Istanbul A year ago, anyone who wanted to fill up their VW Passat in Turkey had to pay around 300 lira. It is now 1200 lira. The prices at the pumps have almost quadrupled.
Overall, inflation in the country is now 73 percent, and some Turkish economists are even assuming that actual inflation is more than twice as high. And the lira is weakening. Since the beginning of the year, it has lost 29 percent of its value against the US dollar.
A trend reversal is not in sight. On the contrary: the government in Ankara is apparently determined to support the national currency with new measures and to further stimulate the real economy – even though this is fueling inflation.
For example, Turkish exporters who convert their foreign income into the local currency should receive cheaper loans. These rediscount loans are issued in lira but must be repaid in US dollars. So President Recep Tayyip Erdogan is lowering interest rates through the back door.
This is intended to curb demand for foreign currency – one of the main reasons for the currently weak lira, which is making Turkey less attractive for investors and thus weighing on the economy.
In addition, the Turkish Ministry of Finance is now offering a new savings product. The return comes from the state, the interest is linked to the net profits of the state-owned companies and is thus calculated anew every year. The Treasury Department did not provide any further details.
Investors believe government default is possible
In order to combat inflation, however, the central bank would have to raise the key interest rate, which is currently at 14 percent. But higher interest rates would make credit more expensive and slow consumption and investment – the economy would cool down and the already weakened currency would also lose ground.
Ankara is therefore now using unconventional methods. According to calculations by the major US bank Goldman Sachs, the central bank pumped more than three billion US dollars into the financial markets in order to stabilize the economy and the lira.
It is becoming increasingly risky for international investors to invest their money in Turkey. This is indicated by credit default swaps (CDS), which investors use to protect themselves against default. According to the data service provider Markit, CDS in Turkey are more expensive than ever – an indication that providers of these swaps consider a government default to be more likely.
Anyone wanting to insure $10 million worth of Turkish bonds against default now has to pay $837,000, $12,000 more than a day earlier. For many institutional investors, this is too expensive to make a net profit in the end.
Investors are selling more and more Turkish government bonds. If the demand for such investment products falls, the issuer – i.e. the state – has to raise the interest on the bonds: in order to finance itself, it tries to at least attract investors who are willing to take risks.
Yields on Turkish dollar bonds due to expire in 2034 have now risen to a record high of 10.3 percent. This also fuels the fear of default – a vicious circle.
Which leads to the question that should also be of interest to other inflation-stricken countries: Where is Erdogan’s financial policy leading?
If you ask people in the country what the financial policy of President Erdogan is leading to, the answer is clear: it will quickly lead to the Turkish president being voted out of office. His coalition with the right-wing MHP is far from the majority in polls. The citizens protest against high prices. Every measure taken by the presidential office or the treasury in Ankara seems to fizzle out on the markets: inflation continues to rise, investors are withdrawing their money from the country.
Rating agency Fitch raises growth forecast
However, there are also arguments against Erdogan’s departure: The Turkish economy is growing – contrary to all generalizations about Erdogan’s interest rate policy. The rating agency Fitch raised its growth forecast for the emerging market this week from 2.4 to 4.5 percent. Industrial production rose 10.8 percent in May, beating estimates of an average of 8.3 percent.
The balance of payments deficit has deteriorated significantly on a twelve-month average, from minus 24.5 billion to minus 25.7 billion US dollars. However, this is mainly due to the high prices for oil and gas. If you exclude energy and gold imports, the country has a balance of payments surplus, which has recently increased by three billion US dollars.
Erdogan’s calculus: If the Turkish population holds out long enough, his policy will result in a strong economy that can keep itself alive without large imports. That would also stabilize the lira.
However, two points speak against it: the high oil price and the turnaround in interest rates in the USA. Since Turkey does not have its own oil reserves, it is dependent on the markets. Interest rates across the Atlantic ensure that money is withdrawn from the emerging market.
And so the uncertainty in Turkey is still great: the population fears for their income and expenses – and Erdogan for his re-election.
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