Turkey’s newly reelected president, Recep Tayyip Erdogan, has performed a rare and dramatic policy reversal. With the country facing a financial crisis, Erdogan has abandoned his controversial economic policies and turned to a market-friendly policymaker to lead the finance ministry.
Erdogan’s appointment of former US banker Mehmet Simsek as finance minister is widely seen as heralding an end to the Turkish leader’s unorthodox economic policy of cutting interest rates to tame soaring inflation, which is running officially at around 40 percent.
Erdogan, while reiterating his belief in the low interest rate policy, said he was ready to allow Simsek to follow the orthodox economic theory of raising rates.
Analysts describe it as a remarkable pivot.
“It marks a 180 and about-turn in economic policies from Erdogan,” said economist Timothy Ash, an associate fellow at Chatham House and senior strategist at Bluebay Asset Management.
“Remember, he has run unorthodox policies for much of the last decade,” Ash recalled.
“Simsek was in the previous Erdogan administration with unorthodox policies and left because he didn’t like them. So I think the fact that he has come back suggests that Erdogan has recognized he has to do something differently.”
Cost-of-living crisis
Many blame Erdogan’s low-interest rate policy for fuelling inflation, which remains stubbornly high, especially for food, with traders and buyers hit hard.
“Everyone’s purchasing power is decreasing, that is very clear,” warned Istanbul food market trader Gurol Simsek.
“Especially on the days when fruits and vegetables are sold in the market, it is very visible how much people’s buying capacity has decreased.”
The Turkish lira has weakened to record lows after Erdogan’s reelection, and Turkey has few foreign currency reserves left to defend it.
But the arrival of some of the world’s largest cruise ships in Istanbul is heralding the start of the lucrative tourism season. Tourists from abroad are expected to replenish foreign currency reserves, but time is running out to avert a crisis.
“Turkey is heading very rapidly to a currency crisis or, more formally speaking, balance of payments crisis,” said Atilla Yesilada, Turkey analyst for GlobalSource Partners.
“I personally think Turkey cannot survive this winter without major, substantive and credible economic policy change.”
Step towards the West?
Returning to the economic orthodoxy of increasing interest rates to rein in inflation is seen as opening the door to more foreign investment, and even moving closer to traditional Western allies.
“A return to orthodox economic policies will emphasise the importance of Western markets, Western lenders, financial institutions, etc,” explained Serhat Guvenc, a professor of international relations at Istanbul’s Kadir Has University.
“And this will probably have a bearing on the political aspect of foreign policy.”
However, slaying inflation with high interest rates is a painful process. It risks reducing economic growth and especially hurting Turkey’s large construction industry, which depends on cheap money.
Moreover, with the construction industry having close ties to Erdogan, questions remain as to whether the government will continue with an orthodox economic policy.
“The concern is that [if] six months down the line and before local elections that are due early next year, Erdogan may have enough of this tight policy and may actually change, put pressure on Simsek not to do what he needs to do or even fire him, the markets would react very badly,” says Ash.
But Turkey will pay a heavy price if it reverts to unorthodox policies, the economist warns.
“Turkey probably would face the most serious crisis in over 20 years. There would be a risk of runs on banks, the collapse of banks, sovereign debt crisis, maxi devaluation, and then a lot of inflation – building on hyperinflation, if he doesn’t do something now,” Ash says.
Erdogan has already declared his priority is to retake the Istanbul mayorship from the opposition. Politics – as ever – are likely to dictate whether the Turkish government makes difficult economic decisions and sticks with them.
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