51吃瓜

On the night of May 28, Turkish President Recep Tayyip Erdo臒an took to the podium and gave his victory speech. Following an election day whose results defied both domestic and international , Erdo臒an thanked his supporters and gave a speech which conciliatory messages with partisan rhetoric. The content of the speech, however, was less surprising than the location where it was delivered. Erdo臒an stood on the balcony of the presidential compound, a lavish new residence and official complex completed in 2014, which the president had constructed in defiance of court and opposition protests.

The situation highlighted the paradox of the entire Turkish election. After a year of , historic lows for the Turkish lira and a devastating series of earthquakes, all odds seemed to favor the opposition. However, the economic difficulties faced by Turkish citizens did not dissuade a majority from voting for Erdo臒an. On the night of his victory, the president spoke from the balcony of a compound that had cost north of , or about 15 billion liras at today鈥檚 exchange rate. He addressed supporters鈥攎any from 鈥攚ho had seen their lira savings erode and their cost of living in the last 18 months. Several observers the choice of platform and how citizens could freely elect a leader whose policies created such tangible difficulties.

Harnessing the economy as a rhetorical tool

It has that Erdo臒an鈥檚 victory depends on his constituency鈥檚 willingness to ignore the state of the economy. After all, economic crises generally for incumbent governments. In Turkey this effect should hold doubly true, since Erdo臒an鈥檚 unorthodox views on economics鈥攊n particular his on slashing interest rates鈥� to inflation and the depreciation of the lira. While supporters might hope that Erdo臒an鈥檚 unorthodox position on interest rates in the long run, it would make sense to avoid mentioning economic topics at a time when the pain is still so acutely felt by every family in the country.

Yet the Erdo臒an campaign chose a different approach, bringing the economy to the of political rhetoric. In the leadup to the election, Erdo臒an to continue slashing interest rates, encouraged citizens to take pride in the lira and even his own economic bona fides. Over the past years, these messages have been wrapped in rhetoric that鈥檚 unusually politicized for such economic topics, with the president going so far as to , 鈥淚f they have their dollar, we have our Allah.鈥� Pro-Erdo臒an commentators frequently that Western governments try to the Turkish economy and devalue the lira. In Erdo臒an鈥檚 words, his policy nothing short of an 鈥渆conomic war of 鈥� where Turkey 鈥渇ighting against the interest rate lobby鈥� and 鈥渆nemies of production and employment.鈥�

This rhetorical approach works surprisingly well. Erdo臒an can pinpoint how slashing interest rates helps Turkish citizens in direct ways, by easing access to and . Even the approval rates for loans reflect this political strategy, with small and medium-sized businesses, domestic employers, lira-heavy corporates, and export-oriented firms seeing a steep in credit approvals. Meanwhile, the second-order effects of slashing interest rates鈥攏amely the slump in demand for liras in international currency markets and the inflation caused by higher costs for importers and increased spending by domestic consumers鈥攁re too abstract for most citizens to consider. This leaves Erdo臒an with a unique ability to claim credit for the benefits of low interest rates while blaming the more indirect negative consequences on foreign actors. 

A uniquely receptive audience

Turkish economic history lends tailwinds to Erdo臒an鈥檚 narratives on the economy. Interest rates in Turkey have historically been by Western standards. Even in the last five years, Erdo臒an occasionally made concessions that allowed the central bank to its policy rate鈥攚ith the results usually proving very short-lived. Turkish citizens have witnessed a steady and seemingly inexorable weakening of their currency, regardless of different interest rate policies. This peculiarity has led some Turkish economists to infer that Turkey from developed countries in its economic policy. Considering the experience of the average household, it is easy to understand Turkish citizens鈥� aversion to conventional economic wisdom and their openness to strong rhetoric on economics. 

Another aspect of Turkish economic history lends credence to Erdo臒an鈥檚 arguments. Historically high inflation and the unpredictability of the lira鈥檚 exchange rate in the 80s and 90s鈥攚ell before the first Erdo臒an government鈥攍ed citizens to change domestic assets into . This 鈥渄ollarization鈥� of the Turkish economy has continued, with now held in foreign currency or gold. Such dollarization for countries since it reduces the government鈥檚 monetary control, more volatile inflation, and in the banking system due to uncovered foreign liabilities. Moreover, the concept of dollarization relates directly to the debate on interest rates. Historically high interest rates made borrowing in liras unattractive to most Turkish citizens, and the resulting preference for dollar-based loans contributed to the of the Turkish economy. The increasing preference for dollars among the domestic population further exacerbated the instability of the lira.

