Experiments in Erdonomics are pushing Turkey to the brink

The country’s central bank cut interest rates by 150 bps to 10.5 per cent on Thursday, even as Turkey’s official inflation rate exceeded 83 per cent in September.

This is the third rate cut in as many months. It runs contrary to the global cycle of monetary tightening in which central banks across countries are raising borrowing costs to clamp down on inflation.

Turkey’s real interest rate is now minus 72 per cent, probably the lowest in the world. Its central bank has indicated that it could halt the monetary easing after one more round of rate cuts but there’s no word yet on what it plans to do about the economy’s severe inflation problem.

Monetary policy is getting politicised everywhere but much more so in Turkey. President Recep Tayyip Erdoğan, who has scant patience for established economic policy approaches, leans by his own admission religiously towards cheap credit. In his two decades of being in power, flooding the economy with cheap money has helped him win elections in the past. Last December, he evoked Islamic beliefs that forbid the receiving or charging of interest by Muslims in support of his economic ideology. According to his economic theory, lowering borrowing costs will lower inflation and strengthen the Turkish Lira that has been plumbing record lows (is down more than 25% against the dollar since the beginning of this year, having lost 44% in 2021 after a dramatic plunge to record low last December following the series of interest rate cuts by the central bank).

Pursuing this unconventional line of thinking, and to woo the constituency of small business owners ahead of parliamentary and presidential elections to be held next June, he has vowed to take borrowing costs below 10 per cent, promising that, “interest rates will continue to come down with every passing day, week and month," as he readies for the toughest election of his political career. Lowering borrowing costs will, he asserts, sustain GDP growth, jobs creation, investments and feel-good sentiment among voters.

He is also gung-ho on big-ticket spending programmes and is widely expected to roll out a huge fiscal stimulus comprising largesse for voters, all of which will further stoke inflation.

Erdoğan’s policies make him, to borrow the words of former US Treasury Secretary Lawrence Summers, the world’s first practical modern monetary theorist. Modern Monetary Theory, or MMT, is a heterodox economic school that argues governments can spend freely without stoking inflation. But if that was possible, there would be no need for taxes. Governments could simply print money for all their spending needs. Turkey’s inflation record is in fact evidence that there can be no free lunches, and that the promise of MMT is a mirage.

The price that the country is paying for Erdoğan’s outlandish experiments is a currency crisis, runaway inflation at levels not seen since 1998, slowing growth and an embattled central bank with little independence.

The rating agency S&P isn’t buying any of what it called the country’s “heterodox" economics and is worried that the “loose monetary and fiscal policy settings, and low net foreign currency reserve levels" make the Lira vulnerable and pose risks to financial stability and the health of the public finances. It has downgraded the rating on Turkey’s sovereign debt.

Turkey’s average yearly GDP growth between 2002 and 2021 was just under 6%. Erdoğan’s exceedingly stimulative fiscal and monetary policies helped Turkey grow very strongly during the pandemic. But the global energy crisis – Turkey depends on imports for most of its energy needs – and other problems of its own making, are slowing down the economy now. GDP growth was 7.6% in the second quarter of this year.

Murmurs, including in international media of repute, suggest that money fleeing from Russia to escape Western sanctions is finding its way to Turkey’s foreign currency reserves. The evidence cited in support of this is the discrepancies cropping up in the official Balance of Payment accounts. The fact remains that after the Argentinian peso, the Lira is the second worst-performing emerging currency of 2022. With as much as $182 billion in external debt payments due in the next 12 months, a currency collapse would put further pressure on the already large current account deficit.