Turkey’s economic crisis threatens Erdogan’s political sway

An economic crisis in Turkey? The Turkish government says there is none. It pursues an unorthodox economic policy, centered first and foremost on economic growth. And indeed, the Turkish economy is expected to end 2021 with double-digit growth. As a result, the government considers it a success, even at the cost of a sharp depreciation of the Turkish Lira (TL) and extraordinarily high inflation.

This leads to the paradox that neither the economic growth of 2020 nor that of 2021 has been felt by the population. With wages and salaries falling as a percentage of gross domestic product (GDP), private households suffered a loss of purchasing power. To mitigate the effects, the minimum wage was raised significantly, as well as pensions and wages in the public sector. However, international financial institutions expect an inflation rate of 50% in 2022. This means that the increase in the minimum wage would already be canceled at the beginning of this year.

A new economic model

To understand the context, you have to go back a year and a half. In the fall of 2020, then-finance minister Berat Albayrak countered the consequences of the first wave of the pandemic with low-interest loan programs. Secret support purchases for the Turkish lira had depleted central bank reserves and the currency began to weaken in the fall. After the appointment of a new finance minister, credit expansion slowed and the central bank raised the key interest rate to 19% in March 2021.

The dollar exchange rate rose from 8.30 TL/dollar to peak at over 18 TL/dollar on December 20, 2021.

After another change of minister, the key interest rate was reduced from 19% to 14% in four interest rate cuts from September to December 2021. At the same time, the dollar exchange rate fell from 8, 30 TL/dollar to peak at over 18 TL/dollar on December 20, 2021. Over the same period, year-on-year inflation rose from 13.8% to 36.08%. A 79.89% rise in producer prices in December 2021 shows that 2022 will also be marked by persistently high inflation.

When the Turkish lira started falling last fall, the government linked this to the presentation of a new economic model. In November, President Erdogan said that the weakness of the Turkish lira was desirable because of the advantages it created for exports. At the same time, imports would become more expensive, thus improving the balance of payments. After a short period, the Turkish economy would show a permanent balance of payments surplus, thus reducing the need for foreign currency. This would stabilize the Turkish lira in the long term.

At the same time, President Erdogan repeated his idea that high interest rates were the main reason for inflation, as they made investments more expensive and thus reduced economic growth. Low interest rates would serve to encourage investment and thus create new jobs. And all of this should happen within six months. To absorb the initially perceptible negative consequences of this policy on the population, he resorted to the metaphor of a war of liberation that Turkey was waging against the imperialist powers who wanted to destroy the country’s prosperity and development. In addition, the minimum wage for 2022 has been increased by half. About half of all employees in Turkey are paid minimum wage or less.

Erosion of trust

However, one of the fundamental problems with this model is that it is based on a conflict of objectives. Almost all Turkish export products depend on imported raw materials and intermediate products. The promotion of exports by the weakening of the Turkish lira is therefore based above all on the reduction of labor costs. With the decline in purchasing power, however, it is difficult to have such a policy accepted. The result can be read in opinion polls in recent months, showing both a sharp loss in popularity for the government and a loss of confidence in the presidential system. The measures to stabilize the Turkish lira as well as the wage increases were aimed at restoring confidence. But this came at the cost of high inflation.

Given the high inflation, lending rates increased significantly above the level of September 2021, when the new economic model was adopted.

Another unintended effect is the burden on public budgets. Only 14% of public debt bears a fixed interest rate. The remaining 86% are debts in foreign currency or linked to the exchange rate or to inflation. The weak Turkish Lira and rising inflation have significantly increased public debt and interest charges. Support purchases of the Turkish lira reduced central bank reserves. Moreover, the real objective of reducing the general level of lending rates by lowering the central bank’s key rates has not been achieved. On the contrary, given the high inflation, lending rates have significantly exceeded the level of September 2021, when the new economic model was adopted. Instead of increased economic growth, as envisaged by the new economic model, a slowdown is therefore to be expected in 2022.

Instead of triggering booming economic growth, economic policy has mostly come at the expense of predictability and confidence, both of which are important prerequisites for the investment climate. Even before the start of his economic adventure, President Erdogan’s popularity was declining. Recent opinion polls indicate that he would not be re-elected at this stage. Although the date of the regular elections is still a year and a half away, it is unlikely that the purchasing power of the population, which has fallen sharply over the past three years, will recover in this short period of time. Erdogan therefore relies on economic crisis denial, attempting to use religious and nationalist motives to bind his electorate to himself and drive a wedge between opposition parties. The tone of Turkish politics, turbulent at the best of times, has hardened.

A growing opposition

Local politics is an important battleground between the opposition and the government. Already at the start of the pandemic, the CHP-led metropolises of Istanbul and Ankara had developed municipal-level approaches to tackle poverty, but these were blocked by the government. The price of electricity more than doubled for most people around the turn of the year. Additionally, the price of bread, the most important staple, increased by half from November 2021 to January 2022.

With their affordable bread program, municipal bread factories in major cities such as Ankara and Istanbul contribute significantly to poverty reduction. Thanks to a donor arrangement for water and natural gas bills in Istanbul, not only was it possible to circumvent a ban imposed by the Interior Ministry on municipal donation collections, but needy households were also able to been relieved of more than 300,000 bills. Practical skills and a more transparent leadership style have helped make Ankara Mayor Mansur Yavas and Istanbul Mayor Ekrem İmamoglu some of the most popular politicians in Turkey today.

The victory of the opposition depends on the ability of the common opposition candidate to count on the support of the Kurdish leftist HDP.

Whether this is enough to enable the opposition to win presidential and parliamentary elections depends on many factors. Falling living standards are undermining trust in the AKP and President Erdogan. However, this does not automatically lead to a revaluation of the opposition parties. A deciding factor will be their choice of presidential candidate, which will not be determined until immediately before the election.

The example of the municipal elections in Istanbul in 2019 shows that an opposition victory depends on the ability of the common opposition candidate to count on the support of the Kurdish leftist HDP. Overcoming the current presidential system, which has a paralyzing effect through unpredictable decisions, is essential for a return to economic growth that improves the living conditions of the population.

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