Turkey’s economic fate is still in the president’s hands

“The century of Türkiye has begun, and the doors of our country’s growth have been opened,” bellowed President Recep Tayyip Erdoğan on Saturday at his inauguration following a tightly fought election victory last month. A shake-up of his cabinet over the weekend to bring in more technocratic hands opens the possibility that Turkey might start to unlock its long-term economic potential. Years of the strongman’s unorthodox policies have battered the Turkish lira and led inflation to hit 24-year highs of 85.5 per cent last year. The hope is that Erdoğan’s rejig ushers in a permanent pivot away from that approach. The concern is that change will only be skin-deep.

In a surprise move, Erdoğan appointed the well-regarded Mehmet Şimşek as finance and Treasury minister. Simsek was previously a finance minister under Erdoğan, and before that a senior bond strategist at Merrill Lynch. He has pledged a return to “rational” economic policy. Cevdet Yilmaz, a respected former planning minister, was also appointed vice-president. How much they will affect economic policy will have to be tested, however. Erdoğan has a record of backtracking after making market-pleasing overtures.

Turkey desperately needs to shift away from Erdoğan’s economically illiterate agenda, dubbed Erdoganomics. The president has sacked three central bank governors in under four years, ramming home his belief that lower interest rates would reduce the country’s surging inflation. Rates have fallen from 19 per cent to 8.5 per cent in two years. Big pre-election giveaways have exacerbated the problem. As a result, the lira has fallen 67 per cent against the dollar in the past three years and foreign currency reserves have been drained to protect it. Restrictions on foreign exchange and a scheme that protects lira deposits from devaluation have been implemented to stem the outflow.

The economy has miraculously stayed afloat: last year, real gross domestic product grew 5.6 per cent. Hefty fiscal support, including doling out free natural gas last month, has masked some of the pain. Lower interest rates may have had unintended consequences too: higher inflation expectations may be raising the yields some lenders are demanding on loans. But the status quo cannot continue. Foreign reserves are drying up quickly, the cost of living is unbearable for the poorest, and fiscal strains will grow.

Erdoğan needs to loosen his grip on economic policy and the central bank must be able to operate independently to deliver the large rate increases necessary to reduce inflation sustainably. Replacing its pliant, incumbent governor with a respected economist is an important step. Unwinding foreign exchange restrictions and the lira deposit scheme will help build economic credibility too. Şimşek needs latitude to pursue reforms, including to reverse Turkey’s huge current account deficit, attract foreign investment, and thereby replenish foreign reserves. With inflation so high, prudent fiscal management is crucial.

Reversing course will not be pain free. The policy rate needs to rise steeply. That will hurt borrowers, and growth. Easing foreign exchange interventions and eventually allowing the lira to float more freely may also drive further depreciation in the short run. Indeed, some analysts think the sins of Erdoganomics mean the lira is still overvalued. In time, that will help it regain its export competitiveness. Broader reforms will also take years to reap rewards.

Erdoğan has his sights on next year’s municipal elections, in which he is hoping his party regains the influential mayorship of Istanbul. Şimşek may have made his return conditional on the president shifting towards more orthodox economic policy, but Erdoğan’s populist and authoritarian instincts may also be reinforced by his recent election. Enabling Turkey’s $900bn economy to reach its potential will require the president’s patience and willingness to reduce his hold on policy. He may claim the doors of Turkey’s growth have been opened, but he still holds the key.