Home Finance Erdoğan’s Re-Election Has Profound Economic and Geopolitical Consequences

Erdoğan’s Re-Election Has Profound Economic and Geopolitical Consequences

by internationalbanker

By John Manning, International Banker

 

While it did not quite go down to the wire, Recep Tayyip Erdoğan’s continued hold on power in Turkey following a second-round election runoff vote on May 28 (which saw him receive 52 percent of votes from the electorate versus 48 percent for the opposition leader, Kemal Kılıçdaroğlu) was nonetheless a decidedly closely run contest. With another term now secured as president—a position he has occupied since 2014, before which he served as prime minister of Turkey beginning in 2003—following the toughest political challenge of his presidency, Erdoğan faces a more divided Turkey than was previously the case. And with the country still reeling from the impacts of dire economic mismanagement in recent years, as well as now being positioned as a crucial geopolitical part of the world as a NATO (North Atlantic Treaty Organization) member and neighbour to Syria, the president kicks off his new term with some crucial issues to resolve.

The good news for Turkey is that Erdoğan’s continuation as president does not simply mean it is back to “business as usual” regarding the economy—far from it. The evidence thus far amply demonstrates a dramatic departure from his previous ill-fated economic policies, which saw him refuse to raise interest rates despite enduring some of the world’s worst inflation rates, which peaked at a whopping 85.5 percent in October 2022. At the time, Erdoğan insisted that Turkey had no inflation problem but rather “a cost-of-living problem”, dubbing interest rates “the mother of all evil”.

Indeed, much of this economic chaos was spurred by reductions in Turkey’s benchmark one-week repo rate, from 19 percent in the third quarter of 2021 to 8.5 percent by March 2023, largely initiated to drive domestic demand, private investment, cheaper borrowing costs and a more favourable trade balance with the rest of the world, but with prices heading skyward all the while. This unorthodox approach drastically weakened Turkish citizens’ purchasing power, as well as the Turkish lira, which has plummeted by around 40 percent so far in 2023. And with a hugely devastating earthquake hitting Southeastern Turkey in early February, further compounding Turkey’s economic woes, Erdoğan’s economic strategy urgently needed a comprehensive overhaul.

Thankfully, some common sense has been restored to Turkish policymaking, at least on the monetary-policy front. On June 22, the central bank raised rates by a mammoth 650 basis points to 15 percent, although even this hike was significantly more modest than the 21 percent that market analysts had widely anticipated. But anchoring inflation expectations has become a clear priority for Turkey. Policymakers have also adopted policies designed to boost the value of the lira, such as trimming the securities maintenance ratio from 10 percent to 5 percent and the threshold for the share of lira deposits from 60 percent to 57 percent.

This sharp reversal in macroeconomic objectives can be partly attributed to Erdoğan’s new, decidedly more orthodox economic team. Among them is newly installed Treasury and Finance Minister Mehmet Şimşek, a former economist for US wealth management firm Merrill Lynch who was highly regarded during his previous positions as minister of finance and deputy prime minister between 2009 and 2018. And a more market-oriented central bank chief has also been chosen in Hafize Gaye Erkan, an ex-Goldman Sachs banker and former co-CEO of First Republic Bank. “We thought we would have a woman administrator for the central bank for once, and we took this step. Of course, we told her of our expectations,” Erdoğan said regarding Erkan’s appointment. “We hope that with these steps neither our treasury and finance minister nor our central bank will let us down.”

Erdoğan has said he is committed to returning Turkey to a “low inflation, low interest rate” economy. But it might take a few additional gargantuan rate hikes for him to achieve this objective, given that the annual inflation rate remains at a staggering 38.2 percent as of June. And although he has “accepted” the changes proposed by this new team, he continues to express disagreement with their views. “Some of our friends should not fall into the error of (asking), ‘Is the president going to make a serious change (concerning) interest rate policy?’ I remain in the same position,” Erdoğan recently said. “We accepted that (Şimşek) should take the necessary steps rapidly and effortlessly with the central bank,” he added, thus strongly indicating that he has allowed for a more conventional monetary policy to be pursued by the central bank.

