While his country’s economic crisis deepens — not least due to his reckless policies — Turkish President Recep Tayyip Erdogan is cozying up to Russian President Vladimir Putin and meddling in the Russian-Ukraine war. He’s spent the week trying to raise his international stature, restoring diplomatic relations with Israel and participating in high-level talks in Lviv — which went nowhere. This is unlikely to end well for Erdogan at next year’s parliamentary elections.
With Thursday’s surprise 100 basis-point Turkish interest-rate cut, one has to wonder whether Erdogan fits the definition of insanity by doing the same thing over again yet expecting a different result. Erdogan keeps pressuring the Turkish Central Bank to cut interest rates with a view to curbing inflation — even as with each chop the Turkish lira plumbs new lows and inflation soars to new highs.
The latest interest-rate cut comes as Turkey’s inflation is almost 80% and the lira has already lost a further 25% of its value this year. The country’s international reserves are depleted, and investors are increasingly concerned about Turkey’s ability to service its external-debt obligation. This is reflected in a widening in Turkish credit-default swaps to their highest level in the past 20 years and to very high dollar-borrowing rates for Turkey.
Making Erdogan’s monetary policy all the more difficult to understand is that it flies in the face of basic economic theory and experience. If there is one thing on which almost all economists can agree, it’s that higher interest rates are needed to regain control over galloping inflation and a currency in free fall. This highlights how out of sync Erdogan’s monetary policy is with the tightening interest-rate cycle underway in the rest of the world. Most of the world’s major central banks, including most notably the Federal Reserve, are raising interest rates to regain control over inflation.
Again by aggressively cutting interest rates at a time of already very high inflation and external economic weakness, not only is Erdogan risking putting his country further on the path to hyperinflation; he also seems to be inviting a full-blown currency crisis by further incentivizing domestic residents to ship their capital abroad. Such a crisis would make it very difficult for the country to service its external-debt obligations, which could require the imposition of economically damaging capital controls.
Heightening the risk of a currency crisis is the Federal Reserve’s interest-rate hiking cycle, which is causing a generalized repatriation of capital from the emerging market economies. So too is Turkey’s gaping external current-account deficit, which has been adversely affected by higher international oil prices and the European economic slowdown.
If Erdogan’s reckless monetary policy makes no economic sense, it also makes no political sense. In June 2023, Erdogan will face the electorate in scheduled parliamentary elections. One would have thought the last thing he’d want is voters mad at him because of galloping inflation and a collapsing economy. Yet that’s what he’s setting himself up for by pursuing his highly idiosyncratic monetary policy.
Rudi Dornbusch, the late MIT economist, famously said that currency crises take a lot longer to occur than you might have thought likely. When they do occur, however, they do so at a much faster pace than you thought possible.
Erdogan would do well to heed Dornbusch’s warning and make an early monetary-policy U-turn to regain control over inflation. He might thereby spare his country from yet another full-blown currency crisis in the run-up to next year’s election.
He might also spare us from a debt crisis in yet another medium-sized emerging market economy, which is the last thing an already-challenged global economy needs.
If there’s a silver lining to Turkey’s economic mess, it is that Erdogan will likely be forced to leave the political stage after next year’s election. If that happens, we might have a more reliable Turkish NATO partner to help us in standing up to Russia in its war with Ukraine.
Desmond Lachman is a senior fellow at the American Enterprise Institute. He was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.
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