Turkey Economic Crisis Explained

Opeyemi
4 min readMar 3, 2022

--

Image by Batın Özen via Pexels

Turkey (now Türkiye) is currently experiencing an inflation crisis.

Official inflation is at 49%. Unofficial inflation is at almost 110%

Source: Hanke’s Inflation Dashboard (24/02/2022)

So what’s exactly is happening on??

It is important to understand the Turkish economy before anything else. The tourism and manufacturing sector are the major contributors to the Turkish economy.

These industries were really affected by the pandemic which in turn affected the Turkish economy.

Let’s talk about the current president of Turkey. A little backstop on President Erdoğan. Erdoğan was elected in 2014. He prioritized Islamic Finance in his administration.

A major principle of Islamic Finance is that “interest is evil”. Charging interest is haram (forbidden). For instance, in a regular mortgage agreement, the individual pays around 20% of the house price then the bank spreads the repayment over 10 to 30 years. The house is then used as collateral in case of default.

In Islamic Finance, the bank buys the house and rents it to the person at an inflated price. This way, the two parties have a shared interest in the asset.

The person usually ends up owning the house, unlike the regular mortgage where there is a risk of foreclosure. The concept is called Ijarah

Back to Erdoğan

Erdoğan was really focused on adopting the principle of Islamic Finance. He even once referred to (central bank) interest rates as the “mother of all evil”.

The pandemic hit and the economy shut down because international trade and travel ceased. However, private companies had a lot of foreign debt, the repayment drove down the value of the Turkish Lira in the foreign market.

There was a high supply but low demand as Turkey wasn’t exporting or receiving tourists.

This caused inflation to rise in the country. Though this occurrence is not unique to Turkey, all countries were experiencing the same. The global inflation rate grew from 3.18% in 2020 to 4.35% in 2021.

However, the Turkish situation is peculiar. The government initially raised interest rates in response to the rising inflation — as most economies did — but Erdoğan disagreed and wanted the rate lower.

He reportedly sacked multiple central bank executives who refused to agree with him on lowering interest rates. His thinking is not entirely illogical. He believes that the lowering of rates will devalue the lira which would make Turkey’s export cheaper and more attractive and help the economy recover.

China did similar in 2021 which helped their economy recover. However, the Turkish context is different. Turkey is more import-dependent than China.

They import food and fuel. The devaluation of the lira made things very expensive for small businesses and individuals. Big companies could hedge this risk with futures and holding US dollars in their reserves instead of the Lira

So, inflation ran rampant, citizens experienced daily price changes, yet Erdoğan refused to raise rates. Citizens began removing their money from banks as there was no point in saving. Banks started offering US dollar saving accounts to the wealthy to keep in operation.

This meant that Turkey had started losing its monetary autonomy as the US dollar was more preferred than the Lira. The government came up with a plan to create a special saving account that was inflation-proof.

The account would give holders a 14% annual interest and pay holders any difference that exists as a result of a decline in the Lira.

For example, if a citizen saves 1,000 Lira, they get 140 Lira in interest making 1,140 in total. If the lira loses half of its value against the dollar, the government will pay an extra 860 lira to make it 2,000 Lira.

Essentially, protects their money from inflation.

Following the announcement of this account type, the value of the lira increased by 50%, however, there is data that shows that the government bought its own currency to artificially pump the price of the lira.

This was done to create an impression that people were converting their US dollars to Lira to put in the savings account.

Reports show that the government spent $7 billion to prop up the Lira. This dropped the foreign reserve of the country to a 2-decade low of $8.6 billion

All these because Erdoğan doesn’t want to raise interest rates. The most recent attempt by Erdoğan is to buy “under the mattress” gold from its citizens. Reports state that the Turkish people have around 5,000 tons of gold worth $250 billion in their homes.

This could potentially save the Lira — theoretically.

The government would buy the gold below market price then sell for dollars to buy lira which would increase the value of the lira.

Will the citizens be willing to voluntarily sell their gold to the government?

If the government makes it mandatory, it will incur additional costs and time to acquire the gold.

Final Thoughts:

This is another example of a politician pushing their agenda against sound advice.

However, economic models and theories unlike scientific ones cannot be tested in a controlled environment. Economic theories are proven or disproven from real-life events.

What I mean is that we can’t exactly tell what would have been the effect on the Turkish economy if Erdoğan raised rates.

Most analysts only compare economies — which are usually hard to compare — or historical events to arrive at a conclusion. So we can’t really tell.

Ultimately, we will just have to wait and see.

--

--

Responses (1)