Unorthodox policymaking and insufficient action to purify the financial system highlight the high stakes.
Turkey's president Recep Tayyip Erdogan
Turkish analysts are becoming more circumspect about its investor prospects despite an encouraging, but small, improvement in Euromoney’s most recent country risk survey in Q3 2021.
The higher risk score – indicating a slightly safer environment – was largely down to a period of relative calm politically at that point, and not least the economic improvements witnessed since the pandemic struck such a heavy blow.
Economic activity has stepped up several gears and in October the IMF’s latest forecasts depicted GDP growing by an eye-watering 9% in real terms this year after weak growth of 0.8% and 1.8% respectively in 2019 and 2020.
Despite this, Turkey ranks a lowly 91st in Euromoney’s global risk rankings, making it a high-risk option within the fourth of five categories, on a par with Namibia and Ecuador.
Turkey’s total risk score is also down on a five- and 10-year trend basis, and quite markedly so, which Euromoney has invariably flagged previously, quoting the views of its panel of experts:
Several aspects of the economy are a problem. The lack of foreign direct investment for instance, along with low foreign-exchange reserves, a high unemployment rate of 12% and the return of high inflation.
Consumer prices have been rising at a faster pace each month this year to reach 19.9% year-on-year in October. Core inflation measures eased a little last month, but remained high nevertheless, with sky-high rates recorded for various goods and services.
At the same time, the Central Bank of the Republic of Turkey (TCMB) has been pursuing an unorthodox – read politically pressurized – monetary policy, cutting interest rates in the belief this will boost exports and combining it with an industrial policy targeting key export sectors to address the current-account deficit.
President Recep Tayyip Erdogan is no monetarist, that’s for sure. His belief is that higher interest rates worsen inflation, and his compliant governor Sahap Kavcioglu seemingly agrees.
“Turkey’s interest-rate policies are upside-down,” says Steve Hanke – a professor of applied economics at the Johns Hopkins University and a member of Euromoney’s country risk experts panel – who is already attaching rock-bottom risk scores to the country.
“When the money supply surges, inflation surges. Then, interest rates rise. Look at any country with high interest rates and you will see a country that has pumped up its money supply. And as night follows day, inflation has surged, and then interest rates have tagged right along in an attempt to catch inflation.”
He adds: “Thanks to Erdogan’s nutty ideas about the relationship between interest rates and inflation, Turkey’s central bank has produced an enormous supply of excess money since late 2017 and is continuing to produce money at a rate that is much faster than that consistent with hitting its inflation target of 5% per year.”
In October, the TCMB lowered its one-week repo auction rate at a second successive monetary policy committee (MPC) meeting by a larger-than-expected 200 basis points, to 16%, increasing the negative real rate.
Euromoney survey contributor and AM Best economist Graziano Brady says: “It is difficult to predict how firmly Erdogan believes high interest rates cause inflation and just how far he is willing to put his beliefs into practice, despite evidence to the contrary, but it is worth noting that low interest rates help his allies in the construction and tourism industries.
“There is a possibility that some element of Erdogan’s low interest-rate obsession is therefore tactical, and this would suggest Erdogan will keep interest rates low so long as inflation does not become so high that even construction and tourism are negatively affected.”
However, the policy has seen the lira lose around a fifth of its value this year, which is indeed adding to an inflation problem already worsened by global supply shortages and rising energy costs.
Kavcioglu is the third governor in as many years, too, while two deputy governors and a third member of the MPC were shown the door in October, not that many months after four dismissals were announced in May – signalling there can be no dissenting voices.
The latest rate cut was more than business leaders could bear, who took to openly criticizing the TCMB’s approach. Their frustration is echoed by other members of Euromoney’s Turkey risk panel, such as Timur Han Gur, a professor of economics at Hacettepe University in Ankara.
He says that although some sectors will benefit, low interest rates will continue to create pressure on the lira, exacerbating high inflation and price instability.
“This point is extremely important for the future stability of the economy, because it may easily go back to the old pattern of high inflation leading to economic and political turmoil, and chaos,” adds Gur.
“With lower interest rates, I believe that the government has clearly given up on price stability, and has chosen economic growth and current-account balance as the major goals of its monetary policy. But the cost of high inflation and depreciation of Turkish lira will be extremely harmful in the long run for sure.”
Pressure on the lira’s exchange value has indeed continued as investors have sought to liquidate ‘hot money’ portfolio assets against the backdrop of another concern.
Specifically, Turkey has been placed on a ‘grey list’ by the global Financial Action Task Force for failing to address money laundering and terrorist financing, requiring increased monitoring – discouraging investors even more.
Erdogan may even become more desperate to please voters next year with elections coming into view in June 2023, and a united opposition plus credible presidential challengers presently on course to oust him and his party from power.
There is a real chance for the opposition to take over, not least because of the diminishing purchasing power that Turkish citizens now face, says Brady at AM Best.
“Erdogan’s authoritarian leadership style, intrusion into state institutions and deep suspicion of political opponents may lead him to cling on to power in the event of a narrow electoral defeat, precipitating a political crisis,” he says.
Investors are unlikely to be calmed by a populist leader acting out of line at home, through increased repression, while flexing its muscles and irking partners on the world stage.
“Turkey continues to alienate itself from Nato and its western allies without finding high-quality alternative allies, leaving it geopolitically vulnerable,” says Brady.
Hopkins’ Hanke adds that Turkey’s most significant economic risks all centre on Erdogan.
“He has a propensity to meddle and micro-manage Turkey’s internal economic policies, and he does so armed with bizarre economic ideas,” says Hanke. “If that isn’t bad enough, he is also attracted to foreign adventures that could leave him with burnt fingers and Turkey with economic burdens.”
With Turkey’s other economic and social problems also factored in, which Gur refers to as the “severe reduction of purchasing power of poor and middle-class families, low foreign-exchange reserves, high social tension and corruption”, it is no wonder that several analysts taking part in Euromoney’s survey have indicated that their intention is to downgrade Turkey in the next survey round in Q4.
Be this a warning to investors.