Türkiye raises interest rates while Erdogan goes through an economic turn

Turkey raised its main interest rate from 8.5% to 15%, reversing one of President Recep Tayyip Erdogan’s unorthodox economic policies.

The 6.5-point rise was far less than economists had expected, but it marked a significant policy shift by his new economic team that was brought in to tackle rampant inflation.

The Turkish leader has so far insisted on keeping interest rates low.

Inflation is running at 40% and Turks are in the grip of a cost-of-living crisis.

Turkey’s central bank chief, Hafiz Gay Erkan, 44, was recruited from the United States only this month in the wake of Erdogan’s re-election as president.

Its decision marks the first hike in interest rates since December 2020, after a turbulent period during which three central bank governors were sacked in less than two years, as they sought to stick to traditional economics.

Although the increase nearly doubles Turkey’s policy rate to 15%, it is far less than many economists had expected. US investment bank Morgan Stanley had suggested it would rise to 20%, while Goldman Sachs said it could go as high as 40%.

The bank’s Monetary Policy Committee said in its statement that Thursday’s move marked the beginning of a gradual process aimed at bringing inflation down to 5%.

The problem for President Erdogan is that Turkey’s inflation rate remains stubbornly high, and its central bank’s reserves have fallen to rock-bottom levels, after spending billions of dollars trying to prop up the lira.

Interest rates have fallen from 19% two years ago to 8.5% in recent months, and the change in direction will have ramifications for a country already in economic crisis.

“It’s a risk, but it’s a cycle that’s hard to break,” says Ozge Zenioglu, senior lecturer in politics at the University of Liverpool. “He has to do something for the economy, but a clear shift to traditional economic policies would hit a large section of society and he wouldn’t want that to have an impact on local elections.” [next year]. “

The Turkish economy grew significantly in the early years of President Erdogan’s leadership. But in recent years, he has abandoned conventional economic wisdom by blaming rising inflation on high borrowing costs and seeking to stimulate economic growth.

In the past five years, the Turkish currency has lost more than 80% of its value and foreign investment has declined. Turks are now trying to get foreign exchange out of local banks.

Mehmet Kerim Koban of Kadir Has University said that the Turkish economic model needs capital to survive because its reserves have vanished.

Erdogan has been in power in Türkiye for more than 20 years. He defeated his opposition rival last month in an election that international observers said suffered from an “uneven playing field” that gave the incumbent an undue advantage.

During the election campaign, he maintained his mantra that interest rates would remain low as long as he was in power, ensuring that there would be no change in economic policy. The opposition promised to reverse his focus on low interest rates.

However, within days of his re-election, he signaled a change had occurred.

First, he appointed former banker and economist Mehmet Simsek as Minister of Finance. Despite being a former member of Erdogan’s government, Mr. Simsek has made it clear that Turkey’s only economic option is to return to “rational ground” and “comply with international norms”.

Subsequently, he appointed Hafiza Gay Erkan, as the first female central bank governor. A well-known figure on Wall Street, she had never had a role in Turkey before and was CEO of the US First Republic Bank before its collapse.

Erdogan said last week that his position on interest rates has not changed, but that “we have accepted it [Mr Simsek] It should take the necessary steps quickly and without bothering with the central bank.”

Emerging markets specialist Timothy Ash warned ahead of the decision that if Ms. Erkan does not “raise front-loading prices,” she risks “always playing catch-up and waiting in the waiting room at the presidential palace to demand a price hike.”

In the short term, Turkish households will suffer from a sharp increase in loan payments and a more conservative fiscal policy, said Bartosz Sawicki, an analyst at Conotoxia fintech, but there is no other way to “extinguish the fire of inflation within two to three years.”