On Sunday, Turks will go to the polls for municipal elections. While he’s not on the ballot himself, President Recep Tayyip Erdogan has been campaigning vociferously in support of candidates from his Justice and Development Party, or AKP. The vote is a litmus test of Erdogan’s management of the economy, and the results will help him assess how much political capital he has left for dealing with the mounting challenges facing the Turkish economy.
Having registered two consecutive quarters of contraction, the economy is now officially in recession. Inflation reached 20 percent in February, leading to drastic increases in the cost of living for average Turks. While Erdogan has overseen meaningful growth in the Turkish economy during his tenure, much of that growth has been fueled by external debt, and the weakness of the lira, driven by credit-fueled inflation, is now coming home to roost.
Erdogan’s response has been, unsurprisingly, to blame everyone from grocers to bankers. With food prices rising and people struggling to afford basic staples, Erdogan blamed greedy, “treasonous” grocers for profiting unduly from the country’s economic woes (even though grocery stores are a notoriously low-margin business). In an attempt to curb food inflation, the government has instituted price controls on a number of items and police have been dispatched to supermarkets to ensure compliance. Ankara has also begun purchasing food on its own dime and opening government-run food stalls that sell produce at prices below what grocers can afford. This has the added benefit of making the government look like the good guy.
Earlier this week, in classic diversionary form, Erdogan blamed JPMorgan Chase for the decline in the lira. He said it wasn’t a result of years of external debt-fueled growth combined with current account deficits but rather JPMorgan’s mere prediction of a decline in value. Though Turkey was able to stem last year’s currency slump after the central bank raised interest rates in September, the lira again fell more than 5 percent last Friday when new data showed a greater-than-expected decline in the country’s net international reserves – a drop of about $10 billion in the first three weeks of March to $24.7 billion. Turkish officials have claimed this week that the decline in reserves was expected, resulting from the central bank’s sale of foreign currency to energy-importing firms to facilitate the purchase of foreign energy (another example of how fluctuating oil prices impact economies worldwide).
In the run-up to this weekend’s elections, Erdogan has again intervened in the economy, this time by restricting Turkish banks from lending money to short sellers of the lira. This move could have serious long-term consequences. Short selling a currency requires first borrowing it, selling it for a profit, then repaying the amount borrowed at a lower price. The result of Erdogan’s restriction has been a radical rise in the overnight borrowing rate of the lira to over 1,200 percent (by the end of the day, the rate settled at 750 percent, and now is back closer to 30 percent). The logic behind the move is that, if short sellers can’t borrow liras in the first place, then short selling will be limited and the downward pressure on the currency will be minimized, thereby preventing another major currency slide before the elections. But the measure is also trapping a number of foreign investors; if their investments are denominated in lira, they can’t cash out, since banks are not allowed to provide lira liquidity.
Though this intervention is “designed to be temporary,” according to an anonymous Turkish official who spoke to Bloomberg, its long-term ramifications might not be. Turkey, as we’ve discussed, has accumulated substantial external debt to fund its economic growth. That puts the country on shaky ground; if the lira declines, it becomes more difficult to repay debt denominated in foreign currencies. Turkey, therefore, needs more foreign capital inflows to fill its foreign reserves, which serve as a buffer against external debt. Yet after interventions like this, investors will likely feel that their Turkish positions are particularly insecure and poorly insulated from near-term political pressure, which in turn is likely to restrict the flow of foreign investment into the country. Erdogan is making a dangerous tradeoff: short-term political gain for a long-term economic cost.
A similar tradeoff exists with food price controls. While providing cheap food might give the AKP a boost in ratings before the election, doing so for too long risks driving grocers out of business. If this travels up the supply chain, then food producers may also be in danger. The government will end up footing the bill one way or another – either by paying for imports or subsidizing farmers and grocers. These sorts of palliative measures are not sustainable in the long run, as Venezuela so clearly shows.
How, then, should we interpret Erdogan’s decision to intervene in a way that further weakens the bedrock of Turkey’s economy? It’s possible that Erdogan is simply ignorant of basic economic theory and is pursuing politics that will benefit himself and his party. Yet, given that Erdogan is arguably the most powerful Turkish leader since Mustafa Kemal Ataturk and that this level of power could only be achieved by a shrewd operator, this explanation doesn’t make sense. Erdogan must know that these moves will damage the Turkish economy. His willingness to undertake these sorts of interventions to improve his party’s position in the arguably less important local elections is a sign that the AKP’s grip on power in Turkey is wavering. It’s also an indication that Turkey’s economic vulnerabilities will constrain its leaders’ ability to exercise political power in the years to come.
Cheap food and near-term measures to keep the lira from plunging may well work in the AKP’s favor this Sunday. If the AKP prevails, expect a greater push by Erdogan in the next four years to significantly weaken the opposition, either by persecuting opposition leaders (and Erdogan is already going after the pro-Kurdish opposition party) or by undermining institutional checks and extending term limits on the presidency.