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Erdogan makes an economic turnaround as Turkey raises interest rates.

Turkey hikes interest rates as Erdogan stages economic U-turn

ANKARA, TURKEY - JUNE 9: Newly appointed Chief of Turkiye's Central Bank Hafize Gaye Erkan (L) poses for a photo with Former Chief of Central Bank Sahap Kavcioglu during a handover ceremony in Ankara, Turkiye on June 9, 2023 (Photo by Emin Sansar/Anadolu Agency via Getty Images)

Turkey has reversed one of President Recep Tayyip Erdogan’s unconventional economic policies by raising its main interest rate from 8.5% to 15%.

Although the 6.5-point increase was significantly lower than what economists had anticipated, it represented a significant policy shift by his new economic team, which was brought in to combat inflation.

Up until now, the leader of Turkey has insisted on keeping interest rates low.

The Turks are in the grip of a cost-of-living crisis as a result of nearly 40% inflation.

In the wake of Mr. Erdogan’s re-election as president, 44-year-old Hafize Gaye Erkan was brought in from the United States.

After a turbulent period in which three central bank governors were fired in less than two years as they sought to adhere to orthodox economics, her decision marks the first rise in interest rates since December 2020.

Although the increase brings Turkey’s policy rate to 15%, it is significantly lower than many economists had anticipated. Goldman Sachs and Morgan Stanley, an investment bank based in the United States, stated that it could reach 40%.

The bank’s monetary policy committee made it clear in its statement that the move on Thursday was just the beginning of a gradual process with the goal of bringing inflation down to 5%.

“Decided to begin the monetary tightening process in order to establish the disinflation course as soon as possible… and to control the deterioration in pricing behavior,” the group’s members stated.

Turkey’s central bank has spent billions of dollars trying to support the lira, but its reserves have dropped to critically low levels, making President Erdogan’s problem worse. Turkey’s inflation rate remains stubbornly high.

The downward trend in interest rates—from 19% two years ago to 8.5% in recent months—will have consequences for a nation already experiencing an economic crisis.

Ozge Zihnioglu, a senior politics lecturer at the University of Liverpool, states, “It is a risk, but it is a difficult circle to square.”

Erdogan “has to do something for the economy, but a clear shift to orthodox economic policies would hit a large portion of society, and he wouldn’t want that to affect local elections” the following year.

During the early years of President Erdogan’s presidency, Turkey’s economy experienced significant expansion. However, in recent years, he has defied conventional wisdom in the field of economics by attempting to boost economic expansion and placing the blame for high inflation on high borrowing costs.

Foreign investment has plummeted and the Turkish currency has lost more than 80% of its value over the past five years. Currently, Turks are attempting to remove foreign currency from local banks.

According to Kadir Has University’s Mehmet Kerem Coban, Turkey’s economic model needed capital to survive because its reserves had vanished.

The Turkish lira continued to fall against the dollar even though the rate increase was intended to stabilize it. However, investors appeared unimpressed.

In Turkey, Mr. Erdogan has been in charge for more than two decades. In elections that, according to international observers, had an “unlevel playing field” that gave the incumbent president an unjustified advantage, he prevailed over his opposition rival last month.

Throughout the election campaign, he remained steadfast in his promise that economic policy would not change because interest rates would remain low. His focus on low interest rates would be reversed, according to the opposition.

Yet he indicated a shift within days of his reelection.

Mehmet Simsek, an economist and former banker, was first appointed by him as finance minister. Even though Mr. Simsek was a government official under Erdogan, he has made it clear that Turkey’s only economic option is to go back to “rational ground” and “compliance with international norms.”

He then appointed Hafize Gaye Erkan as the first female governor of the central bank. She is a well-known Wall Street figure, but she has never worked in Turkey. She was chief executive of the US bank First Republic before it collapsed, leaving about a year later.

Last week, Mr. Erdogan stated that he had not altered his position regarding interest rates, but “we accepted that [Mr. Simsek] should take the necessary steps quickly and effortlessly with the central bank.”

Timothy Ash, a specialist in emerging markets, issued a pre-decision warning that Ms. Erkan ran the risk of “always playing catch-up with the market and waiting in the ante-room of the presidential palace to plead for rate hikes” if she did not “front-load rate hikes.”

Conotoxia fintech analyst Bartosz Sawicki stated that while a more conservative fiscal policy and a steep increase in loan installments would hurt Turkish households in the short term, there was no other way to “extinguish the inflationary fire in two to three years.”

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