Since June 2023, when Recep Erdoğan was reelected as president, Turkey’s economy has, once again, been going through difficult times. Given the scale of the financial crisis and the consequences of February’s devastating earthquake, Recep Erdoğan was forced to appoint technocrats with degrees from US business schools to the government’s financial team.
The two new appointees, Mehmet Şimşek (Minister of Treasury and Finance and Treasury) and Hafizeh Gaye Erkan (Governor of the Central Bank), in a bid to stabilize prices, have pushed through a number of tough and unpopular monetary policy measures that, in the short term, will inevitably trigger an increase in inflation, reduce production activity and slow down economic growth.
Economics is governed by universal rules, and these measures, as every economist knows, basically involve increasing bank interest rates. That means that the real economy will be deprived of the opportunity to make quick profits, as not all companies can afford to take out new bank loans at the higher rates. With less money available to the real sector of the economy, production turnover (money – goods – income) will decrease, and any increases in costs will lead to a fall in business activity.
Given the current crisis, the best hope for the national economy is foreign investment on advantageous terms, which will help stabilize prices and ensure an increase in trade in a relatively short period of time. However, attracting foreign loans for domestic industry is often not so much an economic issue as a political one. In other words, depending on the crisis-beset state’s foreign policy course and international relations, foreign partners, generally economically developed countries and international financial organizations, decide whether or not to invest or offer loans.
Turkey, in this sense, has a long history of financial ties with Europe and the United States. As readers will remember, in the 19th century the Ottoman Empire was known as “the sick man of Europe,” and in 1875, as a result of a systemic state crisis the Ottoman state bank actually defaulted and found itself in direct dependence on the financial whims of England and Germany. A century or so on, the second half of the twentieth century proved to be a financially challenging time for the Turkish Republic. In particular, a series of economic crises provoked major domestic political upheavals, leading to four US-backed military coups (May 27, 1960, March 12, 1971, September 12, 1980, February 28, 1997).
However, each time, Turkey managed to find the internal strength necessary to work as a partner with the leading Western countries and get back on the road to economic stabilization and recovery. Financial crises are a reaction not only to external factors (e.g. high dependence of the financial market on the international situation), but also to internal factors and disturbances to natural economic processes. Those disturbances are frequently the result of the government’s ill-considered financial policies (including administrative interference with the Ministry of Finance and Central Bank, their subordination to the executive, and personal decisions and personal rule by the head of government).
Many experts agree that the financial crisis of the 2020s in Turkey was largely a consequence of the populist economic policies of Recep Erdoğan, who for political reasons artificially supported the policy of keeping Central Bank interest rates low to support the economic activity of Turkish business, and, clearly hoping that the middle class would reward him by keeping him in power for many years to come. And as Erdoğan, in his foreign policy, began to demonstrate to the financially secure West that Turkey intended to follow an independent course, with a tendency to imperial revanchism, Turkey found itself in an unenviable economic situation.
Meanwhile, after a century as a regional power, Turkey is showing signs of wanting to upgrade its status. Largely thanks to the West, primarily the UK and the US, by 2006 Turkey had become an important transit center for the export of Azerbaijani oil and gas, bypassing Russia. The latter was a consequence of the collapse of the USSR and the geopolitical weakening of the Russian state. Later, Erdoğan began to pursue a pragmatic policy of building more independent foreign economic ties with the West’s opponents, China and Russia, thus expanding the export potential of the Turkish economy and increasing its energy supply.
But unfortunately, the current Turkish leader is not able, as his predecessors in the second half of the twentieth century did, to encourage the emigration of declassified labor migrants to the prosperous countries of the West and the Arab East, thereby reducing the social burden on the Turkish economy. After all, both in Europe and the Persian Gulf, the economies of the developed countries have evolved, and their economic growth is now closely linked to technological innovation rather than manufacturing, which they have outsourced to developing industrial centers in Asia, thus dramatically reducing their need for cheap foreign labor. Moreover, the current economic recession, or slowdown in the growth of GDP, in the EU countries, the result of their own irresponsible submission to the will of the US in response to the Russian-Ukrainian crisis, has reduced Turkey’s export potential.
To return to Turkey’s current monetary policy, since the appointment of Şimşek and Erkan, the Turkish Central Bank has raised the interest rate on a monthly basis, taking it from 8.5% in June to 40%, almost five times the June level, by the beginning of December. As a result, the Turkish lira has fallen to record lows against global currencies, including the US dollar, with inflation reaching 65% by the end of 2023.
The Turkish Central Bank forecasts that price increases will peak in May 2024 at 75%, after which the stabilization measures will cause inflation to fall to 34-36% (just over half the peak level) by the end of next year. Turkey’s economy has experienced a marked slowdown since the Central Bank raised its rates. According to Turkey’s official statistics, the country’s GDP grew by just 0.3% in the third quarter of 2023, when compared to the second quarter on a seasonally adjusted and weekday basis. That is less than the revised 3.3% for the previous quarter, and worse than the growth predicted by economists at Bloomberg, who had predicted 1% in the third quarter. Turkey’s exports of goods and services grew by only 1.1%, while imports increased by 14.5%.