One can also not rule out the possibility of a change of heart further down the line from Erdoğan, one that could see another return to economic unorthodoxy, which, while not particularly likely, is not out of the question, either. “Erdoğan hasn’t really hesitated to sack [central bank] governors that raise rates in the past, so investors will never feel fully at ease as long as he’s president,” Craig Erlam, senior market analyst at Oanda, recently noted.

Indeed, this year has seen Erdoğan also implement policies that do not exactly align with the goals of inflation reduction, including the use of the central bank’s foreign-currency reserves to prop up the lira, massively expanding government spending to protect Turkish people from the effects of soaring inflation, facilitating early access to government pensions for millions, boosting the minimum wage on two separate occasions to give workers a total 107-percent wage increase from last year’s levels and also raising wages for civil servants. “If inflation does not slow down, the wage increase is meaningless,” Ergun Atalay, head of the Confederation of Turkish Trade Unions (TURK-IS), recently told Bloomberg. “We hope that the prices in the market will be taken under control as soon as possible.”

Nonetheless, a statement from the central bank confirmed that its rate hike was implemented to bring down inflation “as soon as possible” and that it would continue raising rates “until a significant improvement in the inflation outlook is achieved”. According to Capital Economics, Turkish interest rates could reach as high as 30 percent this year, with the London-based research firm’s senior emerging markets economist, Liam Peach, recently noting that there were “encouraging signs” from the central bank that further rate hikes lay ahead.

On the international front, meanwhile, Turkey’s initial opposition to Sweden’s bid to join the North Atlantic Treaty Organization (NATO) represented perhaps the most significant geopolitical implication of Erdoğan’s re-election. But Ankara reversed course on this blockage during the NATO summit held in Vilnius on July 11-12 when the military alliance’s chief, Jens Stoltenberg, confirmed that the Turkish leader would submit Sweden’s application to Turkish parliament and “ensure ratification”. Should Sweden’s NATO application be approved, then it would mean that along with Finland, two northern European nations will have discarded their decades-long policies of military non-alignment following the outbreak of war in Ukraine.

The acceptance by NATO-member Turkey follows months of pressure applied on Stockholm to do more to stop harbouring groups that it considers terrorist organisations, including supporters of the outlawed Kurdistan Workers’ Party (PKK) and members of an organisation the Turkish government holds responsible for a 2016 coup attempt against Erdoğan. Recent months had seen demonstrations held in Sweden’s capital city containing visible signs of support for the PKK, which Sweden has also classified as a terrorist group, along with many other Western nations.

Instead, Sweden’s ratification will reportedly materialise in exchange for formal Swedish support for Turkey’s accession to the European Union, $20 billion worth of F-16 fighter aircraft provided by the US, and 79 modernisation kits for existing aircraft. Reports have also emerged that US president Joe Biden offered an International Monetary Fund (IMF) credit line worth over $11 billion to his Turkish counterpart to green light Sweden’s NATO admission.

Some also believe it is simply a matter of time before Erdoğan normalises ties with neighbouring Syria, which could have seismic implications for the Middle East. A meeting in Moscow of Turkish, Syrian and Russian ministers in December 2022 and the further thawing of relations between the two nations this year suggest that restoration of full diplomatic relations could transpire before too long, which, in turn, would precipitate the return of millions of Syrian refugees to their homeland. Indeed, the issue of the continued refugee presence in Turkey became a hotly contested one during the elections, with Kılıçdaroğlu labelling such Syrians with “temporary protection” status as “crime machines in the making, threatening national security” and pledging to demand their departures within two years.

Turkey would have to withdraw its troop presence from northern Syria before such a détente is finalised; this remains a key sticking point given that Turkey still occupies roughly 10 percent of its neighbour’s territory and has been among the leading sponsors of forces seeking to overthrow Syrian President Bashar al-Assad. Erdoğan declared on July 17 that Turkey has never “shut the door” to discussions with the Syrian government, and that he would be “open to a meeting with Assad.” Damascus’ condition of a complete withdrawal of Turkish forces for such a meeting was “unacceptable,” he also reiterated, however. Nonetheless, given the peace deals that have materialised in recent months across the Arab world, as well as the welcoming of President al-Assad back into the Arab League, negotiations over such issues could well begin in earnest over the coming weeks.

 

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