Turkey’s Erdogan set for an economic turnaround and a sharp increase in interest rates

Turkey is poised to reverse some of the unorthodox economic policies of President Recep Tayyip Erdogan as his new economic team tries to bring down rampant inflation.

Less than a month after Erdogan won re-election, interest rates are expected to rise dramatically from the current level of 8.5%.

Inflation is almost 40% and Turks are in the grip of a cost of living crisis.

But Turkey’s leader has so far insisted on keeping interest rates low.

The big question is how far the policy rate will rise. Economists are divided on how strong the increase will be, with US investment bank Morgan Stanley suggesting an increase of 11.5 points to 20%, while Goldman Sachs expects the rate to reach 40%.

Other economists believe the recovery will be steep, but possibly more gradual.

President Erdogan’s problem is that Turkey’s inflation rate remains stubbornly high and the central bank’s reserves have fallen to critically low levels, after it spent billions of dollars trying to prop up the lira.

Economists are widely in favor of raising interests to tackle high inflation, but Turkey’s leader fired three central bank governors in less than two years as they tried to stick to orthodox policy.

Interest rates have fallen from 19% two years ago to 8.5% in recent months. Now they will rise again, and that will have consequences for a country that is already in economic crisis.

“It’s a risk, but it’s a difficult circle to square,” says Ozge Zihnioglu, senior lecturer in politics at the University of Liverpool. “He has to do something about the economy, but a clear shift to orthodox economic policies would affect a large part of society, and he would not have that impact on local elections [next year].”

Turkey’s economy grew dramatically in the early years of President Erdogan’s leadership. But in recent years he has rejected conventional economic wisdom by blaming high inflation on high borrowing costs and trying to stimulate economic growth.

Over the past five years, the Turkish currency has lost more than 80% of its value and foreign investment has fallen. Turks are now trying to move foreign cash out of local banks.

Mehmet Kerem Coban of Kadir Has University said Turkey’s economic model needed capital to survive because reserves had melted away.

Erdogan has been in power in Turkey for more than 20 years. He defeated his opposition rival last month in elections that international observers said suffered from an “uneven playing field” that gave the incumbent president an unjustified advantage.

During the election campaign, he maintained his mantra that interest rates would remain low as long as he was in power, guaranteeing that there would be no change in economic policy. The opposition promised to turn the focus on low interest rates.

And yet within days of his re-election he signaled a change.

First, he appointed former banker and economist Mehmet Simsek as finance minister. Although a former member of Erdogan’s government, Simsek has made it clear that Turkey’s only economic choice is to return to “rational ground” and “adherence to international norms”.

He then appointed Hafize Gaye Erkan (44) as Turkey’s first female governor of the central bank. A well-known figure on Wall Street, she has never had a role in Turkey before and was the CEO of the US bank First Republic before its collapse.

Erdogan said last week that his stance on interest rates had not changed, but “we accepted it [Mr Simsek] should take the necessary steps quickly and effortlessly with the central bank.”

Emerging markets specialist Timothy Ash believes Erkan will have to “front-load rate hikes”, rather than introducing them gradually. The risk, he warned on Twitterwas that she would share the same fate as a predecessor, “always playing catch-up with the market and waiting in the antechamber of the presidential palace to plead for rate hikes”.