Clearly, dollarization cannot be blamed on foreign actors, since Turkish citizens made their own decisions to open dollar accounts and take dollar-based loans. However, viewed as a characteristic of the current economy, Turkish citizens understandably worry about the predominance of foreign currencies and the instability this causes for the lira. Erdo臒an鈥檚 economic messaging astutely builds on this concern, harnessing patriotic and anti-dollar slogans to support the government has implemented over the past years. Even from a conventional economic perspective, de-dollarization efforts hold merit, although the social consensus around them is built with simplified explanations.

Naturally, the label of de-dollarization should not exempt individual policies from scrutiny. Certain measures, such as Erdo臒an鈥檚 flagship policy of slashing lira-based interest rates, can cause harm even if they nominally contribute to de-dollarization. But to truly understand how these policies are received by the majority of the population, observers must acknowledge Turkey鈥檚 unique historical experience with high interest rates and an overly dollarized economy. These factors make Turkish voters more receptive to the kind of political rhetoric and economic experimentation that Erdo臒an has pursued.

The dangers of raising rates

A further characteristic of Erdo臒an鈥檚 economic narrative is that it constrains any attempt to change course. In the leadup to the May elections, opposition leader Kemal K谋l谋莽daro臒lu Erdo臒an鈥檚 economic policies and his intention to reassert the independence of the central bank. However, he kept relatively about concrete plans to raise interest rates. His hesitation is understandable because the Turkish economy now runs on the cheap access to capital Erdo臒an has enforced. With inflation still above 40%, a hypothetically victorious opposition government would have needed to raise rates drastically鈥攑otentially targeting a central bank policy rate between and 鈥攖o quickly bring the real (inflation-adjusted) interest rates out of the red. 

Households would immediately feel the burden of such a dramatic rate increase, as consumer loans, credit card debt and mortgages become prohibitively costly, the equity value of real estate property , and corporate credit dries up. Meanwhile, Turkish banks would experience similar issues. Government regulations require banks to buy government bonds, which Turkish bond yields and thus artificially reduces the worth of these bonds as assets to the banks. Rapidly increasing interest rates would widen this spread and leave banks with strongly under-valued bond assets on their balance sheets. 

Coupled with currency instability and a presumably higher ratio of non-performing loans, banks would therefore be hard-hit by a steep rate increase. Their capital adequacy ratio (the portion of the bank鈥檚 outstanding loans that are covered by their assets) from 17% to an estimated 12%鈥攔isky territory by Turkish standards. Banks would respond by severely cutting back lending and imposing tougher conditions for credit approval, thus further restricting the economy鈥檚 access to capital. In such an extremely tight monetary environment, corporations would respond with layoffs, possibly putting the economy on track for a true recession. 

Given the severity of these impacts, K谋l谋莽daro臒lu and his allies found their range of maneuver constrained. After all, it is impossible for a politician to campaign on a recession platform. Erdo臒an could credibly communicate a message centered on , arguing that millions of jobs depend on him remaining in power and continuing his loose monetary policy. Meanwhile, voters the opposition and their international advocates with the prospect of recession and unemployment, which rendered the electorate more receptive to Erdo臒an鈥檚 rhetoric on foreign threats to the economy.

The dangers of not raising rates

Understandably, the Erdo臒an campaign neglected to highlight one fundamental fact about the economy: that recession may be inevitable even if the president stays in power. As late as last year, the government might have hoped Turkey could use its high growth鈥� year-over-year in the second quarter of 2022, now down to a still-strong 鈥攖o 鈥溾�� inflation. This view is made more attractive by the fact that Turkey a classic fiscal problem and avoided steep deficits in the years leading up to the election, thus eliminating one of the root causes of inflation found elsewhere in the world. But severe risks attend Turkey鈥檚 extraordinarily loose monetary policy, primarily in the form of continued currency depreciation. The lira has already since the election. Despite recent and foreign currency loans from Turkish private banks, the central bank has most of its convertible foreign exchange reserves in a bid to prop up the lira prior to the election. This leaves no ammunition to respond to future fluctuations.

This circumstance holds three distinct dangers for Turkey. First, in a country so heavily on imports, a drop in the value of the lira immediately raises costs for Turkey鈥檚 many importers, who then pass on these costs to consumers in the form of higher prices. The central bank has exhausted its tools to directly strengthen the lira, leaving Turkey more vulnerable than ever to this form of pass-through inflation.

Second, Turkey may find itself in a balance of payments crisis, where the stock of foreign currency available proves inadequate to cover the cost of imports. The influx of foreign currency during the summer tourist season can delay this crisis. However, increased demand for energy imports during the winter looms large. Turkey no longer has the resources to cover the gap, even if some natural gas from Russia can be imported . 

