The financial crisis in Turkey calls for a tight monetary policy and a tough banking regulator. But Turkey’s Central Bank is being headed by one US business school graduate after another. But how will Fatih Karahan be more successful than Hafize Gaye Erkan?
In terms of its financial situation, Turkey is going through difficult times. In real terms, annual inflation in 2023 has reached 65% (and some independent sources claim it is as high as 128%), and, unfortunately, is still largely the same in February 2024. Wages are not growing in line with inflation, and the poverty rate is growing. The Turkish lira continues to depreciate against world currencies, and now stands at 30-31 lira to the US dollar. The Central Bank is being forced to pursue a tight monetary policy, leading to an increase in interest rates. Thus, between June 2023 and February 2024, the Central Bank’s interest rates rose from 8.5% to 45%. And this is not the end of the situation.
The Turkish government’s monetary expansion measures have not yet achieved their goal of stabilizing the lira, and reining in or stopping inflation. In the run-up to the 2023 presidential elections the Turkish authorities in effect conducted a so-called “electoral economy”, i.e. a pre-election policy aimed at stimulating the economy and creating jobs in order to boost the incumbent leader’s chances of re-election. The reasons why the Turkish lira has lost so much value, however, remain obscure, leading to uncertainty about Turkey’s financial health.
After winning the election, President Recep Tayyip Erdoğan was forced to reshuffle the government’s financial wing and appoint technocrats, i.e. finance and banking specialists trained in US business schools and with experience of working in the US. Mehmet Şimşek was appointed Minister of Finance and Hafize Gaye Erkan was appointed head of the Central Bank. The head of state gave them a relatively free rein, enabling them to take tough financial and economic measures to stabilize the situation.
With a lack of major foreign investments and soft loans, Turkey’s government is being forced to take unpopular measures such as raising interest rates to tackle inflation, and this is resulting in job cuts, cutting the purchasing power of salaries and plunging many people into poverty.
The increase in the Central Bank’s lending rates from 8.5% to 45% in the space of 7 months, although it did not happen all at once, has had a significant financial impact on businesses and the manufacturing sector. Turkey’s state-controlled financial market analysts predicted that by the end of 2023 the Turkish lira would be within the range 24-27 lira to the US dollar. However, these forecasts failed to materialize, and at the end of the year the exchange rate stood at 30-31 lira per 1 dollar. The gulf between the government’s expectations and the reality of the market may be a sign of uncertainty about how the financial crisis will pan out, or it may simply reflect the authorities’ attempts to pass off wishful thinking as analysis in a bid to stem public disappointment and unrest (panic) in the run-up to the local elections.
In all cases, Turkish independent experts have raised concerns about the government’s lack of transparency concerning the true extent of the damage caused by Erdoğan’s “electoral economy”.
Şeref Oğuz, an expert writing for the Turkish newspaper Ekonomi speculates that the government’s financial wing was given a public loan for three months. “The new leaders of the economic bloc have neither unorthodox fantasies nor far-fetched economic theses. The problem is that unless the new specialists are supported by senior management from time to time, then the positive mood in the markets may evaporate very quickly. So Şimşek and Erkan really should be given more freedom to do their job. That is the only way that the hopes for recovery in the second half of the year be maintained.”
President Recep Tayyip Erdoğan provided substantial support to Mehmet Şimşek and Hafize Gaye Erkan, in order to enable them to develop effective strategies and programs to reboot the Turkish economy. In fact, the wave-like increase in the Central Bank’s lending rates, a tactic which Erdoğan had not previously allowed, is evidence of this. But it has to be said that, in the end, it is the president himself who determines the limits of the government’s freedom to choose its own economic course and there have been times when for foreign policy reasons he has intervened – for example by canceling Mehmet Şimşek ’s planned trip to New York to take part in an investment conference and to Davos for the annual foreign economic forum.
Meanwhile, in early February the Central Bank suffered a staffing crisis when its head, Hafize Gaye Erkan resigned. She was replaced by her deputy Fatih Karahan.
