Is there life in Turkey after 15 percent inflation?

All eyes are on Turkish President Recep Tayyip Erdoğan after inflation surged to the highest level since 2003.

The inflation rate of 15.4 percent for June, announced this week, completely shocked investors and economists. Prices appear to be spiraling out of control and could be increasing by 18 to 20 percent by the height of the summer.

So, the question is will Erdoğan wake up to the changing environment in international markets – in which money is flooding out of emerging markets deemed less stable – and revert to orthodox economic policies that proved a success story in the early days of his rule. Or will his government insist on continuing to pursue economic growth, an approach that will turn into a losing game.

Should Erdoğan choose economic prudence, Turkey might succeed in beating away a looming economic recession, once the Federal Reserve ends its program of rate hikes and money starts flowing back into emerging markets.        

Turkey’s June inflation reading turned out to be the most horrible nightmare. Annual consumer price inflation hit 15.4 percent from 12.2 percent in May. Meanwhile, the producer price index rose to an astounding 23.7 percent.

Consumer price increases are set to accelerate further due to the gap between CPI and PPI, the impact of the 20 percent depreciation in the lira this year, the reintroduction of price hikes in the public sector – delayed by the June 24 presidential and parliamentary elections – and the ongoing spike in global energy costs.

It’s a doomsday scenario for Turkey and its struggling consumers and business. And it’s an all-new inflation “plateau” for the economy.

Turkish inflation

But the deterioration in Turkey’s inflation dynamics hasn’t been so sudden, but more like a creeping problem. CPI averaged 8 percent to 9 percent between 2010 and 2013. This was the time when global liquidity, or so-called “easy money”, peaked for emerging markets. It was also when the central bank switched from an inflation-targeting regime to an unorthodox monetary policy based on multiple rates of interest in an apparent effort to placate Erdogan and his aversion to higher interest rates.

Inflation then shifted up to 10 percent to 11 percent in 2013 to 2016 as the strengthening U.S. dollar and global volatility led emerging market currencies to weaken.

The Turkish lira has depreciated almost 20 percent against the dollar in the past three months. But now what we have is a full=blown currency shock that will take a heavy toll on Turkey’s inflation dynamics, meaning the current 15.4 percent level is certainly not the peak.

Turkey’s central bank was far too slow in raising interest rates this year to help pare back inflation and the weakening currency. It’s last minute action in increasing rates a total of 500 basis points has now produced an interest rate shock as well.   

Thus, CPI is headed for 18 percent to 20 percent by August. What we have is an environment of stagflation in which third-quarter economic growth is set to turn negative. This will be followed by a couple of quarters where a recessionary environment will dominate.

The scary fact is that, over the past eight years, inflation in Turkey has become sticky at ever-higher levels, as described. This time, Turkey’s CPI will probably stabilize at 14-15 percent for the period 2018 to 2020.   

After asking the question as to whether there is life in Turkey after 15 percent inflation, the answer is “it depends”.  It all depends on how Erdoğan approaches management of the economy under the new presidential system, a first for the country and unique in terms of such systems across the globe. 

It is no secret that the Justice and Development Party (AKP) administration had focused very well on restructuring the Turkish economy through an IMF program during 2002-2008. But then it gave priority to economic growth thereafter.

Low borrowing costs and ample liquidity in the global financial markets opened the way to such policies without much of an apparent burden to the economy. Macro imbalances were swept into a cupboard. Yet, those times have changed.

Now, as investors in global financial markets are focused on an inevitable and extended period of higher interest rates and inflation, the smart money is leaving those emerging markets whose governments have made profound macroeconomic mistakes during the easy-money times.  Or to put it differently, smart money is seeking out countries where governments were not lazy in putting their houses in order during those summery years, now that the winter has come.

Erdoğan has changed Turkey’s governing culture so deeply, especially after last year’s nationwide referendum on his strengthened presidency, that his re-election on June 24 means that he first needs to put the bureaucracy in order so that the state and the new and enhanced office of president can function smoothly. The expected appointment of a new team of ministers on July 9 won’t give us any clues about how the economy will really be run, since the powers of those ministers will be trimmed severely under the new presidential system.

Instead, Erdoğan is set to get more sway over the day to day running of the economy. He will give more formal economic roles to his many advisors who are notorious for their clashes with the capitalist ways of Western market forces.

Turkey’s increasing economic problems are not just limited to very high inflation, which is set to go even higher. Inflation is just the by-product of the policy mistakes that have been made during the last ten years of the AKP government’s 15-year rule.

Turkey has a ticking bomb in its hands -- a huge external corporate debt load to the tune of 25-30 percent of its GDP in an economy that is struggling to focus on productive sectors in the absence of effective leadership.

When Deputy Prime Minister Mehmet Şimşek helped pave the way for this year’s rate hikes, which were carried out despite the well-known position of Erdoğan against higher interest rates – he promised investors what amounted to an IMF-style program following the June polls. 

But with local elections set for March 2019 and the AKP in danger of losing Turkey’s major cities of Istanbul and Ankara, it is very unlikely that Erdoğan and his close advisers can turn away from their plans for high economic growth and follow a path of austerity more suitable for slowing inflation.

Erdoğan will be busy shaping the state into a presidential system that, in his own words, will act on “any issue and every issue”. This is the fate that awaits Turkey under an empowered Erdoğan. At the same time, the president has to deal with the pressing economic problems that can no longer be hidden under the carpet of money that had flowed into the country during easier times. 

So, everything depends on Erdoğan’s choices and his ability to grasp the economic reality.