Guldem Atabay
Mar 07 2018

Turkey’s dangerous game with growth…

The repercussions of U.S. President Donald Trump’s unexpected announcement that he plans to impose 25 percent tariffs on steel imports is stirring global debate.

Global economic imbalances created by the now famous currency wars over the past two decades are at risk of being ramped up again as Trump is now pulling the trigger for global trade wars.

The biggest foreign supplier of steel to the United States is Canada, followed by Brazil, South Korea, Mexico, Turkey, the European Union, Japan and Russia. The United States was the largest market for Turkey’s steel exports, with a 12 percent share as of the first quarter of 2017. Thus, Turkey may be negatively affected by Trump’s decision to the tune of $1.1 billion.         

Possible retaliatory moves from the European Union and China have been disturbing financial markets across the globe, especially in the light of China’s sway over the price of U.S. Treasuries due to its vast investments there. Combined with Federal Reserve Chairman Powell’s enthusiasm for stemming inflationary forces at home – four rate hikes are now possible this year – the outlook for emerging markets appears to be deteriorating.

Turkish steel exports

In Turkey, the release this week of February consumer price inflation and the country’s core inflation, which now stands at 11.9 percent, has reminded investors how single-digit inflation is a thing of the past. This is increasing pessimism in financial markets, especially when the central bank stays put on interest rates, refusing to acknowledge the simple fact that the brewing forces of higher inflation keep on pushing Turks away from the lira and into hard currency, feeding a vicious circle.

Added to this bleak picture is the cost-push momentum of intermediary goods price inflation, now at 17 percent on a yearly basis. Thus, keeping interest rates on hold, which the central bank decided to do this week, means the so-called fight against inflation in Turkey has become a lost cause.  

Turkish deposits
Turkish core inflation/lira

Nevertheless, President Recep Tayyip Erdoğan is keen to pull down interest rates as he marches toward presidential, parliamentary and local elections next year.

On his return to Turkey from a tour of Africa last week, the president once more raised the issue of “high” interest rates in Turkey.

According to unpublished plans, public banks will inject funds at lower rates of interest into the lending market. Erdoğan argues that banks in Turkey are making huge profits by charging unreasonably high rates of interest on loans. He also, confusingly, sees high interest rates as the main cause of double-digit inflation in Turkey, rather than the other way around. Thus, according to Erdoğan’s logic, pulling down lending rates from current levels of 18-20 percent would serve two purposes: supporting economic growth and lowering the inflation rate. The conundrum of inflation versus interest rates is of course not that simple, as per basic economic theories, known as Macro 101.     

The precise details of Erdoğan’s rate cutting plans are not yet clear. Yet, with the president himself mentioning public banks several times, it is obvious that they will play the major role in his efforts to lower lending rates.

There is no doubt that such a scheme to give Turkey’s economy an artificial push will have severe side effects. The balance sheets of banks will deteriorate, adding fresh burden on the Treasury.

As the president is ordering banks to cut lending rates, that would also necessitate that the central bank plays along, in the name of coherency. If such plans also include the central bank providing additional liquidity to support growth, efforts to lower inflation will be even more at risk.  

Alongside monetary measures, the government is gearing up for the approval of a gigantic tax amnesty to boost the economy from the fiscal side. Ten million indebted tax payers will bring about 100 billion liras ($26 billion) into the government’s coffers over the next 18 months, the plan foresees. Interest penalties are also being erased. The amnesty will cover traffic penalties, customs tax liabilities, motor vehicles, stamp duty debts, property tax liabilities, student loan debts, contribution loan debts and income tax debts.

Last week, the government also overhauled Turkey’s 33-year-old value added tax system. The new bill means the government will now pay out VAT returns to taxpayers without any major delay, according to Finance Minister Naci Agbal. Companies’ VAT return receivables from the state were 140 billion lira at the end of the first half of 2017. Newspapers close to the government say that around half of the accrued amount will be delivered to companies in order for them to meet their short-term financing needs. Such a hefty payment was not booked in the 2018 budget, in which the deficit was forecast at 67 billion liras, or 1.9 percent of GDP. 

Turkish budget deficit

Such steps on both the fiscal and monetary side add up to perhaps the most populist and economically dangerous move by the governing Justice and Development Party’s (AKP) in its 15 years of government.

The change in the global monetary environment is accelerating just as Turkey is over-heating its economy at the cost of fiscal discipline and higher inflation. Erdoğan is seeking to flood the economy with “cheap” money in ways that do not match economic realities. Clearly, this means he is playing a dangerous game with Turkey’s economic stability.