A number of different theories about the possible reasons for her resignation were voiced in the media. For example,
– some speculated that it was due to a scandal concerning her family (they accuse Hafize Gaye Erkan’s father, a mechanical engineer, of taking advantage of his daughter’s official position, using official cars, and even secretly advising his daughter on monetary policy);
– others were of the opinion that President Recep Erdoğan objected to Erkan’s assessments of the scale of the crisis in the country, which forced her to give up her expensive (at least compared to Manhattan) rental housing and stay with her parents. In fact it is clear to Turks, without citing Ms. Erkan’s living arrangements, that living standards in Turkey are far behind those in the US);
– yet others linked the resignation to a recent news story of about Erkan’s being provided with a separate room in the Central Bank premises as a nursery for her one and a half-year-old child (although it is unclear what a young mother is expected to do when she has a baby that needs breastfeeding and has a responsible position in government. What is more, surely the fact she had a young child must have been known when she was appointed. And anyway, Turks are generally very protective of children and family values).
In any case, it is not the present author’s job to speculate about the reasons for her resignation as head of the Central Bank. They could relate to the inbuilt sexism of the Turkish political system, or possibly to attempts by the US Treasury Department to influence Turkish banking policy, something which, naturally, the Turkish intelligence services and President Erdoğan cannot allow.
Significantly, when Brian Nelson, US Treasury Department Under Secretary for Counterterrorism and Financial Intelligence, visited Turkey in late November 2023, what did he discuss with his Turkish colleagues if not the financial and banking sector? In particular, they discussed sanctions against Russian legal entities and the actions of the Palestinian Hamas movement. As head of the Central Bank, it would have been impossible for Erkan to avoid talking about certain issues with Nelson, particularly if he voiced the US concerns about Turkey’s banking operations with Russians and Palestinians? And then what action did Turkish banks take in January 2024 against Russian companies? They suspended Russian payments and then refused to conduct transactions with Russian legal entities. This was the result of US pressure on Ankara and its financial institutions, and naturally Russia’s action was far from positive (even though the Kremlin entirely understands that Erdoğan was acting under a great deal of pressure from the US).
Another question, also with no clear answer, is whether Erkan should be seen as a victim and a scapegoat, her fall precipitated by the Central Bank’s dealings with its Russian partners.
Outwardly, at least, the appointment of the new head of the Central Bank, Fatih Karahan, has not really changed anything. Fatih Karahan, like his predecessor Hafize Gaye Erkan, was educated in Turkey (he graduated from the Faculty of Industrial Engineering and Mathematics at Boğaziçi University) and then moved to the United States and six years later defended his master’s and doctoral theses in economics at the University of Pennsylvania. He then worked at the Federal Reserve Board in New York, where he started as an economist and rose to the position of head of the labor and product market department and advisor for money politics. He returned to Turkey in 2023 and was appointed to a position in the Central Bank.
Obviously, the sudden departure of the Central Bank Governor may have a negative impact on Turkish markets. Mehmet Şimşek, Turkey’s Minister of Finance and Treasury, in comments on Hafize Gaye Erkan’s resignation, said that her resignation was her own decision and not related to Turkey’s financial policy, and that President Recep Tayyip Erdoğan has full confidence in the policy followed by the Ministry of Finance.
The US financial services company Morgan Stanley predicts that the new head of the Turkish Central Bank, Fatih Karahan, will continue to follow a tight monetary policy in order to combat inflation, and does not expect any interest rate cuts.
JP Morgan, on the other hand, believes that the Turkish Central Bank, in line with its anti-inflationary policy, may actually increase interest rates.
Five days after his appointment, Fatih Karahan predicted that by the end of 2024, inflation in the country will be 36% (a fall of 45%). In particular, in an interview with Haber TV channel he said: “We will continue with our tight monetary policy until inflation falls… Despite the ongoing global risks, inflation is expected to continue to decline and is projected to be 36% by the end of 2024.” He also said that there had been an improvement in the balance of current payments and the dynamics of foreign trade growth for January. However, Turkey’s National Institute of Statistics earlier reported that in January inflation amounted to 64.86%, an by 0.09% on the figure for December.
Only time will show whether Fatih Karahan’s optimistic prediction for December this year is realistic. To achieve this figure he will have to cut inflation by 4.5% each month for the next 10 months. However, in addition to following a tight monetary policy, Turkey can also promote financial and economic stabilization by adopting a flexible foreign economy (for example, by accelerating the implementation of the Russian road map for its ambitious “gas hub” project, or by restoring payments to Russian companies, which will stimulates Turkish re-exports). So far, however, instead of a stabilization of finances in Turkey, we have seen a change of guard in the banking sector.
Alexander SVARANTS – Doctor of Political Sciences, Professor, exclusively for the online magazine “New Eastern Outlook”