the high return on equity announced by Turkish banks, after adjusting for inflation, there is not much left. The same situation has been experienced by foreign companies that have terminated their physical investments in Turkey in recent years. The high annual inflation and the declining value of TL made investments in Turkey unattractive. Of course, instead of using the available resources in sectors such as construction, it is necessary to use them in areas such as technology, research, development, and education.
Inflation accounting has become mandatory in Turkey’s triple-digit inflation environment. If inflation exceeds 100% in the last three years and 10% in the last year, it is obligatory to make an inflation adjustment in the financial statements. According to the data announced by TÜİK, the Domestic Producer Price Index (D-PPI) is 79.9% as of the end of 2021, and 141.70% for the last three years. Therefore, the technical conditions for inflation accounting emerged.
Although inflation accounting was introduced in 2004 with a great social consensus, it has not been applied for 17 years. Inflation accounting is the calculation of the non-monetary values in the assets of the enterprises in terms of purchasing power at the date of the financial statement by multiplying the amounts to be taken into account in the inflation adjustment with the adjustment coefficient.
It can be said that it will be difficult for companies to adapt to inflation accounting. In this process, operating profits will decrease significantly. For example, Garanti Bank announced in June 2022 that it will switch to hyperinflation accounting. This practice of the bank reduced its first quarter net profit by 324 million euros. The current financial statements of companies do not reflect the real situation due to high inflation. Equities of companies become taxable because inflation accounting is not applied.
Changes in Macroeconomic and Financial Indicators
Let us examine in detail the changes in Turkey’s economic and financial indicators in the new system. Since the new form of government started in mid-2018, the first half of the year was spent with the old regime and the second half with the new regime. Therefore, the indicators for 2018 were excluded from the evaluation. The table below shows Turkey’s macro-economic and financial indicators for 2015, 2016, 2017, 2019, 2020 and 2021.
| Indicators | 2015 | 2016 | 2017 | 2019 | 2020 | 2021 |
| Growth | 5,9 | 3,2 | 7,4 | 0,9 | 1,8 | 11 |
| Inflation | 8,8 | 8,5 | 11,9 | 11,8 | 14,6 | 36,8 |
| Unemployment | 10,3 | 10,9 | 10,9 | 13,7 | 13 | 12 |
| GNP (USD) | 855 | 861 | 851 | 761 | 717 | 803 |
| GDP Per Capita (USD) | 11.010 | 10.883 | 10.597 | 9.213 | 8.599 | 9.528 |
| Budget Balance/GNP (%) | -1,0 | -1,1 | -1,5 | -2,9 | -3,4 | -2,7 |
| Account Balance/GNP (%) | -3,8 | -3,8 | -5,5 | 0,9 | -5,0 | -1,8 |
| Foreign Debt (%) | 49,7 | 47,4 | 53,3 | 54,7 | 60,4 | 54,9 |
| Benchmark Interest Rate (%) | 11 | 8 | 8 | 12 | 17 | 21 |
| USD/TL | 2,92 | 3,6 | 3,8 | 6,0 | 7,4 | 13,32 |
| CDS | 268 | 267 | 158 | 283 | 310 | 560 |
| Credit Ratings (Fitch Ratings) | BBB- | BBB- | BB+ | BB- | BB- | BB- |
In 2003, when AKP came to power, Turkey was 21st in the world with a GDP (Gross Domestic Product) of $315 billion. Prior to the transition to the presidential system of government, in 2017, it was ranked 17th with a GDP of $851 billion. Turkey fell to 21st place in the world ranking with a GDP of 807 billion dollars in 2021. In 2003, the unemployment rate in Turkey was 10.1%. The unemployment rate was 10.9% in the year before the new system was introduced. At the end of 2021, the unemployment rate was 12%.
In 2003, the budget deficit was 8.6% of GDP. In 2017, the budget deficit/GDP ratio decreased to 1.5%. The budget deficit at the end of 2021 was 2.7% of GDP. It is observed that the budget deficit increased with the new system. Before the new system, one of the areas where the Turkish economy was strong was fiscal discipline. In other words, it was a low budget deficit. It is seen that the budget deficit will increase even more before the elections in 2023. The Ministry of Treasury and Finance announced an additional budget in June 2022. In this budget, the end of 2022 budget deficit was 278 billion TL. According to the Medium Term Program (OVP), announced on September 4, 2022, the budget deficit for 2022 was increased to 461 billion TL. In the OVP, the 2023 budget deficit was projected to be 659 billion TL. Accordingly, the ratios of budget deficits to GDP may be around 4% in 2022 and 2023. The most important reason why the budget deficit will increase is the burden that KKM accounts will bring to the treasury. In addition, there is a 53% increase in personnel expenses before the election. This indicates an increase in expenditures for civil servants and retirees.
Inflation, the most burning economic issue in the new system, was 18.3% in 2003. In 2017, the year before the presidential government system was introduced, inflation was 11.9%. At the end of 2021, inflation was 36.8%. In August 2022, inflation in Turkey rose to 80.2%. When we look at the budget deficit forecast in the OVP, the losses of the state-owned enterprises (KİT), the large difference between the TCMB’s policy rate and inflation (-67%), and the fact that people put their demands forward with the expectation that “goods and product prices will be higher in the future”, it can be said that the only factor that can reduce inflation in the period will be the base effect. To give an example, monthly inflation was 13.58% in December 2021. If monthly inflation was 4.58% in December 2022, there would be a 9 point decline in inflation due to the base effect.
