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Analysis | What Erdogan’s Unusual Economic Ideas Mean for Turkey

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Turkish President Recep Tayyip Erdogan is not the only politician who doesn’t like it when the country’s banks charge people relatively heavily to borrow money. What sets him apart is his unorthodox belief in low interest rates and determination to wrest control of monetary policy from central bankers. The result: A succession of benchmark rate cuts that has fueled runaway inflation and precipitated a collapse in the currency. 

1. What’s Erdogan’s beef with high interest rates?

He says that they slow economic growth and fuel inflation. The thesis has unnerved international investors for years. While the country’s spending and credit binge during the pandemic propelled growth, the economy has also suffered from double-digit inflation and unpredictable policy moves. He has also referred to Islamic proscriptions on usury as a basis for his policy.

2. Are his arguments reasonable?

The point about weaker growth is. When a central bank increases rates, banks are less able to borrow to maintain mandatory reserves and tend to lend at their own elevated rates. This makes loans for businesses rarer and more expensive and so can slow the economy. But Erdogan’s second notion — that elevated interest rates cause prices to rise — contradicts conventional economic theories. 

3. What’s the basis of Erdogan’s theory?

It’s likely that it’s partly based on his experience running businesses, mostly in the food industry, before his career as a politician took off. Many Turkish companies borrow relatively heavily to cover operating expenses, making volatility in borrowing costs a source of uncertainty and rate hikes an added expense. In Erdogan’s view, higher rates result in higher prices because businesses have to pass on increased costs to their customers. This makes assumptions that orthodox economists challenge, namely that interest rates make up a significant part of companies’ costs and that producers have sufficient pricing power to impose their will on consumers.

4. Who agrees with Erdogan?

The argument is based on a theory by Yale University economist Irving Fisher on the relationship between inflation, nominal interest rates and real interest rates. Critics of the neo-Fisherites say that even if their theory had merit, it wouldn’t apply to an economy like Turkey’s, which suffers from chronically high inflation and is reliant on foreign funding. That’s because cutting interest rates reduces the return on investing in Turkish assets, and the local currency tends to weaken when foreigners decide to put their money elsewhere. That increases the cost of imported goods in liras and results in higher prices, or more inflation. 

5. What has Erdogan done to put his views into action?

Many central banks have raised borrowing costs to fight inflation after the pandemic. Turkey has gone the other way, cutting its benchmark interest rate by 7 percentage points to 12% in the 13 months to September. Over that period, the lira gradually weakened and inflation accelerated. The government increased the national minimum wage in December and July to limit the hit to households. This further inflamed prices, sending inflation to a 24-year high above 80% in August — the fourth highest among 120 countries tracked by Bloomberg. Erdogan has held firm, saying what Turkey needs is more investment, production and exports, not higher interest rates. 

6. What’s been the impact on financial markets?

Interest rates on commercial debt began to diverge from benchmark rates as lenders balked at offering ever-cheaper loans when the supply of short-term central bank funding was in doubt. In response, monetary authorities imposed rules to force banks to bring their loan rates closer to the benchmark. They were also obliged to increase their holdings of lira-denominated, fixed-rate government debt. As a result, the cost of lira debt fell, while yields on Turkey’s junk-rated dollar bonds went in the opposite direction. 

7. What’s it done to the economy?

Homes, cars and many essential goods became unaffordable for a swathe of Turkey’s 84 million population. Food inflation hit low earners, while the middle class saw a squeeze in living standards. On the flip side, economic growth outperformed Turkey’s peers and unemployment was relatively low due to an abundance of cheap labor. While the stock market rallied, keeping pace with inflation, bond investors have struggled to adjust to a world of 68% real negative yields. The lira hit an all-time low against the dollar in September, even though the central bank has spent an estimated $75 billion to prop up the currency this year, according to calculations by Bloomberg Economics. 

8. Could Erdogan reverse course?

Erdogan has signaled he’ll do whatever it takes to keep his low-rate policy intact. Finance Minister Nureddin Nebati told investors frustrated by low bond yields they can find good returns in Turkish stocks. With elections looming in 2023, Erdogan is wary of changing course and risking a blowout in borrowing rates that could inflict further pain on consumers. To shore up popular support, he announced a $50 billion project to increase home ownership, introduced a cap on rents, erased some student loans and promised another big minimum wage hike. He’s aware the economy is his biggest challenge, and economists aren’t ruling out a policy rethink after the elections. 

More stories like this are available on bloomberg.com

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