Turkey’s central bank just did something doubly bold. It hiked interest rates to a whopping 24%, up from the 17.75% level instituted in June. And in so doing, it defied president Recep Tayyip Erdogan, Turkey’s strongman and self-proclaimed “enemy of interest rates.” Behold:
The Turkish lira rallied more than 4% on the news, reversing its dizzying descent of the past few months. But there are many more tests to come—not least of which is Erdogan’s reaction. “Any sign that he will try to reassert his influence over policy could cause sentiment towards Turkey to deteriorate again,” say analysts at Capital Economics. Throughout his 15-year tenure, Erdogan has pushed for lower rates to ensure cheap credit for businesses.
Even if the president holds his tongue, the good people of Turkey are still in for a brutal slog—and there’s not much their central bank or Erdogan can do about it.
Quite simply, Turkey is caught between the proverbial rock and hard place.
Back in 2010 and 2011, during the heady days of BRIC-mania, Turkey was one of the world’s fastest-growing economies.
Foreign capital funded this torrid expansion, as you can see from its current account deficit (the deficit indicates the excess of outside investment and domestic savings).
That isn’t inherently bad, provided that capital is channeled into building a balanced economy. Turkey didn’t do that, though. The Patron Saint of Low Interest Rates (aka Erdogan) doubled down on what economist Ümit Akcay calls “neoliberal populism” (pdf). Working-class incomes fell, and household debt surged. Growth started foundering in 2013—not coincidentally, around the time that markets began anticipating the US Federal Reserve’s wind-down of quantitative easing. That should have signaled to Erdogan an urgent need for reform to build domestic engines of growth. Instead, Turkey’s dependency on outside finance to fund economic activity deepened.
Flash forward to 2018. Turkish businesses have racked up massive dollar debts. The Turkish lira’s precipitous plummet against the dollar—it has dropped around 40% since the beginning of 2018—makes those debts vastly more expensive to pay back. On top of that, inflation keeps surging, hitting nearly 18% in August.
Acceding to Erdogan’s will and lowering rates might revive domestic demand. But the lira will continue to plunge, triggering defaults.
On the other hand, raising interest rates might help halt the unfolding debt crisis; higher rates should stabilize the lira by drawing in foreign inflows back into the country, as well as cooling price growth. But higher local borrowing costs will also throttle domestic demand, stifling potential growth all the more. Whatever course its leaders choose to follow, Turks will suffer the consequences of Erdogan’s catastrophic embrace of financial globalization for years, maybe decades, to come.