Erdogan performs a rhetorical turnaround to save the lira

The Turkish lira has been falling for years, which means a high rate of inflation and a threat to the entire economy.

Companies are mostly indebted in foreign currencies and are finding it increasingly difficult to service their loans.

Erdogan is now rhetorically turning around and is open to a restrictive monetary policy by the central bank – but action must follow.

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While in Germany and all of Europe all of the central bank’s measures do not lead to the goal of boosting inflation, Turkey is struggling with a persistently high rate of inflation. The decisive factor here is the rapid devaluation of the lira. The currency has been sinking for years, putting a strain on consumers and the entire economy.

The high rate of inflation means that prices – for food, for example – are rising. In October, the Turkish authorities reported an inflation rate of 11.9 percent, but experts doubt the informative value of these data. “A decline in value like the one with the lira usually leads to a rising inflation rate. Most recently, this remained stable in Turkey at around twelve percent, which at least raises doubts as to whether the data adequately reflect reality, ”says Sören Hettler, foreign exchange analyst at DZ Bank in an interview with Business Insider. A higher rate seems conceivable.

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The fact that consumers are burdened more by this is only one aspect. Rather, the entire economy is affected. “Companies run the risk of no longer being able to service loans that are due in foreign currencies. This can lead to bankruptcies, with corresponding consequences for the economy and the labor market, ”says Hettler. But companies also have problems in their operational business, for example in the energy sector: They generate their sales in their weak domestic currency, while they have to buy oil and gas in US dollars.

Erdogan speaks out against a rising key interest rate

With the aim of ensuring price stability, the central bank is responsible for counteracting the developments mentioned. The problem: The Turkish head of state Recep Tayyip Erdogan does not allow them to act independently. According to current economics, high inflation is combated with rising key interest rates. Erdogan’s opinion, however, is that a high key interest rate is not a means against inflation, but rather its cause.

Therefore, he repeatedly speaks out against an increase in the key interest rate. But Erdogan’s rhetoric has been changing for almost two weeks. “Head of state Erdogan is making a clear change of course and stressing that a restrictive monetary policy is necessary to lower inflation and end the devaluation of the lira. In addition, Naci Agbal, as the new head of the central bank, is seen as a promise of more independence in monetary policy in Turkey. It is important here to act, ”analyzes Hettler.

In fact, Agbal, who was finance minister until 2018, is considered a technocrat. Just a little over a week ago, Erdogan had replaced the previous central bank chief, who had only been in office for a little over a year. Investors value him and his positions, but the question remains whether he can actually act independently with the central bank. The first test will take place on Thursday, when the Turkish central bank decides on the key interest rate. “An important step would be to raise the key interest rate from the current 10.25 to at least 15 percent. If the interest rate stays below that, international investors are likely to react disappointed, ”Hettler expects.

Turkey sold dollar reserves to stabilize the lira

In addition to the decision, it is also important to solve the structural problems in monetary policy. Since the central bank gave in to Erdogan’s pressure and had not raised the key rate any further, they had to find another way to stabilize the lira. To do this, they sold dollar reserves and bought their own currency, which creates a shortage and increases the price.

In fact, the currency had stabilized, but the trick is only short-term. “In principle, the official key interest rate must once again become the central bank’s first control instrument. Most recently, the central bank tried to stop the depreciation of the lira by selling dollar currency reserves, among other things, but this effect has fizzled out, ”says foreign exchange analyst Hettler.

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The usual structures would therefore have to be restored in order to regain the trust of international donors. Erdogan’s political appearance often counteracts this. In terms of foreign policy, sometimes aggressive actions by Erdogan stir up concerns about possible sanctions, which also scares off donors.

Erdogan: A rhetorical U-turn must be followed by action

The latest statements could therefore actually represent the beginning of a structural upheaval. A stable currency would be of great importance for the entire country – but there is still a long way to go. “Erdogan’s rhetorical change of course now has to be followed by a structural change,” says Hettler. “The central bank must be able to act independently, even if Erdogan does not always agree with the measures. Only then can the trust of international investors be regained and the currency decline stopped. “

One day before the central bank meeting, Erdogan reiterated that he was against high interest rates. One should “not allow our investors to be crushed by high interest rates,” Erdogan said to business representatives in Ankara on Wednesday, according to the DPA. “What high interest rates lead to is obvious. Can we really invest with high interest rates? (…) Can we create employment? Impossible ”, the agency continues to quote him.

“The lira is at a crossroads, but it is also clear that even if the central bank raises the key interest rate significantly, the currency will not revalue to previous levels anytime soon. For a clear appreciation potential, the structural problems, especially with a view to monetary policy, must first be solved sustainably and reliably, ”said Hettler. Nonetheless, the central bank meeting on Thursday could be the first small step out of the lira crisis if Erdogan followed up his accommodating rhetoric with deeds.

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