The Turkish economy is in a very difficult situation: according to analysts, the current policy of President Erdogan is a direct threat. But any solution would require painful measures.

For his re-election, Tayyip Erdogan mobilized billions of dollars in campaign promises, while many tens of billions more were needed to prop up the Turkish lira.

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

Backed by cheap labor and an efficient banking system, the Turkish economy is facing a self-inflicted problem that few other countries face.

Tayyip Erdoğan thus began a crusade against the increased interest rates, which were promoted, in his words, by a foreign “lobby”. After all, the strongman of Turkey had in the past invoked the rules of Islam that prohibit usury.

Fall of the pound

To implement his monetary policy, Erdogan changed the governors of the central bank like shirts. The results were disastrous: the Turkish lira plummeted and inflation exceeded 85% year-on-year in the autumn.

Today, the Turkish lira continued its decline, at the level of 21.69 per euro and 20.44 against the dollar.

The Turkish “economic miracle” of the 2000s, Erdogan’s first decade in power, is over: foreign investors have bolted, spooked by instability and the imposition of government control over institutions once run by impartial technocrats.

“The holding of Turkish bonds by foreign bondholders has fallen by 85% compared to 2013, a year in which the Turkish lira lost about 90% of its value against the dollar,” emphasizes Bartosz Sawicki of Conotoxia.

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 prop up the pound, the central bank has pushed its foreign reserves into negative territory for the first time since 2002.

“The current situation is simply not sustainable,” says Timothy Ash, an analyst at BlueBay.

Competitiveness and exports

Experts see only two solutions: interest rate hikes or a free fall of the pound, as monetary support measures nullify the advantage that low interest rates represent in an economy dominated by the manufacturing industry.

According to analysts at Allianz, the pound’s real exchange rate has appreciated by almost 35% since the unorthodox monetary policy stance was fully implemented in December 2021.

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

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

A strong rate hike could help break the vicious cycle, but President Erdogan has ruled that out during the election campaign.

Atilla Yesilada, of consultancy Global Source Partners, fears that Turkey’s central bank will be forced to print money to fund the civil servant wage and pension increases that Erdogan has promised.

Reconstruction after earthquakes

Turkey should also finance the reconstruction of the earthquake-stricken provinces, where damages have been estimated at 100 billion dollars.

“How will the government finance reconstruction without printing money, which will cause hyperinflation?” This is a question no one wants to answer,” says Atilla Yesilada.

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

Emre Peker of the Eurasia group center estimates that Turkey will initially try to contain demand for dollars through “macro-prudential measures and capital controls”.

Tayyip Erdogan may finally be forced to abandon his crusade against interest rates.

“But the increase in interest rates will reduce the equity capital of banks, which will not be able to borrow for a long time,” warns Atilla Yesilada.