By Monica Johnson, International Banker
While much of the world continues to battle against surging consumer prices this year, few countries are dealing with as seismic an inflation problem as Turkey. Indeed, the Eurasian country of almost 85 million people saw its annual inflation rate hit a mammoth 78.6 percent in June, its highest in 24 years, and beat the 73.5 percent it recorded in May, according to the Turkish statistics agency. It has also risen by 42 percent since last December, further underlining how much economic damage Turkey has experienced in 2022.
The government data showed that food and fuel costs were chiefly to blame for June’s surge which, along with the continued depreciation of Turkey’s currency, has contributed to skyrocketing costs. Producer prices rose by a massive 138 percent in June, while food prices have soared by over 93 percent from a year ago, and transportation prices have climbed by 123.37 percent. The lira, meanwhile, weakened by some 44 percent against the US dollar in 2021, while this year it has already lost a further one-fifth of its value to exacerbate the pain of spiralling living costs for Turkish people.
What’s more, a growing consensus of analysts have been contending that actual inflation in Turkey is much higher than what is being reported. A recent report by Turkey’s Inflation Research Group (ENAG) of leading economists and academics suggested that consumer prices in June had actually risen by a whopping 175% on an annual basis, and that prices had also risen by 71.4% since the start of the year. The Istanbul Chamber of Commerce, meanwhile, estimates that the biggest Turkish city was experiencing annual inflation of 94%. “No one actually believes official Turkish data anymore,” Timothy Ash, an economist at BlueBay Asset Management, told the UK’s newspaper The Guardian. “There is no expectation of anything like a credible policy response.”
According to Turkey’s treasury and finance minister Nureddin Nebati, it is the “the persistence of high increases in global commodity prices, particularly in energy and agricultural products” that is underpinning such horrendous inflation rates at present. Nebati has previously insisted that this bout of inflation was “temporary,” and promising the country that inflation will drop from December onwards. President Recep Tayyip Erdoğan had also promised in April that he would protect Turkish citizens against inflation. “As the Turkish economy is getting ready to become one of the world’s top 10 economies, we have said that we will not waste this opportunity with careless and thoughtless steps,” he said. “We will get out of this situation in a way that will not crush our citizens with inflation.”
But it would seem as though that help is yet to materialise, and may never do so given the Turkish president’s somewhat bemusing approach to economic policy. Indeed, Erdogan continues to maintain that Turkey does not have an inflation problem, but rather “a cost of living problem.” And given that he has previously called interest rates “the mother of all evil,” it should perhaps come as no surprise that inflation has resulted from a stubborn reluctance to rein in prices through higher rates. “We will lift this scourge of interest rates from people’s backs. We certainly cannot allow our people to be crushed by interest rates,” Erdogan announced in November 2021. “I cannot and will not stand on this path with those who defend interest rates.”
More than anything, then, Turkey’s economic crisis can be viewed as the result of quite transparent economic mismanagement, and one that could have easily been avoided in good time. Even though prices rose considerably throughout much of last year, Erdogan insisted that the central continue to slash borrowing rates. And because the central bank has no independence from the whims of the government, it duly obliged, despite enduring the departure of four governors in just 2 years, along with others who spoke out against this suicidal monetary policy. The second half of last year thus saw interest rates being cut from 19 percent to 14 percent, and it has remained at this level throughout 2022.
The decision not to use higher rates to contain runaway prices has seemingly been done to boost the use of the local currency and make long-term investment loans more appealing to borrowers. Erdogan himself has defended dovish monetary policy by arguing that lower rates will boost production and exports, and has blamed foreign interference for Turkey economic woes. But the cost of pursuing this policy has been brutal for the ordinary Turkish citizen in terms of skyrocketing prices, and things do not look set to improve anytime soon. “Despite rising inflation, we do not expect the Central Bank of the Republic of Turkey to hike interest rates given the political constraints and President [Recep Tayyip] Erdogan’s call for lower interest rates,” Abu Dhabi Commercial Bank economists Monica Malik and Thirumalai Nagesh acknowledged in a recent research note.
It is not surprising, then, that “spiralling inflation” and questionable policies that increase macro and external risks are the key reasons for Fitch’s decision on July 8 to slash Turkey’s sovereign debt rating further into junk territory. The cut from B+ to B means that Turkey’s rating is now a full five notches below investment grade. “Guided by political considerations, the central bank has maintained its policy rate at 14% since December 2021, despite rapidly rising inflation, the impact of the war in Ukraine on commodity markets and tightening monetary policy in most advanced economies,” Fitch said. “The government’s focus on maintaining high growth feeds FX demand, depreciation pressures on the lira, decline in international reserves and spiralling inflation, and discourages capital inflows to fund the higher current account deficit.”
Fitch now expects Turkey’s annual inflation to average 71.4 percent this year, which is the highest of sovereigns rated by the agency as its trajectory remains highly uncertain due to “increased risks of backward indexation, rising expectations and additional lira depreciation, as the exchange rate pass-through has increased in both speed and magnitude.” Fitch also estimates that inflation will average 57 percent in 2023 due to the overall policy mix remaining “overly accommodative” until the general elections in June 2023.
S&P Global Ratings, meanwhile, has cited the combination of surging food and energy prices and ultra-accommodative monetary policy to explain why inflation will remain above 70% until the end of the year, before dropping in December on the base effect and softening energy prices. As such, acute exchange rate and inflationary pressures will continue to weaken private consumption, S&P noted. “The Turkish lira has resumed its slide, which is adding to price pressures. We don’t see any sign of a change in the monetary stance of Turkey’s central bank, and expect it will keep the key rate unchanged at 14% in the coming months, while using various macroprudential measures to curb credit growth and support the currency,” according to an S&P research report published June 28. “Inflation expectations have surged and even under the assumption of lower energy prices and a relatively stable lira next year, we expect inflation to remain above 20% until at least mid-2023.”
The ratings agency also cited the likely recession in Russia and Ukraine, alongside the slowdown in growth in the eurozone and the UK, will weigh on Turkey’s export income, which has long been a significant driver of growth for the country. That said, relief may well come in the form of a resurgence in international tourism, the report noted, which should boost demand for the lira and thus help to lower the cost of imports.