The change was rather abrupt: Recep Tayyip Erdogan exchanged his central bank governor and the finance minister both within a few days in November. Shortly after, interest rates were dramatically hiked to halt the fall of the Turkish lira. If he had planned to surprise the markets, he has succeeded, but observers still question his motivation behind the moves.
Frustration had mounted for months about the unorthodox economic policies pursued by the Turkish government. The country’s lira was in freefall, continuing the slide that had begun some ten years ago, which weighed heavily both on the economy as well as private investors.
For them, debt held in foreign currency became ever more expensive, at a time, when the pandemic had affected demand.
The Turkish state also was struggling with the effects of the weak currency. Together with the hazardous political stance of the government, it meant that capital markets would keep more than just a close eye on the economy, with the combination being a poisonous cocktail for investors. Under such conditions, capital markets infallibly will place an extra-high premium on investments. The problem was that the central bank no longer had (has) enough currency reserves to intervene in the currency market in an attempt to shore up the lira.
Faced with this dynamic, observers despaired about Erdogan’s insistence on low interest rates. After all, the orthodox reading of market economy dictates that high rates shores up your currency because investors will get a higher return in exchange for the bigger risk that they are taking. A rate increase reduces the availability of cash and therefore has a dampening effect on inflation.
Back in spring of 2020, the president had attacked foreign capital for what he claimed was damaging speculation against the country’s currency. This was in no small part aimed at a domestic public, but the effect of the measures, which also were directed at Swiss giants UBS and Credit, was soon to evaporate.
The Turkish leader in the autumn had few options left. The slide of the currency, lower income from tourism and a drop in exports – both in no small part a direct consequence of the pandemic – soaring inflation, currency reserves reaching rock-bottom: it was high time to act.
Some sensible advisers among the top echelons of power assembled and decided to make a push for change. For such change to go through, two key players had to go. The first to lose his position was Murat Uysal on November 7. The head of the central bank, who had been installed only in July of 2019 to take the place of Murat Cetinkaya, had to go because he wouldn’t be a credible source of change. After all, he was the man who had enforced Erdogan’s choice of low-interest monetary policy, which had belied all orthodoxy.
But it was the second change that made it clear just how deep the rift had become. Erdogan’s son-in-law and finance minister, Berat Albayrak, stepped down on November 8, claiming ill health. Albayrak was the person who had protected the president from advice he didn’t want to hear and who had been the figurehead of economic policy in a government that increasingly lacked proper expertise.
It was clear from the beginning that Albayrak wouldn’t be able to work with Naci Agbal, the new governor of the central bank. Agbal is well respected among economists in Turkey, and they trust him to fulfill his promises, steering the central bank into calmer waters. His counterpart in the government now is Lutfi Elvan, another trusted and experienced government official.
On November 19, the central bank followed through with a rate hike of 4.75 percentage points to 15 percent, which was in line with market expectations. Observers agree that though this will help, it will hardly suffice to steady the ship. The economy was moving close to collapse and the rate increase and changes of personnel did come at the last moment possible.
The key question to ask is why exactly the president decided to undertake this change of course – after all, for years he had subscribed to a policy that ran counter to what he signed off now, and he had rejected all the good advice by experts in Turkey. To get a better understanding of why he changed course, one needs to take a close look at politics.
In a situation that isn’t entirely unlike that of the U.S. under Donald Trump, there are two important trends in Turkey. First of all, there is the government’s attempt to make elections more predictable and less precarious (for itself) and second, despite this first point, elections remain a difficult beast – in other words, some of the institutions have survived the more authoritarian tendencies prevalent in Turkish society, both from the side of the military and the government’s concentration of power in the hands of the presidents. The most glaring rebuke for the policies pursued by Erdogan was issued by Istanbul’s voters, who elected Ekrem Imamoglu in June 2019 as their new mayor. The victory for the opposition candidate was a major blow to Erdogan, because he started his career as mayor of that same city.
The next general elections in Turkey are slated for 2023 and all the current surveys are showing in all clarity that citizens no longer support their “sultan” unreservedly. He risks being ousted and with him his party, the AKP. They have lost some 10 percentage points in support since the elections of 2018 and today are backed by some 35 percent of voters. Observers say that the main reason for this decline is the poor economic performance. One has to keep in mind that Erdogan’s AKP helped Turkey generate a reasonable degree of welfare and growth, something that has propelled him in earlier elections. Now though, his success is fading like old photography and so is the support he enjoyed among ordinary Turks.
Faced with the options of being ousted at the next elections or changing his economic policies, Erdogan chose what any successful populist would do – he adapted his strategy in a bid to consolidate his powerbase. Whether it will suffice to retain and boost the body of voters remains to be seen.
The economists in Turkey are keen to see the change as a sign of hope, but they can’t be sure that Erdogan actually supports the moves wholeheartedly. For too long, the president preached something entirely different. Scientists agree that the basic problem facing the country are systemic. The presidential system has led to a concentration of power in the hands of Erdogan and the centralistic approach has excluded the checks and balances typically in place in a European-style democracy. Institutions such as the central bank can’t properly do their job because they are exposed to the whims of the government.
Many therefore believe that a true change for the better isn’t possible as long as the political system remains as it is. Central bank experts say that the reserve bank needs at least three years to first stop the capital outflows and then to begin replenish the stock of foreign reserves to reach a minimum level necessary for its operations.
This will only be possible if Turkey again becomes a reliable partner for foreign investors by reinstituting the rule of law and once the economy is gathering pace. Should the combination of higher interest rates and a Covid-19-induced contraction lead to a renewed economic slump, Erdogan might be tempted to again pull the strings. That would make Abgal’s position untenable, even as he only just became Erdogan’s key economic adviser.
Turkish economists are pretty pessimistic about the durability of the new strategy, because Erdogan has invariably disappointed the scientific community. Not to be forgotten are his activist foreign policy operations near and far that have become a source of constant uncertainty.
In Libya, Erdogan has sponsored the central government against the attacks of General Haftar’s army (and Russian elements), in Syria, he fought the Kurds and the government of Bashar al-Assad (and his Russian allies), and in the battle between Azerbaijan and Armenia, Erdogan supported the attack of Baku against Armenia (which enjoyed a degree of protection by Russia). In other arenas, Erdogan’s Turkey confronted Greece (and the EU) over the refugee policies, and in the Eastern Mediterranean, his exploration ships are looking for gas reserves in disputed waters.
A long list of disputes near and far showing how delicate the situation of Erdogan’s Turkey has become. It also witnesses of a dogged and stubborn pursuit of his strategic goals.
Changing economic tack probably was the easiest of the ills. Experts say that he now is likely to introduce a phase of consolidation and calm that may last some 6 to 12 months to allow the economy to recover. They also say that without real reform, political reform, the situation will remain fraught.
Monetary policy requires more than just stability, it thrives on transparency, independence from political influence and a clear plan for how inflation (currently at about 12 percent) can be tamed and reserves replenished. The bank had enjoyed a period of independence after the turn of the century. It was lost two decades later. Erdogan replaced Cetinkaya in July of 2019 because he had, against the president’s wishes, increased rates to stop the fall of the lira.
The economists who were trained in the period of central bank independence hope that this key ingredient of modern monetary policy shall be restored in due course, helping the bank again take the place it ought to as guardian of the currency. But they also realize that the latest twist in AKP’s economic policy won’t likely include letting the bank regain independence.