It seems that the economic fundamentals are breaking away from the very fabric of rationality ever since the pandemic upended the world last year. While the world is lumbering to tighten the monetary policy after awarding trillions to expand undeterred, there is a country operating on a completely different tangent. Growth is beginning to stagger around the world as the delta variant spews uncertainty yet it seems some defy the laws of economics – at least to an unobservant mind. And while inflation spares no country today, the policy in question to quench the damage somehow varies significantly. This fascinates me since globalization and subsequent economic interconnectivity have set each country on a trajectory that makes it surprisingly difficult to variate in decision-making – especially in terms of monetary policymaking.
I was recently taken aback when I came across a study regarding the economic health of Turkey. I was fortunate enough to have recently observed the European economy in detail (ECB’s Historic Shift in Inflation Targeting) to realize that Turkey defied the regional dynamics and continues on the path unapologetically. The Turkish economy grew by about 7% year-on-year in the first quarter of 2021. It was a healthy yet expected rebound as Turkey stood robust in the face of the pandemic last year – one of the few European economies – when it grew by 1.8% year-on-year. As covid restrictions eased in April, the Turkish economy boomed past expectations: expanding at a beleaguering rate of 21.8% year-on-year. Now take a moment and compare that to the plunge of 10.3% in the Turkish economy in the second quarter of 2020. Clearly, the economy rebounded spectacularly despite undergoing brief lockdowns in April and May.
Recently, Turkish President, Mr. Recep Tayyip Erdogan, cast his optimism in the performance of the Turkish economy: touting the annual growth to surpass the figures clocked in the first quarter. However, he substantially overlooked the growing threat of burgeoning inflation.
With an official inflation targeting of 5%, the Turkish economy is anything but close to containing the price increases. In fact, Turkey is on the verge of experiencing hyperinflation on the back of hiked commodity prices as the economy opens up. The Central Bank of the Republic of Turkey (CBRT) reported that inflation has bloomed to double digits, inching closer to 18.5% in July. It astonishes me that while the CBRT has hiked policy rates since last year – by as much as 10% – it has done next to nothing to contain the inflation responsibly. The CBRT policymakers have claimed that the surging inflation could be devoted to high consumer demand coupled with rising international commodity prices. However, while supply constraints are the clear culprit behind the raging inflationary pressures around the world, rising commodity prices could be attributed to another factor as well – specifically in the case of Turkey.
Another legitimate reason behind soaring domestic inflation and blooming dent in the Turkish exchequer relate to the massive depreciation in the Turkish Lira that has contributed to high import costs and in-affordability at the ground level. The devaluation of the Turkish Lira is one of the main reasons driving some of the sharpest price rises in the world. My analysis is concurred by the recent data released from the Turkish Statistical Institute revealing that while exports have climbed by 10.2%, imports have jumped by 16.8% compared to July 2020. However, the devaluation in Lira has broadened the Turkish trade deficit by 51.3% year-on-year in July, standing at $4.278 billion. It is apparent that despite a tight monetary policy and growing exports, the imports are driving inflation to nearly unstoppable levels – all while a plunging Lira is exacerbating the deficit.
Nonetheless, the CBRT has pledged to keep the policy rate at the highs of 19% – above nominal inflation rate – to subdue the raging prices and retain the purchasing power of the national savers and investors. However, President Erdogan seems persistent to campaign rate cuts later this month. Apparently, he feels that the economy needs more stimulation despite growing beyond expectations. While the central banks around the world are clambering to draw down dovish policies to curb inflation, Turkey seems to be pondering over a perverse strategy amidst catastrophic inflationary pressures. No doubt, it is a problematic situation. Over-the-top pressure from Mr. Erdogan to ease the policy later this month could drive inflation beyond the sinister 20% mark – as we observed that the consumption demand currently stands extremely strong. Therefore, while it seems enticing to prolong the growth regime and guarantee re-election in 2023, President Erdogan is simplistically overlooking the cons of searing inflation wreaking havoc over the emerging economy. Primarily, he is massively undermining the currency crisis that could worsen if inflation persists at such a high level. As a result, Turkey could turn into another Venezuela when the global economy rebounds while the inflation refuses to diffuse – even with conventional monetary policy tools.
I anticipate that when the CBRT convenes on 23rd September, the policymakers would be undertaking a crucial question: could Turkey afford interest rate cuts? Nevertheless, the economy is growing at a substantial pace. And despite inflation raging way past the conventional 5% mark, unemployment has contracted by an impressive 2.5% to stand at 10.6%. While I truly comprehend the urge to fuel the growth further, the economy is already overheated. For example, the Turkish economy is expected to further expand by 10% by the end of 2021 (unless intermittent lockdowns impede speedy recovery).
However, while the CBRT deems inflation as perfunctory – expecting inflation to dip down to 14% by the end of 2021 – economists expect the inflation to hold its ground and mist around the 18% mark by the fourth quarter. Thus, the real risk exists and would continue to haunt until the CBRT convenes later this month. I fear that if the policymakers truly end up downplaying the persistence of inflation and heed the pressure from President Erdogan to ultimately slash the policy rate, then the Turkish economy would be on the verge of another currency crisis – extending economic instability unlike ever before and long far into the future.