A Look at Turkey's Economic Background
When thinking about Turkey, one might picture a tourist destination, the Ottoman Empire, turkeys (the bird), or perhaps Salt Bae. However, Turkey's economy is a fascinating and peculiar case.
Early on, Turkey maintained a relatively closed economy, developing at its own pace. However, after World War II, witnessing the rapid economic growth of Europe, Turkey sought to join the European Union's predecessor several times. It opened its doors to Western capital investment, but this openness led to a significant foreign debt burden for the Turkish government. To counter this, the government resorted to printing money and exchanging it for US dollars to repay debts. This, coupled with the impact of the oil crises in the 1980s, resulted in soaring inflation in Turkey, often exceeding 120%.
This brief overview highlights two core issues that have plagued Turkey's economy: foreign debt and inflation.
Turkey's Economic Transformation and Its Challenges
Recognizing the need for change, the Turkish government embarked on a series of reforms starting in 1999. The most crucial step was granting independence to the central bank, separating it from government control. This move was significant because the central bank holds immense power, controlling both money printing and interest rates. By making the central bank independent, the government aimed to build trust with the market, reassuring investors and trading partners.
In the following years, the Turkish government implemented austerity measures, reducing spending, and successfully lowering the debt-to-GDP ratio to an impressive 30%. To put this into perspective, a ratio below 50% is considered healthy. For comparison, even the fiscally conservative German government has rarely seen this ratio drop below 60%.
Simultaneously, Turkey liberalized its financial system, allowing the Turkish Lira to float freely to balance supply and demand. To combat high inflation, interest rates were raised to a staggering 100%. These reforms marked a complete turnaround for Turkey, shedding its image as a struggling economy and embracing a path of fiscal discipline and economic openness.
These measures ushered in a period of prosperity for Turkey. Significant foreign investment poured in, fueling economic growth. From 2001 to 2016, with the exception of a minor setback during the financial crisis, Turkey's annual GDP growth rate remained between 5% and 12%. Inflation was kept remarkably low, and various sectors, including heavy industry, textiles, and agriculture, experienced rapid development.
However, beneath this economic boom, two significant problems persisted:
- Persistent current account deficit (trade deficit): Turkey's imports consistently outweighed its exports, requiring the country to spend US dollars and Euros to finance the deficit.
- Rising external debt: Although government debt decreased, private debt, primarily in foreign currencies like Euros, British Pounds, and US dollars, continued to rise. While not inherently negative, this reliance on foreign currency loans exposed Turkey to risks associated with currency fluctuations and potential capital flight.
The Erdoğan Era and Unconventional Economic Policies
In 2014, Recep Tayyip Erdoğan, who had served as Prime Minister since 2003, became Turkey's President. While he played a role in Turkey's economic rise, his presidency took the country in a different direction.
Concerns arose about a potential dollar shortage due to the large trade deficit. When Turkey purchased fighter jets from Russia, a move that angered the United States, then-President Trump threatened to "totally destroy and obliterate the Economy of Turkey." International capital started to flee, causing the Turkish Lira to plummet.
To control the situation, the central bank raised interest rates. However, Erdoğan opposed this move, arguing that lower interest rates, not higher ones, were the solution to controlling inflation. He believed that lower interest rates would stimulate demand and investment, ultimately leading to increased supply and lower prices.
Erdoğan's economic views, rooted in his religious beliefs, clashed with conventional economic thinking. He viewed interest as "the mother and father of all evil," aligning with Islamic teachings that discourage profiting from money lending. To bypass the perceived sin of charging interest, Turkish banks employed creative methods like buying and reselling properties at higher prices while offering zero-interest loans.
Despite the central bank's efforts to stabilize the economy, Erdoğan's insistence on lowering interest rates exacerbated the situation. He used his power to replace three central bank governors within two years, ultimately dismantling the institution's independence.
The Impact of Erdoğan's Policies
While Erdoğan's unconventional policies did lead to increased consumer spending and a booming stock market (rising by 300% in 2022 while other global markets faltered), many argue that this prosperity was a facade. Consumers and investors were driven by panic and fear of further currency devaluation rather than confidence in the future.
The most significant consequence of Erdoğan's policies has been rampant inflation. In 2022, Turkey's inflation rate skyrocketed from 20% to 80% (official figures, with unofficial estimates ranging from 100% to 200%). This has eroded the purchasing power of Turkish citizens, particularly impacting low-income households.
Erdoğan's Strategy to Counter the Crisis
Facing growing discontent, Erdoğan has focused on two key strategies:
- Preventing capital flight: He introduced measures to discourage citizens from converting their Turkish Lira to foreign currencies, including a controversial scheme where banks compensate holders of Lira deposits for any losses incurred due to currency devaluation.
- Attracting foreign investment and alliances: Recognizing Turkey's dependence on energy imports, Erdoğan has shifted his stance and strengthened ties with energy-rich nations. He opposed Western sanctions on Russia, increased trade with Moscow, and secured a $9.1 billion deal for a new nuclear power plant. He also mended relations with the UAE, securing a $49 billion currency swap agreement, and sought closer ties with Egypt and Qatar.
The Uncertain Future of Turkey's Economy
The devastating earthquakes that hit Turkey in February 2023, claiming over 45,000 lives and causing an estimated $800 billion in damages, have added another layer of complexity to Turkey's economic challenges. The long-term impact on the country's economy, particularly on inflation, government debt, and public confidence, remains uncertain.
Whether Erdoğan's unorthodox methods will ultimately succeed in taming inflation or lead Turkey down a path similar to Venezuela or Argentina remains to be seen. As Turkey heads towards its presidential election in June 2023, only time will tell if Erdoğan's gamble will pay off or further exacerbate the country's economic woes.