The Turkish Economy following on from the Elections
Author: Davit Shatakishvili, Contributing Analyst, American University, Washington D.C
Recep Tayyip Erdogan changed most of the executive government cabinet members, except for the ministers of culture and tourism, and health, following his victory in the Turkish presidential elections in May 2023. Special attention was paid to changes in the economic team of the government, where the position of the Minister of Treasury and Finance was taken by Mehmet Şimşek, and the position of the Governor of the Central Bank of Turkey was taken by Hafize Gaye Erkan. According to experts, the changes may indicate that Turkey intends to end its unconventional macroeconomic policy and switch to the traditional economic model, due to the record devaluation of the national currency and skyrocketing inflation. It is interesting to discuss what economic consequences Turkey has faced in recent years and what the expectations are from the government's new economic team.
Erdogan's Economic Policy Consequences
First of all, let's briefly explain what traditional and non-traditional economic approaches mean in this case. Mehmet Şimşek is an advocate of orthodox economic policy. According to him, price stability and inflation control are the main tasks of the country's Central Bank. So, the National Bank should actively use all possible levers, including the monetary policy rate. On the contrary, Erdogan believes that tightening of the monetary policy by the Central Bank is ineffective and increases the inflationary pressure. From 2021 onwards, his direct demand was to cut interest rates despite rising inflation, which is in stark contrast to the traditional economic approach. In recent years, Turkey's monetary policy has focused on increasing economic growth and export competitiveness rather than controlling inflation.
According to analysts, the significant devaluation of the Turkish lira and skyrocketing inflation in recent years are partly the consequence of Erdogan’s extraordinary economic policy, his high influence on the Central Bank, and state control over the financial markets. During the past year, the Turkish lira has depreciated by 40% against the US dollar, and in the last 5 years, by almost 250%. For reference, in 2018, the average annual exchange rate of the Turkish lira against the US dollar was 4.8, in 2019 - 5.7, in 2020 - 7, in 2021 - 8.9, and in 2022 - 16.5 liras. Currently, one US dollar equals 26 Turkish liras. According to the Goldman Sachs’s forecast, the value of 1 US dollar will reach 28 liras by the end of this year.
With regards inflation, the average annual rate of price increase in Turkey amounted to more than 70% last year. According to the International Monetary Fund’s forecast, this figure will probably decrease to 51% this year. For reference, the average annual inflation rate in Turkey in 2018 was 16.3%, in 2019 - 15.2%, in 2020 - 12.3%, and in 2021 - 19.6%. In May of this year, the annual inflation rate was 39.6%, which is about 4% less than the previous month.
Unfortunately, the problems the Turkish economy is currently facing are not limited to inflation and national currency devaluation. There are also important challenges, such as the reduction of the Central Bank's foreign exchange reserves and the current account deficit.
As of May 14, the Turkish Central Bank's foreign exchange reserves had decreased by another 2.3 billion US dollars, which is a 21-year low for the country. In recent years, the Turkish Central Bank's foreign exchange reserves have decreased significantly due to costly interventions in the foreign exchange market and efforts to reduce the foreign currency demand. As it seems, the Turkish population is increasingly trying to buy foreign currency, which in turn contributes to the record depreciation of the Turkish lira. In total, from the end of 2022 to the present, foreign exchange reserves have decreased by 27.7 billion USD and currently amount to about 50 billion USD, and the share of reserves denominated in gold is also about 50 billion USD.
On June 12, the Central Bank of Turkey announced that the current account deficit in April increased by almost 1 billion US dollars compared to March, and amounted to 5.4 billion, which is about 3 billion US dollars more than in the same period last year. The current account balance is one of the most widely used economic indicators. Its negative figure means an increase in foreign liabilities of residents and deterioration of the country's international investment position. In other words, the deficit current account shows that the consumption in the country is greater than the incomes and savings of residents, and the difference is financed by international resources, which mostly includes foreign debt, foreign direct investments and various types of transfers.
