Why is the Turkish economy in such a mess?

Turkey’s economy is in tatters.

Rampant inflation and the collapse of the pound are pushing millions of Turks to the brink of financial ruin and blowing up factories, farmers and retailers across the country.

According to a survey by the Yöneylem Center for Social Research, more than two-thirds of Turks struggle to pay for their food and cover their rent, fueling a rise in mental illness and debt.

But it has not always been so. Turkey’s economy has made leaps and bounds over the past two decades, with an average annual GDP growth of 5.8% between 2002 and 2021.

So what went wrong?

“Devaluation spiral”

Ask anyone who visits Turkey every year and they will tell you that the Turkish Lira is in trouble. Starting in 2013, the currency steadily lost value, plunging over the past 12 months.

In September 2021, 1 US dollar was worth around 8 Turkish liras, but in October 2022 it has risen to almost 19.

One of the main consequences of this devaluation is inflation – and lots of it.

When the value of currencies goes down, things imported from abroad become more expensive. Most countries import goods, such as fuel, materials or technology, weaker currencies mean higher prices.

This has fueled record inflation in Turkey, one of the highest rates in Europe.

A man waits for customers at an open-air food market in Ankara, Turkey, Sunday, July 31, 2022. – Burhan Ozbilici/AP

The Turkish Statistical Institute said annual inflation was 83.45% in September, although many said the actual rate was likely even higher. Independent analyst ENAG estimated that annual CPI inflation was actually 176.0%.

Turkish businesses have been hammered by the fall in the value of the lira, which has sent production costs skyrocketing, while people’s wages have been slashed as they can now buy less with their money.

“The situation is even worse for skilled workers,” says Dr Cem Oyvat, professor of economics at the University of Greenwich, leading to a devastating “brain drain”.

The loss of such talent has “the potential to harm Turkey’s economy in the long term, with the economy losing the jobs and businesses that these individuals could have created,” he says.

“The economy is too hot”

However, other factors are at play.

According to Dr Oyvat, the strong GDP growth Turkey has experienced over the past decades was not “even sustainable” in the first place.

This is partly due to deeper structural issues, such as Turkey’s large current account deficit, which means it imports more than its exports, but something else is at play: interest rates. ‘interest.

When economies are growing rapidly, interest rate hikes are often used by central banks to cool the economy. They do this by increasing the cost of borrowing money, which reduces economic activity.

In Turkey, however, the opposite has happened. Interest rates were kept very low by the Turkish Central Bank, which caused the economy to spiral out of control.

“It’s still too hot,” says Timothy Ash, emerging markets expert at BlueBay Asset Management. “Growth is too high, domestic demand is too high, imports are too high. Everything is overheated.”

Confidence in the economy virtually collapsed as a result, while foreign and local investors withdrew their money from Turkey due to the plummeting lira.

Low interest rates are largely due to President Recep Tayyip Erdogan’s “unorthodox” understanding of monetary policy, Ash claims.

In the past, Erdogan has won elections by flooding the economy with cheap money, he says. “But at the end of the day, there is a return on investment.”

Ash also says the lower interest rates have been ‘beneficial’ to Erdogan’s AKP party ‘big money lenders’ such as construction and real estate, which can reap more benefits from lower loans. Dear.

Another part of the story is Erdogan’s “Islamic background,” Ash says.

He was one of the first Turkish rulers to attend a religious school and inherited Islam’s aversion to usury, which considers the lending of money at interest a sin.

“At the end of the day, it’s a combination of all those things,” he adds.

Why don’t things change?

Turkish officials are aware of what is happening and have repeatedly criticized the status quo.

However, unlike the situation in most other advanced economies, Turkey’s central bank is not independent from the government, which means it is difficult for it to solve the problem.

To make matters worse, Erdogan sacked several finance ministers and central bank chiefs “basically for standing up to him” and challenging his unconventional policies, according to Ash.

“Erdogan blames everyone,” he told Euronews. “He has a team of people around him who are men yes. They do not speak truth to power. It’s like the emperor’s new clothes”

A centralization of power in the hands of the Turkish president is at the heart of this problem.

“During the first 10 years of AKP rule, they had pretty orthodox policies and the government was more of a broad church,” says Ash. “Now it’s basically Erdogan and all the other power centers within the party have been kicked out.”

“There are no more checks and balances,” he added.

None of this is lost on the Turkish population.

Burhan Ozbilici/AP

A woman sits in a currency exchange office, in Ankara, Turkey, Thursday August 18, 2022. – Burhan Ozbilici/AP

Erdogan and the AKP party have fallen in the polls as the economy has deteriorated, losing control of Turkey’s two major cities of Istanbul and Ankara in local elections in 2019.

“People are pretty upset,” Ash said. “They see their own standard of living dropping.”

Judgment day for Erdogan comes in 2023 when Turkey is due to hold national elections, although there is a chance he could turn the tide, including using public spending.

“Erdogan can spend a lot of money to isolate certain sections of the population, such as pensioners, contributors to social security [and] public sector workers,” Ash explained. “He will certainly use the budget to help those he thinks are essential to winning the election.”

The statutory minimum wage was recently doubled in Turkey in light of rampant inflation.

Still, his government’s long-term outlook will be bleak if the polls stay low and its economic policies don’t change.

“It’s hard to predict an election,” Ash said. “But it will be the most contested vote for 20 years. “The stakes are high, Erdogan has a lot to lose.”

“It’s going to be interesting,” he added.

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