After History of Erratic Economic Policy, Erdogan Plunges Turkey Into Fresh Turmoil

After History of Erratic Economic Policy, Erdogan Plunges Turkey Into Fresh Turmoil

Unorthodox economic policies have long fueled unease among investors, who have pulled money out of the country in recent years over concerns about Turkey’s stability

Turkey’s economy is facing fresh turmoil after the surprise ouster of the central bank governor by President Recep Tayyip Erdogan added another chapter to years of unpredictable economic policy, spooking foreign investors and possibly sowing the seeds of a financial crisis.

Last Friday, Mr. Erdogan replaced Naci Agbal with Sahap Kavcioglu, a former member of parliament for Erdogan’s Justice and Development Party, who publicly sided with the president’s calls for lower interest rates, despite inflation hitting 15.6% annually in February.

Mr. Erdogan, who has fired three central bank chiefs in less than two years, prefers low rates as a part of a strategy to encourage growth.

He opposed policies set by Mr. Agbal, who raised interest rates in an effort to fight inflation and help Turkey pull back from the brink of crisis. Mr. Agbal’s policies encouraged investors to pour billions of dollars back into the country since he was appointed in November.

The dismissal of Mr. Agbal triggered on Monday one of the worst single-day selloffs of Turkish lira-denominated assets, as investors scaled back their exposure to the currency. The lira fell 7.5% against the dollar in one day. Mr. Kavcioglu has sought to reassure markets by saying he would curb inflation but hasn’t said whether interest rates will change.

Mr. Erdogan defended his policy during a speech to a summit of his party on Wednesday, saying this week’s market volatility didn’t reflect the strong foundations of Turkey’s economy.

“We proved repeatedly that we are resilient against all kinds of shocks,” he said.

Mr. Erdogan, who has governed Turkey as prime minister and later as president since 2003, oversaw years of rapid economic expansion during his first decade in power as the government invested in infrastructure and adopted policies to encourage growth.

But over the last decade, Turkey has wrestled with increasing instability, including popular protests against Mr. Erdogan, an influx of millions of refugees from neighboring Iraq and Syria, and terrorist attacks by Islamic State and Kurdish militants.

Separately, the adoption of low interest rates and other unorthodox economic policies by Mr. Erdogan’s government, has at times seen international investors pull money out of Turkey over concerns about the stability of the country.

Turkey was plunged into a currency crisis in 2018 after former President Trump doubled steel and aluminum tariffs during a dispute over an American pastor who was being held in the country. At the height of the crisis, Mr. Erdogan appointed his own son-in-law, Berat Albayrak, to lead the ministry of finance, further adding to investors’ concerns about the narrow circle of advisers around the president.

“Eventually all the heavyweights have been eliminated, and Erdogan has been surrounded with yes-sayers,” said Atilla Yesilada, a prominent Turkish economist.

The currency only stabilized after the central bank was forced to hike rates to 24% in September 2018, where they remained for about 10 months.

The 2018 rate increases stabilized the economy and reduce cheap loans, which helped Turkey to cut its current-account deficit and create a current account surplus in part of 2018 and part of 2019.

By mid-2019, Turkey began cutting rates again and state banks, encouraged by Mr. Erdogan’s government, began giving loans to Turkish households and businesses, once again fueling demand for imports.

Mr. Agbal, who was appointed in November 2020, raised interest rates in an effort to contain inflation and draw back some foreign money.

“Agbal was not given a chance to finish what he started,” said Selva Demiralp a Professor of Economics at Koç University in Istanbul and a former economist at the Federal Reserve Board.

The ousting of a central bank chief trusted by many foreign investors has renewed fears of a balance of payments crisis, in which Turkey would be unable to pay for essential imports or service its foreign debts. Turkey relies on funding from foreign investors to fund its current-account deficit.

Turkish banks have $88.7 billion in short term, foreign currency, external debts maturing in the next year, according to Capital Economics, equivalent to about 12% of its gross domestic product.

In past years, banks have been able to roll over those loans to the future, but the shake-up in confidence has some worried that institutions will want repayment and not push back loans.

“This is a kind of event that can be the trigger of a balance of payments crisis because now the credibility to me seems to be lost,” said Nikolay Markov, a senior economist at Pictet Asset Management.

Mr. Erdogan is unlikely to pursue an agreement with the International Monetary Fund for a bailout. During the crisis in 2018, government officials said an agreement with the IMF wasn’t on Turkey’s agenda.

The most likely path, investors say, is for Turkey to seek an agreement with Qatar. Last year, Qatar gave Turkey a $15 billion swap agreement—a short-term lending facility to help stabilize the lira. Ankara has previously also used swap lines with China.

The instability at the central bank has made it harder for Turkey’s economy to recover from a series of external shocks. In recent years, Turkey has had to deal with wars in neighboring Syria and Iraq, terrorist attacks, and the coronavirus pandemic. Turkey’s military also launched a violent coup attempt in 2016 that failed.

Mr. Erdogan has also expanded his own reach within the Turkish state in recent years, clamping down on domestic opponents and sidelining rival leaders within his own party. He has repeatedly rejected the advice of other Turkish officials like Mr. Agbal, who have advocated a more conventional approach to the economy.

“The power is with the president,” said Cavit Dagdas, a former deputy undersecretary of the Turkish treasury. “At the end of the day they don’t have the power or they can’t convince the president,” he said, referring to Mr. Erdogan’s advisers.

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