Erdogan changes economic course: what will happen to the lira


Personnel leapfrog

Erdogan’s views on monetary policy in the previous presidential term were repeatedly criticized by the world economic community. Trying to stimulate consumption growth at the expense of the low cost of domestic credit, he forced the Turkish Central Bank to constantly lower the key rate, ignoring inflation data and the constantly declining exchange rate of the national currency. The leaders of the Central Bank, who disagreed with such views of the head of state, were forced to leave their post. Recall that in the summer of 2019, after Erdogan’s regular calls to lower the key rate were ignored, the president dismissed Murat Chetinkay, who had headed the Central Bank since 2016. The Turkish lira began to decline even under him, at the end of 2017. By 2019, it has almost doubled in price. In addition, unemployment in the republic has reached record levels.

The new head of the Central Bank, Murat Uysal, followed Erdogan’s demands and first of all reduced the key rate from 24% to 19.75% per annum, but this did not improve the situation in the country’s economy. Thus, Turkey’s budget deficit reached 21.1 billion liras, the national currency continued to depreciate, and GDP decreased by almost 3% in 2019. The country’s economy entered recession for the first time in a decade. As a result, Murat Uysal also had to leave the post of head of the Turkish Central Bank. He was replaced in November 2020 by Naji Agbal, who was able to stay in the chair of the head of the regulator for only five months. The official left his post in March 2021, after he sharply increased the key rate from 17% to 19%. Erdogan did not tolerate such self-will and parted ways with the “rebel” from the economic bloc, and he offered the post of head of the Turkish Central Bank to Shahap Kavdzhioglu, an economics professor from Istanbul Marmara University. Mindful of the difficult fate of his predecessors, he began to systematically reduce the key rate, not daring to argue with the president. During Kavcioglu’s tenure as head of the Bank of Turkey, the key rate was reduced from 19% to 8.5%, which led to a record acceleration in inflation and the collapse of the Turkish lira. By the time of the elections in May this year, inflation in Turkey was 40%. And it could still be called a success, since it slowed down from the April figure of almost 44% and was significantly lower than the March value of 50.5%.

Turkey’s national currency has been declining for many years. As Sofya Glavina, head of the Digital Economy program at RUDN Institute of Economics and Economics, noted, due to the growing trade balance deficit over the past 10 years, it has weakened against the dollar by almost 14 times: from 2 lira per dollar in 2012 to 26.1 Turkish lira per unit of US currency today. In this area, Erdogan has not had good news for a long time.

woman at the helm

The Turkish leader himself, judging by the first reshuffle in the government, decided to abandon the controversial economic policy pursued earlier. Almost immediately after winning the election, in early June, he appointed 44-year-old Hafize Gaye Erkan as head of the country’s central bank. This was a landmark event, not only because it was the first woman to hold this position, but also because she is an adherent of the traditional monetary policy, which she promised to implement. After graduating from Turkey, Erkan received a diploma from Princeton University in the United States, held senior positions at Goldman Sachs and First Republic banks (a year after her departure, the bank went bankrupt). Fulfilling her promises, she immediately began tough measures and raised the key rate from 8.5% to 15% at the very first meeting of the Monetary Policy Committee (MPC) of the regulator (it is this body in Turkey that decides on the level of the key rate) . “The Committee decided to start the process of tightening the monetary policy in order to set a course for disinflation as soon as possible, consolidate inflationary expectations and control the deterioration in price dynamics,” Yulia Kuznetsova, investment adviser on the register of the Central Bank of the Russian Federation, explains the actions of the new head of the Turkish regulator. “Erkan’s main task is to stabilize the Turkish economy, as well as to establish international financial contacts.”

True, despite her efforts, after raising the rate almost twice, the Turkish lira paved the way for a fall, but there is an explanation for this. Dmitry Babin, an expert on the stock market at BCS World Investments, noted that the Turkish lira depreciated by about 10% against the US dollar after the decision to raise the key rate, although national currencies usually react by strengthening to monetary tightening. But in this case, such a reaction of the lira just reflected the disappointment of the market with an insufficiently strong increase in the rate. As Freedom Finance Global analyst Vladimir Chernov noted, on the eve of the meeting of the Turkish Central Bank’s MP Committee, most experts expected the rate to rise to 21% per annum immediately. However, changes for the better are already evident. The Lira has managed to stabilize near a new all-time low, where it trades for the third week in a row. Inflation is also starting to slow down.

“On Thursday, July 20, a new meeting of the regulator will take place, and the range of predicted interest rates from key investment centers differs by tens of percent,” says Alexei Murashev, Managing Director of AM Capital. This uncertainty is rather negative, because it was precisely because of the mismatch between investors’ expectations and reality that the lira sank so much against the dollar the previous time.

At the same time, Erdogan appointed a new head of the Turkish Ministry of Finance and Treasury. They became Mehmet Simsek, who previously worked for seven years as an economist at the London branch of Merrill Lynch. He was already Minister of State for Economic Affairs, in 2009-2015 he headed the Ministry of Finance of the Republic, and then became Deputy Prime Minister of Turkey, but left his post in 2018, when Erdogan appointed his son-in-law as Minister of Finance. According to the Finanical Times, now Simsek, whom the publication calls “a favorite of foreign investors,” found common ground with the Turkish president, who was re-elected for a third term, on key issues of financial policy. “The presidential election, which clearly exposed the dissatisfaction of the financial markets with Erdogan’s unorthodox policies, served as an incentive to revise it,” said Artur Meinhard, head of the analytical department for global markets at Fontvielle Investment Company. “Decisions such as lowering interest rates to fight inflation and draining reserves to protect the lira have prompted foreign investors to sell Turkish stocks in recent years, bringing their share of the stock market to an all-time low.” Now they have already assessed the path chosen by the new management team. Thus, the inflow of foreign funds into Turkish stocks reached a weekly high in June of $262 million – there have been no such values ​​since December 2022, the analyst noted.

