Whenever you’re inclined to lament high inflation exacerbated by a legacy of too-loose monetary policy in developed economies, just remember that it could be worse. You could be living in Turkey, where Recep Tayyip Erdogan is years deep into a cartoonish experiment with economic heterodoxy.
Documenting every twist and turn in Erdogan’s farcical “war on interest rates” (which he views not just as politically expedient but also as a kind of religious imperative) is a largely fruitless endeavor. There are new developments every day commensurate with the cascading fallout and unintended consequences of desperate policies aimed at staving off the inevitable and making the untenable tenable.
It wasn’t always like this. There was a time (not so long ago in the grand scheme of things) when lira fireworks tied to Erdogan’s theatrics were episodic and intermittent, such that it was possible to present flareups as “news.” Now, though, it’s just one ongoing, never-ending currency crisis, with no commercial breaks or reprieves.
As such, it’s tempting to ignore it, with apologies to the scores of everyday people in Turkey for whom the situation is highly vexing. But ignoring it indefinitely isn’t possible because Turkey isn’t some economic and political backwater of no consequence. Erdogan is a major player on the geopolitical scene, and not just because he has a NATO card. He’s a key regional power broker with one foot in the West and, crucially, one of the only four people on the planet capable of staring at Vladimir Putin without turning into stone. He’s also a skilled opportunist with a knack for exploiting crises. Ankara’s offer to help free Ukraine’s trapped grain is the most recent example.
Complicating attempts at economic analysis is the iron-fisted nature of Erdogan’s rule and particularly the extent to which his autocratic tendencies are now inhibiting the tabulation of accurate inflation statistics. A series of high profile departures from Turkey’s statistics office cast considerable doubt on the veracity of the data, which means documenting the evolution of one of the world’s most acute inflation crises is mostly impossible if you care about accuracy.
With all of that in mind, official data out Monday showed annual inflation reached 78.6% in June (figure on the left, below). That was actually “cooler” than expected (critics would say the data can’t be trusted) but nevertheless marked the hottest reading since 1998.
Sahap Kavcioglu, Turkey’s beholden central bank governor, kept rates unchanged for a sixth consecutive meeting late last month, which means implied real rates in Turkey are now negative 65% (figure on the right, above).
Kavcioglu delivered four consecutive rate cuts late last year, despite knowing full well the moves would worsen the lira’s already egregious slump. December’s cut risked triggering an outright economic crisis. Subsequently, Erdogan devised a convoluted plan to avert a bank run, while state intervention arrested the currency’s slide. But the writing was on the wall: Additional rate cuts weren’t feasible.
Instead, Kavcioglu simply kept rates on hold, which, in world where developed market central banks, including the Fed, are aggressively tightening policy to fight inflation, is more than enough to push the lira inexorably lower.
Even if the lira were to stabilize (wishful thinking for a variety of reasons), inflation will likely keep rising. Pipeline pressure is intense. Factory-gate inflation is running north of 138%, Monday’s data showed. PPI has been in the triple-digits since March (figure below).
In a world of soaring inflation for critical goods and services, a weaker currency is a very risky proposition — it can exacerbate price pressures through the imports channel. The lira is among the world’s worst performers in 2022.
Late last month, following a series of characteristically defiant remarks, Erdogan decided to impose borrowing limits on corporates with high FX balances. The idea, generally speaking, was to force such companies to sell foreign currency or risk losing access to lira credit. It didn’t work. State banks quickly found themselves selling dollars to offset purchases by corporates.
On Monday, Erdogan hiked the discount rate on linkers in open market operations, an apparent bid to dissuade lenders from holding inflation-linked bonds, thereby boosting demand for fixed-rate securities. The central bank took related steps in mid-June as part of the broader “liraization” campaign. As of July 22, at least half of commercial banks’ swap collateral must be in lira bonds.
To be clear, none of this is going to work. The only way to reduce dollarization is to hike rates. “The macroeconomic reality of Turkey suggests that an interest rate hike remains the most effective (and perhaps only) way to start resolving deeply entrenched macrofinancial issues,” TD’s Cristian Maggio said recently.
At this point, the situation is probably too far gone. Kavcioglu would need to deliver a series of gargantuan hikes to restore confidence. It’s not too much of a stretch to say Erdogan would rather die than let that happen.
If you’re wondering how bad Turkey’s inflation problem really is, note that on the IMF’s estimates, annual inflation will only be worse this year in Sudan, Venezuela, and Zimbabwe (figure above).
Last week, Erdogan said he’s hiking the minimum wage by 29%, a move that’ll affect nearly half of the country’s workers. It was the second increase in just six months. In January, Turkey raised the minimum by a record 50.5%.
Unfortunately, that’s likely to exacerbate the situation. In January of 2021, the central bank, then under the leadership of Naci Agbal, warned that a “considerable rise in the minimum wage… will affect inflation adversely.” In the linked report, Agbal’s CBT suggested a 10% rise in the minimum wage could result in a 1% increase in headline inflation. So, a simple interpretation of this year’s minimum wage hikes is that Erdogan has thrown 8 percentage points worth of gasoline on an inflation fire he continues to stoke every time he so much as mentions the economy.
Agbal’s brief stint as CBT governor marked a rare moment of sanity which temporarily stanched the lira’s bleeding and restored faith in the currency. Agbal was replaced by Kavcioglu in March of 2021, opening the door to the current debacle.
“In order to lower inflation to target, hikes would have to be large in scale,” TD’s Maggio wrote last month, noting that a simple Taylor rule estimate suggests Turkey should set the policy rate somewhere between 80% and 110%.
Barclays sees inflation in Turkey peaking at 88% in October. The IMF’s estimate for Zimbabwe in 2022 is 86.7%. For reference, annual inflation in the African nation was 192% in June. Unlike Erdogan’s central bank, Zimbabwe’s monetary authority responded. Late last month, the central bank hiked rates 12,000 (that’s twelve thousand) bps at a single meeting, to 200%.
