Erdogan undermines Turkish Central Bank’s autonomy

Erdogan undermines Turkish Central Bank’s autonomy

On 30 April, the Governor of Turkey’s Central Bank, Erdem Basci, announced an interest rate cut in the near future, but specified neither number nor schedule.

The announcement came a week after reaffirming the Bank’s stance that tight monetary policy would remain in effect going forward in order to maintain a stable currency and reduce inflationary risks. Turkey’s inflationary outlook has not changed between announcements. The inflation rate is still projected to continue to rise from its current rate of 8.39%, the highest it has been in eight months

Such a decision to sow uncertainty and potentially stoke further inflation and currency depreciation comes at a difficult time in Turkey, both politically and economically.

It seems likely that Governor Basci will be dismissed from his position, casting doubt on the Turkish Central Bank’s independence from an increasingly domineering Turkish government, headed by Prime Minister Recep Tayyip Erdogan. Both Turkey’s future and Erdogan’s next move are contingent upon whether Governor Basci capitulates to increasing political pressure.

Source: Anadolu Ajans

Turkish prime minister Erdogan with governor of the central bank, Erdem Basci. Source: Anadolu Ajans

Dire effects on the Turkish economy

The economy is already suffering from high inflation and faces currency risks that a lower interest rate would only exacerbate. These are a product of a 30% depreciation of the Turkish lira in the beginning of 2014 due to political instability, the U.S. Fed’s tapering of Quantitative Easing (QE), and servicing a large current-account deficit.

On 17 December 2013, Prime Minister Erdogan was implicated in allegations of corruption as Turkey geared up for municipal elections, held on 30 March. As the controversy intensified, The Turkish lira reached a low of 2.39 TL per USD on 27 January, and the Turkish Central Bank spent 27% of its foreign reserves defending the currency.

In late January, the Turkish Central Bank increased interest rates to 10%, a move that Erdogan opposed, but one that caused the Turkish lira to appreciate and stabilize. As the election neared, Erdogan’s methods became increasingly more authoritarian, and he took steps to ban Twitter, on 20 March, and YouTube, on 27 March.

This trend looks likely to carry forward to the Presidential elections.

The political instability occurred as the US Federal Reserve continued to taper its bond-buying policy, increasing the likelihood that emerging market liquidity will soon come to an end. The Turkish lira needs to be made more attractive to defend against the shift of capital from emerging-markets, where higher growth and interest rates have absorbed capital, back to developed countries, where growth is beginning to pick up and institutions are stronger.

The situation is particularly dire in Turkey, thanks in part to its use of short-term capital to finance its current account deficit, currently at $5.2 billion. The deficit is exceptionally high because Turkey imports expensive energy, mainly oil from Iran and natural gas from Russia, among other suppliers, and exports relatively less expensive manufactured goods, such as textiles.

Turkey only has $34 billion in currency reserves to cover $129.1 billion of its external debt that will come due in the next year. Turkey will need more than $5 billion of FDI a month to service its current account deficit. If political instability increases, hot money will be pulled out, FDI inflows will decrease, and Turkey will not be able to service its debt.

The lagged effects of the currency depreciation have translated into imported inflation, as Turkish firms pay for relatively more expensive intermediate inputs. Over time, they will become less competitive as their products become more expensive relative to lower cost alternatives in the CEECs and Asia.

Inflation has also hit tourism, a $101.2 billion industry, or roughly 12.3% of Turkish GDP, and employing roughly 9% of Turks. The 10.12% price rise on imported processed foods has hit restaurants and hotels particularly hard. As prices and political instability increase, Turkey as a destination for Northern European tourists will falter next to other Southern European countries like Spain, Italy, and Portugal.

Erdogan’s incentive to reduce central bank independence

Erdogan is increasing political pressure on the central bank to cut interest rates because the AKP’s political rise and continued strength lies in the economic growth that Turks have come to expect. Increased interest rates translate into higher interest rates on borrowing, and, coupled with higher capital requirements, will lead to less capital availability, increased savings, and decreased investment in the private sector.

The effects of interest rates on credit are immediate and explicit, and facilitate fairly abrupt economic decline, as opposed to inflation, which tends to be a more gradual process.

The stronghold of the AKP is in the Anatolian region of Turkey, an area that has experienced rapid growth as labour shifts from agriculture to manufacturing and as the population becomes increasingly urbanized. The growth of manufacturing and EU ascension in several CEECs, and the rise of low-wage labour based manufacturing in Asia, has forced Turkey to increase its competitiveness and to diversify its export markets, notably to the MENA region.

This growth has led to “Anatolian Tigers,” leading businessmen in the region, who are generally pro-AKP, and hold political capital in their cities and regions. As a prime region for capital investment, a manufacturing stronghold, and the political and geographic base of AKP support, Anatolia would disproportionately benefit from currency depreciation and suffer from increased interest rates. The effects of currency depreciation have already taken hold, as exports to the EU have increased by 13.5%, and will only increase as the EU begins to grow.

The presidential elections

On 10 August 2014, Turkey will directly elect its president for the first time. The AKP did well in the municipal elections, and this momentum is expected to carry forward. The majority of the population lives in Anatolia, and this is where the AKP received the predominance of its votes in March’s municipal elections.

It is unclear whether Erdogan plans to run for the largely ceremonial role of President, appropriate powers from the Prime Minister, or rewrite the AKP’s constitution to allow for more than three terms as Prime Minister, which requires a super-majority.

If this turns out to be unfeasible because of current monetary policy and fragmentation within the AKP, he will run for President effectively unopposed, and, depending on his political capital and Turkey’s economic state, appropriate powers from the Prime Minister.

His very decision may depend on how the Central Bank acts.

Turkey needs to rectify its current account deficit through increased domestic savings, not currency-depreciation fuelled exports, and stem inflation, both of which necessitate a high interest rate. As such, Erdogan’s assertion on 4 April to lower interest rates to facilitate growth is more about his election prospects than what would be for the good of Turkey. If Governor Basci capitulates, he will undermine the Turkish Central Bank’s autonomy, and compromise an institution necessary for Turkey’s future growth.

Categories: Economics, International

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