Who is leading the parade?

So, Erdogan, after his re-election, decided to give a team of Western-educated officials and a traditional monetary approach to the economy the opportunity to correct the situation. However, the question is how independent they are in their decisions. According to the Associate Professor of the Department of World Financial Markets and Fintech of the Russian University of Economics. Plekhanov Ilyas Zaripov, raising the key interest rate to 15% in June is clearly not enough to counter inflation, which is in double digits and continues to grow. Such monetary policy measures, which may be correct, but insufficient in terms of rigidity, do not convince market players and foreign investors of a radical change in monetary policy. “In reality, it was necessary to raise the interest rate to 35-40%. Only such measures can lead to a sharp contraction in the money supply and attract money from businesses and the population to deposits, reducing inflation and sharply strengthening the Turkish lira,” the expert is sure.

The economic situation in Turkey remains tense. The only positive indicator is the increase in the reserves of the Central Bank of the Republic by $14.2 billion from May 26 to June 30, to the level of $108.6 billion. In the future, only cardinal steps to raise the interest rate will be able to defeat inflation and stabilize the national currency. But does the new management team have a mandate for such decisions from Erdogan? Most experts fear that as long as all actions in the financial and economic sphere are controlled by the head of the Turkish state (and his point of view can sometimes change unpredictably), the situation will be unstable. It is necessary to prove to domestic consumers and foreign investors that Turkey will pursue a predictable course to reduce inflation and strengthen the lira. Only then will Turkey’s much-needed foreign investment return. Erkan set a course to build up the state’s foreign exchange reserves. Only a serious tightening of monetary policy, sterilization of the money supply (this term means the withdrawal of part of the money from the economy by central banks through operations on the open market, such as the sale of securities), inflation control, combined with an increase in exports to reduce the trade balance deficit, can help strengthen the national currency. currencies in the long run.

Eastern deceit

The interviewed experts differed in their assessments of the prospects for Russian-Turkish relations against the backdrop of changes in Erdogan’s economic policy. Moscow supported him during the election campaign, including by extending the grain deal, but after the victory, Erdogan has already taken many unfriendly steps. He returned to Ukraine the commanders of the Azov regiment (the organization was recognized as a terrorist organization in the Russian Federation and banned), supported Sweden’s entry into NATO and even spoke in favor of Ukraine’s potential membership in the North Atlantic Alliance. According to Kuznetsova, such a position of the head of state can have a very negative impact on relations between Russia and Turkey.

Homeowners and Russians with a residence permit in the republic should follow the developments. Erdogan violated agreements with Russia on the issue of military conflict. “Our government may recognize Turkey as an unfriendly country with all the ensuing complications,” Glavina warns. In addition, this republic has long sought to become a member of the European Union. In the process of integration, the European authorities may require her to join the implementation of anti-Russian sanctions.

At the same time, Turkey is an important partner for Russia both in terms of energy supplies and as a transit route for the capital of our citizens. The rupture of these relations will be extremely painful. Last year, it was Turkey that became the largest hub of our country in terms of parallel imports. Truck traffic alone between the Islamic Republic and Russia grew by almost 40% in the first half of 2022. However, in March 2023, in connection with Ankara’s accession to the Customs Union with the EU, the first refusals to process transit cargo of non-Turkish origin began to arrive, where Russia was indicated as the country of destination. Cargo clearance de facto takes place in the European customs system, which has a ban on the export of sanctioned goods to our country, Glavina noted.

In addition, Russia has a lot of big projects connected with Turkey. So, in 2024, the state corporation Rosatom must complete the construction of the Akkuyu NPP, make a physical start-up of the reactor and begin a phased increase in power so that in 2025 the power plant will already produce energy steadily. And this is not the only major project. Recall that after the Nord Stream bombing, Russia invested in the construction of the Turkish gas hub, which energy experts have already called the only alternative to American influence in the EU energy market.

Do not forget that ordinary Russians also need a “Turkish coast” after the closure of routes to many familiar European resorts. In 2022, 5.2 million compatriots visited the resorts of this Islamic republic, which is 11.8% of the country’s total tourist flow. In addition to tourists, it should be noted that hundreds of thousands of Russians who have moved to Turkey since February 2022 have invested millions of dollars in real estate in this country and continue to spend their money while in this state.

The Russian market is also very important for Turkey. And it’s not just about vacationers. We are talking about the export of food, textile and leather goods. Türkiye imports from Russia, in addition to fuel and energy products, a large amount of fertilizers for its agro-industrial complex. The republic has a trade deficit (that is, it imports more than it exports). But, according to Zaripov, the situation with the country’s trade balance may change for the better when the gas hub starts working and other joint projects enter the implementation stage. Further relations between Russia and Turkey will depend more on the desire of the leadership of both states for long-term cooperation than on external factors, the expert is sure.

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