By Marta Carina Franco
10 years ago, Turkey was the poster child of emerging market economies, ripe for foreign investment and potential for growth. The implementation Kemal Derviş’s economic policy following the 2001 economic crisis allowed Turkey to surpass expectations. By 2005 Turkey was even taking strides towards EU membership. Offering an energetic, young labor force, growing industry, and a structured, well-regulated banking system, Turkey was a hotspot for foreign direct investment.
Today, however, mention of Turkey arouses unease and panic. The Economist has recently dubbed Turkey an “investment darling” turned “junk rated emerging market.” How did Turkey get to this point, and what has changed in the last 10 years? The answer lies in political uncertainty and a dangerous dependence on foreign capital.
In 2017 Turkey had the fastest growing G20 economy, boasting 7.4% GDP growth. The government portrays this statistic as a positive sign of Turkey’s global economic influence. In reality, Turkey’s rapid growth is indicative of an overheating economy headed for crisis.
2017 growth was largely driven by government sponsored construction projects and the Credit Guarantee Fund (KGF). Established by the government in May of 2017 to sustain Turkey’s growth, the KGF backs loans given by Turkish banks to certain industries with government collateral. Under the KGF, banks were able to extend loans to Turkish businesses with financial guarantee by the government, accelerating economic growth throughout 2017.
Reliance on foreign capital has also plagued the Turkish economy for some time, as corporations have largely funded their growth with foreign loans. Today, the IMF estimates that corporate debt is 55% of Turkey’s GDP. Combined with skyrocketing inflation and a plummeting lira, foreign debt places the entire economy at risk for the largest crisis since 2001. It is no wonder that in June and July of 2018, Moody’s downgraded the ratings of Turkish banks to Ba2 and Fitch downgraded the country’s debt rating to BB.
Although this paints a grim picture of Turkey’s economic outlook, there is a way to lessen the effect of economic decline. That solution may be the implementation of Derviş’s 2001 structural reforms, as ensuring Central Bank independence would instill confidence in markets.
Investors and the business community have called for the Central Bank to act independently and pursue the policies it sees best fit for the economy. Economists widely agree that raising interest rates is the best way to stabilize the lira. Yet the Central Bank’s reluctance to raise rates has demonstrated the influence of executive government. In mid-May 2018, President Erdoğan gave an interview with Bloomberg in London where he identified high interest rates as “the mother and father of all evils,” much to the confusion of economists and investors everywhere. He has expressed a distaste for high interest rates, citing them as the cause of inflation.
His remarks rattled markets, with the lira dropping in a week from 4.32 TL/USD to 4.9 TL/USD. Shortly after on June 7, the Central Bank did raise interest rates to 17.75%, prompting the lira to raise in value by 2%. While this raise was a positive step, it was not enough to put investors at ease, or significantly stabilize the economy. Concerned investors emphasized the need for an independent Central Bank to further raise interest rates. But on July 10, when President Erdoğan appointed his son-in-law, Berat Albayrak, minister of finance, the lira began to freefall and dipped to a record low of 4.94 TL/USD on July 11.
On July 24, many were hopeful the Central Bank would announce a raise in interest rates. To the dismay of investors, the Central Bank announced it would not be raising rates and the lira dropped again on July 24. In 2018 the lira has lost about a quarter of its value. This currency devaluation paired with high inflation has already begun to affect Turkish citizens, with food prices rising drastically. The need for a contractionary monetary policy was most recently ignored on August 6, when the Central Bank changed reserve rules and called on banks to sell their loans to increase liquidity. The more the Central Bank stalls on the decision to raise rates, the more the economy will suffer when reality sets in.
Another important factor in the decline of the Turkish economy has been Turkey’s global image. As a NATO ally, Turkey enjoyed a level of credibility for years making it a reliable market for US and EU investors. Yet tense relations and estrangement from Western values have harmed Turkey’s image as a Western-oriented state bridging the East and West. Recently, estrangement between Turkey and its NATO allies has been highlighted by Turkey’s interest in purchasing the Russian S400 missile defense system. The US has threatened to sanction Turkey if it buys the S400, claiming the Russian system would compromise NATO’s defense and intelligence systems.
Questions about Turkey’s commitment to the rule of law at home have also largely harmed Turkey’s image. The detention in Turkey of American pastor Andrew Brunson most prominently underlines the decline in US-Turkey relations. Brunson lived in Tukey for over 20 years before being arrested in October of 2016 on charges of conspiring in the attempted July 2016 coup attempt. Since his arrest, the Turkish courts have consistently pushed back his court date. Turkey has been accused by the US of using Brunson as a bargaining chip to extradite Fetullah Gülen. Despite calls by the American government to release Brunson, the Turkish government moved him to house arrest on July 25 and decided to continue his detainment until his next court date in October.
As a result, on August 1, the US Treasury imposed sanctions on Turkey’s Ministers of Justice and Interior, citing the Magnitsky Act. President Erdoğan announced on August 4 that Turkey would be imposing retaliatory sanctions on US officials with the same positions. The fraught US-Turkey relationship has arguably reached the lowest point since the 1973 embargo on Turkey that followed the Turkish intervention in Cyprus. Since August 1, the lira has plumetted to its lowest point ever of 5.4 TL/USD. The more relations worsen, the more the lira will drop.
On June 27 at an event by the Brooking’s Institution, TÜSİAD Senior Fellow and Director of the Turkey Project, Kemal Kirişci said “the writing is on the wall” with regards to Turkey’s political situation and the need for reform. The same applies to the economy. Political instability and misguided economic policy have resulted in high inflation, unemployment and volatile exchange rates. Although much harm has been done, the Turkish government can lessen the damage. The writing is on the wall, but whether Turkey addresses that writing is a question that only time will answer.