Turkey’s central bank is anticipated to significantly increase its key interest rate for the second consecutive month, marking a shift towards more conventional economic policies under President Recep Tayyip Erdogan.
However, economists remain concerned that Turkey may still be on a risky path, as interest rates are considerably lower than the levels needed to counteract rising consumer prices. This dynamic encourages Turks to spend their savings quickly before their value erodes, potentially contributing to an overheated economy.
President Erdogan expressed satisfaction on Wednesday with the growing confidence in Turkey’s economic stability since the presidential elections in May. He highlighted this sentiment during an event organized by the Türkiye-US Business Council in New York.
Turkey’s tug of war on interest rates
Turkey is currently grappling with one of its most severe economic crisis in decades, largely attributed to President Erdogan’s unconventional belief that high-interest rates contribute to inflation. Erdogan has persistently advocated for lower borrowing costs to stimulate economic growth, often referring to high rates as “the mother and father of all evil.” This stance was a central theme of his re-election campaign. However, the annual inflation rate has been on the rise again, approaching 60 percent in August and outpacing projections made by Erdogan’s newly appointed economic team, comprised of former Wall Street executives and respected technocrats.
The team convinced Erdogan that Turkey was on the brink of a systemic crisis unless interest rates were raised promptly and significantly. The policy rate has surged from 8.5 percent at the time of Erdogan’s re-election to 25 percent last month. In August, the central bank implemented a substantial five-percentage-point increase; another hike is anticipated this Thursday. If the rate reaches 30 percent, it will be at its highest level in two decades—an action Erdogan implicitly supported by endorsing “tight monetary policy” this month.
According to Liam Peach, an analyst at Capital Economics, Turkey’s economy is not decelerating as rapidly as previously anticipated. Fitch Ratings recently upgraded Turkey’s outlook from “negative” to “stable” in response to the policy shift. However, they cautioned that uncertainty remains regarding the extent, duration, and effectiveness of the policy adjustment to combat inflation, partly due to political considerations.
Finance Minister Mehmet Simsek, credited by Turkish media with influencing Erdogan’s economic perspective, foresees the need to maintain elevated interest rates until the middle of next year. He stated that starting from the second half of 2024, they will discuss lowering interest rates.
Turkey’s lira delicate balancing act
Turkey is facing financial strain due to a costly bank deposit support scheme that compensates for the lira’s depreciation against stronger currencies. Unwinding this system could lead depositors to seek out dollars, renewing pressure on the lira. The lira’s value has dropped from 10 to the dollar two years ago to 29 this week.
Simsek took cautious steps towards reducing the support measures last month. However, he later stated his intent to bolster hard currency reserves to better support the lira before making more significant cuts to the $124 billion scheme.
Emerging markets economist Timothy Ash described the program as a “ticking time bomb” left for Simsek by the outgoing team. Given the high inflation rate, he pointed out that the lira needs to be allowed to adjust to a weaker exchange rate. Still, each depreciation results in compensation payments to depositors, incurring costs for the central bank. Ash suggested implementing much higher policy rates, ensuring they are realistically positive, could be a solution. However, it might also require the confidence-boosting impact of an external anchor, such as an IMF program.
