Turkey’s central bank is anticipated to implement a significant increase in its key interest rate for the second consecutive month, signaling a shift towards conventional economic policies by President Recep Tayyip Erdogan. This reversal in policy direction followed Erdogan’s challenging re-election in May and the country’s severe economic crisis, largely attributed to his unconventional belief that high interest rates fuel inflation.
Erdogan’s previous stance, advocating low-interest rates to spur economic growth, has been abandoned in favor of the advice from his new economic team comprising former Wall Street executives and respected technocrats, who have emphasized the necessity of substantially raising interest rates to avert a systemic crisis. The policy rate has already surged from 8.5 percent during Erdogan’s re-election to 25 percent last month, and another substantial increase is expected. Despite these changes, concerns linger as interest rates still remain considerably below the level required to combat rising consumer prices, potentially causing an overheating economy.
In a brighter outlook for Turkey, Fitch Ratings has upgraded the country’s outlook from “negative” to “stable” due to the recent policy shift, though it cautioned about uncertainty surrounding the effectiveness and duration of the inflation-control measures, partly influenced by political considerations. Finance Minister Mehmet Simsek, credited with influencing Erdogan’s change in approach, anticipates keeping interest rates elevated until the middle of the next year.
However, a significant challenge lies in unwinding the costly bank deposit support scheme, which compensates for the depreciation of the Turkish lira against foreign currencies. Scaling back this system cautiously is essential, as abrupt changes could prompt depositors to flock to the US dollar and further depreciate the lira. Emerging markets economist Timothy Ash suggests that significantly higher policy rates, ideally positive in real terms, may be a solution, potentially requiring external support such as an IMF program. Nevertheless, Erdogan has consistently rejected seeking assistance from the International Monetary Fund.
