Erdoğan positions himself as saviour of Turkish economy after two years of failure

Turkish President Recep Tayyip Erdoğan may be positioning himself as the saviour of his government’s own economic failures after sacking the central bank chief at the weekend and his son-in-law resigned as treasury and finance minister.

Erdoğan has proven himself a master tactician in domestic politics and international affairs since assuming power 17 years ago, cementing his executive grip on the country and seeing off a series of challenges to his rule.

In 2007, he knocked back an attempt by the country’s generals to have a say in who ran for president. In 2013, he ordered a successful police crackdown on nationwide civilian protests. Three years later, he emerged victorious against an attempted coup, allegedly masterminded by a clandestine Islamist network led by a former political ally.

After acquiring far-reaching executive powers at presidential elections in 2018, Erdoğan arguably set himself up for the biggest challenge of his political career. But this time, it was of his own making.

In July 2018, he shocked many senior figures in his own party by discarding Mehmet Şimşek, a Merrill Lynch economist who had helped oversee Turkey’s economy for nine years, in favour of his inexperienced son-in-law, Berat Albayrak, who began to lead a merged Treasury and Finance Ministry. Share prices and the lira fell sharply.

Berat Albayrak
Erdoğan chats with his son-in-law, Berat Albayrak

In the two years that followed, Erdoğan worked hard to turn Turkey into a regional powerhouse – intervening in Syria and Libya and sending survey ships into the Mediterranean to challenge the sovereign rights of neighbouring Greece. He bought S-400 air defence missiles from Russia in defiance of the United States. He challenged Saudi Arabia over the murder of a dissident journalist while cementing his own control over the country’s media.

But the past two years were also characterised by a series of economic missteps that threatened to undermine Erdoğan’s regional ambitions and his status as Turkey’s most powerful leader since the death of its founder Mustafa Kemal Ataturk in 1938.

Erdoğan’s attempts to centralise and personally take control of economic decision-making with the help of Albayrak, a former energy industry CEO married to his daughter Esra, helped spark a currency crisis in the summer of 2018 and a second bout of severe financial turmoil this year.

At the centre of the troubles were a set of economic policies termed by many analysts as Erdoğanomics. This ‘magical thinking’ sought to depict interest rates as an evil tool of foreign powers seeking to skittle Turkey’s ambitions of becoming one of the world’s top 10 economies. Higher interest rates, Erdoğan claimed, were inflationary and were being used by foreign financiers and their local allies to control his government and the wealth of his people.

Through his depiction of a looming foreign threat to Turkey, Erdoğan sought to exploit the vulnerabilities of Turkey’s less educated and poorer conservative classes and rally them with the promise of impending victory against these so-called shadowy plotters.  

In July last year, Erdoğan sacked the governor of the central bank for failing to lower interest rates. Following classical central bank procedure, former Governor Murat Çetinkaya had hiked borrowing costs substantially and kept them elevated to reverse sharp losses for the lira and ensure the 2018 currency crisis was not repeated. But he paid for those efforts with his job.

In late 2018, Erdoğan appointed himself chairman of the country’s sovereign wealth fund, which was established two years earlier, and made Albayrak his deputy chairman. The fund, made up of Turkey’s largest public industrial enterprises, had also assumed control of Turkey’s state-run banks. Erdoğan set about using the banks’ funds to help prop up companies closest to his party and to engineer a borrowing boom by businesses and consumers.

The lending splurge by Ziraat Bank and Halkbank was underpinned by the policies of Erdoğan’s new hand-picked central bank governor Murat Uysal, who slashed interest rates by almost two-thirds to 8.25 percent within 10 months of his arrival.

But the boom in borrowing led to a surge in demand for imports just as the outbreak of COVID-19 began to hit Turkey’s export sales. The country’s current account deficit widened markedly and the lira started to spiral downward once more.

The central bank had begun spending billions of dollars of its foreign currency reserves to defend the lira as ordinary Turks switched their savings into dollars, euros and gold. It was also engaging in cross-currency swaps with the state-run banks to the extent that its foreign exchange reserves, net of liabilities, started to turn negative.

