The Turkish Economy: Temporary Crisis?

Turkish President Recep Tayyip Erdogan, who has been invariably positive about the Turkish economy, caused a surprise on April 18 when he said “although some people are not noticing it, the numbers show that the Turkish economy has been sliding for three years.” After noting that the GDP had “fallen from $840 billion to around $800 billion because of the decline in the value of the currency,” he said that this was “a temporary crisis that would be overcome.” Erdogan recalled that he had been correct in predicting that “the 2008 global financial crisis which had a very serious impact on Europe and the United States” would have “a limited effect on Turkey” and said that after a partial slowdown in 2009 the government had “ensured that Turkey did not go off the rails” by “taking the appropriate measures, implementing them decisively and strengthening confidence and stability.” He confidently predicted that “the current slide would not last long” and that “Turkey would focus on its 2023 goals and continue on its path stronger than before once the global economic turbulence settles at a certain level.”

Erdogan’s comments were made in the context of a speech in which he once again made an appeal for a transition to a presidential system and were designed to strengthen his case for a new form of government in which he said “decisions could be made and implemented quickly.” Nevertheless, they drew attention to the negative economic trends in Turkey, most notably on the currency front. The dramatic decline in the value of the Turkish Lira (TL) reached a record low of 2.74 against the U.S. dollar on April 24, a loss of 15 percent since the beginning of 2015. Although it has recovered slightly in line with indications that the U.S. Federal Reserve is likely to delay its long-anticipated rate rise decision, the TL has nonetheless lost more than 20 percent of its value relative to the dollar during the last year and over 30 percent in the last two years.

It was also announced at the end of March that Turkey’s economic growth in 2014 had fallen to 2.9 percent, below the initial 4.0 percent government forecast and the revised forecast of 3.5 percent. Another unwelcome development was the rise in youth unemployment to 20 percent in January 2015, an increase of 2.0 percent from December, and of overall unemployment to 11.3 percent, its highest level in four years. At the same time, Turkey has been unable to reap the anticipated benefits from the fall in the price of oil since it is traded in dollars and Turkish export levels have not risen in spite of the weaker TL.

Although the large current accounts deficit has been shrinking with the slowdown in the economy, the problem it constitutes has nonetheless persisted with imports exceeding exports by a substantial margin, thus necessitating continued reliance on external funds. However, net foreign direct investment in Turkey –the amount of foreign investment in the economy minus Turkish investment abroad– which had risen to around $20 billion in both 2006 and 2007 fell to $8.8 billion in 2013 and to $5.4 billion in 2014. Consequently, the Turkish financial system, particularly since the global crisis of 2008 and the subsequent introduction of the U.S. Federal Reserve’s easy monetary policy, has become increasingly dependent on external short-term funds – often referred to as ‘hot money’– which move from country to country lured by attractive interest rates.

The continuous injection of foreign funds into the Turkish financial system has facilitated the provision of easy credit, allowing both corporations and individuals to borrow and spend on a massive scale and thus fuel the high level of domestic consumption that has helped to sustain the perception of a growing and thriving economy. It is estimated that household debt has increased from TL 7 billion in 2002 to TL 372 billion in 2013 while private sector external debt (long-term and short-term) rose from $43 billion in 2002 to $278 billion through February 2015. However, the growing reliance on foreign capital has inevitably left the Turkish economy more vulnerable to external factors and currency fluctuations. The recent loss in the value of the TL, in addition to its unavoidable impact on the rate of inflation and the burden on households, has made it much more costly for companies to pay back or roll over their $115 billion dollar portion of the $131 billion in short-term external debt (due within a year or less), particularly as 55.7 percent of it is owed in dollars.

The textbook response to a falling currency is to raise the interest rate, as was the case on January 29, 2014 when the TL tumbled to 2.23 to the dollar and the Turkish central bank raised the repo interest rate from 4.50 to 10.00 percent in an unusual midnight move. However, implementing such a policy has become very difficult for Central Bank Governor Erdem Basci, who has actually been under sustained political pressure to lower interest rates to reduce the debt burden for consumers and companies. Citing concerns about the negative impact of high interest rates on business investment and domestic consumption, Erdogan warned on January 21 that the Central Bank would “continue to get criticism as long as it continues to take wrong steps.” Consequently, despite the further depreciation of the TL, Basci has felt obliged to cut the rate five times since January 2014, most recently to 7.75 in January and to 7.50 in February and kept it unchanged at the Central Bank meeting on April 22.

Erdogan’s campaign against what he has been consistently calling “the interest rate lobby” goes as far back as January 2012, when he claimed that the lobby was seeking to reduce “the spending power of citizens.” Since then, he has continued to accuse it of trying to undermine Turkey’s economic success and in February charged that “anyone who defends [high rates] is at the beck and call of the interest rate lobby” which is “treason against this nation.” It is worth noting that Basci was appointed to the post of Deputy Central Bank Governor in October 2003 and promoted to the top job in April 2011 by the Justice and Development Party (AKP) government. He has also enjoyed the unwavering support of Deputy Prime Minister Ali Babacan, who has had overall responsibility for the economy for most of the past 12 years of AKP government. Both agree on the imperative of maintaining Central Bank independence, one of the key conditions of the International Monetary Fund’s emergency financial assistance plan to Turkey after the 2001 financial crisis and a fundamental requirement of foreign investors.

In an effort to ease tensions, Babacan and Basci provided a special briefing for Erdogan on March 11. The statement issued by the Presidential Palace after the meeting noted that it had focused on “Turkey’s strong economic fundamentals, policies implemented in line with strong and balanced growth targets, as well as the President’s sensitivities regarding interest rates and economic output.” While the criticism of the two men has been toned down since the meeting, it is clear that differences in how Turkey’s economic challenges should be confronted persist and, consequently, there is growing speculation about the likelihood and implications of a change in the stewardship of the economy. Babacan has been a crucial figure in instilling and maintaining external as well as domestic confidence in the Turkish economy since 2002. His likely imminent departure, mandated by the AKP’s three-term limit, coupled with the potential resignation of Basci, would raise additional questions about the durability of the mutually satisfactory relationship Turkey has enjoyed with foreign investors, especially ahead of the likely rise in the Federal Reserve interest rate.

The condition of the economy has been an essential component in the AKP’s successful strategy of gaining and consolidating power. The AKP came into office under Erdogan’s leadership in the aftermath of the 2001 crisis with its promise of economic recovery and the perception of sustained improvement has undergirded its unbroken string of successes at the ballot box. If Erdogan once again proves to be right about the temporary nature of the current crisis, all will probably continue to be well for him and the AKP in the elections of June 7 and beyond. On April 27, even after weeks of sustained depreciation in the value of the TL, the Minister of Economic Affairs, Nihat Zeybekci, who echoes the views of the president, sought to reassure the Turkish public by saying that there was “no cause for concern.” It is nevertheless worth recalling that the upward trend of votes for the AKP was interrupted in the 2009 local elections in the aftermath of the downturn caused by the global crisis.

Bulent Aliriza is director of the Turkey Project at the Center for Strategic and International Studies (CSIS) in Washington D.C. Craig Bonfield is a research assistant at the CSIS Turkey Project.

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