Why economic growth could be a problem

Now business is up and running again. Alone, their expenses are growing faster than their income. A year ago a packet of eggs cost 17 lira. “Now it’s 34 lira,” says Kilic. She continues to the tomato stand. Tomatoes would have increased in price from four to seven lira per kilo, potatoes from two to five lira. A five-liter jar of yogurt at the dealer next door now costs 20 lira instead of 13 lira. For an overnight stay, however, she could not ask for more than 80 lira, around 7.90 euros including breakfast and dinner. That is as much as a year ago. If she raised the price, the tourists would stay overnight with the competition. Kilic says she’s not political. “But that cannot go on with those who rule us.”

What the pensioner is going through is currently happening across the country. Müjdat Kececi, CEO of the wire manufacturer Er-Bakir in Denizli in western Anatolia, is also pleased about the new orders. “But the high energy prices are hindering production,” warns the manager. His gas bill alone has increased by 70 percent since the beginning of the year, and his company had to spend 21 percent more on electricity. “Overall, we are now spending 40 percent more on energy,” he explains. He also has to dig deeper and deeper into his pockets for steel and other raw materials. He said he couldn’t raise prices fast enough to compensate for this overspending.

Turkey: The economy is growing, but inflation is rising even faster

It sounds paradoxical: In the 2020 pandemic year, the Turkish economy was one of the few that grew at all. In the second quarter the Turkish gross domestic product grew by 21.7 percent, the highest increase since 1999. The International Monetary Fund (IMF) raised its growth forecast for the full year 2021 from 5.8 to 9 percent.

The problem: Hardly any of it was received by the population and industry. Inflation in the country reached a record high of around 19.6 percent in September. The lira has lost around 50 percent of its value against the euro and US dollar since the beginning of the pandemic. Everything is becoming more expensive, despite wage increases, people can no longer afford them. Investments are also becoming more expensive: the surcharges for credit default insurance (CDS) have risen from 300 to 419 basis points since the beginning of the year.

The high inflation rates correlate with the polls – not for the government, but for the opposition. A good one and a half years before the next presidential elections, the ruling party AKP of head of state Recep Tayyip Erdogan is weakening and could soon lose an absolute majority together with its coalition partner MHP. Confidence in the administration in Ankara is falling. “They only do what keeps them in power, but no longer what brings growth and stability,” observe high-ranking foreign diplomats in the Turkish capital, Ankara.

Head of state Erdogan reinforced this impression overnight. He dismissed three members of the Monetary Policy Committee on Wednesday and appointed two new members in their place. The decree was published shortly after midnight local time, the reasons were not disclosed. The rate of the local currency fell after the announcement to a record low of 9.17 lira for one dollar.

That doesn’t sound like a departure, but rather like maintaining power. “We have sclerosis in the system, there is a lack of will to reform,” summarizes Markus Slevogt, President of the German-Turkish Chamber of Commerce in Istanbul. He is convinced that the country has great economic potential. But the institutional and regulatory framework is lacking to leverage this potential. The opportunity turns into a risk.

Instead, Erdogan is lowering key interest rates in order to artificially increase economic growth. “If, however, interest rates are raised soon in the USA or in the euro zone, then Turkey and other emerging markets with a similar financing structure will have a problem,” warns Slevogt.

The country lacks the economic model

The country lacks an economic model to benefit from the upswing in the long term. Much has to be imported, and raw materials are currently becoming more and more expensive on world markets. “The Turkish economy absorbs and imports relatively more technology than it creates and exports,” explains Slevogt. The rising energy prices will worsen the situation in winter. The Turkish economy is threatened with a dangerous spiral of crisis.

The government in Ankara has tried several times since 2014 to avoid recessions with loan-financed growth programs. However, any loan program worsens the country’s current account deficit and increases reliance on foreign donors. In addition, the debts to companies and households are increasing massively. If the lira also loses value, loans taken out abroad become all the more expensive.

Experts such as AHK President Slevogt also criticize the fact that the Turkish economic model is one-sidedly geared towards consumption or individual sectors such as the construction sector. The quality at schools and universities is poor. “Too much is repeated, nobody is trained to be creative,” criticizes Slevogt, who worked for Deutsche Bank in Istanbul for many years.

The one-sided fixation on quick money is now taking revenge. Turkey is in danger of being stifled by the hectic, orchestrated and credit-financed upswing. The work of the government doesn’t make it any better. When rumors arose that Erdogan had lost confidence in the current head of the central bank, the lira dropped again briefly. And the weaker the lira, the more expensive imports become; the more expensive the imports are, the less Turkish companies and consumers benefit from their own upswing. A vicious circle.

