Turkish Government Pursues Step by Step an Unorthodox Economic Path

Business leaders in Turkey not only face uncertainties over the growth of the economy, with the pandemic far from over. They also hope that the central bank is right in claiming that the lira will not drop much further this year after last year’s fairly dramatic plunge.

When the Turkish government at the start of the year introduced a new requirement whereby exporters have to sell 25 percent of any foreign currency income to the central bank, it upset Turkish companies. Businesses worry that this rule will increase their operational costs because they will be exposed to a currency that is fluctuating fairly wildly. The lira has lost some 44 percent in 2021 and it is anybody’s guess where the new year will take the Turkish currency.

Economic orthodoxy suggests that the troubles are at least partially linked to the monetary policy of Turkey. It is well known that President Recep Tayyip Erdogan doesn’t believe that higher inflation ought to be contained by raising interest rates, essentially because this hurts economic growth and employment in the short term. For a government, this is bad news and for Erdogan, whose AK Party faces elections in 2023, employment is a key aspect.

The Replacing of Central Bank Governors

After a period of repeated changes to the country’s monetary policy, the president and his party roughly a year ago seem to have decided that enough was enough and sacked the then central bank governor, Naci Agbal. He was replaced by Sahap Kavcioglu, a man more in tune with the policies of the government and clearly more than happy to oblige with the governing party’s economic direction.

However, faced with soaring inflation, the new crew at the top of the central bank initially held back on interest rates cuts. Then, towards the autumn of 2021, the TCMB started with a series of cuts, shaving altogether 5 percentage points of the key lending rate to the current 14 percent. This opened the spread to the country’s inflation rate to roughly 5 percentage points.

Drop in Lira Makes Energy Price Surge Worse

As the market had expected, this prompted a massive drop of the lira, a decline that led to manifest concern among consumers and companies alike. For both, the drop in the currency exacerbated the surge in energy prices this winter. Therefore, the government was forced to step in and raised the minimum wage for people.

At the same time though, the problems of the central bank increased because it had previously intervened in the market to stop the fall of the currency. But, crucially, the bank already had drained its foreign currency reserves with no obvious way to replenish the coffers. Turkey is running a current account deficit of as much as $15 billion, to which the pandemic-induced drop in tourism contributed greatly.

Forex for Central Bank

Therefore, the decision by the AK Party this year to require companies to sell part of their forex to the central bank made sense. In a meeting with business leaders, the bank governor promised that the decision wouldn’t hurt them much. According to “Reuters” news agency, Kavcioglu told them that the lira would stabilize and they shouldn’t therefore worry.

Companies in Turkey on average pay more in advance for their imports than they receive in proceedings for their exports. The gap, which is evident from the trade statistics from the TUIK, means that the companies need a stock of working capital and that they are exposed to currency fluctuations, according to economists based in the country.

Given that Turkey has a negative trade balance, this imbalance between cash in advance and open account between exports and imports is a true concern and is the reason why the company owners were so concerned about the recent change.

Stock Market Wobbles

How difficult the situation will become this year depends on several factors. Some of these elements hold true for all economies and can’t be controlled by any government. For instance, the rate of economic growth seems relatively open at a time when countries across the world are battling to contain the Omikron strain of the Covid-19 virus. At the same time, inflation is soaring in most advanced countries and in particular in the U.S. and Western Europe, bringing an end to the ultra-cheap money that central banks have poured into the markets. How much this will affect growth appears unclear so far, but the wobbles in stock markets are a sign of greater uncertainty.

It is almost impossible to predict how the tourist season will shape up in this traditional holiday hotspot, even though the low lira will likely help the industry lure foreign travelers back – once they dare to travel again. Still, with the complications that follow the unorthodox economic path of the government and central bank, market participants might be tempted to shun the country or, more precisely, place a higher price tag on investments, which may put off risktakers.

Boost Growth With Fiscal Measures

Economists such as Özgür Orhangazi at Kadir Has University expect the government to do everything it can to boost growth while the effects of the currency shock will slowly sink in. The government is likely to use fiscal stimulus measures and credit growth in its attempt to maintain growth. But the problem seems that any attempt by the government to increase growth using low interest rates and credit growth results in a further weakening of the lira, Orhangazi warned.

“The main issue will be the re-financing of the external debt,” said Orhangazi. “The government has been able to increase its foreign borrowing, albeit at higher interest rates and the non-financial corporates have been decreasing their foreign currency debt.” The financial services industry meanwhile has not so far had any problem in re-financing.

Going to the Polls in 2023

Obviously, the government relies on growth for its chances at the polls, while it is well aware that the spread between interest rates and inflation is leading to a sharp fall in real incomes and increased poverty.

Most economists have been saying that the monetary policy wouldn’t hold in the long run, even with the measures taken by the government to offset the difficulties. But whether, how and to what extent such a change of course might occur is a tough one to predict.

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