In the year AKP came to power, the current account deficit, that is, the foreign exchange deficit, was 2.5% of GDP. Before the new system, the current account deficit/GDP ratio was 5.5%. At the end of 2021, the ratio of current account deficit to GDP was 1.8%.
In 2003, the average per capita income in Turkey was $5,960. Before the transition to the presidential government system, in 2017, per capita income in Turkey was 10,540 dollars. In 2021, per capita income was $9,528.
The Credit Default Swap (CDS) is determined entirely in the market. Before the transition to the new system, the indicative 5-year CDS of Turkey was 158 basis points in 2017. At the end of 2021, Turkey’s CDS was 560 basis points. Such a high CDS figure has made Turkey one of the riskiest countries in the world financially.
External debt stock is measured in dollars. This stock is proportioned to GDP calculated in dollars. In this way, Turkey’s external debt burden is calculated. After the transition to the presidential system, an increase is observed here as well.
The most followed financial indicators by investors are USD/TL parity and interest rate. For the interest rate, we take the interest of the 2-year treasury bond, which is indicative. USD/TL parity closed 2017 at 3.8. At the end of 2021, the dollar rate was 13.32. The benchmark interest closed 2017 at 8%. This interest was 21% at the end of 2021.
A country’s credit rating plays a decisive role in the investment decisions of foreign investors. What is meant here is institutional investors. According to the international credit rating agency Fitch Ratings, Turkey’s credit rating at the end of 2021 is two levels below the credit rating before the presidential system.
General Overview and Conclusion
After the transition to the presidential system, macro and financial indicators other than the current account deficit weakened. Let us state that the current account deficit of energy importer Turkey has increased as the rise in energy prices accelerated in 2022. In the balance of payments expectation survey, it is predicted that the current account deficit will approach 50 billion dollars by the end of 2022. Accordingly, the ratio of current account deficit to GDP may be around 6% by the end of 2022. The way to reduce the rapidly increasing external debt burden is to prevent the depreciation of the Turkish Lira (TL). For this, it is necessary to reduce risks and uncertainty.
The unemployment rate for people aged fifteen and over tends to increase after the transition to the presidential system. While the youth unemployment rate, which includes the 15-24 age group, was 20.8% in 2017; 25.4% in 2019; It was 25.3% in 2020 and 22.6% in 2021.
In the period after the transition to the new system, the rises in financial indicators such as CDS, dollar rate and benchmark interest are striking. It is observed that the biggest damage among macro indicators is in inflation. The deadline for this analysis is 31 December 2021. However, the deterioration in financial indicators continued in the first half of 2022. In August 2022, inflation in Turkey rose to 80.2%. In August 2022, producer inflation was 144%.
Fitch Ratings lowered Turkey’s credit rating two more grades in 2022. On 14 July 2022, Turkey’s CDS exceeded 900 basis points. The cost of Turkey, which has a high need for external financing, is crucially high. The foreign currency borrowing costs of the Treasury and companies are in the double digits. The USD/TRY parity broke the all-time closing record with 18.20 on August 26, 2022.
The approach in Turkey’s current economic model is to prefer growth to inflation. It is seen that this policy will continue in this way until the 2023 election. The Turkish economy grew rapidly after the pandemic. With a growth of 7.6% in the second quarter of 2022, it was the second fastest growing economy among OECD countries after Slovenia. High inflation, dollarization, decline in purchasing power, the share of wage earners in growth have reached the worst levels in history. In the second quarter of 2022, the share of workforce from national income decreased to 23.9%. In the same period of 2021, this rate was 32.6%. This rate is seen to be 36% in the second quarter of 2020. The increase in the share of enterprises from the national income in this time period at the same rate highlights the issue of income distribution in Turkey. The decrease in the purchasing power of wage earners shows that the realized growth is not inclusive. Growth in a very high inflation environment does not provide an increase in welfare in the economy. It can be said that there is an impoverishing growth in Turkey. Growing by increasing risks is not sustainable.
The poverty index, created by the economist Arthur Okun and later developed by Barro and Hanke, is published for all countries. This index was 23.5 for Turkey in 2015 and 47.3 at the end of 2018. The index rose to 60.7 at the end of 2021. The current figure is 99.5. The main factor behind such a high figure is inflation. The only way for Turkey to get out of this situation is to reduce inflation. Without solving the inflation problem, no macroeconomic indicator will fall into place. The way to reduce inflation is to raise interest rates, reduce expenditures, and renounce on economic growth. Of course, raising interest rates and reducing expenditures at some point will inevitably erode the growth, which is the goal of the current economic model.
In Turkey, double-digit inflation was seen for the first time in 1971. Double-digit and triple-digit inflations occurred in the 1980s and 1990s. Turkey has learned by experience that it is not easy to reduce such high inflation figures. Even if it is possible to reduce the high inflation that emerged during the presidential system, it can be achieved by going through a really long and arduous road.
Photo: Mathias Reding
- This article has been published in cooperation with Friedrich Naumann Foundation