2023-11-27 23:48:16
After the May election, which President Recep Erdogan won by a narrow margin, Turkey is swapping unorthodox sorcery for good old-fashioned economic orthodoxy.
Erdogan, who has ruled the country for two decades, appointed an Orthodox team in June, as soon as he was proclaimed re-elected, and since then he has been moving away from his monetary experiment that began in 2021, when he tried to prove in practice a bizarre theory according to which cutting interest rates would reduce inflation.
Under the command of Hafize Gaye Erkan, an executive who worked at Goldman Sachs and who was co-CEO of First Republic Bank in the USA, the Turkish Central Bank has been rapidly raising interest rates, at a pace above that predicted by the market.
At the last meeting, last week, the basic rate was raised from 35% to 40% per year, the highest in two decades. It was the sixth consecutive tightening since the elections.
In May, when Turks went to the polls, the rate was 8.5%. In June, the BC raised it to 15%, starting the tightening cycle.
In real terms, however, interest rates still remain in negative territory. Inflation has retreated from peaks above 80% per year reached in 2022, but remains above 60%.
In its recent statement, the BC said that the current level of interest rates is close to the level necessary to “establish the course of disinflation,” indicating the possibility of a residual increase.
According to the Turkish Central Bank’s projections, inflation is expected to fall below 40% next year, on a path of gradual convergence towards the 5% target.
A supporter of state capitalism with heavy interventions in the economy, Erdogan has sustained economic growth in recent years with a policy of rapid credit expansion. His policy is similar to that of the Argentine Peronists – who have just been defeated – and ‘developmentalists’ to the Dilma Rousseff and Guido Mantega.
Turkish imbalances were accumulating, with an increase in the external deficit and the devaluation of the lira, which put even more pressure on inflation. The Government’s response was to introduce new interventions and capital controls.
The BC presidency has become an ‘electric chair’: there have been four changes of command since 2019.
In 2021 came the icing on the heterodox cake, with the monetary experiment.
The world was experiencing soaring inflation amid the pandemic. Brazil and other countries with orthodox economic policies followed the manual and raised interest rates.
Erdogan, however, decided to put an advisor’s ideas into practice… According to this alternative theory, higher interest rates actually fuel inflation, instead of fighting it. This would happen because the drop in the cost of financing for companies would bring lower prices.
The basic interest rate, which was 19% in 2021, began to be reduced until it reached 8.5%.
The result, as predicted by the old economics textbook, was exactly the opposite. The lack of credibility in monetary policy caused inflation expectations to soar, with businesspeople anticipating future price adjustments. The lira lost even more value. The cost of credit for consumption rose.
The lack of control over prices almost cost Erdogan his re-election. But, distributing benefits on the eve of the election, he emerged victorious once more and now promises to bring inflation to single digits.
The president recalled economist Mehmet Simsek to his cabinet, who resumed the Ministry of Finance, which he had already occupied between 2009 and 2015. Before pursuing a political career, Simsek was a strategist at Merrill Lynch in London.
In an interview with Financial TimesSimsek stated that the adjustment program seeks to “cool demand and stabilize the economy.”
“We are on the right path,” said Simsek. “There is evidence that confidence is recovering, but we need patience. It’s still challenging.”
Simsek has been putting people market friendly in key positions in the management of the economy, such as the new president of the BC, Hafize Erkan, 41 years old, a specialist in risk management e the first woman to head the Turkish BC. Born in Istanbul and graduated in Industrial Engineering, Hafize received her PhD at Princeton, in the field of Financial Engineering.
In another sign of surrender to orthodoxy, a new BC director was an economist at the New York Fed.
The question, according to analysts, is to what extent Erdogan gave in and became convinced of the harm caused by his experiment – or whether the change of course will be just a partial retreat in his moves to preserve power.
Sergi Lanau, director of emerging countries strategy at Oxford Economics, estimates that next year, with the elections for governors and mayors, Erdogan will once once more prioritize economic growth at the cost of controlling inflation.
Economic policy has improved markedly since the election, Lanau wrote. But the strategist recalled that Turkey has a history of inflating short-term growth through bank credit, bringing subsequent imbalances.
“We believe the policy will be looser as the election approaches,” Lanau said.
Many people in the Brazilian market feared that Lula, in his third term, would take a path similar to that of Turkey or Argentina. It’s no secret that some of his most faithful collaborators have long had a fondness for heterodoxy. But, until now, orthodoxy has generally prevailed, with the BC acting independently.
“We have an orthodox macro arrangement, albeit somewhat reluctantly,” said Luciano Sobral, chief economist at Neo Investimentos. “The cost of heterodoxy at the beginning of government would be great, with a rise in the dollar and inflation. If anything crazy is attempted, it will be closer to the election.”
Giuliano Guandalini
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