The Trials of Turkish Trade

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Written by Daniel Metz

On Friday August 10, 2018, President Trump announced he was going to double down on tariffs for Turkish steel and aluminum, citing the American pastor who had been jailed in Turkey since 2016. While ongoing devaluation of the Turkish lira preceded Trump’s announcement—August 6 and August 9 suffered 4.25 percent and 4.75 percent losses, respectively—an already fragile Turkish market spawned a 13.75 percent loss that day, dropping from 5.53 to 6.8 liras to the dollar in a span of just a few hours. This was the worst day for the currency since a recession at the turn of the millennium, but it would be unfair to give Donald Trump all the credit.

The lira had lost about 40 percent of its value against the dollar since the start of 2018, clearly beyond the purview of aggressive American trade policies. But what the tariffs threat did was spark the kindling that had been building up underneath the Turkish economy over the past decade.

The 2010s introduced a new era of growing debts for Turkey. An economy rebounding after the 2008 crisis took to accruing massive private external debts. While the proportion of external debt to GDP sat at 36 percent in 2011, this figure barreled up to 53 percent in 2017. Turkish news wire Anadolu Agency reported in June that foreign debt reached $466.7 billion in the first quarter of 2018, 52.9 percent of GDP.

Inflation is another dagger pressing against the back of the Turkish economy. Expectations for inflation at the start of 2018 were sitting around 10 percent. But this number jumped to an annual rate of about 15 percent in July and then even higher to above 24 percent in September. This is the highest inflation rate Turkey’s seen in 15 years.

These elements don’t bode well for Turkey’s economic future. The Turkish people are being hit with rapidly increasing prices keeping pace with the rising cost of importing goods. Turkey imported nearly $250 billion in 2017, close to 30 percent of its GDP. Much of this is pegged to the dollar. When the lira plummeted, imports, lease agreements indexed to the dollar, and interest rates on foreign debt grow considerably more expensive. Accordingly, more than 2,500 companies in the construction sector have apparently declared bankruptcy.

“What are the effects of these developments on growth?” asked Selva Demiralp, an economics professor at Istanbul’s Koc University, columnist at the Turkish newspaper Milliyet, and former Turkish Federal Reserve Board economist. “Financial tightening typically brings with it slowdown in economic growth. Likewise, the increase in the unemployment rate, decrease in the private sector and consumer confidence indices, constriction in import figures, and the drop all at once in PMI figures are strong indicators that a period of slowdown in the economy has begun.”

Demiralp explained that Turkey has begun to exhibit signs of stagflation, the symptoms of which are high inflation, low economic growth, and an unmoved unemployment rate. Columnists in pro-government news outlets began using the term to describe the economy, although still in the same defensive, anti-interest context that Turkish President Recep Tayyip Erdogan is pushing.

“They’re saying crisis,” Erdogan said, speaking to his ruling Justice and Development Party (AKP) in early October. “There’s no crisis in Turkey. Learn economics. There are manipulations, manipulative actions in Turkey related to the economy.” Any comfort in these words might be lost on a public struggling to handle rising prices.

The currency shock in August preceded a massive decrease in imports, dropping 22.7 percent compared with the previous August. Turkey imported approximately $233 billion in goods in 2017, about 27 percent of its GDP. The lira depreciation reflected almost immediately in consumer goods.

Despite the severity of the situation facing Turkey, the only real policy the government took prior to the finance minister’s plan announced in October was the Central Bank (CBRT) raising interest rates. Even this was a struggle, as Erdogan’s disdain for high interest rates was firm and consistent.

“We can’t ever mediate or be conduced to use this tool of exploitation called interest,” he told the Confederation of Turkish Tradesmen and Craftsmen in September. “Our goal is to overcome the issues we face by situating an economic understanding based on production, efficiency, and austerity … When you bring interest to the table as a cause-effect relationship, interest is the cause, and inflation is the effect.”

This logic is diametrically opposed to the prevailing theory in economics, where low interest rates encourage borrowing and spending, thus pulling inflation up. Low interest rates, conversely, lead to less spending and reining in inflation.

