Guldem Atabay
Feb 23 2018

It's 'Alternative facts' for Turkey now

It seems Turkey is never out of the spotlight, and not for such good reasons over the past five years.

These days, the main focus is on the military operation in Afrin in Syria. The situation in the Kurdish-controlled enclave is being closely watched after Syrian regime fighters arrived there after a deal between Damascus and the Kurdish People’s Protection Units (YPG). A possible clash between the Turkish army, backed by Free Syrian Army rebels, and pro-regime fighters is a real cause for concern.

Reports that Russia may have given a green light to the deployment of Syria’s pro-regime militia to Afrin now puts the future of the relationship between Russian President Vladimir Putin and Turkish President Recep Tayyip Erdoğan in some danger, not to mention the lives of many fighting on the battleground. Meanwhile at home, human rights groups have condemned a ruling by a Turkish court sentencing three of the country’s most prominent journalists to life in prison over allegations of involvement in the 2016 coup attempt. All these events are adding to Turkey’s risk premium and driving the lira weaker of course.

The intense political agenda is putting developments on the economic front in the shade. But, it’s the economic backdrop in Turkey that is in fact pushing political developments. Presidential elections are fast approaching. The vote, due by next year at the latest, is a must-win for Erdoğan if he is to establish a full presidential system in Turkey and rule the country until its centenary in 2023.

The International Monetary Fund, in its annual Article IV Concluding Statements, underlined the economic risks Turkey now faces. For the readers of this column, the IMF’s messages will be nothing new, but they should be eye-opening for some because the warnings to the government were made in official IMF documents, not in closed-door meetings.    

The Fund warned that economic growth of seven percent last year exceeded Turkey’s potential, thanks to a supportive fiscal policy and specifically, a sizeable credit impulse driven by state loan guarantees. Its warnings also focused on signs of oversupply in the construction sector. The IMF urged the government to build long-term fiscal buffers and take macro-prudential measures, rather than use the fiscal account for demand management purposes.     

The Fund also said that the current account deficit would remain above five percent of gross domestic product for some time to come, pointing to high oil prices and peculiar gold imports. And, of course, its attention turned to Turkey’s financing difficulties. Last year, Eurobond issues, portfolio inflows and foreign currency reserve drawdowns by the central bank saved the day in the absence of insufficient foreign direct investment (FDI).

With the central bank’s reserves covering only around half of Turkey’s gross external financing requirements of circa $200 billion, rate hikes by the U.S. Federal Reserve, political tensions at home and at the Syrian border, where the situation could spiral out of control, may further curtail quality fund inflows to Turkey. Thus, external financing difficulties, with increasing reliance on short-term capital, stand out as the main fragilities for Turkey’s economic health.      

Regarding Turkey’s double-digit inflation, which is more than double the central bank’s target, the IMF stated that despite positive base-year effects in the first half of the year, consumer price inflation looks set to remain in double digits by the year-end due to deteriorating inflation expectations and continuing cost-side pressures from the weak lira.

Thus, the fund openly urged the central bank to hike rates saying inflation remained an important challenge. With a perfect storm brewing on the inflation front via a combination of demand-pull, cost-push and lira depreciation forces, the fund underlined the need for “recalibrated” monetary policy, that is “front loaded” rate hikes to increase credibility and rein in inflation expectations. Perhaps more importantly, through such rate hikes, the central bank of Turkey could add to its weakened foreign exchange reserves while it still has the chance to take advantage of favourable global liquidity conditions.    

The IMF’s final point on rate hikes unsurprisingly prompted the Erdoğan government to embark on a fresh bout of criticism of the fund’s policies. Enter Erdoğan’s top economic adviser Cemil Ertem, who declared that the government would do the exact opposite of what the IMF was recommending. 

Ertem has always been a sceptic of IMF policies, arguing that the ruling AKP’s rising “new Turkey” was being targeted by the West for its economic success. Ertem argued that 5 percent economic growth in 2018, the government’s official target, would not be sufficient and growth rates of 7 percent would not mean that the economy was overheating. 

Turkish central bank reserves
Turkish loans to deposits

Ertem claimed that the IMF’s call for an upfront rate hike was designed to serve the foreign “interest rate lobby”. The government would seek ways to lower interest rates rather than hiking them further, he said. Ertem, in denial of macro economy 101 rules, has long been a supporter of the idea that inflation is stuck in double digits because of higher interest rates. He argued this week that rather than a wider current account deficit, financing difficulties or double-digit inflation, the main macroeconomic problem for Turkey was high interest rates.

With headline inflation now at 10.5 percent compared to 12 percent at the end of 2017, thanks to the aforementioned positive base effects, Ertem called for a rate cut from the central bank of Turkey, not a rate hike. He also said that he expected state-run banks to start lowering interest rates to support growth in the coming days and called on other lenders to do the same.

Ertem, of course, made no mention of core inflation, which remains stubbornly in the 11-12 percent range, the deteriorating financing that Turkey is using to finance the wider current account deficit, or the need to improve its severely wounded institutional capacity.

Turkish CPI and core inflation
Turkish financial account

Deputy Prime Minister Mehmet Şimşek is also highlighting Turkey’s economic successes, stressing that its 7 percent growth rate is almost three times the average of OECD countries.  Şimşek, who was an economist at an investment bank before joining AKP, is of course more aware of basic economic fundamentals. Yet, he too refrains from challenging Ertem and Ertem-like voices close to the president about Turkey’s unique economic choices that carry the potential of trouble for the country in the coming period.

While loan growth rates in Turkey are slowing significantly following last year’s boom, consumer and business sentiment is souring after what proved to be a temporary jump in December and January. Furthermore, the current account deficit is widening still further. It has also been a very bad start to the year for the budget. Meanwhile, the government is gearing up for more fiscal stimulus to support growth.

It seems clear what is needed as the global backdrop for emerging markets worsens. Yet, in Turkey we are trying to survive in the “post-truth” era. And the “post-truth” calls for closing both eyes to the facts and pushing on within the confines of the government’s narratives, at least so long as such made-up stories can survive.