Turkish central bank nearly doubles interest rate as Erdogan makes economic policy U-turn

ISTANBUL - Turkey’s central bank on Thursday reversed years of unconventional economics promoted by President Recep Tayyip Erdogan and nearly doubled its key interest rate to fight inflation and steady the troubled lira.

The spike in rates, to 15 per cent from 8.5 per cent, came less than a month after Mr Erdogan, Turkey’s dominant politician for two decades, won a third presidential term.

His victory came despite a challenge from a newly unified opposition, high inflation that has left many Turks feeling poorer, and catastrophic earthquakes in February that killed more than 50,000 people.

Members of Turkey’s opposition had feared that Mr Erdogan would capitalise on his victory to crack down on his opponents and further consolidate power.

But to date he has made no drastic moves and has largely stuck to his previous positions, including the use of Turkey’s membership in Nato to block Sweden from joining the alliance.

His largest shift has been in economic policy, in an apparent effort to head off the threat of interlocking economic problems that economists say are largely of Mr Erdogan’s making.

The official annual inflation rate rose above 80 per cent in 2022 and was at 39.5 per cent in May 2023.

It eroded the purchasing power of Turkish families and sent the nation’s currency, the lira, plunging to record lows.

Outside groups have accused the government of manipulating the statistics, saying the actual inflation rate is twice as high.

In the run-up to May’s election, Mr Erdogan tapped the central bank’s foreign currency reserves to prevent the lira from falling further while unleashing billions of dollars of new spending to insulate voters from the immediate impact of high inflation.

He increased the minimum wage, hiked civil servant salaries and changed regulations to allow millions of Turks to draw early government pensions.

Mr Erdogan also insisted on repeatedly reducing interest rates, from 19 per cent in 2021 to 8.5 per cent in 2023, in defiance of orthodox economic theory and practice, which call for raising rates to control inflation.

Since his victory on May 28, Mr Erdogan has not directly announced a change of course.

But he has made several moves that point to more conventional economic policies that, while aimed at taming inflation and reducing the threat of a currency crisis, could also throw the economy into a recession.

He reappointed Mr Mehmet Simsek, a highly regarded former Merrill Lynch banker and minister in his government, as finance minister.

To head the central bank, he named Ms Hafize Gaye Erkan, a Princeton-educated economist and former executive at the now-defunct First Republic Bank. She is the first woman in Turkey to hold the post.

In announcing the interest rate hike, the bank said further increases would follow “in a timely and gradual manner until a significant improvement in the inflation outlook is achieved”.

Fitch Ratings said it expected the benchmark rate to reach 25 per cent by the end of the year.

Despite the latest move, the lira still lost 4 per cent of its value against the US dollar due to investor disappointment that the bank had decided to pursue a more gradual rate-hiking course.

“Not enough. They needed to front-load hike,” BlueBay Asset Management economist Timothy Ash remarked.

“Further hikes are needed at the coming meetings to tackle Turkey’s inflation problem,” said Capital Economics analyst Liam Peach.

Economic overhaul

Other analysts said Ms Erkan wanted to avoid suffering the fate of past governors, whom Mr Erdogan had fired for quickly raising rates.

Mr Erdogan has long promoted the unorthodox idea that lower rates lead to lower inflation, a theory that did not work out but did deliver continuous economic growth.

The Turkish leader pushed the central bank to start slashing interest rates two years ago as part of a “new economic model” focusing on job creation and economic growth.

The policy badly backfired.

The annual inflation rate reached 85 per cent late in 2022, and the central bank burned through most of its reserves trying to prop up the lira – down 90 per cent against the US dollar over 10 years – and avoid even bigger falls.

Mr Erdogan was forced into his first election run-off and then orchestrated one of his trademark policy reversals after extending his two-decade rule until 2028.

‘Clash with Erdogan’

The Turkish media said the new finance minister, Mr Simsek, agreed to join the government only after winning assurances that he would be free to steady the ship as he saw fit.

And Mr Simsek’s presence has already made an impact.

The lira has lost an additional 18 per cent against the US dollar since the May 28 election run-off – a sign that the central bank is slowly unwinding its costly currency defence.

Mr Simsek said on Thursday that a return to a “free exchange regime... will provide a very serious flow of capital to Turkey”.

“This will make financing investments and production much easier, and will ensure that the Turkish lira regains stability and becomes a reliable currency,” he said in a tweet.

But investors who initially cheered Mr Erdogan’s new appointments now worry about how long the Turkish leader’s patience with his new team will last.

Many point to the grim experience of Mr Naci Agbal – a market-friendly central banker whom Mr Erdogan fired four months into his attempts to raise rates in late 2020 and early 2021.

“The scale of the rate hike was lower than the average market expectation of an increase to between 17 per cent and 20 per cent,” said Verisk Maplecroft risk consultancy analyst Hamish Kinnear.

“This is a sign that the new governor is looking to tread carefully to avoid a clash with President Erdogan.”

One of Turkey’s most costly programmes involves a bank deposit protection scheme that Mr Erdogan rolled out in late 2021.

It commits the government to covering any losses lira deposits incur from the currency’s depreciation against the US dollar.

That means that a quick return to a free-floating exchange rate could put an even bigger burden on the strained budget.

Many expect Mr Simsek to gradually phase out the scheme.

AFP, NYTIMES