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Turkey on the brink

In his latest 'Spotlight on Europe' column, Oliver Hartwich turns the spotlight on Turkey, and its deep financial crisis

Turkey is not the country you might expect to read about in a series of columns called “Spotlight on Europe.”

Of course, you could make a geographical argument. A small part of Turkey, East Thrace, is European. It accounts for about 3 percent of Turkey’s land and 14 percent of its population.

But beyond such technicalities, Turkey matters to Europe. For starters, it is in a deep financial and economic crisis. Not that you would have seen this covered in the media in our part of the world, so let’s fill that gap.

To give you an illustration of Turkey’s problems, look at the exchange rate of the Turkish Lira. Back in early 2008, it peaked at 88USc and seemed to move towards parity with the greenback. Today it stands at just 14USc. A depreciation of more than 80 percent over a dozen years.

That is a steep fall for an economy celebrated as an economic miracle in the early 2000s. Back then, annual growth rates hovered near 7 percent, and in 2008 Goldman Sachs even predicted Turkey to become Europe’s third-largest economy by mid-century and narrow its per capita gap to the European Union.

Unfortunately, such forecasts turned out to be too optimistic. Growth has stalled and per capita incomes fell slightly even before the Covid-19 crisis hit.

The only thing that has shot up are prices. For the past half century, Turkey never managed to stabilise prices by developed world standards. It recorded spikes of above 100 percent inflation in the early 1980s and then again in the early 1990s.

Over the past decade, though, consumer price inflation (changes in the price of goods and services) had fallen to moderate levels by Turkish standards, i.e. about 10 percent a year. However, a toxic cocktail of Turkish economic policy and geopolitical events is pushing inflation higher – and driving Turkey to the brink.

Like practically every other economy, Turkey suffers from a Covid-19 recession. However, at a projected contraction of just over 4 percent it may not be as severe as in other parts of Europe.

A recession on its own would not explain the plunge of Turkey’s currency. Economic management by President Recep Tayyip Erdoğan has plenty to do with it.

In July 2019, Erdoğan intervened directly in monetary policy when he sacked the governor of the Central Bank of the Republic of Turkey, Murat Cetinkaya, a year before his term was due to end. In his place, Erdoğan installed his deputy, Murat Uysal.

The move followed a long dispute between the President and the central bank over the appropriate level of interest rates. Where Erdoğan wanted to use low interest rates to stimulate the economy, the Bank had its 1-week repo rate at 24 percent to stabilise the currency (the repo rate is the rate at which a central bank lends money to a private bank).

With the change of governor, Erdoğan took control and drove down interest rates to where he wanted them. The main rate currently stands at just 8.25 percent, several percentage points lower than the official inflation rate.

The result of his meddling was predictable: it drove international investors away and sent the Lira plummeting. When that happened, the central bank intervened directly by using its foreign currency reserves to stabilise the Lira. It hardly had an impact and nearly halved Turkey’s forex reserves.

And because that was not enough, international investors were forbidden from borrowing Lira from other banks so they could not use it to speculate against Turkey’s currency. It only highlighted the precariousness of Turkey’s situation. If investors needed another alarm bell to ring, that was it.

The President’s interventions set a vicious cycle in motion. As investors pull out of Turkey, the exchange rate plunges further. As the rate plunges, inflation shoots up. As inflation shoots up, more investors leave, the exchange rate deteriorates and Turkey’s foreign-denominated debt becomes less sustainable. Since Covid-19 means few tourists visiting Turkey, another important source of foreign currency is depleted for now, which compounds the economic disaster.

All this would be worrying enough in a region not blessed with economic and political stability. However, geopolitics makes Turkey’s troubles worse.

As a member of NATO, Turkey should be a stabilising factor in the Middle East. Except, traditional hostilities with its neighbour and fellow NATO member Greece keep flaring up regularly. Add to that the ongoing tensions between Turkey and the US about Syria but also over Turkey’s cooperation with Russia in the military and energy spheres.

Then there is the ongoing conflict over Cyprus. Turkey does not recognise the South Cypriot state, which has been an EU member since 2004. International attempts to resolve the Cyprus conflict have stalled, and Turkey remains the only country with diplomatic links to the North Cypriot administration. It seems to be an unresolvable international issue.

Perhaps only one thing might eventually lead Turkey back onto a more sustainable path, both economically and politically. And that is a change in the presidency.

Erdoğan is also reshaping Turkey into a Muslim state. This is a complete reversal of the republican system set up by modern Turkey’s founder Kemal Atatürk. The turn away from Kemalist secularism was recently underlined with the redesignation of the Hagia Sophia from a neutral museum into the Hagia Sophia Grand Mosque.

Finally, Turkey holds a crucial position in Europe’s refugee crisis. After the big wave of migrants which reached central Europe in 2015, the European Union and Turkey agreed for Turkey to close its border to Europe for refugees in 2016. In return, the EU would pay Turkey €6 billion.

Turkey’s relationships with Europe and the world are complicated. But an impending currency and economic crisis will not make them any better.

The problem is there is no easy way out. Turkey’s best hope would be a V-shaped economic recovery from its Covid-19 recession. Tourism especially would bring desperately needed foreign currency back into the country. But whether that V-shape materialises, and whether it comes fast enough, is doubtful.

Without such a miracle, its central bank might be forced to substantially increase interest rates to avert the crash of the Lira. Except Erdoğan would have to agree to that and the short-term economic pain it would inflict on an already fragile Turkish economy.

Perhaps only one thing might eventually lead Turkey back onto a more sustainable path, both economically and politically. And that is a change in the presidency.

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