From Turkish economic miracle to meltdown

par Vahid Yücesoy

Has the economic miracle that Turkey lived under Erdogan run out of steam? What are some of the underlying causes of an impending recession in Turkey? How are the emerging economic woes likely to affect Ankara-Brussels ties? This analysis responds to these questions.

Turkey has been grappling with acute macroeconomic problems over the past few months. The currency, the Lira, has lost 40% its value since the beginning of the year and the inflation is feared to exceed 25% this year. Sixteen years into its tenure, the AKP’s (Justice and Development Party), ‘Turkish economic miracle’, as dubbed by many, is now slowly transforming into the Turkish economic meltdown.  In fact, the signs of the economic meltdown had been clear for quite some time.

The causes of Turkey’s economic problems are manifold. Many of Turkey’s economic problems have non-economic origins, in addition to being predicated on the wrong macroeconomic policies.

Political and security-related causes have been some of the prominent indicators of Turkey’s economic problems. For example, the increasingly strained relations with the West, a more authoritarian atmosphere in the immediate aftermath of the June 2016 coup attempt, and a spate of terrorist attacks have created a perfect storm of dwindling foreign direct investment and lower tourist arrivals. The tourism industry has been in the upswing lately, due in large part to improved security and the plummeting currency. However, tourism revenues are far from the peak level of $50 billion in 2014. Foreign Direct Investment, which has been a vital component of the economy, has been following a downward trend since 2015, falling precipitously from $16.8 billion in 2015 to $10.8 billion dollars in 2017What is eye-catching in the case of Turkey is the amount of investment leaving the country. As the economy deteriorates, the perception of an impending recession has been fueling a massive outflow of existing investment in the country. This year so far, $3.5 billion worth of investment has left the country.

Economically, the model that the government of Recep Tayyip Erdogan has prioritized is that of increased indebtedness and spending beyond its means to stimulate growth. The Central Bank of Turkey, which is supposed to be independent, has also become a political tool in the hands of Erdogan. The interest rates were artificially kept low in a bid to further stimulate borrowing and create the same artificial economic growth. For Erdogan’s government, in order to stay in power, economic growth has been one of the main election gambits. That’s why the existing monetary policies, despite the warnings from experts, were deployed by his administration.

Yet, other sectors of the economy have been quite badly touched by Turkey’s plummeting currency as well. One of them is construction. This sector is of enormous importance for the country as it has been one of the major locomotives of growth over the past 15 years. While the sector accounted for 4.6% of the GDP in 2014, when one considers the other sectors of the economy dependent on construction, the share of the GDP rises to 30%. Household consumption is another key component of the economy. Consumption-dependent growth has paved the way for easy lending rules by the banks. Consequently, dependence on these sectors has created a colossal burden of foreign debt to the tune of $457 billion, corresponding to close to 52% of the entire GDP. In other words, as the Turkish economy has been growing over the years, such growth is due mostly to foreign borrowing. As Turkish banks have been lending money to borrowers at very preferential rates, they have also exposed themselves to greater risks of bankruptcies by these same borrowers caused by the decreasing value of the Lira, which makes reimbursing loans contracted in dollar or euro very difficult.

Impact of Turkey’s relations with the West

Turkey’s tense international relations have played a big factor in the Lira’s fall. Over the past few years, the increasingly soured relations with one of Turkey’s historic allies, the United States, has amplified this trend. Turkey blames Fetullah Gülen, a Muslim preacher now living in the US, of being behind the 2016 coup attempt. Because the US refuses to extradite Gülen, Turkey also accuses the US of lending a helping hand to coup-plotters. In reprisal, Turkey has been keeping an American pastor, Andrew Brunson, under house arrest under tenuous charges.

Moreover, Washington has been increasingly discontent with Turkey’s growing proximity to the Russian sphere of influence. When Turkey agreed to buy Russian S-400 missiles this year, Washington suspended the delivery of the promised F-35 planes to Turkey in retaliation. The US also slapped Ankara with a series of trade sanctions. The psychological effects of these sanctions were enormous. The Turkish Lira lost more than 15% of its value overnight. Despite initially resisting to raise the interest rates, the government resorted to a precipitous hike of over 24% of interest rates to shore up the national currency. However, the expected recovery has not yet materialized. As the Turkish Lira plummeted and heightening the interest rates failed to adequately increase the value of the currency, Turkey started witnessing bankruptcies.

The relations with Europe were also strained, in large part due to the EU’s condemnation of growing authoritarianism in the country, Erdogan’s attempts to galvanize the Turks living Europe against their host governments, and Turkey’s disappointment with EU’s initial silence in the face of the coup attempt (instead of swiftly condemning the coup attempt, it took many governments more than 24 hours to officially condemn it). However, an increasingly alienated Turkey seems to have rationally chosen the rapprochement with Europe. After all, both sides have a set of common concerns. First of all, the EU is also increasingly dejected by the Trump administration’s tariffs imposed on the EU. Second, both Turkey and the EU are unequivocally opposed to Trump’s withdrawal from the Iranian nuclear deal and have vowed to preserve it. Finally, European banks have also massively lent money to Turkish banks, which means that an impending crisis in Turkey would also spell out a crisis for the Eurozone. In fact, various European financial institutions such as Spain’s BBVA, Italy’s UniCredit, France’s BNP Paribas, Dutch bank ING and Britain’s HSBC are highly exposed to Turkey and the possibility of a recession in the country can  create considerable losses for these European financial institutions.

For the time being, the Lira’s falloff seems to have slowed down. Yet, structural reforms need to be deployed to save Turkey’s ailing economy. The government needs to grant independence to its central bank and adopt greater fiscal discipline. Turkey also needs to improve its relations with the US while also going back to adopting the EU’s democratic conditionality to resuscitate the EU accession talks.  Yet, such sweeping policy changes seem unlikely in the short term.

Vahid Yücesoy est doctorant en sciecnce politique à l’Université de Montréal. Ses intérêts de recherche portent sur les politiques pétrolières, la démocratisation, les États rentiers ainsi que les Islamistes au pouvoir.

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