For many years, it was not the economy that determined Turkey's voting behavior. The country's President Recep Tayyip Erdogan has won almost every election he has held despite a deteriorating economic outlook.
This is generally explained by the importance of identity politics in a country polarized by the policies of President Recep Tayyip Erdoğan's ruling Justice and Development Party (AK) for 22 years.
But on Sunday, March 31, after Turkey's local elections, President Erdoğan's winning streak came to a screeching halt. His AK Party lost the popular vote for the first time since 2002, while the main opposition group won victories in major cities such as Istanbul and Ankara.
What makes this time different is that the huge costs accumulated over years of policy failures are now beginning to have a profound impact.
So what was the country's economic outlook?
On March 21, Turkey's central bank unexpectedly raised interest rates to 50%. The move was the latest in a series of interest rate hikes since President Recep Tayyip Erdogan was re-elected in May 2023 and was seen as a sign of the central bank's determination to fight runaway inflation, which hovers at nearly 70%.
The rise in interest rates has been widely hailed as a much-needed shift from unconventional monetary policy that lasted far too long. President Erdoğan's unconventional policy stance stems from his deep-seated belief that raising interest rates increases rather than lowers inflation.
The pandemic and Russia's invasion of Ukraine have caused inflation to skyrocket around the world. While almost all central banks raised interest rates in response, Turkey cut interest rates. Keeping interest rates artificially low contributed to rising domestic inflation, making Turkey the king of inflation along with Argentina and Venezuela.
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Decoupling from other emerging economies
Emerging markets have shown remarkable resilience in the face of the global financial crisis. Unlike in the past, many emerging economies have avoided large fluctuations in exchange rates and managed to control inflation without exposing themselves to debt crises.
One reason for this is that emerging economies have been successful in improving their policy frameworks, particularly by increasing the independence of their central banks. More specifically, these countries' central banks have vastly improved their communication and transparency, and have become much better at forecasting inflation. As a result, countries such as Chile, the Czech Republic, and South Africa are outperforming developed countries.
Unfortunately, Turkey has been an outlier in this area. The country has completely given up its monetary policy independence, with six different central bank governors in the past five years.
Politics has also played a disproportionate role in economic policy decisions. Changes to Turkey's constitution that took effect in 2018 gave President Erdogan significant executive powers to push for extremely generous spending in the run-up to the 2023 presidential election.
Minimum wages have increased significantly, expensive pension schemes and subsidized housing projects have been introduced. This expansion in public spending naturally contributed to the inflationary pressures that were already occurring.
Turkey is in an unconventional position in terms of monetary easing, and its decision to cut interest rates from 2021 to 2023 while other countries are tightening is precisely why the central bank is currently lowering interest rates at a time when other countries have just started an easing cycle. This is the very reason why it must be raised.
Why is this important?
Getting monetary policy wrong is important for most countries. But it is especially important for a country like Turkey, which is very open to trade and capital flows, and where exchange rate fluctuations are a key driver of domestic economic fluctuations.
One of the biggest losers of President Erdogan's unorthodox monetary policy is the Turkish lira. Over the past six years, the value of the lira has fallen significantly against the US dollar. In January 2018, he had to part with 3.76 lira to buy 1 US dollar. Currently, this figure stands at 31.9 lira.
Large fluctuations in the value of the lira are important for the Turkish economy for several reasons.
First, a significant portion of Turkey's imports are inputs used in production processes, especially motor vehicles, machinery, and machinery and equipment, which account for almost half of the country's exports. A decline in the value of the lira would increase input costs, which in turn would increase prices and reduce the country's export competitiveness.
Second, Turkey imports a significant portion of its energy from abroad. Similarly, a depreciation of the lira increases the cost of energy imports.
Third, Turkey has a large amount of foreign debt in foreign currency terms. This makes the cost of a weak lira even higher. As that value is lost, the amount of resources required to service a given level of foreign currency debt increases.
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Advance
The good news is that Turkey has returned to more orthodox economic policies. But it is too early, and even a sharp shift in policy will not be enough to change the course of the economy, especially in the fight against inflation. Persistent inflationary pressures are forcing citizens to increase their foreign currency holdings, putting further pressure on the lira.
Faced with slowing foreign capital inflows, authorities had to draw down large amounts of foreign exchange reserves to prevent further depreciation of the lira. In a similar vein, the sharp rise in interest rates on March 21 should be seen as the price the country has to pay for its past policy mistakes.
More importantly, it has been almost a year since Turkey returned to more conventional economic policies, and there are no plans to rebuild the economy with appropriate institutional reforms at its core. If you want evidence of whether robust and independent policy institutions benefit economic performance, you need look no further than the recent resilience of other emerging economies.
Brazil, for example, has not only bounced back strongly from the pandemic. It has been successful in controlling inflation and boasts one of the best performing currencies in the world.
