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SUBWAYsomething is working differently in Turkey than in the rest of the world. Although the pandemic is rampant there as well, interestingly, there are no dynamic or exponential curves. The daily number of infections has remained constant between 1,000 and 2,000 since June. The inflation rate is equally staggering. It was 11.76 percent in July, 11.77 percent in August and 11.75 percent in September, a uniformity not found anywhere else in the world.
Believe it all or not. But there is a clinical thermometer that shows the real state of the country quite reliably – the rate of the Turkish lira. And this is in free fall, it is about to break the historical mark of ten lire per euro, the rate is currently 9.63 lire.
If the crisis continues at this rate, the country could soon face a balance of payments crisis. In the past, this has always been avoided with the help of the International Monetary Fund (IMF), the United States, and Europe. But this time President Erdogan is following a different and dangerous strategy.
The new lira was stable for almost ten years
It was he who once stabilized the coin. On January 1, 2005, Recep Tayyip Erdogan, then Prime Minister, gave the country the new Turkish lira.
It replaced the old currency eaten away by inflation, and a million old lire became a new one. This was worth around 0.55 euros, so one euro cost 1.83 lire. And for almost ten years the rate was also reasonably stable, fluctuating around two lira per euro.
“For many years, President Erdogan was seen as a guarantor of stability and improvement,” says Sören Hettler, currency expert at DZ Bank. “A rapprochement with the European Union was part of its political strategy as much as its status as a reliable international partner for Western allies and NATO.”
Source: WORLD infographic
He also carried out fundamental economic reforms that removed fouling and unleashed the forces of growth. All this significantly increased the standard of living of millions of Turks.
But starting in 2012, Erdogan gradually changed course, at the latest since the failed coup attempt in mid-2016, and then aggressively. Little by little, he turned Turkey into an authoritarian state. Tens of thousands of people were arrested, freedom of the press restricted and the opposition increasingly repressed.
It is not known that most international investors base their investment decisions on factors such as freedom of the press or “flawless” parliamentary elections, Hettler says. But Erdogan made a crucial mistake before his eyes: he also submitted to the central bank. “The president appears to have crossed a red line.”
Especially since the central bank is now not only the executive body of its policy guidelines, but they are also extremely unorthodox. Because Erdogan defends a very crude theory of monetary policy. According to him, inflation is not fought by adjusting money, that is, by raising interest rates. On the contrary, inflation is slowed by putting more money in circulation, that is, by reducing interest rates.
“Since 2011, the real average key interest rate in Turkey has been largely below zero,” says Klaus Bauknecht, chief economist at IKB. Therefore, the inflation rate was always higher than the interest payable. This boosted the economy and even caused it to overheat at times.
But at the same time, the inflation rate continued to rise, and as a consequence, the currency began to fall. Since 2011, the lira has fallen from around 0.50 euros to just under 0.10 euros. The Turkish currency has lost around 80 percent of its value in a decade. The decline has even accelerated recently. Since the beginning of the year, the lira has slumped 30 percent against the euro.
Source: WORLD infographic
Typically, this currency collapse also has a silver lining: it makes exports cheaper and stays cheaper for foreign tourists, an important factor for Turkey, as the tourism sector contributes around 11 percent to economic output.
But this year, the Crown crisis meant that the number of foreign tourists in June and July, for example, was just four and 14 percent from the previous year. At the same time, the cheap lira did not lead to a rebound in exports.
“A devaluation of the lira would put more pressure on domestic demand and therefore on the local standard of living,” says Klaus Bauknecht. In other words: the collapse of the currency leads to an impoverishment of the population, Erdogan destroys the achievements of his early years.
But that is not all. Turkish companies and individuals are heavily indebted abroad. Liabilities in foreign currency maturing in the next twelve months amount to around $ 170 billion, which corresponds to about a quarter of economic output. But the more the value of the lira falls, the more difficult it becomes to service this debt.
“In view of the meager foreign exchange reserve endowment of around seven percent compared to gross domestic product, the situation in Turkey is becoming increasingly precarious,” says Thomas Gitzel, VP Bank Chief Economist, and concludes : “A balance of payments crisis is possible. The rating agencies are now also considering this and are giving the country a correspondingly poor credit rating.”
However, a bankruptcy of Turkey would forever destroy Erdogan’s reputation as a wise leader. And to divert attention from these domestic political difficulties, according to DZ-Bank expert Hettler, the president is repeatedly fueling foreign policy conflicts, most recently in the dispute with Cyprus and Greece over possible natural gas reserves or insulting the president. French.
“The Turkish president does not shy away from military conflicts,” says Hettler. Turkey is involved in Libya, Syria and recently also in Azerbaijan.
That can fuel nationalism at home and, for some, it can put the economic crisis on the back burner. At the same time, however, Erdogan cuts himself in his own flesh.
“In the past, the country always received generous help from the International Monetary Fund IMF in times of crisis,” says Thomas Gitzel. “The interest of the West, that is, the United States and Europe, in a stable Turkey was high due to the geopolitical situation of the country.” But the relationship between the countries has now been largely broken.
The only way out would be a drastic rate hike
“The deep political gap between Turkey and western states makes negotiations difficult in an emergency,” says Tatha Ghose, an emerging markets expert at Commerzbank. Furthermore, the IMF often demands reforms in exchange for help. “Of course, the legitimate question arises as to how far President Erdogan would submit to the IMF’s requirements,” says Ghose.
Therefore, the only short-term solution would be a drastic rate hike by the central bank. In fact, at the end of September, the key rate increased from 8.25 to 10.25 percent. But that is still below the inflation rate.
And instead of raising it even further, the central bank left the rate unchanged at its last meeting, no wonder: Erdogan had fired the predecessor of the current central bank president after he tried to end the lira crisis with a drastic increase in rates.
Source: WORLD infographic
But significant rate hikes alone would no longer be enough anyway. “This would only ensure a sustainable turnaround in the exchange rate if they were combined with a credible turnaround in policy, that is, if the president also revised his own unorthodox views on monetary policy,” says Tatha Ghose.
But for that he would have to admit a mistake, difficult to imagine. Therefore, the lira will continue to fall for the time being. And at some point, when the currency is as eroded by inflation as its predecessor currency, then perhaps a million old lira will be exchanged again.
