Mark Bentley
Jul 02 2018

Erdoğan unchained raises flag over economy

The first concrete signs of a slowdown in Turkey’s economy raise serious questions over economic policy under the strengthened presidency of Recep Tayyip Erdoğan.

Preliminary data for the trade balance in June showed a slide in imports and exports, heralding the start of what should be a rebalancing in Turkey’s runaway economic growth.

But presidential and parliamentary elections on June 24 mark a new era for Turkey. Erdoğan, who has pushed a pro-growth agenda to the detriment of inflation and the current account deficit, is now unchained. He takes the reins of a strengthened presidency, rendering the prime minister’s position defunct and ministries severely weakened.

Parliament, where much of Turkey’s economic policy is discussed and approved, will become little more than a rubber stamping authority. Government ministers, in the words of Erdoğan’s chief economic adviser Cemil Ertem last week, will take on the role of bureaucrats as Erdoğan selects the members of new unelected presidential committees to personally advise him on economic policy.

Turkey’s lira has lost almost 20 percent against the dollar this year, sliding at a faster pace than almost every other emerging market, as concern grew that government incentives to stimulate economic expansion – yearly growth averaged 8.7 percent over the three quarters to March, would lead to a ‘hard landing’. Much to Erdoğan’s ire, the central bank was forced to hike interest rates by 425 basis points in May and June to 17.75 percent as the lira’s sell-off prompted fears of a currency crisis.

Investors are now hoping that figures such as Mehmet Şimşek, deputy prime minister under the previous government, and Hatice Karahan, an economic adviser to Erdoğan, will take a prominent role in the new administration. Both are seen as pro-market policymakers who are needed to counter more unorthodox figures in the presidential palace, such as Ertem and Yigit Bulut, a former TV anchorman and renowned conspiracy theorist.

The Federal Reserve is now tightening monetary policy and prospects of further rate hikes are leading to a sell-off in emerging markets. Therefore, Erdoğan has little time to lose in forming his economic team and to convince investors that he will commit to prudent economic policies, rather than the populism that has characterized his rule since quantitative easing by the Fed and ECB began in 2008 and 2009, respectively. The flood of easy money that had entered emerging markets is now reversing.  

The lira was among the biggest decliners among emerging-market currencies on Monday, falling 0.7 percent to 4.62 per dollar. It had reached an all-time low of 4.92 against the U.S. currency in May.

The supposition of many economists is that Erdoğan will not seek to arrest or tame the impending economic slowdown – the economy is set to contract in the third quarter -- through more populism. Rather his government will take serious measures to slow inflation, which reached 12.2 percent in May, they say. Inflation is set to kick higher in June and July, perhaps to 15 percent, as the impact of the lira’s losses reflects on prices.

Guardedly optimistic predictions of these economists, who include prominent figures such as Tim Ash of Blue Bay Asset Management, are based on the words of Şimşekand Karahan, and may prove unfounded. Quoting Cemil Ertem – the former economics professor wrote an extensive article for the Daily Sabah newspaper last week – Turkey’s economic problems will be dealt with under Erdoğan’s growth model, not without it.

Ministers who previously enjoyed executive power as elected MPs will now act directly in line with the political objectives of Erdoğan, as appointed bureaucrats, Ertem said.

“I think that the figures in the new administration structure to be determined in the upcoming days might be a matter of magazine curiosity rather than of politics,” Ertem asserted, signaling that Erdoğan and his inner circle will be calling the shots when it comes to economic policy.

“In this sense, the road map is clear; investments will not stop, and the wheels of the economy will continue to turn, by essentially handling structural problems such as inflation and the current account deficit in an inclusive growth perspective,” he said.

In the recent past, investors have ignored Ertem’s words at their peril, preferring to take comfort in the statements of Şimşek, Karahan and Finance Minister Naci Agbal, another market-friendly politician whose fate is unclear under the new Erdoğan administration.

But history and the current tone at the palace in Ankara suggest that Erdoğan and his new team do not plan to take the painful measures that will slow inflation to single digits, and towards the central bank’s goal of 5 percent. Serious steps to pare down Turkey’s growing budget deficit are also unlikely as Erdoğan and his ruling Justice and Development Party (AKP) prepare for local elections in March.

The best-case scenario now appears to be a fudge – some steps will be taken to appease investors, while the government continues to pursue growth.

In the aftermath of the election, Morgan Stanley became the first investment bank to predict a further weakening in the lira, recommending that its clients sell liras for rubles. It said it expects the currency to fall to 5.05 per dollar at the end of the fourth quarter.

However, that prediction could prove overly optimistic. Erdoğan is now unchained and set to wield his greater muscle over Turkey’s economy and what remains of its democracy. Investors beware.