On 28 September, the Turkish lira hit its worst rate since 2014, topping TL 7.18 to the dollar. This amounts to a 24 per cent drop in value since the beginning of the year, despite the fact that, just three days earlier, the Turkish Central Bank raised the interest rate by 200 basis points in one go, for the first time since July 2019. The continued deterioration of the lira, despite this attempt to curb the slide, is just one sign that economic recovery will take a total overhaul of Turkish economic policy and its architects.
The Turkish economy shrunk by 9.9 per cent on an annual basis in the second quarter of 2020, down from 4.4 per cent during the first quarter of the year, as the four main growth drivers, especially exports, fell by 35 per cent and private consumption decreased by 8.6 per cent. Meanwhile, rising inflation rates placed further pressure on production and consumption, weakening purchasing power and further straining the pocketbooks of households already hurt by successive declines in the value of the lira and forced to tighten their purse strings even more. Declining demand has naturally led to declining production, resulting in more people being laid off work.
Employment rates have fallen from 47.5 per cent in June 2018 to 41.6 per cent in June 2020. Unemployment rose from 10.2 per cent to 13.4 per cent during the same two-year period. High unemployment and low employment rates mean lower domestic income levels which, in turn, means lower spending, especially given the declining purchasing power of the lira. It is a vicious cycle. Laying off workers generates lower income, reduced spending and decreasing consumer demand, which leads to cutbacks in production and more layoffs. The only way out of the cycle is massive government expenditure aimed at raising income levels in order to stimulate both consumption and production. This brings us to the next point: macroeconomic indicators.
The national deficit is one of the key macroeconomic indicators that reflect the government’s fiscal performance. In Turkey, the national deficit has increased by leaps and bounds in the past five years. It has quintupled from TL 25.1 billion in 2015 to TL 124 billion in 2019. By August 2020, the deficit already clocked in at TL 108.8 billion for the first eight months of this year. The more the deficit grew, the more Ankara was driven to borrow, generating new debt service burdens. In 2019, the government allocated around TL 100 million to pay the interest on foreign loans and another TL 24 billion to service domestic loans. This is double the amount allocated for debt servicing in 2016. This year, TL 91 billion has already been spent on debt servicing through August.
Mounting deficit and loan service allocations translate into higher national debt which stood at TL 1.55 trillion at the end of the first quarter of 2020 whereas it stood at TL 774 million in the same quarter in 2017. The government doubled the national debt in three years. It now finds itself in a long uphill race to come up with the necessary hard currency to pay its debts. This, in turn, puts it in competition with a heavily debt-encumbered private sector, which needs even larger quantities of hard currency. By the end of the first quarter of 2020, Turkish private sector debt totalled $253.4 billion compared to the government’s $169.1 billion. To aggravate tensions, due dates overlap. From May to December 2020, the government will be obliged to pay $16.6 billion and the private sector $34.9 billion. The combined $51.5 billion is placing huge pressure on available hard currency reserves and the dwindling influxes of foreign currency.
Ankara has two ways to address these pressures which have mounted due to Ankara’s expansionary spending. One is for the Turkish president to retreat from his unjustifiable insistence on keeping interest rates down, despite mounting inflation — an insistence so adamant that he dismissed governor of the Turkish Central Bank Murat Cetinkaya in July 2019 for stating a contrary opinion. Through Cetinkaya’s successor, Erdogan pushed the interest rate down eight times from 19.75 per cent in July 2019 to 8.75 per cent in April 2020, or a reduction of 1,100 basis points in less than a year. The sudden 200 basis point hike in interest rates on 25 September signalled a sudden awareness of the need to reverse the trend.
Still, if this course is to succeed, Ankara must overhaul its fiscal and monetary policies beginning with the dismissal of the current finance minister, Erdogan’s son-in-law, Berat Albayrak, and the current Central Bank Governor Murat Uysal, and their replacement with eminent economists whose credentials and teams are capable of regaining the confidence of investors. As this step would usher in economic restructuring that would include further interest hikes, it would pronounce the failure of Erdogan’s fiscal policy strategies. This could cost him dearly as presidential elections approach in 2023, or earlier if Erdogan moves them forward.
The second option is to turn to the IMF for a loan in the framework of a comprehensive economic reform programme that would involve budgetary restructuring aimed at bringing Turkey’s mounting deficit under control. If Ankara goes this route, the Turkish people would have to sustain the burden of austerity measures, much as Egyptians had to do during recent economic reform years. In Turkey’s case, however, IMF approval might be linked to European and American political demands related to Ankara’s purchase of the Russian S-400 missile system, Turkey’s illegal drilling in the Eastern Mediterranean and the question of Syrian refugees. Ankara’s acceptance of this option would not only signal the extent of its economic mismanagement but also the bankruptcy of its foreign policy. Erdogan could never accept this, which is why he and his team will tend towards band-aid measures to stem the economic attrition until the presidential elections. Only afterwards would he institute unpopular sweeping reforms. Alternatively, he might call early elections before the economy grows even worse, wreaking further attrition on his and his party’s popularity in favour of his political adversaries. These include former Islamist associates, such as Ahmet Davutoglu and Ali Babacan who recently split off from the ruling Justice and Development Party (AKP) to establish their own parties, as well as members of the secularist liberal camp, such as Ekrem İmamoglu, the popular Istanbul mayor. All these would stand to benefit from both a call to early elections against the backdrop of the political repercussions of a downward spiralling econ.