Commentary made by Enes Özkan, Economist and Chief Editor of Daktilo1984, on the Recent Developments in the Turkish Economy at European Policy Centre in February 9, 2022.
I am working at Istanbul University in the Department of Economics. However, because of increasing pressure on media freedom in Turkey, I founded Daktilo1984, a new media and research organization, with my fellow friends two years ago. I still comment on and write articles about the Turkish economy at Daktilo1984 and various other media outlets. Together with Özge, we broadcast a Youtube show called Hypothetical Economy on the Daktilo1984 Youtube channel. I want to mention a little bit more about the past. Because the reasons for how things got to this point are rooted in the past. I want to talk about a period in which we lived similar to what we are experiencing today and will enable us to understand better what is happening. I want to cover various milestones in the Turkish economy in this regard.
President Erdogan’s son-in-law, Berat Albayrak, clarified some points on September 29, 2020, saying, “The dollar rate is not important to me.” The process, which started before Albayrak, is an obvious indication that the Turkish Lira would rapidly lose value. During the Albayrak period, the government put pressure on the Central Bank, and the one-week repo auction rate was reduced. However, the market was funded through emergency mechanisms such as the late liquidity window. In other words, the interest rate was reduced, but the market funding was made from a higher interest rate. To not increase the interest rate, not only the system is complicated but also the reserves of the central bank were melted. In this process, the central bank reserves of about 128-140 billion dollars were sold to the market. Of course, this process did not last long, and both the Head of the Central Bank and the Minister of Finance Berat Albayrak were dismissed from their offices. Naci Ağbal became the new Head of the Central Bank. And Lütfi Elvan was appointed to the Ministry of Treasury and Finance.
The central bank governor, who took office afterward, quickly increased the policy rate. The depreciation of the Turkish Lira was prevented to some extent during the period of the new finance minister and the head of the central bank. But for Erdogan, who thought that interest was the cause of inflation, this was not a good thing. Because in Albayrak’s time, strange things were happening not only about policy rates but also about TurkStat data. In Albayrak’s time, monthly inflation could never exceed 1.36%, but the first monthly inflation announced after he left office was 2.13%. Besides the suppression of inflation rates, there is something very interesting in Erdogan’s presidential system. Inflation rates increase abnormally every time the finance minister changes. Because the government announces lower inflation rates than actual numbers. After a while, “truth” imposes itself, inflation rate normalizes. It’s a phenomenon.
The worst thing for people who have been struggling with hyperinflation for many years is to enter the spiral of inflation again. Knowing this, Erdogan was not satisfied with both the inflation data and the increase in interest rates. In this process, Erdogan constantly presided over the Central Bank. And he criticized the interest policy with very harsh words. At some point, the market realized that interest rates could not stay at this level, and the rise in exchange rates started again. The head of the central bank was also dismissed again in this process. An interesting note: since Turkey transitioned to the presidential system, no central bank governor has completed his term.
So actually, we started to discover the answer to the question “What is Next?” during the term of President Erdogan’s son-in-law, Berat Albayrak, and got our response. Again, similar to what is happening today, the Central Bank’s foreign exchange reserve was being sold to stop the rise in the dollar rate; at the same time, it was said that we would grow with the Chinese model, that is, based on export. Of course, it was not taken into account that Turkey had no similarity with China in terms of scale, labor market, or foreign dependency. At that time, interest rates were much lower than inflation. When the exchange rate started to rise, the “Chinese model” was introduced. Afterward, it was decided to sell reserves without increasing the interest rates to keep the exchange rate stable.
There is no difference in purpose between what was done then and what is done now. But there is a difference in method. The policies followed were creating a significant burden and pressure on the Central Bank. These policies, now create a great risk and pressure on both the Central Bank and the Treasury. Currently, Foreign Currency Protected Deposit (under the “exchange rate-protected deposit” system, the government guarantees it will cover losses if the interest they receive when the account matures be less than what they would have earned by keeping the savings in foreign currency) is presented. The government is playing a big gamble and putting all its stones in the same basket for preventing the further increase in currencies. I am almost sure that they will try every way to ensure this. Even lately, my biggest wish is that the dollar does not somehow exceed the psychological limit of 15 TL. At the moment, it is evident that the dollar will not be kept below 14 TL, and for this, foreign exchange is constantly sold through the central bank. If the dollar exceeds 15 TL, the government has the potential to take steps for much tighter capital controls or they may make other arrangements that will harm the fiscal discipline. They even started taking such measures. They first introduced the “exchange rate protected deposit” system only to individual accounts. The foreign currency deposit amount in Turkey is 250 billion dollars. Only 4 or 5 billion dollars of foreign currency deposits were transferred to exchange rate-protected deposit accounts. Then, they extended this implementation to the corporate accounts. Now they are integrating the accounts of Turks residing abroad in Turkish banks into this system. It is very bad for the treasury. If we see a depreciation in the currency, the treasury will have to pay the difference between the deposits’ return and the depreciation. That will put an additional burden on public finance.
