The Turkish economy is in a very difficult position: according to analysts, the current policy of President Erdogan poses a direct threat. But any solution will require painful measures. For his re-election Mr. Tayyip Erdogan mobilized billions of dollars for campaign promises, while many tens of billions more were needed to support the Turkish lira.

“It is likely that the moment of truth is approaching for the Turkish economy,” notes Capital Economics.

Relying on cheap labor and an efficient banking system, the Turkish economy faces a challenge of its own that few other countries face.

This is how Tayyip Erdogan launched a crusade against raising interest rates, which he said was facilitated by the foreign “lobby”. After all, the Turkish leader has in the past invoked Islamic rules against usury.

Fall of the pound

To implement his monetary policy, Erdogan changed the central bank governors like shirts. The results were disastrous: in the fall, the Turkish lira fell sharply, and inflation exceeded 85% on an annualized basis.

Today, the Turkish lira continued to decline, at 21.69 per euro and 20.44 per dollar.

The Turkish “economic miracle” of the 2000s, Erdogan’s first decade in power, is over as foreign investors fled, frightened by instability and state control of institutions once run by impartial technocrats.

The most pressing problem facing Turkey is that the Turkish central bank is running out of liquidity.

Having spent about $30 billion since January 1 to support the pound, the central bank has brought its foreign exchange reserves into negative territory for the first time since 2002.

“The current situation is just unsustainable,” says Timothy Ash, an analyst at BlueBay.

Competitiveness and export

Experts see only two solutions: higher interest rates or a free fall for the pound as bailouts offset the advantage that low interest rates represent in a manufacturing-dominated economy.

The real exchange rate of the pound has risen nearly 35% since the unorthodox monetary policy stance was fully implemented in December 2021, according to Allianz analysts.

“A return to a floating exchange rate regime will be necessary to restore the competitiveness of Turkish exports,” Allianz analysts said.

Many analysts are predicting a free fall in the lira in the coming months, a fall that will further hurt the purchasing power of the Turks and could force the government to seek the many billions of dollars needed to implement household support measures. And this is in addition to election promises.

A sharp rate hike could help break the vicious cycle, but President Erdogan ruled it out during the campaign.

Attila Yesilanda of consulting firm Global Source Partners fears that Turkey’s central bank will be forced to print money to fund Erdogan’s promised salary and pension hikes for civil servants.

Reconstruction after earthquakes

Turkey must also finance the reconstruction of the earthquake-hit provinces, which cost an estimated $100 billion.

“How will the government finance reconstruction without printing money, which will cause hyperinflation?” Nobody wants to answer this question,” says Atilla Yesilada.

According to analysts, the Turkish government will have no choice but to raise interest rates.

Emre Peker of the Eurasia group center believes that Turkey will first try to contain demand for dollars through “macro-preventive measures and capital controls.” Tayyip Erdogan may finally be forced to abandon his campaign against interest rates.

Source: APE-MPE, AFP.