Gas prices: Turkey faces a “black winter”

In the summer, the Turkish economy was allowed to take a breather. Tourists brought foreign currency into the country, the increasing vaccination quota in connection with increasingly lax exit restrictions let the economy revive. But for the winter, many see black, in the truest sense of the word.

“We are facing a black winter,” warned the Turkish business newspaper “Dünya”. Low temperatures and rising import prices for oil and gas could lead Turkey into the next economic crisis. And it doesn’t look like the government has any means of avoiding the next depth.

That sounds like a homemade crisis. But the difficult situation in Turkey can also affect the neighbors. Turkey plays a role in almost every geopolitical conflict, from the migration crisis to disinformation campaigns to the current difficulties in global supply chains. This has not only given Turkey a place at many negotiating tables. At the same time, the country has become more and more dependent on global developments.

When the president influences the exchange rate

After President Erdogan hinted at a possible military offensive in neighboring Syria this week, the Turkish lira widened its decline to a record low. Erdogan said Turkey is determined to remove the threats from Syria “either through forces active there or with our own means”. Previously, two Turkish security forces were killed in an attack in the civil war country.

The situation is so unstable, confidence so shaken, that even half-announcements like Erdogan’s one are already affecting the markets. “Market participants seem to perceive these comments as a possibly resolved military operation,” said Emre Degirmencioglu from Iktisatbank in an analysis of the short-term lira sell-off. Washington is already warning that it could again impose sanctions on Turkey.

Political and economic risks are dangerously intertwined

Political and economic risks are regularly linked. Take the customs union with the EU, for example: A new version of the agreement does not only depend on technical specifications and business wishes. It was the Turkish government that wanted the negotiations on a customs union to be linked to a new migration agreement.

And now, on the other hand, it is the EU that wants to measure further negotiations on the customs union against democratic standards. “Only if there is progress in terms of human rights and the rule of law will we talk about an enlarged customs union,” said the Turkey rapporteur for the European Parliament, Nacho Sánchez Amor, the Handelsblatt. The EU parliament has the final say when treaties such as the customs union with Turkey are concluded. “We need progress on the one hand, otherwise there will be no progress on the other,” demands Sánchez Amor.

The mood, especially of the opposition in the country against refugees, makes the situation even more difficult. She would like to cancel the refugee agreement and get rid of the four million “guests” in the country as quickly as possible. A growing part of the population likes this view. The government can hardly hold back. A new risk arises: if the EU and Turkey continue to clash on the issue of migration until the next election, it will be all the more difficult to cooperate on economic issues.

Turkey, a country with great potential and a country with even greater risks. Entrepreneurs and investors react differently. Volkswagen stopped its plans for a plant in the country two years ago. Others, such as the bus supplier Farhym, a company of the Hymer Group, are considering building another plant in Turkey.

Economist considers the economic course to be legitimate

Credit insurer Euler Hermes estimates that the number of bankruptcies in the country could rise by 17 percent this year and next. Sell-offs also dominate the Turkish financial markets. At the same time, experts such as ex-banker Slevogt explain that Turkish stocks are currently valued incredibly cheaply – a possible buy signal. One thing is clear: Turkey is no longer a sure-fire economic successor. And the government fails to reverse this impression. On the contrary: Actions like the overnight evictions only make it worse.

There are also dissenting voices. Ugras Ülkü from the Institute for International Finance (IIF) considers the economic course of the administration in Ankara to be legitimate. “The weak currency will help to minimize Turkey’s foreign trade deficit in the medium term,” he is convinced. While the inflation outlook is becoming more difficult, the weaker lira has supported the realignment of the Turkish economy towards a more export-oriented model. The weaker lira had slowed down the demand for imported goods in the same period. “This will continue to support exports and at the same time dampen import growth in the coming months and years,” says Ülkü.

Chamber of Commerce President Markus Slevogt is actually positive when it comes to Turkey. He has lived there for 22 years and has experienced significantly worse crises than the current one. Slevogt is optimistic and believes that the Turkish economy will soon regain strength. “Unfortunately, at the moment there is not so much willingness to introduce the necessary reforms.” The next elections are scheduled for June 2023. “It’s an eternity for the Turkish economy.”

More: Erdogan’s wrong track – a comment.