Economics Update April 2023 - Turkey before the presidential election: Extremely fragile economic situation

Turkey is in a very difficult economic situation ahead of the upcoming presidential election: high inflation, a significant current account deficit, the steady depreciation of the lira and fragile public finances are a dangerous mix that carries the latent risk of economic disruption and a balance of payments crisis. The situation today is strongly reminiscent of the time of the 2002 parliamentary elections, when Erdogan and his AKP achieved an overwhelming election victory for the first time. The successful economic policy at that time formed the foundation of Erdogan's power, which he has been steadily expanding for twenty years now, but in the end no longer knew how to use for the economic good of the country.

Inflation as a result of erratic monetary policy

The symbol of the current economic misery is the extremely high inflation rate: although it has fallen from 86 per cent at its peak in October 2022 to 55 per cent most recently, this was mainly due to base rates: However, this was mainly due to base effects. The underlying monthly price dynamics suggest that inflation will remain well above 10 per cent in the long term. This is not surprising in view of a completely misguided monetary policy: while central banks all over the world are trying to fight inflation by tightening monetary policy, the Turkish central bank has been following Erdogan's opposite idea for one and a half years now, according to which lowering interest rates is the right way to fight inflation. The key interest rate, which has been cut several times, is currently 8.5 per cent - far too low to curb high inflation.

Turkish lira in free fall

The direct consequence of this unorthodox monetary policy, the sense of which is obviously not clear even to financial market players, is a steady decline in the value of the Turkish lira, which has lost around 70 per cent of its value in trade-weighted terms since 2019. The associated rise in import prices (more than 100 per cent in 2022) is itself a major source of high inflation. Overall, the country is living well beyond its means, as evidenced above all by the persistently high current account deficit of most recently around 4 per cent of GDP, combined with an equally high budget deficit of a similar magnitude. The range of foreign exchange reserves has steadily declined in recent years; at present, imports for only the next two months could be paid for with the existing foreign exchange reserves.

The fact that an economic collapse has so far failed to materialise is due, on the one hand, to the great geostrategic importance of NATO member Turkey at the interface between Europe and the Middle East and the extremely flexible foreign policy of the Turkish president, who knows how to skilfully use his position, especially in the conflict between Russia and NATO. On the other hand, despite all the uncertainties, the country still represents an attractive location for globally active companies, as evidenced by the continued positive direct investments.

A lot of work awaits the future president

Nevertheless, the next president of Turkey, regardless of whether his name is Erdogan again or Kilicdaroglu, will have to put the country's economic base back in order. This means, above all, allowing the central bank to raise interest rates significantly in order to get inflation under control. The consequence of this monetary tightening would be a stabilisation of the currency, a reduction of the current account deficit, but in all likelihood also a severe recession, from which the Turkish economy, given its potential, could subsequently emerge stronger. In this respect, the future president should take an example from the young Erdogan, who started his political rule in exactly this way.