How inflation affects the struggling Turkish economy

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The signs of Turkey’s dire economy are everywhere. Long queues meander past government-subsidized bread kiosks. The prices of medicines, milk and toilet paper are skyrocketing. Some gas stations have closed after exhausting their stock. Explosions of anger erupted in the streets.

“Unemployment, the high cost of living, price increases and bills are breaking our backs,” the Confederation of Progressive Trade Unions said last month.

Even before the coronavirus pandemic and supply chain bottlenecks began to wreak havoc on global economies almost two years ago, Turkey was trying to avoid a recession as it grappled with it. mountainous debt, significant losses in the value of the Turkish lira and rising inflation. But in recent weeks, this idling train wreck has accelerated with ferocious intensity. And the foot that presses the accelerator hardest belongs to the country’s authoritarian president, Recep Tayyip Erdogan.

Turkey’s economic problems have deep roots, but the most recent crisis was caused by Mr Erdogan’s insistence on lowering interest rates in the face of soaring inflation – precisely the tactic against which economists almost universally prescribe.

Mr Erdogan, who ruled Turkey for 18 years, has long resisted this particularly painful prescription, but his resolve to continue cutting interest rates even as the country’s inflation rate exceeds 21% appears to be pushing. Turkey beyond a tipping point.

Normally, investors and others look to a country’s central bank to control inflation and set interest rates. But Mr Erdogan has repeatedly shown that if Turkey’s central bankers and finance ministers don’t do what he wants, he will get rid of them, having already laid off three in two years.

The value of the lira has plunged in recent weeks and hit a record low on Monday – hitting 14.3 per dollar, down from around 7 per dollar earlier this year – pushing some businesses and households that have borrowed money from the foreigner in bankruptcy. . The sharp decline in the currency means that the prices of imported products continue to rise. Shortages are common and people struggle to buy food and fuel. The youth unemployment rate is 25%. The president’s popularity is collapsing and his opponents are emboldened.

As the elections approach in 18 months, Erdogan seems convinced that his strategy will enable the Turkish economy to emerge from its difficulties. Most economists, however, say a crash is more likely.

Mr. Erdogan’s aggressive growth strategies have already worked for him. Since he started ruling Turkey in 2003, he has undertaken expensive infrastructure projects, courted foreign investors, and encouraged businesses and consumers to take on debt. Growth has taken off.

“Turkey was seen as an economic miracle,” during the first decade of Erdogan’s reign, said Kadri Tastan, senior researcher at the Brussels-based German Marshall Fund. Poverty was cut in half, millions of people joined the middle class, and foreign investors were eager to lend.

But Mr Erdogan’s relentless push to grow has become unsustainable. Rather than back down, however, the dizzying borrowing continued.

The increasingly unstable economy was caught in a stalemate. High interest rates made foreign investors accept the risk and continue to lend, but they would hold back growth. Mr Erdogan was unwilling to accept this compromise and continued to support cheap borrowing as inflation took off and the value of the currency declined.

And he insists that high interest rates cause inflation – even though it’s low interest rates that put more money into circulation, encourage people to borrow and spend more, and tend to drive up prices.

“Erdogan has his own economic philosophy,” said Henri Barkey, member of the Council on Foreign Relations.

The economy hovered between these conflicting goals until 2018, when growing political tensions between Turkey and the United States caused the value of the lira to plummet.

The political stalemate eased, but the underlying economic problems remained. Mr Erdogan continued to push state banks to offer cheap loans to households and businesses and the borrowing frenzy continued. “Things never really normalized,” said Selva Demiralp, an economist at Istanbul Koc University.

When the central bank chief resisted pressure from the president to lower the interest rate by 24% in 2019, Erdogan fired him, the start of a scheme.

To support the lira, Turkish banks have started selling their dollar reserves. Those dollar stocks are running out now.

The global economic slowdown caused by the coronavirus pandemic has escalated tensions by limiting sales of Turkish products globally. Tourism, which was one of Turkey’s fastest growing sectors, was also hit hard.

By keeping interest rates low, Erdogan argues consumers will be more willing to continue shopping and businesses will be more inclined to borrow, invest money in the economy and hire workers.

And if the pound loses value against the dollar, he says, Turkey’s exports will simply become cheaper and foreign consumers will want to buy even more.

This is true to some extent, but it is expensive. Turkey is very dependent on imports like auto parts and medicines, as well as fuel and fertilizers and other raw materials. When the pound depreciates, these products cost more to buy.

At the same time, Mr. Erdogan’s contempt for conventional economic theory has scared off some foreign investors, who were eager to lend hundreds of millions of dollars to Turkish companies but are now losing faith in the currency.

And the more rates fall, the faster inflation rises. Over the past year, the pound has lost over 45% of its value and the official inflation rate has passed 20%, although many analysts believe the rate on the streets is much higher.

By comparison, an inflation rate of 6.8% so far this year in the United States (the highest in nearly four decades) and a rate of 4.9% in the euro area are enough to trigger the alarm.

In Turkey, soaring prices are causing misery for the poor and impoverishing the middle class.

“We cannot make a living,” said Mihriban Aslan, as she stood in line to buy bread in Istanbul’s Sultangazi district. “My husband is 60 years old, he can’t work much now. He has a small pension of 1,800 lire – currently worth around $ 125. “I sometimes do needlework at home to earn extra money,” she said.

Companies prefer to accumulate assets rather than sell them because they don’t think they can afford to replace them.

Ismail Arslanturk, a 22-year-old cashier at a neighborhood grocery store, complained that the price of green lentils has almost doubled. “I don’t believe the economy will be fixed after this point,” said Arslanturk, who added that he was forced to drop out of high school to help support his family. “I am hopeless.”

The president doubled down on his approach, saying he “will never compromise” on his opposition to higher interest rates. “Interest rates make the rich richer, the poor poorer,” he said in a national television interview last month. “We have prevented our country from being crushed in this way.”

The president invoked Islamic precepts against usury and called the interest charges on loans “mother and father of all evils,” and blamed foreign interference for the rising prices. Analysts like Mr Barkey of the Council on Foreign Relations have said that such comments are primarily aimed at attracting the more conservative religious segments of the country who represent the core of Mr Erdogan’s support.

The fundamental problem with Turkey, argues Barkey, is that it has an overconfident leader who has been in power for a long time. “He believes in his omnipotence and he makes mistakes,” said Mr. Barkey, “but he’s surrounded by so many men yes no one can challenge him.”

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