Why does Turkey have such high inflation?
Updated: Dec 30, 2022
Prices are rising quickly across the globe, due to elements such as Covid-related supply shortages and the Ukraine conflict, pushing energy and food prices higher. Many countries have responded by raising interest rates to encourage people and organisations to borrow and spend less, with the goal of hindering inflation. The Bank of England has raised the interest rate to the highest level since 2009, while the US Federal Reserve announced its largest rate increase in more than two decades.
But Turkey's issues have been made worse by its president's reluctance to raise interest rates. Mr. Erdogan has defined interest rates as "the mother and father of all evil," and has used more unusual policies to attempt to dampen prices, including by intervening in foreign exchange markets. Facing pressure from the Turkish president, the country's central bank has slashed rates to 13% from 18% since September 2021.
Charlie Robertson, global chief economist at Renaissance Capital, stated that although the conflict in Ukraine was contributing to inflation, much of the underlying reason for high prices were due to "Turkey's very odd monetary policies".
Turkey’s consumer prices rose by more than 80% in September from a year ago, its highest in 24 years, as the country grapples with soaring food and energy costs and President Recep Tayyip Erdogan’s long-running unorthodox strategy on monetary policy.
Another key aspect of the current Turkish economy is the sharply weakened lira. This time five years ago, the lira traded at 3.5 to the dollar; now it’s more than 18 to 1. A weaker currency has resulted in less imports to Turkey as foreign goods and services have become more expensive, and more exports as Turkish goods and services have become cheaper for people that live outside of Turkey. This caused a massive influx of money into the country and directly spiked the aggregate demand therefore causing inflation.
With the instructions from Erdogan to the country’s central bank to consistently slash borrowing rates for the past 2 years, Turkey has experienced massive currency instability. The depreciation of the Turkish Lira is used as an instrument to increase exports and therefore improve the current account position of the country. Central bank heads who expressed opposition were fired. By the spring of 2021, Turkey’s central bank had seen four unique governors in two years.
Turkey’s authorities have made a show of diplomatic overtures to numerous oil-rich Gulf states, mending previously strained ties to draw much-needed investment, and they’ve also remained enthusiastically open to Russian enterprise and trade despite Western sanctions on Russia due to the conflict in Ukraine.
Timothy Ash, a senior emerging markets strategist at BlueBay Asset Management commented “Ridiculous move. Obviously they have got cash in their pockets from Russia and the Gulf and think they can cut rates + hold the Lira.”
The Turkish government is implementing a range of unconventional techniques to try to appreciate the lira, most of which involve spending significant foreign exchange reserves or blocking lira loans to companies deemed to be holding too much foreign currency, which many economists warn is unsustainable as it only can be implemented in the short-term and if there were to be any major falls in the value of the lira the scenario would be harsher capital controls methods to boost the use of Lira in the banking sector.
London-based Capital Economics wrote in a note that there is likely to be more trouble ahead for Turkey. Jason Tuvey, the firm’s senior emerging markets economist stated that this could yet trigger another currency crisis.
Tuvey also concluded that it is clear that the Central Bank of Republic of Turkey is taking its instructions from President Erdogan, whose unorthodox views form the basis of the government’s “new economic model” of low real interest rates.
The country, a key economic and political crossroads among the east and west, home to millions of Middle Eastern and South Asian refugees and the second-largest military in NATO, is likewise tormented by a widening current account deficit, “large short-term external debts and perilously low foreign exchange reserves”.
References:
Countryeconomy, ‘Turkey Central Bank Key Rates 2022’ (countryeconomy.com 19 August 2022)
‘Turkey Interest Rate - 2022 Data - 1990-2021 Historical - 2023 Forecast - Calendar’ (Tradingeconomics.com 2022)
Turak N and Clinch M, ‘Turkey Shocks Markets with Rate Cut despite Inflation near 80%’ (CNBC 18 August 2022) <https://www.cnbc.com/2022/08/18/turkey-surprises-markets-withrate-cut-despite-inflation-near-80percent-.html>
News B, ‘Turkey’s Cost of Living Soars Nearly 70%’ (BBC News 5 May 2022) <https://www.bbc.co.uk/news/business-61332272>
FocusEconomics, ‘Turkey: Inflation Comes in at Highest Level since Our Records Began in June’ (FocusEconomics | Economic Forecasts from the World’s Leading Economists 6 July 2022) <https://www.focus-economics.com/countries/turkey/news/inflation/inflation-comesin-at-highest-level-since-our-records-began-in-june>