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The ongoing state of emergency and the crackdown on the Gülen movement after the failed coup attempt are generating uncertainties that are taking a toll on the Turkish economy, economist Selva Demiralp from Koç University in Istanbul has told the Hürriyet Daily News.
The debate over shifting to a presidential system, steady divergence from the West, and the new U.S. administration’s economic policies, also generate uncertainty and do not bode well for Turkey’s economic situation, Demiralp added. What do you see when you look at the current economic situation in the country?
Firstly, Turkey is an economy with has a very low savings rate, while we have a production structure in which we import intermediate goods. Both of these contribute to the wide current account deficit. That means we have to borrow from the rest of the world.
We are in a world where the dollar is appreciating against all other currencies. The U.S. Federal Reserve [Fed] is about to increase interest rates for a second time, and President-elect Donald Trump is saying he will pursue an expansionary fiscal policy. That means inflation in the U.S. is going to go up, and that in turn means the Fed will increase interest rates further, which means dollars will flow into the U.S. much faster.
For countries like Turkey with external debt we have to find dollars, no matter what it takes. That’s why the value of the dollar is appreciating against the Turkish Lira. Our Central Bank has been cornered into a situation because normally if your currency depreciates you have to raise interest rates. But after the July 15 coup attempt there has been an economic slowdown and there is a serious threat that Turkey could enter into recession.
We think the growth rate in the third quarter of 2016 is going to be negative. If that continues for another quarter, that is the technical definition of recession. When there is a recession, you can implement an expansionary policy and cut interest rates, which is what the government wants. But at the same time the lira is depreciating, which is going to put pressure on the inflation rate. So there could be a currency-triggered economic crisis.
The Central Bank faces a dilemma: It cannot raise interest rates to protect the value of the lira, but it also cannot really cut interest rates to support the economy. But this is not a problem of the Central Bank anymore. The government has put a lot of pressure on the Bank. The day before the Bank’s latest meeting, we heard President Recep Tayyip Erdoğan
saying interest rates should be lowered. The Central Bank ended up doing the opposite.
There had been a further depreciation that day because of the decision of the European Parliament to freeze Turkey’s EU membership talks. I think the Bank made a smart move, otherwise we could have seen the beginning of a financial crisis. We may see further rate hikes by the Central Bank even though it might hurt - indeed it will hurt the economy as we are facing a potential recession. So you don’t think we are yet in a crisis?
There is a danger there might be crisis, especially if the Central Bank is not allowed to implement optimum monetary policy. I understand the government’s perspective; it wants to increase investment and encourage consumption. But at the moment the reason for low investment is not high interest rates. Even if the Central Bank cuts interest rates, you are not going to see an increase in investment.Why not?
When there is so much uncertainty, investors basically don’t see what Turkey will look like in six months’ time. It is not known when the state of emergency will end. When they borrow or lend to each other they do not know whether the borrower is going to be shut down because of links to the Fetullahist Terror Organization [FETÖ]. This uncertainty has elevated the risk that we can see from the credit default swap premium as well, showing the overall credit risk of a country. That is going up.
From the foreigners’ perspective, they do not know whether Turkey will follow the rule of law, or whether it will be a transparent country with full respect for democracy. When they have such questions in their mind, they simply find it more difficult to bring their money into the country.How did we get to this point? What was the effect of the failed coup?
The signals of economic slowdown were received before the coup, amid the increase in terrorist attacks and the slowdown of tourism after the tension with Russia. The lack of structural reforms has also taken a toll on the economy, and in addition we have alienation from the European Union, which will hurt us big time. Basically what you are saying is that the aftermath of the coup has aggravated a situation that was already ringing alarm bells.
The coup itself caused great uncertainty. Then came the state of emergency, with the government taking over many companies. The government may have to do certain things in a certain ways, but because transparency has completely gone Turkey looks like a black box right now. From the investor’s point of view we don’t know what will come next. Until the government says it has finished investigating companies, until people start trusting their partners, there will be an economic slowdown.
Our relationship with the West has worsened. From the government’s perspective, the EU did not show enough empathy after the coup attempt, and this has worsened the alienation in our relations with Brussels. People say we were never a member anyway and nothing will change as we will stay in the customs union, but data shows that just the hope prompted by the start of negotiations led to a peak in foreign direct investment in Turkey between 2002 and 2006. What about the effect of the debates on reinstating capital punishment?
As soon as we started to talk about the death penalty, strains in our relations with EU got deeper. Turkey needs to be pragmatic. If this is going to hit the economy, let’s not bring back the death penalty.Why do you think the government isn’t opting for that pragmatism?
When it comes to the stage [of passing the law] they will not bring it to that point.There are many quarters in Turkish society that underline the importance of the EU. So why is the government using different?
What we hear are emotional responses, but when it comes to decision-making point they will make the more pragmatic decision. We saw that with Russia: When the deterioration in our diplomatic ties hit our economy, the government stepped back. The same will happen with Europe.Some would argue that all this is related to the debate over the presidential system.
That is one factor. The concern is that there is less transparency and a more authoritarian regime. Some people say investors don’t care about authoritarian rule, so long as there is stability. But I diverge from that view. The presidential debate is only generating more uncertainty. We don’t know what kind of Turkey will come afterwards. If this was clearer it would not have been so disruptive. But that is not the case. The prime minister has suggested that currency fluctuations will continue until Trump officially enters office in the U.S.
I can’t see why it will stop on Jan. 20, as we will still not know how many of his promises he will implement. Uncertainty will continue for a while. When you look in general, how do you think the government is dealing with the current situation?
It is aware of the slow down and it is -pressuring the Central Bank. But it is barking up the wrong tree. Yes there is a slowdown and we feel the pain, but the answer is not the Central Bank. The government has increased the budget deficit from 1 to 1.9 percent of GDP, so government spending is going to increase, but that will not be sufficient. It won’t be able to stimulate investment by increasing its own spending. We need a decline in the uncertain environment and we need structural reforms.In the short term, what do you see happening?
The Central Bank should not be pressurized to change interest rates. The Bank started inflation targeting in 2006, but apart from two years since it has never met its targets. There has always been some reason to stimulate growth, but there is also a reason why they do price stability: Once you lower the inflation rate, long term interest rates will go down and then investment will go up.
The biggest risk in the Turkish economy is that people don’t take inflation targeting very seriously and don’t take the Central Bank very seriously. Whenever there is another priority we put monetary policy second. This is a mistake that leads us into a vicious cycle. Is it a fair bet to project that uncertainty will continue for some time?
Unfortunately. I don’t like making pessimistic projections but I do think there will be considerably more uncertainty.
Who is Selva Demiralp?
Selva Demiralp was an economist at the Federal Reserve Board from 2000 to 2005, when she joined the Economics Department at Koç University. Since 2013, she has written weekly articles for daily Milliyet.
Over the past decade, Demiralp has had extensive interaction with several central banks, including the Federal Reserve, European Central Bank – for whom she also worked as a consultant – and the Central Bank of Turkey. Demiralp has received grants for her research on monetary policy including the European Commission’s International Outgoing Fellowship (IOF), as well as numerous grants from the Scientific and Technological Research Council of Turkey (TÜBİTAK).
Demiralp’s research has been published in leading economic journals, including the Journal of Money, Credit, and Banking, as well as the Journal of Economic Dynamics and Control.