For the first time in Turkish history, the governor of the central bank has been removed by presidential decree, putting its independence in question at a time of economic turmoil.
President Recep Tayyip Erdogan replaced Murat Cetinkaya, whose term was due to end in April 2020 with a deputy close to his Islamist Justice and Development party (AKP), Murat Uysal.
While no official reason was provided for the June 6 sacking, Erdogan made his reasons clear in recent days, signaling that his administration – and not the bank – would dictate monetary policies.
“Everyone will see how our interest rate policy will be shaped and the central bank will provide more support for the government’s policies,” he told reporters on DAY.
Erdogan has labeled interest “the mother of all evils, the mother of inflation”. He has told reporters on various occasions that the former governor had not been successful in securing market confidence.
It seems the Turkish president needed a scapegoat for growing economic problems, which are thought to have cost him the major cities during this year’s local elections.
Erdogan for years capitalized on cheap credit expansion thanks to low interest rates to enact his government’s projects. This boosted debt-led high growth rates, but it also created major fragilities in the economy, such as high dependency on foreign capital inflows, which in turn put high pressures on interest rates. The party ended in 2013, when conditions in the international financial markets shifted.
Debt at 15-year high
Turkey’s external debt stock is now 61% of GDP, the highest level in 15 years. The economy shrank 2.6% in the first quarter of 2019, and inflation soared due to the Turkish lira’s slide last year. The lira lost more than 50% of its value over the past two years, while the country is dependent upon foreign funds, requiring a high-risk premium, in order to finance its debt. During his term, Cetinkaya was compelled to hike the benchmark interest rate by a total of 11.25 percentage points to 24% at present.
It seems that the new Central Bank governor has been appointed not only to cut interest rates but also to boost the economy by other monetary measures which will have an expansionary impact on credit. Bloomberg reports that Turkey is preparing to provide a boost to the economy through faster credit growth by tweaking a number of reserve rules for commercial lenders.
Analysts believe the bank may start easing monetary policy as early as an upcoming July 25 meeting.
Erdogan and his governments have long been accused of choosing appointees for public positions according to how close they are to the AKP.
Adding to the controversy of the Central Bank governer’s sacking, an academic in the Department of Economics of Ankara University has found that the new appointee, Murat Uysal, plagiarized his master thesis by copying pages directly from three papers – two of which were also written by Central Bank researchers. Ironically, Uysal’s thesis was on inflation targeting, the main policy direction of the Central Bank since the 2002 crisis.
Even Cetinkaya, the sacked governor, had been chosen despite his close ties to the AKP after appointment rules for the Central Bank were changed. After working at private banks and in Islamic banking, Cetinkaya had senior administrative positions in public banks, like the new governor Uysal. Cetinkaya was criticized several times by market analysts, who said he was pressured by Erdogan and always late to increase interest rates when the lira was weakening, which caused larger rate hikes than necessary in the end.
His sacking is only the latest symptom of Erdogan’s short-term thinking in regard to the economy. On the eve of local elections in March, economic authorities are understood to have pressured Turkish banks not to lend the struggling national currency to foreign financial institutions.
This caused the lira’s liquidity to dry up in foreign markets overnight, while the cost of offshore borrowing in the currency rocketed by more than 1,000%. The move was aimed at stemming the lira’s trend of dropping against the dollar, as well as convincing voters at home that foreign interests would have hurt the economy otherwise.
Despite these desperate measures, Erdogan lost Istanbul not once, but twice in an ordered recount in an embarrassing defeat.
It appears impossible for the Turkish leader to think of long-term consequences or strategy at this point, and he is doing everything in his power to postpone impending economic grief for his constituents.
The markets and major Turkish companies want Erdogan to follow austerity policies, which would hurt him politically. Turkey is not only going through an economic crisis but also a political and regime crisis, with little room for sane economic policy and strategy.
Waiting in the wings
Ali Babacan, the former economic affairs minister who was kicked out of the government in 2015 by Erdogan, has hinted at the formation of a new party with the support of former top AKP cadres.
Abdullah Gul, the former president and once very close friend of Erdogan, plus Davutoglu, the former prime minister and architect of Turkey’s aggressive Middle East and Syria policies, are reportedly working with Babacan.
Since the first Istanbul elections, Davutoglu has been openly criticizing Erdogan and the AKP. Babacan is seen as the main actor responsible for the so-called economic success of the AKP in its early years. However, what he did was just follow an IMF standby program signed after a crisis in 2001, which only worked for Erdogan when everything was going well.
Babacan also was in charge during the irresponsible debt-led economic boom, financed by short-term foreign capital inflows – the main driver of the economy, particularly after the 2008 crisis.
Speculation about the new party range from founding a Macron style, center-right party, to a coalition with Turkey’s main opposition party, the CHP, which currently governs major cities including Istanbul and Ankara. In either case, it would be an alternative to the Erdogan regime.
Down, not out
But, the economic downturn in the US and EU could offer Erdogan a lifeline if expansionary monetary policies are employed by the world’s largest economies and lead to interest-rate cut, as happened after the 2008 global crisis.
In this case, developing economies such as Turkey would be able to attract foreign capital flows even though the risk premium would be higher due to the developing world’s high level of debt. Turkey’s credit default swap (CDS) is currently 390 after hitting 450 during the last year’s currency crash.
Thanks to the shrinking economy, the current account recorded a $151 million surplus in May, reducing the 12-month rolling deficit to $2.37 million after a $6.17 million deficit in the same month in 2018, the Central Bank reported.
The fast decrease in the current account deficit is expected to lift some of the pressure on interest rates as the need for foreign capital inflows decrease in parallel. Nevertheless, the state of financial inflows may not support a rate cut. Direct investment recorded a net inflow of $204 million in May, down by $51 million compared to the same month in 2018. Portfolio investment showed a net outflow of $456 million, indicating that Turkey is not very popular despite offering one of the highest real interest rates among developing countries.
Another interesting observation is the rising trend in public foreign debt. In the first quarter of 2019, the ratio of private external debt in total gross foreign debt dropped to 66% – from 69.5% in 2018, while public foreign debt has been rising. These are all signs that the private sector is struggling with debt, the economy shrinking, and that the government is creating another deficit while the current account deficit is turning positive.
In May, the unemployment rate was just over 14% and there are some forecasts that it could hit 15% in June, despite expansionary credit and fiscal policies.
But the rising trend in government debt, both domestic and external, offers a sign of where Erdogan wants to direct the economy. Austerity measures, as expected by the markets, do not appear to be part of his plans.