‘Erdoganomics’ under the microscope as Turkish lira plummets

Turkish President Recep Tayyip Erdogan’s insistence that interest rates are inflationary, a concept labelled by its critics as ‘Erdoganomics’, may be in its death throes after the lira slumped to a record low against the dollar.

The country’s central bank has slashed borrowing costs to below the rate of inflation over the past year to match Erdogan’s unorthodox economic thesis and to support growth. The benchmark rate has fallen to 8.25 percent from 24 percent in July last year. Inflation stands at 11.8 percent.

Investors say that the central bank’s pandering to Erdogan’s questionable logic has left its reputation in tatters and risks sparking a repeat of a currency crisis in 2018, which sent the economy into a tailspin. Erdoganomics jars with conventional economic wisdom that states interest rates can be increased to curb inflation.

The lira hit a record low of 7.3677 per dollar on Friday afternoon in Istanbul, taking losses for the year to almost 20 percent.

Turkey’s central bank has paid a hefty price for following Erdogan’s lead. Governor Murat Uysal, who arrived last July after Erdogan sacked his predecessor for failing to cut rates, has spent tens of billions of dollars of the bank’s foreign exchange reserves to defend the lira, leaving its net reserves deep in negative territory.

Now Uysal faces the unenviable choice of either towing Erdogan’s line or hiking interest rates. The latter option, if unapproved, could cost him his job.

Murat Çetinkaya, Uysal’s doomed predecessor, embarked on a series of rate hikes between May and September 2018, tripling the benchmark rate to 24 percent from 8 percent. An overheating economy, spurred on by government stimulus measures, had spurred inflation to its highest levels in 14 years in June 2019, then helped plunge the country into a currency crisis two months later.

Erik Meyersson, senior economist at Swedish bank Handelsbanken, said an increase in interest rates may do nothing to sway Erdogan’s approach to the economy.

“At this point I wouldn’t be surprised if we get another mass hike, but don’t expect a change in the ‘framework’,” Meyersson said on Twitter. “Another mass hike however would require someone to fall on their career sword.”

Uysal has thus far stuck to the official line.

Last month, the governor started tapping into dollars and euros held by Turks in their deposit accounts to reinforce the bank’s war chest, insisting that lenders park some of them with the central bank as reserves. In the meantime, he busied himself defending the lira at 6.85 per dollar, a level that the currency had remained at for weeks before it began to slide last week.

The central bank’s low interest rate policy has helped Erdogan conjure up a borrowing boom and bolster his political support just as the economy began to reel from the impact of the COVID-19 pandemic.

Instead of hiking interest rates, Uysal halted the central bank’s rate-cutting series in May citing inflationary pressures.

Last month, Uysal said that the central bank’s monetary stance remained conducive to reducing consumer price inflation to a year-end forecast of 8.9 percent. The approach has enabled state-run banks, controlled by Erdogan in his capacity as chairman of the Turkey Wealth Fund, to extend their lending spree.

As a result, Turkey’s current account deficit has widened, reviving imbalances in the economy. Imports have exceeded exports as consumers and businesses used the cash borrowed from banks to buy up imported goods and raw materials.

The Turkish authorities traditionally finance the current account deficit with the help of inward investment and tourism revenue. The latter had surged to a record $34.5 billion in 2019.

But income from tourism has dived this year due to the COVID-19 pandemic, as has foreign investment. Foreigners sold a record amount of Turkish stocks during July and have fled the bond market after regulators sought to prevent them from hedging their investment risk by shorting the lira.

Interest rates in the offshore swaps market, used by foreigners who want to short the lira, soared to more than an annualised 1,000 percent this week. The surge was reportedly caused by Turkish banks withdrawing funding on government orders.

In an effort to calm markets, the central bank said that it would phase out additional lira liquidity measures introduced during the COVID-19 outbreak and use all available instruments to reduce excessive volatility in the markets.

Instead of raising rates, Uysal may seek to avoid Erdogan’s wrath and stabilise the lira by following his predecessor in tinkering with monetary policy.

Çetinkaya had used a so-called “late liquidity window” to tighten monetary policy between December 2018 and May last year, hiking the rate by 425 basis points to 16.5 percent while leaving the benchmark rate unchanged at 8 percent. But on May 28 it more than doubled the benchmark to 16.5 percent, saying it was simplifying monetary policy by making the benchmark the only lending rate.

But pursuing a more complex monetary framework, while giving possible temporary relief to the lira in the form of higher borrowing costs, may not go down well with investors, who maintain that a simple monetary policy is the most effective.

In an analysis last week, Desmond Lachman, a former deputy director at the International Monetary Fund, said Erdogan was flouting the teachings of the world’s most renowned economists such as Nobel laureate Milton Friedman by insisting higher interest rates were inflationary and seeking to fix the value of the lira.

Lachman drew attention to Turkey’s external debts of $450 billion and its highly indebted corporate sector, which has more than $300 billion in borrowings. The companies would have difficulty servicing those foreign currency obligations should the lira plunge, putting even more pressure on an already shaky banking system, he said.

“For the sake of the global economy, and especially for the sake of the poor Turks who have to bear the brunt of Erdogan’s policies, we should all hope that he will prove Friedman and a host of other economists wrong,” Lachman said. “Not that I’d bet on it.”


Mark Bentley is the former bureau chief of Bloomberg in Turkey, with more than a decade of journalism experience there.

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