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At the end of last week, the Turkish lira had lost nearly half its value, compared to the beginning of this year. Last October alone, the Turkish lira lost almost 27 per cent of its value in just one month, to reach its lowest levels ever at the beginning of this month.
Consequentially to the deterioration of the local currency exchange rate, and the rise in the imported commodities and raw materials prices, annual inflation rates rose to 21.31 per cent; the highest price increase witnessed in Turkey during the past three years. In short, what Turkey has been going through for weeks is no longer just a limited decline in the value of the local currency but has turned into an accelerated fall in its value and an unbearable rise in inflation rates.
These developments were enough to ignite the endless debate about Recep Tayyip Erdoğan’s financial policies and his crude interference in monetary policies from non-pragmatic ideological premises. Today’s Turkish lira exchange rate is practically related to three successive decisions taken by the Turkish Central Bank since last September.
These decisions slashed interest rates gradually from 19 per cent to 15 per cent. All of them were prompted by Erdoğan himself, who dismissed several senior officials in the Central Bank during October to freely impose his monetary vision of hurriedly and strictly reducing interest rates. In March 2021, Erdoğan had also dismissed the former governor for the same reasons and appointed a new one aligned with his aspirations regarding interest rates.
Today, most scientific and economic analyses link the decline in the exchange rate of the Turkish lira and inflation rates to the aforementioned quick and perhaps hasty decisions. The current state requires Erdoğan to reconsider his monetary policy. There are even those who link the market distrust in the Turkish lira with Erdoğan’s interference in the affairs of the Turkish Central Bank and its monetary decisions, specifically concerning the overthrow of senior officials of the monetary authority to impose his vision of Turkish monetary policy.
Erdoğan replaced three Central Bank governors in a two and a half-year span, as his orientations on the issue of interest rates contradict the axioms of monetary policy that any Central Bank governor usually follows. Even Finance Minister Lütfi Elvan, a long-standing member of Erdoğan’s party – Justice and Development Party – had to resign earlier this month due to Erdoğan’s intransigence.
Despite everything, Erdoğan insists on cutting interest rates and dismissing senior officials in charge of monetary policy, regardless of all the repercussions that occurred after that. He does not show any flexibility in reconsidering the pressures he exerted to make these decisions. Erdoğan, who has always described himself as a historical enemy of high-interest rates, blamed everything on a foreign economic war that wants to keep Turkey hostage to “the high-interest and the major countries’ lobby”. At the same time, in his opinion, the required treatment is nothing but a campaign to investigate currency speculations in the black market on the Turkish lira.
These developments call to wonder about what happened, to investigate the secret of the relationship between interest rates, the local currency exchange rate, inflation rates, and the nature of economic developments in Turkey during the past years that caused the country’s local currency exchange rate to plummet. It also raises questions about why Erdoğan insists on obstinately fighting high-interest rates and about the ideological backgrounds from which he proceeds in this insistence, not to mention the quality of the local interests he serves by simply maintaining low-interest rates in this way.
The Turkish Debts Bubble
Turkey’s historical crisis with debt, interest and the exchange rate, like many developing countries, is due to several developments related to global financial markets that took place since 2009 on multiple stages. As a result of the global financial crisis in 2008, central banks in Western countries resorted to reducing interest rates to near-zero levels, attempting to encourage markets to borrow and push for economic growth.
Precisely for this reason, developing countries such as Turkey were poured with vast amounts of liquidity in foreign currency from abroad by investors looking for relatively higher interest rates compared to the meagre interest rates in Western countries. The failure of Western central banks due to the consequences of the financial crisis represented an additional reason for financiers to search for investment opportunities in developing countries such as Turkey. For these reasons, the World Bank indicates that developing countries benefited from financial inflows with a total value of nearly $675 billion in 2009 and $1,130 billion in 2010.
The influx of foreign currency into Turkey was tempting. It prompted the Turkish government to encourage borrowing in foreign currencies to use the liquidity flowing into Turkish banks, whether by families and individuals in consumer loans (car, housing, personal loans, etc.) or by companies in debt securities.
With foreign currency flowing easily from abroad, Turkish banks did not need to raise their rates much to attract foreign deposits from the West, as long as Western competitor banks offer near-zero interests or even negative interest rates in some cases. Consequently, Turkish banks can obtain liquidity from abroad with low-interest rates, allowing them to lend these funds with reasonable interest inside Turkey.
Gradually, a giant bubble of loans formed inside Turkey due to all these developments, especially after the mass of loans inside Turkey gradually increased by more than two-folds between 2009 and 2018. More than 80 per cent of these loans were granted by Turkish banks, which benefited from the influx of deposits from abroad, while foreign banks gave the remaining 20 per cent to Turkish individuals and companies.
