Wednesday, June 19, 2024

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    Turkey’s Economic Realignment- Inflation Surges, Growth Trimmed as Erdogan Embraces Interest Rate Hikes

    President Erdogan's Pivot Towards Prudent Policies Shapes New Economic Forecasts

    In a profound shift, Turkey has revised its economic forecasts, amplifying projections for inflation while moderating expectations for economic growth. President Tayyip Erdogan’s tacit support for substantial interest rate hikes has sparked this transformation toward more orthodox fiscal policies.

    This policy about-face, initiated in June, has garnered praise from analysts for its realistic approach in addressing the relentless inflation that has plagued Turkey for years. However, the short-term economic turbulence that accompanies this shift poses a significant test to Erdogan’s resolve.

    The government now foresees annual inflation scaling the dizzying heights of 65% by the close of this year before experiencing a gradual descent to 33% in the following year. This stark contrast to its forecasts from a year ago, which anticipated 24.9% and 13.8% for the same periods, underscores the gravity of the inflationary challenge.

    In tandem with these inflationary concerns, the government has opted to reduce GDP growth projections to 4.4% for the current year and 4% for the forthcoming year. These figures, though lowered, remain higher than the expectations of most economists. It represents a recalibration from the previous forecasts of 5% and 5.5%, respectively.

    Further insights from the annual “medium-term program” in Ankara reveal that the current account deficit is expected to reach $42.5 billion in 2023 and decline to $34.7 billion in 2024.

    This shift in economic projections is not an isolated event but rather a milestone in a broader policy realignment that commenced in June, marked by Erdogan’s appointment of a new cabinet and central bank chief.

    Underpinning this transformation is the central bank’s aggressive interest rate hike strategy, raising rates from 8.5% to a robust 25%. President Erdogan, in presenting the program, articulated, “With the support of tight monetary policy, we will bring down inflation to single digits again and improve the current account balance.”

    A significant rhetorical pivot is evident in Erdogan’s statements, considering his long-standing opposition to high-interest rates, often grounded in unorthodox theories that tied them to inflation. At one juncture, he had even described himself as an “enemy” of interest rates.

    However, following his re-election in May, Erdogan, faced with severe economic challenges and dwindling foreign exchange reserves, entrusted Finance Minister Mehmet Simsek and Central Bank Governor Hafize Gaye Erkan to implement rate hikes and instigate reforms in credit and forex markets.

    As a consequence, the Turkish lira has witnessed a depreciation of approximately 25%. This depreciation, coupled with other factors, catapulted annual inflation to nearly 59% last month. As of the latest update, the lira has stabilized at 26.8175 against the dollar.

    The GDP projections disclosed in the program allude to Ankara’s anticipation of the lira averaging around 23.9 this year and 36.8 in the following year.

    The Turkish economy is expected to decelerate in the coming months, particularly in the lead-up to nationwide municipal elections scheduled for March next year. The stimulus associated with the May elections is dissipating, and the weight of the 1,650 basis-point increase in interest rates is starting to make its presence felt.

    A Reuters poll from the previous month indicated an expectation of 2.9% full-year growth, falling short of the trend in Turkey’s emerging market economy. This shift aims to reverse the years-long trend of foreign investors exiting the Turkish market.

    With Erdogan’s ruling AK Party aiming to regain control of major cities, such as Istanbul and Ankara, from the opposition in the upcoming March elections, higher inflation, rising unemployment, and slower growth could challenge the President’s patience with this economic realignment. Erdogan’s track record includes the dismissal of four central bank governors in as many years, and his previous advocacy for rate cuts amid rising prices resulted in a historic currency crisis in late 2021, propelling inflation to a peak exceeding 85% last year.

    Commerzbank analyst Tatha Ghose aptly encapsulated the prevailing risk, stating, “The risk is ever-present that… Erdogan could lose patience,” while highlighting the potential for prolonged high inflation and its ripple effect on wage settlements.

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