The Government's New Economic Team - Expectations
Turkey's new Minister of Treasury and Finance, Mehmet Şimşek, has a great international authority and is a widely respected economist among global investors. He was the Minister of Finance of Turkey from 2009 to 2015, and Vice Prime Minister from 2015 to 2018. Many experts assumed that Şimşek would return to his position, in case of Erdogan’s victory in the current year's presidential elections. After the second round of elections, on May 28, Erdogan announced that the country would have an internationally reputable financial management, which was a clear hint for the appointment of Şimşek. As far as is known, he had several conditions for his return to office. First – the authority to make his own decisions, second - the opportunity to design the country's economy teams, and third - adequate time to fix the economy’s problems. In addition to Şimşek, the new member of the economic team is Hafize Gaye Erkan, who, along with a western education, also has working experience in managerial positions in the largest financial institutions. Moreover, Çevdet Yilmaz, also a great supporter of the orthodox economic approach, was appointed as the Vice President of Turkey. Thus, the mentioned decisions raise logical expectations regarding the transformation of Turkey's economic direction.
First of all, the expectations from the new economic cabinet are related to the tightening of the monetary policy. At the end of 2021, the Central Bank of Turkey reduced the monetary policy rate from 19% to 8.5%. Despite the growing inflation, the refinancing rate has not been changed. Under the new management, experts expected an increase in the monetary policy rate from the end of this month. On June 22 of this year, the Governing Council of the Central Bank of Turkey increased the monetary policy rate by 650 basis points, which reached 15%. Although this figure is less than expected, it is undoubtedly an important decision in terms of controlling inflation. According to the bank's explanation, the monetary policy is expected to be gradually tightened before an improvement will be seen in the inflationary picture in the country.
There are also expectations from Şimşek regarding the attraction of foreign direct investments in the country. In this regard, it is important that investors are convinced in his real independence and see the possibility that adequate forecasts can be made about the country's economy. Obviously, Turkey's expected return to traditional economic tracks will not be enough to attract long-term foreign investments, although it is undoubtedly one of the important components. Overall, encouraging investments will have a positive effect on the current account deficit reduction.
From 2021, the economic policy of Recep Tayyip Erdogan was based on monetary and credit stimulation. According to him, low interest rates in the country would increase the production volume and export dynamics, and encourage foreign direct investments. However, low-interest loans resulted in an increase in demand, which caused record high inflation and a historically devalued national currency. The devaluation of the Turkish lira naturally led to an increase in the prices of imported products. Also, interest payments were increased for households and business entities that had a loan in a foreign currency.
The country's budget was burdened with colossal sums that were accumulated to compensate the damage caused by the devastating earthquakes in southern Turkey in February this year. Additionally, the increase in salaries and pensions for civil servants, as well as the natural gas subsidy for the population, was a significant budgetary pressure in the pre-election period, initiated by President Erdogan. The following government spending has helped economic growth to some extent, but on the other hand it has encouraged inflation.
The political and economic processes taking place in Turkey, as Georgia's largest trade partner, have a direct impact on Georgia. First of all, the skyrocketing inflation in Turkey increases the prices of goods and services, which directly affects the prices of Turkish products imported to Georgia. High inflation also reduces the purchasing power of the Turkish population, which raises the risk of a decrease in demand for products exported from Georgia. Further, the current economic circumstances in Turkey may also be reflected on the number of Turkish visitors arriving in Georgia or the amount of spending they outlay in the country, as well as on remittances and investments. Thus, the difficult economic situation in Turkey affects the general macroeconomic stability of Georgia, increases inflationary pressure and playing a major role in inflationary expectations and their management.
It is likely that Erdogan, with the support of his new economic team, will return to a relatively traditional economic model, which means tightening the monetary policy as much as possible when the inflation is extremely high. Restraining the growing inflation should be his main task, with the prices of energy resources increasing with the approach of winter, and also considering that, at the end of the year, the state has to pay obligations to its creditors. Along with this, local government elections are scheduled in Turkey in March 2024, and before that the governing team will need to take some effective steps for voters to feel their economic betterment. In this regard, the most important steps are inflation containment and protection of the national currency. Obviously, it being just four weeks since the elections, it is difficult to make concrete conclusions and predictions, although the vector of Turkey's economic orientation will become apparent with the next few decisions made in government.
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