Inflationary pressures are not likely to disappear easily unless you follow a highly tight monetary policy. However, last month Nebati said that in a Nebati meeting –I called these meetings Nebati meetings because Nebati will be very happy when he meets people, always smiling and saying, “Don’t talk about interest rate”. He also said, “We have removed the policy rate from being an effective monetary policy tool.” It’s ridiculous. However, Erdogan feels the need to securitize the problems he faces. There is often a discourse of an economic war. I don’t understand how to build trust in such an environment. Treasury and Finance Minister Nurettin Nebati says that interest rate hikes are never on their agenda at every meeting he holds. Thus, the possibility of getting another rabbit out of the hat continues. It is one of the things that economists in Turkey are most concerned about right now. I wonder what other rabbit will come out of the hat; this question is on everyone’s mind.
Everything seems to be ready for the Turkish Lira to depreciate. January inflation was announced today, and according to TurkStat, monthly inflation was 11.1%. Yearly inflation was 48.69%. Inflation in the Euro Zone is 5.1% per annum. Also, the producer price index is higher than the consumer prices index. It is yearly at 93.53%. We face a foreign trade deficit that has reached its highest level in the last ten years. The increase in energy prices enhances Turkey’s foreign trade deficit. In addition, this situation reduces the possibility of reducing the current account deficit and preventing the increase in the exchange rate by exporting. In January, the foreign trade deficit amounted to 10.4 billion dollars. It was also the highest deficit since September 2011. The current account deficit has always been one of Turkey’s biggest problems. And it is one of the most important reasons for the increase in exchange rates. In other words, we will probably experience the cycle of Berat Albayrak’s term again.
Let me remind you of this cycle again:
1. Exchange rates increase first.
2. The government takes a rabbit out of the hat to curb the increase in exchange rates.
3. Unorthodox policies give short-term results.
4. The government shouts this out by all means of communication it has.
5. But after a while, problems emerge more strongly.
6. The government adopts an orthodox economic policy and increases interest rates.
What I’m saying is just a guess. The situation might be a little different this time around. Because this time, Erdogan uses religious terms much more in his statements regarding interest rates. He says that it is Allah’s command to decrease the interest rate. In addition, after the change in the Ministry of Finance and the change of the Head of the Central Bank in the previous cycle, the voting share did not increase as much as expected after the decline in the dollar’s price. In other words, they might have thought that the method of raising interest rates is not the way that helps them stay in power.
Erdogan constantly makes statements that, will please his core voter base in every crisis. It even increases it so much that it transforms its base. As we all know, politicians are the voice of the grassroots. If the politician in front of us is a populist, this situation emerges much more strongly. But voters also transform themselves mainly by the discourse of politicians. After a while, this causes the discourses to become more and more radical in the form of a crescendo. Erdogan has a religious base. For this reason, Erdogan expresses the arguments about religion much more strongly. The more he uses religious arguments, the more conservative his voter base becomes.
The factors that threaten the Turkish economy are not only caused by internal problems. Russia’s invasion of Ukraine, with which we have established strong military relations, will also affect the Turkish economy. If this tension reaches its peak and a conflict arises, the whole world economy, especially Europe, will be involved in this economic turmoil to some extent. However, the Turkish economy will be affected more. Unfortunately, the Turkish economy is highly fragile and has much closer relations with Russia and Ukraine than other fragile economies. The engines of some crewless aerial vehicles and planes produced by Turkey come from Ukraine. Most of the natural gas used by Turkey comes from Russia. It is almost impossible for Turkey to go out of the conflict between these two countries unharmed. The existence of a populist leader like Erdoğan, who sees foreign policy only as a tool of domestic policy, can further increase this damage.
All these things I have mentioned are happening today. And they will continue to exist if Erdogan’s rule continues this year. I think the probability of an early election this year is relatively low. But if there is an early election, the ruling coalition might change, and the opposition might win both the presidency and the parliamentary majority. And such an enormous change will change the situation in Turkey. I know international investment institutions are not waiting for such a broad coalition, and I understand the reasons behind this. However, any political change that will save politics from marginal discourses and bring it to a more central position will improve the Turkish economy. A strong alliance is not afraid to agree with the IMF, and it is not afraid to make up for its mistakes.
I am not an expert on this subject, but there is an economic fact: Turkey is a foreign-dependent country in the energy sector. It is difficult for a country that wants to grow with the “Chinese Model” to deal with such a significant dependency. Turkey’s energy bill is increasing every year. In January, our energy imports increased by 241 percent compared to the same month of the previous year and became 8.96 billion dollars. Turkey might soon lose its status as a “cheap production” country with these energy costs. Due to the decrease in natural gas supply from Iran last week, the natural gas given to the industrial sector was reduced by 40 percent. In contrast, the natural gas supplied to the organized industrial zones was completely cut off for three days.
As Daktilo1984, we conducted a series of interviews with the area experts regarding the energy crisis we are experiencing. Two things stand out in the discussions: 1. Lack of planning, and 2. Wrong moves in foreign policy. Due to the reducing effects of the pandemic in the world, the energy need of the industrial sector will increase in summer. Turkey already consumed most of the gas in its warehouses. The government resorted to using gas in the warehouses not to make the natural gas payments to the foreign countries. In other words, the issue comes up again as a foreign currency problem. It is an excellent example of planlessness. The wrong moves in foreign policy are mostly concentrated around Russia. According to experts, natural gas contracts are made long-term, and Turkey was late in making these agreements. And there is still no news in the media about whether Turkey has made a long-term deal with Russia.