An imbalance of payments leaves Turkey with hard choices

“If a country continues to spend so much more than it earns, it will eventually translate into a drastic devaluation of the national currency and a spike in inflation. That this was avoided in Turkey for a long time was only due to one factor - the foreign direct investment (FDI) that poured into the country.”

Erik-Jan Zürcher (2017)

The amount of FDI which Turkey has attracted has steadily declined from a peak around 2006-7. Investor confidence in Turkey as a place to base regional hubs and to invest in companies and capital seems to have been going downhill for a long time.


source: tradingeconomics.com

This is a big problem, because while Turkey does export a lot, it’s often a net importer, and this has become more pronounced during the COVID-19 pandemic. Although Turkey’s trade deficit narrowed in 2019, it is now expanding again. Imports have increased while exports, particularly in mining and manufacturing declined, as the global economic fallout of the COVID-19 pandemic reduced demand.

This week, Turkey posted a large current account deficit of $4.6 billion in August compared to a surplus of $3.3 billion in the same month in 2019.


source: tradingeconomics.com

Citing a balance of payments crisis, Moody's downgraded Turkey’s sovereign debt last month from ‘B2’ from ‘B1’. Analysts have been warning of a severe balance of payments crisis since 2018, and the 2 percentage point interest rate increase by the Turkish central bank (to 10.25 percent) in late September appeared to be an acknowledgement that the situation is dire and something must be done.

Yet despite the interest rate increase, the underlying problem remains the same. The independence of Turkey’s central bank is in doubt, and foreign investors lack confidence in the Turkish economy.

The economic success of the early years of Justice and Development Party (AKP) rule, from 2002-2007, were based on a solid economic foundation created by Kemal Derviş, Economy Minister during the Ecevit government in 2001-2. One of Derviş’s successes was in making the central bank independent of government policy. 

The AKP initially stuck to the fiscally conservative economic programme created by Derviş in partnership with the IMF, but important reforms like making the central bank independent have been rolled back. 

The consumerism inherent in the economically liberal worldview of the AKP has arguably contributed to the balance of payments crisis, as Turkish demand for imported consumer goods expanded. Growth based on foreign investment and debt-driven consumption is always likely to be vulnerable and subject to global economic trends.

This ongoing balance of payments crisis also helps explain to some extent Turkey’s actions in the eastern Mediterranean. Turkey desperately needs its own energy sources to reduce dependence on fuel imports. The falling value of the lira has also been seriously affecting the construction industry, and so the Turkish government needs to diversify in order to halt the ongoing slide in Turkish GDP which has been accelerating as inflation eats into living standards.


source: tradingeconomics.com

Turkey is energy dependent on Russia, from whom it imports around 38% of its fuel needs. Given that Turkey and Russia are supporting opposing sides in proxy wars in Syria, Libya, and to some extent now in Nagorno-Karabakh, this is a huge liability, as well as a contributing factor to Turkey’s balance of payments crisis and therefore the lira’s weakness.

Former policymakers at the Central Bank told Reuters in September that the interest rate needed to rise, but that the background problem was the bank’s lack of policy independence. Turkey’s deteriorating diplomatic relations also cause problems for investor confidence, as happened in 2018 with U.S. sanctions over the Pastor Brunson dispute, and now over Turkey’s purchase of Russian military hardware.

Notwithstanding the inherent problems associated with IMF structural adjustment programmes, the IMF and the EU presented two external economic balancing forces for Turkey in the early 2000s which no longer exist. Turkey’s EU accession process is on life support, while Erdoğan has repeatedly said that the days of Turkey needing an IMF loan are over.

Despite some analysts seeing an IMF loan as the only way out of Turkey’s economic turmoil, it is likely that Turkey’s economic situation will have to get a lot worse before Erdoğan is forced to reverse his hostile attitude to IMF assistance.

The other pressure on Erdoğan which may force his hand is the loss of support for the government created by an economic crisis. Turkish voters repeatedly thanked the AKP for the improving living standards they experienced for the first 10-15 years of AKP rule, but the growth that has been created is also uneven, and poor, working class voters who make up a large part of the AKP base are being harder hit by the combination of the pandemic and inflation.

The AKP have some very hard choices to make. It makes sense for the AKP to call early elections if they think the economy will get worse, but they don’t have a three fifths majority in the Grand National Assembly which they need to call an election before 2023. They also need to take drastic economic measures which carry political costs.

Last Thursday, Economy Minister Berat Albayrak released an economic plan for 2021-23, envisaging 0.3% growth in 2020, 5.8% growth in 2021 and a budget deficit of 3.5% of GDP by 2023. However, these figures seem optimistic, with a Reuters poll of economists in July suggesting a contraction of 4.3% in 2020. In September the OECD suggested a contraction of 2.9% for Turkey in 2020.


source: tradingeconomics.com

Turkey has been running small but consistent budget deficits throughout much of the AKP’s rule, but these deficits have been rising in the past few years, and decreased tax revenues may now force the Turkish government to abandon some of its more expensive monumental projects, such as the Kanal Istanbul, which would open a second sea lane between the Mediterranean and Black Sea.

Nobody can be sure for how long COVID-19 will continue to affect world economies by reducing demand for goods and key service industries like tourism. With few options left to tackle Turkey’s balance of payments crisis, it is hard to avoid the impression that Turkey is headed either for a serious currency collapse, or for greater, and politically unpalatable, economic intervention.

The opinions expressed in this column are those of the author and do not necessarily reflect those of Ahval.