In May 2016 Turkey elected a parliament dominated by the AK Party. At that time a prime minister and a cabinet were supposed to run the government while the Turkish president was supposed to be neutral. But Recep Tayyip Erdogan, AKP leader, former prime minister, then president was still the dominant figure and the government was practically chosen and run by him. Two months later a coup attempt against Erdogan failed. Since then Erdogan ruled by emergency decrees. More than 100,000 people were sacked or suspended and 50,000 arrested in an unprecedented crackdown. All independent media companies were taken over or eliminated.
A spring 2017 referendum, barely won, officially changed Turkey's executive into a presidential system. The government would no longer be elected by the parliament but picked by the president. The new system would come into full force by the next election in late 2019. The wannabe-Sultan Erdogan would thereby achieve near absolute power.
In April 2018 Erdogan called for a snap election on June 24. He feared that a worsening economic downturn would otherwise diminish his chances to win. But the downturn has since accelerated. Today the Turkish currency fell rapidly and the presumed surety of Erdogan's reelection is now in doubt:
The Turkish lira has fallen more than 5% to hit a record low against the US dollar.
The currency has lost more than a fifth of its value this year as fears grow that the government might undermine the powers of Turkey's central bank.
Many investors want to see a rise in interest rates to bring down inflation, which is in double figures.
For consumers of foreign products in Turkey the effect of the currency drop is noticeable:
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Tourists to Turkey will like the move, the Turkish people not so much.
The Turkish government is blaming, as usual, foreign powers:
[Erdohgan's] deputy Bekir Bozdag has implied that foreign powers were to blame for the lira's collapse.
"The people have seen the game and the player, the people have seen the puppet and puppeteers. They will not allow them or give an opportunity," he said.
Two weeks ago Melkulangara Bhadrakumar, a former Indian diplomat, also opined that foreign powers were causing the downturn in Turkey:
Turkey already seems to be facing an intensifying economic and financial storm originating from Washington. On April 30, the International Monetary Fund posted a warning that Turkish economy is showing “clear signs of overheating” (after expanding 7.4% in 2017 as against potential growth pegged at 3.5% to 4%.) On May 1, Standard & Poor’s dealt a surprise blow by downgrading Turkish economy to double-B-minus, on the specious plea that it feared a “hard landing.” Such things do not happen by coincidence.
I believe that Bhadrakumar is wrong. This is not a foreign induced crisis but has been coming for a long time. Already in 2013 I wrote:
Throughout the last years Turkey's economic boom depended on foreign investment -hot money that can leave overnight- and on an increase in consumer debt. With the Lira falling, credit tightening and interests increasing the Erdogan boom will become a bust.
The process took longer than I anticipated at that time, but it has now reached its critical point.
Turkey has a consistently high current account deficit of about 5% of the its GDP. It imports way more than it exports and needs a constant inflow of foreign capital to keep going. Over the last years Qatar was one of Turkey's biggest investors. It inserted huge amounts of money in exchange for Turkish troops protecting Qatar from a Saudi invasion. But even Qatar's capability and willingness to take risk is limited.
Internationally Turkish debt has been downgraded to junk, but not for political reasons. International lenders demand high interest rates from Turkey because they see a high risk.
Erdogan is an Islamist. He has an ideological problem with interests which are (on first sight) prohibited by Islam. The central bank has held the nominal interest rate at 8% even as the core inflation rate rose above 12%. Its primary lending rate is at 13.5% which is lower than the real overall inflation rate. The bank would like to hike rates and run a more restrictive monetary policy to a. lower inflation and b. lower the current account deficit. But Erdogan has bullied the central bank for years to keep its rate (too) low. He believes that higher central bank interest rates causes higher inflation rates. I am not aware of any economist who agrees with that theory. Erdogan has long threatened the political independence of the central bank. On May 14 he was most explicit:
[Erdogan] said the central bank, while independent, would not be able to ignore signals from the new executive presidency that comes into effect after the June polls. A self-described “enemy of interest rates”, Erdogan wants borrowing costs lowered to fuel credit and new construction.
“I will take the responsibility as the indisputable head of the executive in respect of the steps to be taken and decisions on these issues,” he said in the interview broadcast on Tuesday.
Turkey has called snap presidential and parliamentary elections for June 24 and polls show Erdogan as the strongest candidate to win the presidential vote. Turks narrowly backed a switch to an executive presidency in a referendum last year. That change is due to go into effect after the vote.
If Erdogan wins the June 24 election he will practically end the autonomy of the central bank. The bank will have to lower its interest rate and run an even more expansionary monetary policy. An already high inflation rate will increase further, the Turkish Lira will drop even deeper and Turkey will – in the end – default on its debt.
Since the beginning of the year the Turkish Lira fell 20% to currently 4.9 Lira per dollar. On January 1 4.5 Turkish Lira were needed to pay back a 1 Euro loan. Now 5.65 TL are needed. Turkish companies who bought European machinery on credit will get ruined by this fall.
Turkey has an external debt of about 450 billion dollars. While the government debt is relatively small with 23% of GDP, the total private debt is above 170% of GDP and constantly rising. With the drop in the Lira it will be very difficult for Turkish banks, companies and private households to pay back their foreign denominated loans. With interest rates lower than the inflation rate and an ever dropping currency new foreign investments in Turkey lack profitability.
Nominal growth is still high at about 7.5%. But even with that high growth the unemployment rate is still above 10%. Youth unemployment is about 20%. A lack of investment will cause the nominal GDP growth to come down, unemployment will rise and the crisis will accelerate. Consumer confidence, already in negative territory, just dropped further.
This was all inevitable under the expansionist Erdogan program of constant private debt expansion and an ever higher current account deficit. It is quite astonishing that the model worked this long. His public bullying of the central bank has finally destroyed the trust of the foreign investors his model depended on.
Turkey's economy long needed a cooling period to tame inflation and to weed out bad loans. Erdogan has managed to avoid such a period again and again. But that only increased the severity of the eventual downturn which may now end up in a full blown debt crisis.
There is no need to blame "foreign powers" or the "interest mafia" for this outcome.
Depending on how the crisis will develop over the next days and weeks Erdogan may be in big trouble. It is for now still likely that he will win the presidency but his AK Party may well lose its parliamentary majority. That would create a quite interesting "cohabitation" of an executive president with an opposing parliament.
Update – just during the final editing of this piece came news that the Turkish central bank increased one of its primary lending rates from 13.5% to 16.5%. The lira jumped from 4.9 to 4.63 per US$ but is still below yesterday's opening value. Even this relatively large move may have been too little and too late to stop the coming tide.
