Since the start of 2021, the Turkish lira (the currency in place in Turkey since the 19th century) has lost over 40% of its dollar value. This is more than any other major currency this year. The violent depreciation worsened in the last few months, with rates falling of 34% since October.
In response, the Central Bank of the Republic of Turkey guided by President Erdogan’s orders, continuously lowered interest rates. The latter are now instead fixed at 15%. They are predicted to be cut again to 14% by the end of this quarter.
This unusual reaction from the Central Bank comes from Erdogan’s unorthodox economic policy. This policy consists of,when faced with a falling currency, keeping interest rates low to promote economic growth.
Interests rates are considered to be “an evil that make the rich richer and the poor poorer”. Although a falling currency is a symptom of an unstable economy, Recep Tayyip Erdogan’s tactics seem to be justified by an apparent economic growth.
Indeed, Turkey’s economy grew by 21.7% in the three months to July. Exports were very strong as well, as explained proudly by the president. A growing economy should therefore suggest improved living standards, which however, is not the case at all.
Why isn’t this strategy working?
Turkey’s strategy has led to high inflation. In October, inflation was flirting with the 20%s, four times the country’s 5% target. Traditional economic theory explains this: when central banks lower interest rates, money becomes cheaper to borrow. The money therefore becomes less valuable, and eventually, a cycle of inflation is underway.
An example of this inflation is the soaring price of the tomato. A product essential to Turkish food: tomato prices are up 75% since August 2020. A more tangible or human indicator of the state of the Turkish economy is a significant decrease in living standards.
The decrease of living standards caused by inflation is dramatic: the GDP per person is below 2009 financial crisis rates, amounting to 8,538USD in 2020.
The first decade of Erdogan’s time in office marked improvements in living conditions, and the emergence of a Turkish middle class. However, according to the World Bank, the last few years have seen 3.2 million households sinking into poverty. Erdogan’s warnings of the poor getting poorer is an undeniable reality.
What is causing this decrease in the Turkish Lira?
The most recent explanation for this significant loss of currency value is Turkey’s economic policy, especially regarding interest rates. Erdogan’s departure from traditional strategies have sparked worries and created mistrust in the Turkish lira, decreasing investments.
The Central Bank’s three-time leadership change in only two years is an additional testimony of Turkey’s loss of credibility in international markets. This rupture was clearly symbolised and made clear when the President declared an “economic war of independence” in a recent speech. However, recent political instability is not the only cause of this phenomenon.
Turkey has already been in a currency crisis in 2018 and has had difficulties emerging entirely of it since. The lack of trust in the Turkish lira finds its roots in the continuous inability of Turkey to have economic growth without soaring inflation. Inflation causes exports to be cheaper than imports, resulting in an excessive account deficit.
While there are many economic justifications for the fall of the lira, political implications are considerable when assessing why international investments mistrust the currency. Indeed, there have been remains to the 2018 tensions between the United States and Turkey.
The tariffs slapped by the Trump administration on steel and aluminium weighed heavy on the economy, which are in the top ten exporting products for the country. Although Turkey was slightly less impacted by the pandemic than other countries, the fight against COVID-19 further worsened the economic situation.
The threat of a resurgence could shadow economic growth prospects.
Uncertainty and dissent
President Erdogan does not seem to budge his economic policy stance. But, few believe that his new economic model could turn the situation around and stop the fall. Turkey’s leader has attempted soothing the public with calming words.
His focus on small wins over addressing general worrying trends, has, in turn, initiated demonstrations among young Turks.
Economist Arda Tunca explains the atmosphere of uncertainty reigning over the country well. He states: “this is the first time we are using a model completely beyond economic theory. Even when there were crisis’s we could guess what would happen. Now, it’s impossible”.