In September, Uysal was forced to increase the benchmark interest rate to 10.25 percent to support the lira, but then kept it unchanged at a meeting the following month, confounding economists’ forecasts of a substantial hike. Most analysts put the decision down to Erdoğan and his opposition to higher borrowing costs.

As of last Friday, the lira’s losses against the dollar since the start of the year had ballooned to more than 30 percent. The currency had lost almost half of its value since Erdoğan and Albayrak took up the reins of the economy in July 2018.

Albayrak’s departure on Sunday, announced on his Instagram account, came as a personal shock to Erdoğan. But a compliant mainstream press failed to report the resignation for more than 24 hours, waiting for the presidential palace to confirm it, which it finally did late on Monday. Erdoğan had considered and accepted his son-in-law’s request to be pardoned from his duties, according to a press release.

With Albayrak reportedly holed up in London, Erdoğan appointed Lütfi Elvan, a party loyalist and former deputy prime minister, to take his place. Elvan expressed surprise at getting the job, saying he just hadn’t seen it coming.

Meanwhile, reports in the media had begun to circulate that Erdoğan had sacked Uysal after he discovered that the central bank had burned through most of Turkey’s foreign currency reserves. The president was apparently shocked at how little hard cash the bank had left, despite widespread coverage of the decline in the foreign media and in the opposition press.

With the president preparing to deliver a key speech to his party on Wednesday, Abdulkadir Selvi, a well-known columnist for Turkey’s leading pro-government broadsheet Hürriyet, published an article saying that Erdoğan had now begun to take a much greater interest in the economy. Aware of how important the state of the economy was for his party’s supporters, the president would assume a much larger role in decision-making, he said.

The stage had been set for Erdoğan to revise his government’s misguided economic plans and to position himself as the driving force behind a rescue.

Not wanting to appear as if he were embarking on a significant climbdown, in a speech on Wednesday the president repeated his view that interest rates caused inflation in a nod to his voter base. But past accusations levelled at foreigners went unmentioned and were replaced by an appeal for foreign investors to return to Turkey.

Turkey’s new economic team would hold a series of meetings with foreign institutions. In the meantime, the government would support the efforts of the central bank to slow inflation towards targets and start to enact sweeping economic reforms, including to the judiciary and financial markets, Erdoğan said in the speech at parliament.  

Naci Ağbal, the new governor of the central bank, will chair his first Monetary Policy Committee meeting on Nov. 19.

Some economists expect the bank to increase the benchmark interest rate substantially at the meeting. U.S. investment bank Goldman Sachs is forecasting a hike of 4.75 percentage points, taking the rate to 15 percent, though it questioned how long the central bank could sustain such levels of interest.

Time will tell whether the possible rate increase is followed up by further conventional measures to stabilise Turkey’s financial markets and economy.

Erdoğan, seeing that fears among investors of a looming financial crisis have subsided, would be faced with the political ramifications that higher interest rates bring. They would include an economic slowdown, further increases in the unemployment of over 13 percent and more troubles for the country’s construction industry, in which many of his closest business allies operate.

Massive rate hikes during the currency crisis of 2018 - they tripled to 24 percent from 8 percent between May and September of that year - led to a so-called ‘sudden stop’ for the economy, bankruptcies and a deep, painful economic downturn that persisted almost until the outbreak of the COVID-19 pandemic in March of this year. The central bank has already increased average borrowing costs for banks from 7.5 percent in July through unconventional, backdoor means.   

It would be a big ask for Turkey’s authoritarian president to relinquish some power and come good on pledges to enact significant market-friendly reforms and to fully restore confidence in the economy. A return of central bank independence would be top of the list for both foreign investors and non-partisan local conglomerates, as would guaranteeing the rule of law and ensuring autonomy for key economic institutions and a level playing field for doing business.   

The country will soon be heading towards presidential and parliamentary elections, due in Turkey’s centenary year of 2023 at the latest. Much more likely is that Erdoğan will return to the populist and nepotistic policies that have characterised his recent rule as he seeks a third term in power.