Economic crisis in Turkey: an introduction

What’s going on in Turkey?

Turkey has been facing currency and debt crisis for a long time. The value of the Turkish lira has recently fallen, losing significant value against the dollar. In November, it depreciated, losing more than a quarter against the dollar. In 2021, the lira has lost more than half of its value.

The exchange rate in 2014 stood at 2.189, which reached 13.49 in 2021, implying that 13 lira would be needed to buy 1 dollar worth of goods compared to 2 lira in 2014. In addition, the country faces a sharp rise in the rate of inflation accompanied by an increase account deficit, rising borrowing costs and defaults.

This could be due to the unconventional policies adopted by Turkish President Recep Tayyip Erdoğan regarding interest rate changes and Turkey’s fluctuating exchange rates.

What caused this crisis?

  • Compared to other currencies like US Dollar, Euro, the supply of liras in the market was growing rapidly which led to weakness of the currency in international markets.
  • The main reason for the current economic crisis in Turkey could be the unconventional monetary policy of the Turkish President and his authoritarian regime. He believes that a reduction in the interest rate would make it possible to contain the rise in prices and stimulate economic growth thanks to exports and the increase in production capacity. This is unlike the popular beliefs of most prominent economists, which fueled the lira’s depreciation. Last year, the lira lost 44% of its value as the country’s administration lowered the interest rate successively.
  • In 2019 he sacked three central bank chiefs over their opposition to his policy of maintaining the value of the pound. Currently, inflation in the country is around 20% according to official estimates, while unofficially it is 40%. These events raised doubts about the independence of the Turkish Central Bank, causing a loss of confidence in the lira.
  • Additionally, Turkey has a large current account deficit, which has been covered by fueling foreign investment. Foreign investors want some level of protection against exchange rate fluctuations to forecast their business prospects and understand the value of their investment while converting the pound back into the dollar. However, the exchange rate becomes unpredictable due to the Central Bank’s erratic behavior towards the lira supply. Hence, the demand for liras from the foreign investor has decreased in the market and hence their supply has increased leading to frequent depreciation.
  • Nowadays, people are converting their currency to US dollars, cash or US dollars to stop the erosion of their wealth. Many citizens began to migrate to other regions.

Problem of escalating geopolitical tension

There is ongoing tension between the United States and Turkey and it has escalated since the Trump administration. In 2016, Turkey arrested an American pastor for plotting against Turkish President Recep Tayyip Erdogan by supporting a failed coup. In its response, America in 2018 announced sanctions against Turkish officials.

Moreover, as the Turkish currency deteriorated against the dollar, US President Donald Trump announced an increase in tariffs on imports of steel and aluminum products from Turkey, which severely affected their relationship. . Therefore, Turkey raised tariffs on iPhone, alcohol, cars, tobacco and other products in retaliation.

Recently, the president was condemned by ambassadors from 10 countries for the imprisonment of Osman Kavala. Kavala, the 65-year-old businessman, has been accused of plotting to overthrow the president. Ambassadors from the United States, Germany, Finland, Denmark, France, the Netherlands, Canada, Sweden, Norway and New Zealand demanded his release as they believed the allegations against were baseless to him. This has led to Turkey’s poor relationship with partner countries.

The Turkish president and their comrades believe that the fall of the lira is due to a plot mounted by foreign actors to overthrow his regime. He blames the conspirators for May’s fall in the value of the Turkish lira. Turkey’s relations with various Western partners are already strained and have further worsened. This can lead to increased volatility of the Turkish lira and increase inflation by more than 20%. His authoritarian ideology would create economic turmoil in Turkey, and Turkish residents would have to bear the brunt of his movements and actions.

Other disputes

  • The dispute over maritime rights and natural resources between Ankara and Greece in the eastern Mediterranean is also amplifying geopolitical tensions.
  • Growing geopolitical disputes between Turkey and various countries are also raising concerns about Turkey’s development prospects. Turkish President Recep Tayyip Erdogan has encouraged a boycott of French products in the face of the deepening rift between Ankara and France.

Current situation

The annual inflation rate in Turkey increased by 36.1% year-on-year in December 2021, the highest in the past 19 years. According to data from the Turkish Statistical Institute, consumer prices rose by double digits by 13.58% in December, eroding people’s savings and wealth.

Last year, the lira lost 44% of its value as the country’s administration lowered the interest rate successively. In the spring, the inflation rate could reach around 50% unless monetary policy is corrected, as some economists predict.

According to CPI data, due to rising import prices, December’s producer price index rose 19.08% month-on-month; transportation prices and the food and beverage basket jumped 53.66% and 43.8%, respectively.

Statistics show the inflation rate in Turkey from 2004 to 2021. In 2021, the average inflation rate was around 16.98% compared to the previous year. The inflation rate started picking up momentum in 2016 and reached 16.33% in 2018. This was due to an uncommon policy adopted by the Turkish government to control economic growth by lowering interest rates in times of rising inflation. This eventually led to a further deterioration in inflation, a depreciation of the Turkish currency and a situation similar to a debt crisis.

The figure above shows the exchange rate between the Turkish Lira and the USD. It indicates how many liras are needed to buy 1 USD; the chart rises, indicating the weakening of the Pound against the USD. Five-year monthly data is shown in the chart; a strong increase can be observed between July 21 and November 21. Overall, there is an upward trend in the exchange rate indicating a weakening of the lira against the US dollar.

Future prospects

Ahead of the 2023 elections, Erdogan plans to continue cutting borrowing costs to support his low-interest monetary policy. As the Fed hints at tight monetary policy, this could further weaken the lira against the dollar. Due to strong inflationary pressures emerging in the US economy, Fed Chairman Jerome Powell plans to accelerate the rollback of the bond-buying program, which could hurt the already depreciating pound.

To maintain currency and price stability in Turkey, the administration must reverse its monetary policy and actively maintain positive diplomatic relations with other countries.

The main problem is the rising rate of inflation which creates obstacles to economic growth. Foreign investors are losing interest and confidence and are essentially diverting their investments from Turkish assets. Residents are worried as their wealth and savings frequently lose value. Many countries and international organizations are assessing their impact on Turkey’s currency crisis. Unless the president backs down from his unorthodox policies and takes significant steps to correct inflation, the economy could suffer in kind. An essential part of successfully managing this situation could be to maintain friendly relations with other countries, especially the United States. Fighting the world has never been a solution to any economic or political problem. Appropriate measures must therefore be taken to maintain a positive geopolitical dynamic with the major countries.

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