For economists, Turkish President Recep Tayyip Erdogan has become something of a running joke. Stubbornly defying conventional economic wisdom and the experience of the Turkish economy, he has long insisted that high interest rates cause inflation and as a rule, has put his words into action.
There was a brief moment in November when many hoped that the Turkish leader was finally bowing to reality.
He fired his son-in-law/finance minister and the central bank government and vowed "uncompromising structural reforms." But this week Erdogan was back in interest rate la-la land, declaring that a rate cut was “imperative” sometime this summer.
“If we remove the burden of interest rates from investments and costs, then we will enter a calmer environment because it’s the interest rates that cause cost inflation in the first place,” he explained.
Naturally the already bruised and battered lira was knocked about some more, falling to a new low of 8.88 to the dollar during trading on Wednesday. It continued to decline on Thursday, despite some reassuring remarks by the central bank governor that worries about a premature-rate rate cut were “unjustified."
Enter the Anatolian Tigers
The fact is Erdogan eats central bank governors for lunch and spits them out – he’s gone through three in less than two years as well as some deputy governors, to boot. If his current governor, Sahap Kavcioglu, doesn’t cooperate, he’ll be out, too.
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However much economists see Erdogan’s views on interest rates as a joke, they are a critical part of an economic policy that has worked well for the Turkish leader over the years. He scores points with voters not just because of his Islamic piety and his confrontational foreign policy, but also because of his record on the economy.
In particular, he counts on the support of the so-called “Anatolian Tigers,” religious-conservative entrepreneurs from central and southern Turkey who have grown equally rich and indebted under Erdogan’s rule.
Turkish economic growth has been driven for more than a decade by cheap loans to people like the Tigers, much of it going into the construction sector, with much of the capital coming from abroad. Even last year, when the world economy was ravaged by the coronavirus, Turkey’s gross domestic product actually grew by 1.8%, not because the government spent heavily but because the banks made loans left and right.
This kind of growth isn’t sustainable. A chronically overheated economy stokes inflation and the heavy reliance on foreign currency inflows has weakened the lira, stoking inflation even further. Erdogan’s son-in-law tried to square the circle by selling off foreign currency to keep the lira from weakening, which led to his firing last November when reserves fell to dangerously low levels.
That followed a brief flirtation with economic orthodoxy by the Turkish leader. But, as it turns out, orthodoxy hasn’t worked or, more properly, it takes more time to work than Erdogan is willing to give it.
Opinion polls show his AK Party is losing support among other reasons due to Turkey’s poor economic performance. Yes, the economy grew in the coronavirus year and even surged 7% higher in this year’s first quarter. But inflation is deep into the double digits; unemployment is almost as deep.
The devil’s triangle
Indeed, the Turkish public may be finally getting wise to the existential failure of Erdogan’s economics: The economy has been growing, but only measured with a devalued lira. In dollar terms, per capita GDP has shrunk 40% since 2013 to $7,700, Enver Erkan, chief economist at Istanbul investment bank Tera Yatirim, told Bloomberg News recently. He called Turkey’s GDP growth data an “exchange rate illusion.”
Illusory for ordinary Turks, but it seems that for Erdogan, the policies of the last decade have become a kind of addiction he can’t break.
He is certainly not the only politician who favors cheap money to keep the economy going, but most of them do it simply because it’s politically expedient. For Erdogan, however, cheap money seems to involve a deep principle quite possibly linked to the Muslim ban on lending with interest. In fact, at various times he has condemned interest rates in quasi-religious terms, calling them “the mother and father of all evil” and speaking of the “devil’s triangle” of interest rates, inflation and exchange rates.
Turkey doesn’t have a lot of room to maneuver economically. It seems, for now, to be exiting the worst of the COVID pandemic and has an opportunity to ride a global economic recovery.
Orthodox economics, which in this case means imposing tight monetary policies to break the inflation-depreciation spiral, would be painful but a necessary tool for fixing Turkey’s structural imbalances. That would help it generate sustainable long-term growth.
But as long as Erdogan remains at the helm, the best Turkey can expect is an occasional tactical withdrawal from his principles, as occurred last November.
Although a presidential election is not due to be held until 2023, the opposition, sensing Erdogan’s weakness, has been calling for early polls, so even a tactical withdrawal probably looks too dangerous from his point of view.
For those of us in Israel, this all smacks of being someone else’s problem. But it isn’t. As long as the Turkish economy is in a funk, Erdogan will need things to distract attention. Another way he has staged a tactical retreat from his usual behavior of late has been to lower the flame on his many diplomatic disputes. Don’t expect that to last much longer either: Erdogan will be back to stirring up tensions over East Mediterranean gas and the Palestinians.