We have often written about Turkey in the last few weeks. The catalyst for this has been the presidential and parliamentary elections that took place in May, the first round held on the 14thand the second round on the 28th. In our initial preview, we asserted that a period of change, and potentially instability, could emerge during the election period. That would have been exacerbated by a potential victory for the leader of the wide-ranging coalition that opposed incumbent president Recep Tayyip Erdoğan, which was led by Kemal Kılıçdaroğlu.
In our review, we discussed how Erdoğan managed to win his third mandate, and his third decade in power, with a narrow (52%-48%) victory over his opponent in the presidential race. Erdoğan maintained a comfortable majority with his nationalistic allies of the MHP, further indicating what might be lying ahead for Turkey, in terms of the country’s policies. Finally, in our column for last week’s ViewsLetter, we discussed the appointment of Mehmet Şimşek as the new finance minister. Turkey is again in the news this week, for the appointment by Erdoğan of the new central bank governor.
Turkey is an important country to watch, for a number of reasons. First, from a geopolitical perspective, Turkey has long tried to become the intermediary to broker a Russia-Ukraine conflict. Being a NATO country, Turkey can reassure Ukraine that Russia will be opposed in its most outrageous territorial requests. At the same time, Erdoğan has attempted to keep an open relationship with Vladimir Putin, even after the beginning of the war. Long gone are the days in which the two leaders were at loggerheads over the issue of the Russian fighter jet downed by a Turkish warplane, back in 2015.
Erdoğan instead brokered a U.N-backed deal on grain exports from Ukrainewhen the risk existed of a devastating food crisis in emerging markets, especially in Africa.
Second, Turkey sits at the boarder of several political fault-lines. It is the gateway between Europe and the Middle East and Asia, being an Islamic country but with secular institutions established by Mustafa Kemal Atatürk – the first Turkish president. At the same time, it is also a primary example of the ongoing phenomenon of the “autocratization” of democracies, with Erdoğan having also brought back the respect for Islamic rules in public affairs, though short of re-establishing the Shari’a.
Finally, Turkey is at the centre of attention of financial markets, given the sharp depreciation of the Turkish lira observed in the last few years. The USD/TRY exchange rate moved from 1.18 to 23.4 between 2008 and 2023. This is the end result of the un-orthodox economic policies introduced by Erdoğan over the last few years, which have been branded “Erdonomics.” The most notorious and controversial of these has been the reduction of interest rates carries out in the last few months, which have led to a sharp increase in inflation, which has reached 85.5% y/y recently (before “easing” back to 40%). Erdoğan was in fact convinced that an increase in interest rates would lead to an increasein inflation rather than a reduction, as economics textbooks would traditionally say. (Erdoğan’s rationale being that, when the inflation basket is dominated by administered prices, an increase in rates would lead to an increase in these administered prices).
During his years as president, Erdoğan has appointed several central bank governors, including five in the last four years, until he found someone willing to follow his lead on these policies. At the same time, in the past he appointed his son-in-law Berat Albayrak as Finance Minister, to replace the well-respected Mehmet Şimşek. The result of this has been fiddling economic growth, rampant inflation, a large current account deficit (4.5% of GDP) and a collapsing currency. The failed attempts to prop up the currency have resulted in the depletion of foreign exchange reserves, and the explosion of bank deposits protected against TRY devaluation (which reached USD 92bn in April 2023), which is a clever way to mask foreign currency debt. This is the recipe for a financial crisis to occur sooner rather than later.
Facing that, Erdoğan has decided to change tack, at least on economic policies, soon after his re-election as president at the end of May. As we discussed last week, he re-appointed Mehmet Şimşek as Finance Minister, who promised transparency and accountability. Last week, he appointed Hafize Gaye Erkan as the new central bank governor. Ms Erkan is a well-respected figure in financial circles, having worked for several years at Goldman Sachs after graduating from Princeton, and recently as Deputy CEO in charge of risk management (her specialisation) at First Republic, the now-disgraced American bank that was once considered innovative. Her last stint at First Republic, which failed because – among other reasons – of inadequate risk-management practices and a poor business model, clearly makes her appointment controversial. At first sight investors are likely to approve of the move, however.
In fact, more than the presence of these two figureheads that can reassure markets, the real question is whether they will be left with the freedom to adopt the orthodox policies the country needs to avert a financial crisis in short order. If so, we should soon observe a re-appreciation of the TRY. But if instead they are asked to continue following unorthodox policies, a financial crisis appearing on the horizon will be more likely than not.
