By Jenaline Pyle
President Erdoğan’s successful consolidation of political power often depends on appeals to national pride and a unified political will – but this approach is unlikely to stem the downward spiral of the Turkish lira.
Increasingly threatened by domestic instability, highlighted by Monday’s catastrophic double bombing in Istanbul and an anticipated interest rate increase on Wednesday, the country’s economic woes look set to continue.
The devastating collapse in of the Turkish lira reflects even deeper economic problems, but is being used as a rallying-point as the government announces plans to prop up the currency. President Erdoğan’s efforts at currency stabilization echo his strong-man tactics consolidating his political power. While such an approach may have strengthened his executive powers, it is a more problematic response to economic problems.
Ducks not in a row
The sliding value of the lira has made Turkish exports less competitive and imports more expensive. It threatens price inflation as the rising cost of imported goods puts pressure on the pricing of domestic goods. Profitability is at stake when imported goods become more expensive, necessitating price increases on domestic goods to help cover the rising cost, contributing to price inflation.
With growing unemployment and a weakening currency, the Turkish Central Bank faced a difficult choice: raising interest rates exacerbates inflation, while lowering them risks escalation in unemployment. Having unexpectedly raised rates earlier in November, the Central Bank subverted the government’s prioritization of inflation targeting, but the effect on inflation and currency stabilization was short-lived. Prominent Turkish business leaders such as the head of Sabancı Holding have acknowledged that further increases will be painful, but necessary.
The Turkish government has previously emphasized its intention to prevent inflation by keeping interest rates low, but such policies do little to address price inflation. In fact, low interest rates may be contributing to the economic crisis. MIT economics professor Daron Acemoğlu has speculated that much, arguing that Turkey’s recent growth is due to consumption based on loans.
Some countries have grown their economies with export-led growth (exemplified by China) or by the export of natural resources (look at Russia or Brazil). In contrast, Turkey has grown primarily with domestic consumption and investment, particularly with foreign capital – meaning dollar-denominated loans requiring interest payments in U.S. dollars. According to data released by the central bank at the end of November, non-financial companies face a shortfall of USD 212.8 billion, more than 25% of Turkey’s GDP. Consequently, interest rate increases for both the corporate and private spheres could make repaying these loans more difficult.
The U.S. Federal Reserve is expected to raise interest rates when they conclude their last meeting of the year on Wednesday, the beginning in a series of anticipated increases. This move will undoubtedly complicate the financial health of anyone with significant debt exposure denominated in dollars. President Erdoğan has previous been critical of Turkish Central Bank interest rates and an increase in U.S. rates, particularly as it coincides with the decline of Turkey’s economy and currency value, will be an easy target of blame.
All together now, sort of
President Erdoğan has appealed directly to Turkish citizens to exchange their foreign currency holdings, particularly US dollars, for gold and Turkish liras. Appealing to the image of cautious savers hoarding currency under their mattress, the reality is that financial transactions dwarf the currency held by savers. Financial transactions tend to be conducted using US dollars, even with non-American companies or individuals because of the US dollar’s status as the world reserve currency. Due to the price and value volatility of the lira, individual and corporate transactions tend to be denominated or even carried out with US dollars.
Erdoğan has framed the currency issue as one of national pride and security, arguing that international meddling has weakened the Turkish economy. However, businesses in Turkey benefit from denominating their transactions in US dollars, particularly if they trade abroad, because it supports price stability. Furthermore, a push to encourage savings in liras would in fact require additional lira holdings and necessitate the printing of more liras, which would further contribute to inflationary pressure.
Last week, Erdoğan took his lira defence a step further, suggesting that Turkey would export its goods to Russia, China, and Iran in exchange for Turkish liras, rather than US dollars, as such exchanges are usually denominated. Although the issue may be discussed more thoroughly during Prime Minister Binali Yıldırım’s visit to Moscow, Russian authorities have rejected the plan as unrealistic. The visit is further complicated by the slow pace with which Russia has lifted bans on Turkish goods.
The ban, stemming from the diplomatic fall-out over the shooting of a Russian fighter plane in November 2015, has hit the Turkish tourism and agricultural sectors particularly hard. Although certain sanctions have slowly been relaxed, some Turkish suppliers have been replaced with more competitively priced alternatives. Russia benefits from this competition and a volatile Turkish currency only makes cooperation less likely.
New game, same tactics
The popular and international support Erdoğan received after the failed coup in July 2016 has yet to materialize as economic support. Perhaps by appealing to his fellow citizens in the same way that he did this past summer during the attempted coup, Erdoğan hopes to rally support to the lira. But the uncertainties in the Turkish economy have spooked international investors whose decisions largely control the fate of Turkey’s currency. While institutions and organizations including the Turkish stock market, the Borsa, have fallen in line, denominating transactions in liras, the currency continues to lose value.
In a recent interview, Turkey’s new finance minister Naci Ağbal dismissed the notion that the purge of an estimated 115,000 government officials has had a significant effect on the state’s budget. Ağbal was responding to the notion that the Turkish government is better off with fewer employees and a lightened fiscal responsibility. However, such a perspective ignores the systemic significance of the government crackdown.
Business tends to flourish in a regulated environment, where the state’s impulse for arbitrary rule, appropriation, and detention is held in check. With the current administration’s extension of emergency powers to detain suspected lawbreakers without trial, replacement of executive boards without consultation (as has occurred with media and holding companies), appropriation of private assets valued at nearly 10 billion, and executive expansion without check, business interests both within Turkey and abroad have become wary.
Waves of privatization and the fostering of a business-friendly climate once made Turkey the darling emerging economy of investors and businesses alike. However, with growing political uncertainty challenging the business environment, investors are making their doubts felt. The collapsing lira is simply emblematic, rather than causal, of the economic woes facing Turkey.
President Erdoğan consolidated his political power and prevented a military takeover through strongman tactics that are unlikely to strengthen the economy. Allusions to foreign conspiracies, appeals to nationalism, and emotive policy decrees may buoy nationalist fervour but the central bank, the finance ministry, and Turkish businesses are faced with limited options.
Investors and businesses thrive in stable environments, which the President seems to believe he can provide with strong executive power. But the animal spirits of investors can never be fully controlled. The more the government tries to do so, the more volatile the Turkish economy may become. In the face of worsening economic performance, unprecedented since 2009, Erdoğan may continue to blame the same causes of political instability as economic instability. It remains to be seen the extent to which his audience, both foreign and domestic, has patience for these familiar excuses.