But rather than immediately address this issue, Erdogan pursued less traditional means to manage the currency shock. He urged Turks to exchange their dollars for liras, spurring numerous, almost comical videos of Turks burning, destroying, and even pickling their American currency. He then banned companies from raising the prices of consumer goods and encouraged Turks to report sudden increases in prices. Bloomberg reported that Turkish police even conducted surprise store inspections in Istanbul to catch store managers in the act.

A struggle between the CBRT, which knew raising interest rates would the best solution to control inflation, and Erdogan, stubborn in his disdain for interest, ensued. It culminated in Erdogan taking a step back in mid-September and allowing the CBRT to raise interest rates from 17.75 percent to 24 percent.

Demiralp, the economics professor, emphasized that lowering interest rates alleviates pressures from inflation coming from currency rates and contributes to financial stability. “Indeed, the improvement we observed in the rates, market interest rates, and risk premium after the second half of September is a result of the CBRT’s tough interest rate hike.”

But one move by the CBRT isn’t enough to comfort investors or preclude an economic recession. Erdogan amended a currency-value law, making sales, lease, and service agreements indexed to foreign currency illegal. The Turkish government hired U.S. consulting firm McKinsey to navigate through the crisis, but in a speech at the beginning of October, Erdogan appeared to sever the relationship. “I just told all my minister friends, I said you won’t take any consulting services from [McKinsey]. There’s no reason, we are enough for ourselves.”

Shortly thereafter, Treasury and Finance Minister, and Erdogan’s son-in-law, Berat Albayrak, announced his “All-Out War on Inflation Program”, the first significant policy the government announced to target rising inflation rates. Included in the plan, Bayram stated, are an agreement with some businesses to cut the prices of consumer goods up to 10 percent, a price freeze on electricity and natural gas until the end of the year, and a 10-percent discount for bank loans sold with high interest rates.

Turkish banks have been taking their own approach to the looming crisis by reducing the amount they lend and raising the rates of distributed loans. This is a sharp divergence from the common practice of banks to issue abundant loans with somewhat disregard for credit risks. The resulting “credit crunch” is a form of self-regulation where the banks are much more careful with how they are distributing their liquidity. Credit-rating agency Moody’s downgraded nine large Turkish banks from B1 to B2 in late September, attributed to “the lowering of Turkey’s foreign currency deposit ceiling.”

Some economists view these changes as wholly insufficient for the mounting problems the country faces, and while the inflation hike in September resulted in a brief period of control for the erupting exchange rates, tough times lie ahead.

On September 20, Turkish newspaper Hurriyet reported on changes to the Turkish economic forecast, with 3.8 percent predicted growth in 2018 and 2.3 percent in 2019. Both figures were previously set at 5.5 percent. The OECD also shared adjustments to its forecast, cutting its 2018 prediction down from 5.1 percent to 3.2 percent and 2019 prediction down from 5 percent to 0.5 percent. The IMF issued similar alterations, estimating 2018 economic growth to conclude at 3.5 percent and a dismal 0.4 percent growth for 2019. If inflation can’t be brought into check, rising costs will prove disastrous for the average Turkish consumer.

What this all means for the Turkish economy is entirely dependent on how the government proceeds. Senior officials are unwilling to address the issue of inflation in any capacity that would restrict the spending power of the consumer. Erdogan views a strong economy and the prosperity of his citizens as the key to his success in power. What he may fear is the support of a previously unshakeable base faltering because the government’s policies negatively affect their livelihood. It’s clear that actions to avert a greater disaster, like the slowdown of growth and consumer spending, will result in economic conditions unfavorable to Erdogan’s views on his own power.

What’s left to see is whether the CBRT continues to raise interest rates, whether more policies to lower inflation emerge, and whether Erdogan continues to relinquish control to officials pushing policies that oppose his vision of Turkey.

About the author: Daniel Metz is a writer and translator living in Istanbul who works on topics relating to politics, culture, and language with an emphasis on Turkey and the Middle East. He is a Contributor Diplomatic Courier.