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Mark Bentley
Oct 11 2018

‘Erdoğanomics’ weighs heavy as Turkey battles inflation

Turkish President Recep Tayyip Erdoğan may be realising investors’ worst fears and fully unleashing his own unorthodox brand of economics as the country battles to cap run-away inflation and avoid deep recession.

An anti-inflation plan announced on Tuesday by Erdoğan’s son-in-law – Treasury and Finance Minister Berat Albayrak – bears the clear hallmarks of ‘Erdoğanomics’, namely the theory that inflation should not be tackled by raising interest rates or other traditional measures, rather by employing supply-side measures to lower costs.

The unorthodoxy comes after the lira lost almost 40 percent against the dollar this year, threatening to send the once overheating economy into deep contraction just before local elections in March. The decline in the currency, which came as the central bank delayed rate increases, has helped push consumer price inflation to almost 25 percent, the highest in major emerging markets after crisis-hit Argentina. Producer-price increases now stand at a heady 46 percent.

It was ‘Erdoğanomics’ that spooked investors back in May, leading to a run on the lira. The president told investors in London that higher interest rates cause inflation, rather than reduce it, confounding traditional economic thought. Erdoğan angrily reiterated his opposition to higher rates last month, just as the central bank raised them 625 basis points to 24 percent in an effort to curb price growth.

Erdoğan may now have run out of patience with monetary policymakers and is going it alone.

“An anti-inflation programme that doesn't even refer to monetary policy is certainly unusual and very much in line with Erdoğan's well publicised stance on inflation,” said Inan Demir, emerging markets economist at Nomura in London.

Albayrak’s plan involves persuading businesses to cut prices by 10 percent, particularly of those goods included in the nation’s inflation basket. The measures, which also comprise steps by the government and banks to help cut business costs - including loan restructurings and a freeze on power prices - is sparking consternation among investors looking to the central bank to step in with another rate increase later this month.

Concern that Turkey’s increasingly authoritarian president is determined to stamp his full authority on economic and monetary policy came last week when he binned his son-in-law’s plans to employ renowned U.S. consultancy firm McKinsey to advise the government on its finances. The plan seemingly jolted with his argument that Turkey’s economic ills are caused by conspirators from the western financial world.

Then, hours before the announcement of Albayrak’s anti-inflation package, Erdoğan unveiled a new 10-member advisory council to advise him on economic policy that was bereft of top economists.

Instead, Erdoğan hired Professor Servet Bayındır, an Islamic scholar known for his stern opposition to interest rates, and four of his current advisers. The latter included Cemil Ertem and Yigit Bulut, both big supporters of Erdoğan’s pro-growth policies and contrarian economic theories. And despite earlier promises to include top names from the business world, there was room for only one executive – the little-known Gülsüm Azeri, chairwoman of fuel retailer OMV Petrol Ofisi.

Paul McNamara, director of emerging markets at Swiss investment firm GAM, said Erdoğan’s establishment of the new council was at least as worrying as the government’s anti-inflation programme.

“Nobody in the markets or foreign government will rate it,” he said.

Albayrak’s own appointment in early July, right after Erdoğan was re-elected as president with vastly increased powers, had also riled investors. 

The 40-year-old former energy minister, married to Erdoğan’s daughter Esra, replaced Mehmet Şimşek, a Merrill Lynch economist who was seen as a powerful counterweight to the president’s unorthodox tendencies.

Still, last month’s rate hike, a successful trip to New York and the decision to appoint McKinsey in September had helped Albayrak gain some trust, raising hopes that he could persuade his father-in-law to control his impulses and toe the line of economic tradition.

But the events of the past two weeks, culminating in Tuesday’s announcement of the anti-inflation programme, are showing investors that Turkey may fail to pull itself out of its currency crisis, which is also ravaging economic growth..

“There is zero room for policy error,” said Tim Ash, senior emerging markets strategist at hedge fund Blue Bay Asset Management in London. “Albayrak made decent moves in September, there was hope, but seen backwards steps last the last few days.”

At the heart of Turkey’s problems is corporate debt. A spending spree in industries such as construction and energy meant Turkish companies took on tens of billions of dollars of foreign currency debt that has now become far more difficult to repay after the lira’s collapse. The loans total more than $220 billion and several top firms have already applied to banks to restructure them.

Nora Neuteboom, an economist at ABN Amro, said Albayrak’s campaign for Turkish companies to lower prices, accompanied by policing of shops and other businesses to check labels, “sounds frantic” and will hurt their profits further.

“If you don't want to increase rates, these measures are the only ones left,” she said in comments on Twitter.

Albayrak said the government’s campaign to fight inflation also included pledges by banks to lower the cost of some corporate loans denominated in liras by 10 percent and to defer the repayment of others by six months.

A decision by the central bank to raise its benchmark lending rate at a meeting on Oct. 25 would run contrary to the government’s efforts to lower loan costs.

McNamara warned that the government’s unorthodox price-reduction plans were “deeply stupid” because they would put even more pressure on retailers’ margins.

“This inflation nonsense won’t work,” he said. “If they actually have an impact on CPI, they'll do massive collateral damage that may be worse than inflation itself.”