Third, Turkey experiences a surprising degree of balance sheet risk. Despite a historically healthy fiscal policy and low public debt, Turkey鈥檚 central bank hosts a number of 鈥渉idden鈥� liabilities. In its search for foreign currency to support the lira, the central bank has frequently borrowed dollars from Turkish commercial banks. The result has been to the foreign currency balance sheet risks of private banks to the public sector. The central bank will need to find the foreign currency to cover eurobonds it didn鈥檛 issue, as well as the liquidity to reimburse private banks鈥� dollar deposits should people ever try to withdraw their money. With the central bank鈥檚 foreign exchange reserves exhausted, the only way these obligations can be met is by selling liras鈥攖hus further weakening the exchange rate.

What does the future hold for the Turkish economy?

While rate increases cannot directly regenerate foreign exchange reserves, a significant rate hike could theoretically ease the effects of these crises. Bringing inflation-adjusted interest rates above zero would dampen domestic spending by making deposits more attractive, thereby curbing inflation. Higher interest on lira deposits would also attract foreign investors to buy liras, thereby potentially ending the currency鈥檚 downward spiral while restoring foreign exchange reserves thanks to an uptick in FDI. 

In the weeks following the election, the imminence of multiple crises led many observers to believe that Erdo臒an had no option but to backtrack on his long-held position and raise interest rates. Signs that Erdo臒an 鈥攁long with key 鈥攈ad begun to consider the idea. The reinstatement of former Merrill Lynch economist Mehmet 艦im艧ek to the post of finance minister and the tapping of former First Republic executive Hafize Gaye Erkan to lead the central bank this possibility. International financial institutions watched eagerly, that the policy rate鈥攌ept at 8.5% since March鈥攚ould rise drastically to somewhere between 20% and 40%.

Once in their new positions, however, 艦im艧ek and Erkan found themselves constrained by the same problems that plagued the opposition on the campaign trail. Much of the credibility built by Erdo臒an during this election hinges on his ability to stick to his economic views, , continue providing and avoid the kind of recession that voters feared from a K谋l谋莽daro臒lu administration. Any interest rate hikes that drastically tightened the economy鈥檚 access to capital would ripple through the job market and evaporate credit. A significant change would prove especially dangerous for the ruling party as the country prepares for next March, where Erdo臒an鈥檚 AK Party will seek to control of the Istanbul and Ankara mayor鈥檚 offices.

As a result, when the central bank鈥檚 Monetary Policy Committee on June 22nd finally announced an increase in its policy rate from 8.5% to 15%, . With inflation still at 40%, real interest remains squarely in the negative zone. While some analysts that further gradual hikes may follow鈥攁 position expressed by 鈥攖he market shows unequivocal pessimism. Instead of the increase in value that economists expected from a rate hike, the lira fell a further 7% against the dollar. Ironically, this depreciation may further discredit conventional economists and make the Turkish population even more receptive to Erdo臒an鈥檚 unorthodox views. It could also serve as a rhetorical tool to justify a return to Erdo臒an鈥檚 usual interest-slashing policies.

The observers now surprised by the lackluster hike in the policy rate are ignoring the fundamental lessons of Erdo臒an鈥檚 economic rhetoric over the past three years. The president鈥檚 insistence on low interest rates is more than a personal belief: it is a core tool of political communication. Instead of avoiding economic discussions, Erdo臒an brought the economy to the front and center of campaign rhetoric. The president harnessed Turkish citizens鈥� unique openness to interest rate experimentation while shrewdly embedding economic topics in the core messages of national pride and self-reliance that increasingly motivate the electorate. Meanwhile, the opposition found itself tainted by the fact that a radical pivot on interest rates would end access to cheap capital and endanger jobs鈥攖he same dilemma that now constrains Erdo臒an鈥檚 own finance minister.

It should not surprise us that Erdo臒an proved willing to moderately raise rates on June 22nd. for such a move鈥攁nd all have proved temporary. Much like in past rate hikes, Erdo臒an is ardently that his fundamental position on interest remains unchanged, and that it is a 鈥溾�� to think otherwise. The counterintuitive fall of the lira after the June 22nd announcement may help cement his view. We must therefore not conclude that the Turkish government is pivoting to a conventional economic stance. Difficult times lie ahead, when the electorate鈥檚 vote of confidence in Erdo臒an鈥檚 unorthodox monetary policy must be balanced with the need to fix looming economic crises. It will not be an easy task. 

[ edited this piece.]

The views expressed in this article are the author鈥檚 own and do not necessarily reflect 51吃瓜鈥檚 editorial policy.