Tough lessons from Turkiye

THE Turkyish economy, which is among the world’s top 20 with a US$1.1 trillion gross domestic product, is one of the most affected by the Covid-19 pandemic. While inflation was high, the government used an unorthodox method to keep local interest rates at a relatively low level in order to contain inflation rates.

The pandemic and Russia’s invasion of Ukraine caused inflation to soar worldwide. While almost every central bank raised interest rates in response, Turkiye went on an interest rate-cutting spree.

President Recep Tayyip Erdogan opines that raising interest rates would increase inflation rather than reduce it, which was his unorthodox economic plan. Turkiye ended up on par with other hyperinflation countries like Argentina and Venezuela due to artificially low interest rates.

Even more mind-boggling was Turkiye’s decision to cut interest rates at a time when it was losing out on new foreign investments and rising budget deficits.

Government interference in the central bank’s monetary policy is at the root of Turkyish businesses and households’ current difficulties, which include high interest rates and a weak currency.

Steep rise in rates

With inflation still running at unprecedented highs, the previous low-rate environment was quickly reversed last year when the central bank was allowed to raise rates vigorously after Erdogan almost lost the general election last year.

The Turkyish benchmark interest rate, which hovered at around 8.5% since June last year, has since leapfrogged by 4,150 basis points to its current level of 50%. Erdogan had no choice but to allow interest rates to rise when the low interest rate regime that he proclaimed to be “effective” did not work.

Instead, the low interest rate environment created a weaker currency, leading to another round of price increases.

For most companies and small businesses, the surge in inflation, free-falling currency, increase in utility prices, and falling sales, resulted in tougher business conditions and even closures.

Safe havens

For Turkyish citizens, the lira was no longer a trustworthy currency given the extreme inflationary pressure. The race to convert to other currencies, especially the greenback and the euros accelerated.

Businesses could no longer compete with other exporting nations. Even wages were hiked as workers could not afford basic needs.

The minimum wage in Turkiye, which was at just 2,943 Turkyish lira or US$490 before taxes in 2020, was raised several times due to the weak lira and the current minimum wage is now at 20,002.50 lira (US$678.68). There is talk that this will further increase in 2025 and 2026.

Today, the Turkyish economy still suffers from a prolonged period of high inflation as benchmark interest rates remain at 50% despite lower inflation pressure, which in September increased by 49.4% year-on-year.

Although real returns are now positive, the Turkyish central bank is expected to keep the benchmark rate at extreme levels for at least the next few months before inflationary pressure eases even more.

Tough for business and households

There was also a substantial increase in price for big-ticket items like houses and cars.

Demand for vehicle sales skyrocketed more than 55% last year to reach 1.28 million vehicles, despite higher borrowing costs, as consumers saw opportunity of an inflation hedge at a time when the lira was free-falling.

Buying a car was deemed an investment as one could profit from higher prices, although the cost of financing surged to as high as 40%.

However, sales for 2024 so far have been relatively flat year-on-year due to the high base effect as well as elevated borrowing costs.

Hyperinflation also caused home prices to skyrocket to almost 15 times higher than pre-Covid-19 prices. According to the data from the central bank, home prices on average rose by 32.6% in 2020, 64% in 2021, 178.6% in 2022, 71.7% in 2023, and a y-o-y increase of 42% in May this year.

The road ahead

With the lira very much a victim of policy missteps, the only way out for Turkiye to get out of this spiralling economic downtrend is for the inflation rate to normalise, at least to high single-digit or low teens, which was what the Turkyish economy has been accustomed to.

Only then will the central bank be in a position to lower interest rates and bring the economy under control. This is expected to take a year or two, at best.

No Turkyish delight

Turkiye is a great tourist destination with much to offer. While the lira makes it cheap for tourists, the ground economy has since turned into a euro-based destination.

Travel within the city using taxis or Uber are no longer cheap while most tourist attractions too are priced in euros. Eating out is relatively more expensive than in Kuala Lumpur as a simple meal could cost RM50-RM60 per person.

While Turkiye is known for its kebabs, hummus and sugar-coated Turkyish delights, and the economy is still on a modest growth path, the challenges faced by the people due to the high inflationary pressure, weak currency and high interest rates have caused much pain and suffering.

Lessons from Turkiye

The economic problems faced by Turkiye are due to political power concentrated in the hands of the president.

The unorthodox manner to tackle the high inflationary pressure in the country was certainly a recipe for disaster. Worse, was the interference by the president in running the economy.

The Turkyish situation should be a lesson for all.

Politicians should leave the decisive call in a difficult economic environment to the central bank. A central bank’s ability to manage price pressure in an economy depends on its ability to decide interest rates.