Graph of the week

Graph of the week

04-12-2020 | Einblicke

Erdogan navigates a new economic course

  • Jaap  van der Hart
    van der Hart
    Equity Fund Manager

Turkish president Erdogan is well-known for his outspoken opinions on economic and monetary policy. In his view, raising rates does not lead to lower inflation, as is suggested by conventional economic theory, but is actually pushing up inflation levels. Or as Erdogan put it in 2018: “Because my belief is: interest rates are the mother and father of all evil.”

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As a result, the Turkish central bank came under a great deal of political pressure to lower rates in recent years. And words turned into deeds when the head of the central bank was replaced in July 2019. So no one was surprised to see rates cut in quick tempo in the following months.

Now Turkey is a country with relatively high levels of foreign debt and a history of deficits on both the balance of payments and the budget. This means that the willingness of international investors to invest in Turkey is a major factor in the value of the Turkish lira. However, low rates tend to deter asset investments.

The Turkish lira is therefore one of the emerging market currencies that saw that sharpest declines in value this year. The corona crisis and non-existent tourism also play a major role of course, but the impact of this is exacerbated by a fragile financial position and aggressive monetary policy.

A more stable course

By early November the currency had fallen by 30%, however, and enough was enough. This decline was sufficient reason even for Erdogan to change course. On 7 November the first casualty was the head of the central bank, who was fired and replaced with former Minister of Finance Naci Ağbal. The very next day, Minister of Finance Berat Albayrak stepped down, owing officially to ‘health problems’.

Given that he is also Erdogan's son-in-law and is considered by many as his potential successor, this was a significant move. Erdogan also started singing a different tune: “Like everywhere else around the world, in our country it is the central bank’s job to determine and implement policies needed to rein in inflation”.

The latest important step was when rates were raised on 19 November from 10.25% to 15%. The currency reacted positively to all these changes and rose by no less than 13% in value between 6 and 19 November. These measures are not going to solve all the country's economic problems overnight, and neither is Erdogan’s economic policy going to win back the full confidence of financial markets any time soon. However, an important step has been taken towards a more balanced monetary policy and a more stable exchange rate for the Turkish lira.

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