This slowdown in the Turkish economy was a consequence of the tight monetary policy adopted by the Central Bank after the June 2023 elections. The new Finance Minister, Mehmet Şimşek, expects that this economic policy will cause prices to stabilize and gradually boost GDP. “We will continue our predictable and rule-based policies until inflation and the current-account deficit are permanently reduced and macro-financial stability is achieved,” Şimşek said. “We will thus strengthen the foundation for sustainable high growth.”
The prospect of a “soft landing” for Turkey’s $1 trillion economy would be a vindication for Erkan. Like Şimşek, she argues that price stability is critical to sustainable growth. Prior to her appointment in June, Erdoğan for years relied on policies that boosted the economy at the expense of increasing inflation and weakening the lira.
Meanwhile, in the present author’s opinion, the Turkish government’s stabilization policies and tough monetary measures are guided by pragmatic calculations and expectations. The expected improvements in Turkey’s domestic financial environment are, no doubt, linked to a positive assessment of its expanding financing and credit partnerships with other countries, in particular, in the wealthy West. This conclusion is supported by the professional background and education of the Şimşek-Erkan team, who both have close links with the United States. So, what do current developments have to say about Turkey’s relationship with the US Federal Reserve?
The war between Hamas and Israel has effectively put an end to the brief warming in US-Turkish relations that took place in the early fall, when Senator Robert Menendez stepped down from his chairmanship of the Senate Foreign Relations Committee and the sale of 40 upgraded F-16 fighter jets to Turkey went ahead following the Turkish parliament’s approval of Sweden’s NATO membership bid. But Recep Erdoğan has sharply opposed Tel Aviv and allowed himself to vocally criticize the West (primarily the United States) for its support of Israel, and calling the Americans “accomplices to the crimes” of the IDF in the Gaza Strip. Naturally, Ankara’s position is unlikely to encourage Washington and US-dominated global financial institutions (such as the IMF, the World Bank and the EBRD) to invest in stabilizing Turkey.
As The Wall Street Journal notes, Joe Biden’s administration is still trying to persuade Turkey not to provide financial assistance (including fundraising under the guise of humanitarian aid) to Hamas, and to cut its relations with Russia.
Brian Nelson, the US Treasury Department’s Under Secretary for Terrorism and Financial Intelligence, was hastily dispatched to Turkey for a second time to present to his Turkish counterparts Washington’s demands that they comply with its unilateral sanctions against Russia, and against and Hamas’ financial activities.
In 2023, Turkey ranked second in the world in terms of the volume of its exports to Russia, which totaled $50.2 billion, $22.9 billion more than in 2022. The United States is unhappy with the growth in Turkish-Russian trade relations during Russia’s special military operation, and, accusing Ankara of encouraging the parallel export of dual-use products to Russia, is trying to drag Turkey into the camp of Russia’s military adversaries. As for Hamas, Brian Nelson notes that despite the US sanctions against Hamas, Turkey has allowed Hamas-controlled investment companies, holding companies, real estate brokers and other businesses to operate in its territory outside of Istanbul.
In effect, Brian Nelson warned the Turkish leadership that subsequent disregard for US interests and failure to follow Washington’s instructions would lead to US sanctions against Turkey. Specifically, a number of Turkish companies and entrepreneurs will fall under sanctions for providing Russia with goods and services prohibited by Western export controls. Moreover, Turkey is becoming a financial haven for Hamas, which will also lead to additional sanctions.
As The New York Times reports, Brian Nelson offered the Turks a choice: partnership (the carrot) or sanctions (the stick). Among other things, he said: “We’re committed to [doing] everything we can to cut off all of those things and want to do that in partnership with Turkey, but are prepared to act unilaterally as well.”
The warning by the US Treasury Department and Federal Reserve about financial sanctions against Turkey is probably just a verbal declaration, rather than a way of putting pressure on Turkey. The Americans are fairly well-informed about the reality of the financial crisis in Turkey and the prospects for stabilizing the economy, which could improve or deteriorate depending on the mood in the US. In view of its president’s declarations and the upcoming municipal elections, Ankara will have to make a difficult choice.
It looks as this is why Brian Nelson’s visit to Ankara pushed the planned visit by Iranian President Ebrahim Raisi onto the back burner. It is understandable that in addition to financial aid, Tehran is ready to propose even more radical forms of support for Hamas in Gaza. However, how can Erdoğan possibly accept such proposals from his Iranian counterpart with no end to his domestic crisis in sight…?
Alexander SVARANTS – Doctor of Political Sciences, Professor, exclusively for the online magazine “New Eastern Outlook”.