By Xander Snyder

Turkey’s economy isn’t as strong as it appears. The Turkish national statistics service recently released data showing how gross domestic product grew by a more-than-respectable 7.4 percent in the first quarter of the year. Yet that figure is deceiving: By itself, it ignores the fact that growth was fueled by debt, much of which came from foreign lenders. Growth funded on someone else’s dime isn’t a strength, it’s a vulnerability.

The government in Ankara has been on a bit of a spending spree. The government deficit has continued to grow in recent years, thanks in part to high defense expenditures and economic stimulus, and it will continue. The government has also spent a lot of money on infrastructure and has allocated funds toward providing credit guarantees to private sector lenders, effectively multiplying the amount of money spent by the government by encouraging credit growth. But when a government doesn’t have enough revenue to cover spending, spending is financed with debt. Turkey doesn’t have much in the way of savings, so it doesn’t have much capital to lend. It therefore increasingly relies on external debt denominated in foreign currencies. The risk is that debts become difficult to repay when the Turkish lira depreciates relative to these foreign currencies, which is exactly what it’s been doing over the past several months.

One way to ease reliance on external debt is to provide enough domestic capital for banks to lend more. Raising interest rates appeals to savers who see the opportunity to earn a higher return on their savings. The downside is that people tend to borrow less when rates are high.

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So far, Turkish President Recep Tayyip Erdogan has adamantly opposed interest rate hikes. He fears that it will harm the economy, and leaders tend to lose re-election when economies are weak. Yet he was ultimately forced to capitulate when, after claiming that low interest rates will somehow combat inflation (in truth, it works the other way around), the lira plummeted, threatening to radically increase the cost of servicing the country’s external debt. Turkey’s benchmark interest rate has risen by 5 percent since April, to 17.75 percent. Loans became costlier to repay. The fear of inflation and fiscal insolvency scared away foreign capital, further decreasing demand for the lira and, therefore, its value. Add to this the threat of imports becoming more expensive – especially oil, for which Turkey is almost completely dependent on imports – and it was clear that Erdogan could no longer continue to pressure the Turkish central bank to keep rates low.

At about the same time the central bank began to raise rates, Erdogan announced snap presidential and parliamentary elections, which will be held June 24. His announcement was no mere coincidence. Turkey is being forced to raise interest rates or face capital flight and unserviceable debt, or slower economic growth, or both. Erdogan knows that his chances of re-election will fall as economic growth slows and that the probability of that happening within the next year, when the elections were originally planned, is far greater than it is right now.

Erdogan needs to maintain the appearance of normalcy. Hence his announcement in May of a new spending package worth nearly $6 billion that would provide additional money to 13 million Turkish pensioners. The funds will, of course, be disbursed the week before the June 24 elections. It’s possible that the move will marginally increase consumer spending someday, but it’s hard to not see this as a move to curry favor before the election. Right now, Gezici, a polling firm, is anticipating that Erdogan will not receive the majority needed in the first round to prevent a second round runoff vote. In 2014, Erdogan won a majority, albeit by a slim margin. He’s vulnerable, and he knows it.

Whoever wins will face the same challenges with the same limited means for meeting them. Turkey will still have the structural imbalances that forced it to take on so much external debt in the first place. The country needs to implement economic reforms that will necessarily dampen growth. Erdogan has admitted as much, saying, “Strict measures in the fight against inflation will be taken immediately after the June 24 elections.” Of course, it’s much easier to make hard decisions after winning an election than before.

But it won’t be the only painful economic decision the president will have to make. To stem the budget deficit and a ballooning external debt balance, the government will need to reduce spending. One option is to cut economic stimulus and social spending, something that will be unpopular among voters. Another option is to reduce defense spending – which is about the same size as the total government deficit. But this, too, is unlikely to happen. Turkey has a growing, not declining, need to project power outside its borders, and it can’t do that without a robust military. (To that end, it has been developing its own arms industry, eliminating the need to buy from other countries with an undervalued currency to boot.)

Nor will it be able to meet the security challenges on its southern border if it cuts spending. Northern Syria and Iraq are home to semi-autonomous Kurdish regions that can provide harbor to Kurdish secessionist groups, which Ankara considers terrorist groups. They are also areas in which Iran, a regional competitor, has gained more territory. Turkey has a growing need for a more versatile military that can be deployed regionally in offensive operations to neutralize threats and establish control over territory outside of Turkey.

Difficult challenges require difficult decisions, and if you’re a politician, difficult decisions are always better to be made after an election. Calling for snap elections is a sign that Erdogan sees this clearly and is aiming to secure his power accordingly.

Xander Snyder
Xander Snyder is an analyst at Geopolitical Futures. He has a diverse theoretical and practical background in economics, finance and entrepreneurship. As an investment banker, Mr. Snyder worked in corporate debt origination and later in a consumer-retail industry group at Guggenheim Securities, participating in transactions ranging from mergers and acquisitions, equity and debt capital raises, spin-offs and split-offs to principal investing and fairness opinions. He has worked on more than $4 billion worth of transactions. He subsequently co-founded and served as CFO for Persistent Efficiency, an energy efficiency company that used cutting-edge technology to create a new type of electricity sensor for circuit breakers and related data services. In his role, he was responsible for raising more than $1.5 million in seed capital and presented to some 70 venture capital and angel investors in the process. He also signed four Fortune 500 companies as customers, managed all aspects of company accounting, budgeting and cash flow, investor relations, and supply chain and inventory management. In addition to setting corporate strategy, he helped grow the company from two people to a 12-person team. As an independent financial consultant, Mr. Snyder wrote an economics publication for a financial firm that went out to more than 10,000 individuals and assisted in deal sourcing for a real estate private equity fund. He is an active real estate investor and an occasional angel investor. Mr. Snyder received his bachelor’s degree, summa cum laude, in economics and classical music composition from Cornell University.