Turkish President Recep Tayyip Erdogan (C) attending a ceremony marking the 98th anniversary of Victory Day at Anitkabir, the mausoleum of Turkish Republic founder Mustafa Kemal Ataturk, in Ankara on August 30, 2020. Photo: AFP

ANKARA — The government of President Recep Tayyip Erdogan, hellbent on propping up the Turkish lira at any cost, is setting the stage for fresh economic turmoil in the months ahead.

That is because the swift comeback from last year’s currency crisis, and then Covid-19, proudly heralded by Erdogan and his son-in-law, Economic Minister Berat Albayrak, have only papered over years of growing structural problems.

The accumulated tensions of that purported success came to the forefront earlier this month, when the lira went into free fall, marking the second currency shock in only three months.

Turkey was just emerging from its 2018-2019 currency crisis when Covid-19 hit the country earlier this year.

Now, the economy has contracted even further, nearly 10%, in the second quarter relative to 2019. All economic indicators – dwindling foreign reserves and rapid dollarization – suggest shocks will keep coming in waves.

Turkey is also witnessing some of the biggest capital flight of any country in the developing world since the start of the pandemic, according to Central Bank of Turkey balance of payment statistics.

When Turkey announced Covid-19 lockdown measures in mid-March, its current account deficit was US$4.9 billion. The capital outflows persisted, and in June, the net capital movements reached $6.7 billion in outlflows.

Options narrowing

While achieving little more than losing valuable foreign reserves, the Central Bank of Turkey’s (CBT) options are narrowing.

Since the 2018-2019 crisis, the Erdogan regime’s monetary policy has been singularly fixated on defending the value of the lira, no matter how unconventional and myopic the measures.

Since it would be economically and politically costly in the short- and medium-term to lift the factors pressuring the value of the national currency – those being the current account deficit, external debt and dollarization – Erdogan’s son-in-law has chosen cosmetic, stop-gap measures to keep interest rates low and credit expanding for as long as possible.

On paper, Turkey’s exchange rate is floating, not fixed. In practice, the CBT, which is now under the full control of President Erdogan, has been intervening in the value of the currency through a number of measures.

Those range from drying up lira liquidity in international markets to selling US dollars implicitly via public banks, consuming international reserves and introducing a tax on foreign exchange transactions in a bid to halt dollarization.

Despite these interventions, the lira’s value has dropped by 24% since the beginning of 2020 and 87% since May 2018. In August 2020, yet another psychological level was passed and the lira lost 6% in two days, falling to 7.37 against the US dollar.

To stop the free fall, the CBRT this time worked to dry up the domestic markets by reducing primary dealers’ current lira limits by half in open market operations to tighten lira liquidity.

As the CBRT’s policy space has become extremely narrow, the only option to prevent further devaluation would be to increase interest rates – something Erdogan has publicly and vocally opposed.

Following the president’s directives, the CBT officially maintained the policy rate (one-week repo auction rate) constant at 8.25%. But implicitly, the CBT increased interest rates by raising its average funding rate to banks from 7.7% at the end of July to 9.3% by late August.

As a result, Turkey’s credit and deposit interest rates rose again, signaling the end of another publicly induced credit expansion.

An additional attempt to tighten monetary policy came from the Turkish Banking Regulatory Institution (BDDK).

In order to push private and public banks to increase their lending to the private sector, the BDDK raised the minimum asset ratio of banks (total loans to deposit ratio) to 100% in April.

In August, the BDDK adjusted this minimum asset ratio to 95%, lifting the pressure on private banks to lend. It seems the authorities realized they had reached a limit of printing money and credit expansion.

But despite these measures, the lira did not recover and is down to 7.34 against the US dollar.

Public Ponzi scheme

Ankara’s main strategy to ride out the economic impact of Covid-19 was to provide cheap credit to businesses and households – a blanket solution long employed by the Erdogan regime but which is proving increasingly unsustainable.

For the strategy to succeed, interest rates are being kept low, creating added pressure on the currency and encouraging further capital outflows. Turkey is now offering negative real interest rates, which feeds the dollarization trend despite a new tax on foreign exchange transactions.

This dangerous, publicly-backed Ponzi game has been forced onto businesses and households using public banks.

Even a touted Covid-19 public spending package of 3.8% of GDP for businesses and workers has sourced its funds from the Unemployment Insurance Fund and The Turkish Employment Agency, not the central government budget.

Under the support package, 7.2 million families will receive 1,000 lira in income support for 4.5 months, equaling a monthly payment of 222 lira ($30). Yet the national minimum wage is 2,300 lira, and it is impossible for a three to four-member family to feed themselves with 222 lira a month.

It is very likely that already high levels of poverty in Turkey will rise to unprecedented levels.

Covid-19’s most severe impact in Turkey was on employment. Yet, magically, the official unemployment figure went down to 12.8% from 13% in April 2020. This was made possible by the employment policies introduced for the Covid-19 crisis.

The government banned layoffs and gave leave without pay options to businesses with a daily 39 lira payment, barely half of the minimum wage, to workers.

This payment does not come from the central public budget but the workers’ own fund, the Unemployment Insurance Fund. Therefore, workers who are under the ‘leave without pay’ scheme are not counted as unemployed, despite their income levels being 10% of the monthly minimum wage.

Upon closer inspection of the figures, another dire picture emerges. Employment collapsed for 2.58 million people in the first four months of 2020, with 7.5 million people unemployed in total.

The labor force participation rate was down to 47% from 52% in April 2019. The wide definition of unemployment in April 2020, which includes people who gave up finding a job, rose to 28.7%.

A perfect storm

Rising credit, public spending and public debt helped manufacture a quick recovery at the end of 2019 after three quarters of economic contraction.

Yet this came at the cost of a growing current account deficit (2.6% of GDP in the first six months of 2020), rising gross external debt of 57% of GDP (27% of it short-term) and higher unemployment (14% in 2019 with 27% youth unemployment).

On top of that, demand for Turkish exports started to wane even before the Covid-19 outbreak, seen in a 16% year on year drop in the first quarter of 2020 and 26% drop in the first 6 months relative to 2019.

The number of foreign tourists entering the country dropped drastically as the EU put Turkey on a list of risky countries to visit. Desperately needed tourism revenues were $34.5 billion in 2019 (4.5% of GDP), but the Turkish Statistical Institution stopped reporting tourism statistics for the second half of 2020.

The government is well aware of country’s economic problems. That is why lockdown measures never included factories, particularly in export sectors. The rest of the economy, namely the service sector and particularly tourism, was re-opened before the disease was contained.

Daily infection numbers have risen to about 1,600. The Turkish Medical Association warns that the situation is actually far worse. Contradictory figures coming from individual cities and reports suggesting that intensive care units are full in many cities, including the capital Ankara, raises concerns of an official cover-up.

The mayors of Ankara and Istanbul have publicly accused the government of just that. Given the fact that hoped for tourism revenues and a rise in exports have not been realized, some believe Turkey’s economy is poised for a perfect storm this autumn.

Faced with the high odds of further economic deterioration and a coincident public health crisis, Erdogan’s party appears to be raising its guard for the possibility of social unrest and protests in the months to come.