Post-Debt Bubble Crisis: Exchange and Interest Rates
Nevertheless, this situation did not last long. Since 2015, banks abroad have gradually raised interest rates after global markets recovered from the repercussions of the worldwide economic crisis. For example, the interest rate approved in bank transactions inside the United States at that stage rose from levels close to zero at the end of 2014 to about 2.42 per cent in April 2019.
Consequently, funds started to reverse flow from developing countries, including Turkey, to Western countries, explaining the gradual deterioration of the Turkish lira exchange rate since 2018. Practically, that meant a scarcity of foreign currencies in the foreign exchange market against the Turkish lira, and thus the fall of the Turkish lira value against the dollar and the euro.
With the debt bubble, the decline of the Turkish lira exchange rate meant a catastrophic disaster for foreign currency borrowers in Turkey, both individuals and companies. The value of these foreign currency-denominated debts was rising, compared to the value of their incomes in the Turkish lira, which has since plunged Turkey into a cycle of successive bankruptcies, not to mention the high risks posed to the Turkish banking sector due to the high rate of non-performing loans. With these shocks, foreign investors began to flee the Turkish market, exacerbating the crisis of foreign capital outflows even further, which led to more pressure on the exchange rate of the Turkish lira since 2018.
The Interest Rates Complication Surfaces
The interest rates issue started to impose itself in Turkey in 2018 and is still ongoing until this day. It has become an essential part of all economic discussions in the country. Preserving foreign capital and attracting foreign currency to limit the deterioration of the Turkish lira necessitated raising interest rates so that the state could keep pace with the global rise in interest rates and be able to compete for foreign capital.
On the other hand, President Erdoğan’s policies were an archenemy to high-interest rates at all stages without exception, a fact that the Turkish president himself was keen to announce on every occasion. Erdoğan’s historical stubbornness against high-interest rates was one of the main reasons for exacerbating the Turkish lira exchange rate crisis.
Erdoğan has his reasons for this stance, mainly stemming from his anti-usury Islamist background in general, which aims to neutralise the effects of interest on the local economy as much as possible. At the same time, he considers that raising interest rates harms the productive sector of the Turkish economy by curbing the borrowing used to finance productive projects, not to mention pushing investors to deposit their money in banks to benefit from interest returns instead of investing it in productive projects.
Even with regards to the fall in the local currency exchange rate, which might have been due to not raising interest rates, this development may, in turn, serve the Turkish productive sectors by improving their competitiveness in foreign markets because a low lira exchange rate means low priced exported goods against dollars or euros.
On the other hand, Erdoğan’s opponents focus on the disastrous impact of his excessive focus on a single economic variable, that is, the effect of high-interest rates, while ignoring all other variables: the impact of the devalued exchange rate on the Turks’ wages and savings, and their consumption ability, in addition to the shrinking of the size of the Turkish economy as a whole as a result of the depreciation of the currency used in all internal trade exchanges.
His opponents also focus on his methods of dealing with monetary and financial issues, which is majorly based on fierce interference in how the central bank operates, ignoring the independence it is entitled to in managing monetary affairs, and not giving it the required space to handle this matter in isolation from all of the populist and political considerations.
It should be noted that the relationship of interest rates with inflation and the exchange rate branches into other forms. Reducing interest rates facilitates borrowing and raises the monetary mass of the local currency circulating the markets, which in turn increases the supply of local currency in the foreign exchange market. Yet, it means more pressure on the Turkish lira exchange rate. Raising interest rates would limit the deterioration of the exchange rate by adding to the volume of existing deposits and having the Central Bank absorb the monetary mass circulating the market.
Whose Interests Does Erdoğan Serve?
The interest rates complication remained the main topic of any discussion about the exchange rate in Turkey for the past three years. But this year, in particular, the issue exacerbated rapidly, with the Turkish president carrying out mass dismissals within the Central Bank in preparation for decisions to further reduce interest rates on three stages since last September, which led to the recent accelerated devaluation of the Turkish lira.
Some hint that Erdoğan’s policies are closely aligned with the network of interests he represents in the government, which he has put together from within the ruling Justice and Development Party, revolving around the rising Turkish bourgeoisie elite, taking advantage of low-interest rates to obtain bank financing for their projects. The lira devaluation also serves the interests of industrialists among this elite, who will benefit from the increased competitiveness of their products in foreign markets.
Regarding the future of the current and ongoing crisis, it seems that President Erdoğan has turned the issue into some sort of personal political defiance, which exacerbates all the existing financial and monetary complications. Dealing with national crises of this magnitude with purely personal political backgrounds does not help deal with a problem involving intertwined economic factors and requires overlapping remedies.