Erdogan Rolls Dice. Cuts Rates With Turkish Inflation At 80%

Like most countries in 2022, Turkey has an inflation problem.

I should note, for those unaware, that “problem” is insufficient to convey the severity of the predicament. Turkey has an outright inflation crisis. On the IMF’s estimates, annual inflation will only be worse this year in Sudan, Venezuela and Zimbabwe.

Consumer prices rose an annual 79.6% last month, and in all likelihood, that understates the true rate of price growth by a wide margin. A series of high profile departures from Turkey’s statistics office cast considerable doubt on the veracity of the official data.

Macro factors are, of course, partially to blame. But the underlying issue is Recep Tayyip Erdogan’s “unorthodox” views on the tradeoff between interest rates, the currency and inflation. In short, Erdogan believes (or purports to believe) that the cure for inflation is lower rates, the opposite of prudent policy in emerging markets.

Read more: Turkey Or Zimbabwe? Erdogan’s Inflation Crisis Spirals

Whether Erdogan genuinely believes his own balderdash is debatable, but it doesn’t much matter. His approach is enshrined in policy, mostly because he thinks perpetrating a “war on interest rates” is politically expedient. He habitually describes the struggle in patriotic terms and often justifies what might otherwise be viewed as maniacally reckless monetary policy by suggesting that rate cuts are a religious imperative.

On Thursday, Sahap Kavcioglu, Turkey’s beholden central bank governor, cut rates for the first time since December. The 100bps move blindsided economists and cemented Turkey’s already rock-solid status as a global outlier. The figure (below) illustrates the cartoonish nature of the conjuncture.

Core inflation is nearly 62%. Food prices are rising at a 95% annual rate, energy at a 129% clip and transportation costs at a 119% pace. Factory-gate inflation was 145% last month. And those figures assume you trust the official numbers — the figures Erdogan allowed to be released.

In the new policy statement, Kavcioglu cited Erdogan’s efforts to broker safe passage for Ukrainian grain ships. He also suggested the risk of a global recession justified Thursday’s move. “Global growth forecasts for the upcoming period are being revised downwards and recession is increasingly assessed as an inevitable risk factor,” he said, adding that “the negative consequences of supply constraints in some sectors, particularly basic food, have been alleviated by the strategic solutions facilitated by Turkey.”

Rather than raise rates, Kavcioglu, at Erdogan’s behest, is pursuing a raft of macroprudential initiatives, while promoting a somewhat nebulous whole-economy “solution” often couched in nationalistic terms.

On Thursday, Kavcioglu blamed “the lagged and indirect effects of rising energy costs resulting from geopolitical developments” for inflation, along with “strong negative supply shocks.” The disinflation process, he said, should “start on the back of measures taken and decisively implemented for strengthening sustainable price and financial stability along with the resolution of the ongoing regional conflict.”

He also alluded to the ostensible necessity of cutting rates ahead of a prospective downturn. “It is important that financial conditions remain supportive to preserve the growth momentum in industrial production and the positive trend in employment in a period of increasing uncertainties regarding global growth as well as escalating geopolitical risk,” the statement said.

With Thursday’s cut, real rates in Turkey are now -67% (figure above).

The central bank recently revised its year-end inflation outlook higher by 18 percentage points, to more than 60%. That’s optimistic, and even if fortune smiles on Erdogan (which it sometimes does, by the way), inflation would still be 12 times target.

Needless to say, the weaker currency doesn’t help, and with developed market central banks still hiking rates in determined fashion, Erdogan risks another bout of acute depreciation. As Bloomberg noted, following the decision, “an increase of more than $15 billion in Turkey’s gross foreign reserves over the last three weeks — following money transfers from Russia for the construction of a nuclear power plant — may have given the central bank the confidence that it can wait out [inflation] pressures.”

“The CBRT will continue to use all available instruments decisively within the framework of liraization strategy until strong indicators point to a permanent fall in inflation,” Kavcioglu said Thursday.

The central bank, he promised, “will continue to take its decisions in a transparent, predictable” way and within a “data-driven framework.”