After the victory of Recep Tayyip Erdogan’s re-election on May 29, 2023, Turkey’s economic crisis is worsening and economists suggest calling in the International Monetary Fund (IMF). The re-election enables President Erdogan to serve until May 2028 – he has previously led his country for more than 20 years. Before becoming President, he was Prime Minister of Turkey for 11 years.

Central banks introduce contractionary monetary policy when inflation is rising in the economy – this raises interest rates in hopes of slowing down unsustainable economic growth by reducing investment and consumption.

Erdogan rejects this idea, instead preferring to lower interest rates aiming to reduce inflation and encourage growth. For the past two years, he has been endorsing a “new economic model” that ensures ultra-low interest rates. The model is aimed at achieving price stability by cutting the high costs of borrowing, boosting exports, and changing the current account from trade deficits to trade surpluses.

Turkey is the 19th largest economy in the world in terms of nominal Gross Domestic Product (not adjusted to inflation) and the 11th largest in terms of Purchasing Power Parity. Its major industries include electronics, petrochemicals and automotive production. Political turmoil and involvement in regional armed conflicts have led to both financial and currency market instability and uncertainty about Turkey’s economic future in recent years – this is problematic as the level of Foreign Direct Investment reduces.

Despite facing criticism over the current economic climate, Erdogan is still hopeful and confident that he can cut inflation to single digits with the appointment of Hafize Gaye Erkan as governor of the Central Bank of Turkey, the first woman to hold the position. She has an impressive career, being named in 2018 as the only woman under 40 holding a president or CEO title at one of the 100 largest US banks.

Mehmet Simsek, the former economy chief, was named as Turkey’s treasury and finance minister, who is an advocate of orthodox economic policies. Both appointments suggest that Erdogan is shifting away from his unorthodox economic policies, including the belief that raising interest rates increases inflation. On June 22, the Central Bank of the Republic of Turkey announced that it raised its main interest rates from 8.5% to 15% showing signs of an economic U-turn in Erdogan’s policy.

Hakan Kara, professor at Bilkent University in Ankara and ex-chief economist at the Central Bank of the Republic of Turkey, thinks that the central bank’s announcement of nearly doubling the interest rates in Turkey “will not be enough to reverse the deterioration in the public’s inflation expectations.”

He asserts the importance of lowering inflation as decisive action must take place in order “to avoid longer-term inflation expectations becoming entrenched”. He also believes that the “root cause” of macroeconomic imbalances is due to a “lack of an anchor to assure the public and companies that prices are stabilising” along with “inflation and the country’s external deficit.”

However, Kara does point out that it may be “too early to make a concrete call” and claims that we should give “the benefit of the doubt at this stage to the newcomers [Erkan and Simsek] with hope for positive surprises.”

Despite actions made for economic recovery, there are 4 reasons explaining why the prosperity of Turkey’s economy may be under threat.

High Inflation

Secondly, firms are affected as it leads to a reduction in exports due to a fall in Turkey’s international competitiveness. Investment decreases as inflation makes it difficult for firms to set budgets, causes uncertainty and lowers profits.

Thirdly, the workers are affected as inflation is rising at a faster rate than wage increasing – similarly with consumers on fixed incomes, they enjoy less disposable income and therefore cannot spend more on goods and services.

Finally, inflation leads to the government with problems such as an increase in inequality and a deterioration in the balance of trade. Those on fixed incomes are impacted the most which widens the gap between the rich and poor. The current cost of living crisis

However, it does lead to a fall in the real value of Turkey’s national debt which is beneficial as inflation would reduce the value of the debt owed by the government – becoming less of a burden.

Overall, inflation is an important measure of the success of an economy and high rate of inflation causes damaging effects. These effects cause a greater fall in aggregate demand due to a fall in consumption, investment and trade exports.

Government budget deficit

In February 2023, Turkey’s central government budget hit an all time low record of -170.56 TRY Billion. According to Statista, Turkey’s budget balance next year (2024) is forecasted to be -5.7% in relation to GDP. Running a budget deficit has several short-term and long-term impacts.

In the short run, the government’s national debt will increase as it will borrow more money from the private sector. By having a high national debt, it will attract less investors and thus FDI will decrease. This will cause Turkey’s economy to weaken further as investment spending is reduced. Both the actual and potential productive capacity is lowered which will shift both AD and LRAS inwards.

In the long run, it causes a burden on taxpayers as direct taxation (income tax) will increase to improve the government’s budget by increasing its revenue via taxation. This has a negative consequence as an increase in income tax might cause a disincentive to work. Unemployment rates won’t be reduced since people will be less likely to take jobs while current workers won’t have the same benefits of taking overtime and would likely reduce their working hours further.

This leads to a fall in the economy’s productive capacity as the LRAS will shift inwards. Another possibility to reduce the budget deficit is to cut costs in government spending, but this leads to a fall in aggregate demand and therefore a decrease in the country’s GDP.

Devaluation of the currency

The Turkish Lira has come under pressure since Erdogan’s re-election, its devaluation being attributed to a large budget deficit, high inflation, little foreign exchange reserves and Erdogan’s unorthodox economic policies in the past years.

Devaluation of any currency has both positives and negatives – the current account is improved as exports become cheaper and imports more expensive.

As a result, this makes a country’s goods and services more internationally competitive as foreign countries will be more inclined to buy due to a fall in price. Overtime, this will lead to a trade surplus as the country will be exporting more goods than importing. By having a weak domestic currency, it will encourage economic growth as aggregate demand shifts outwards due to the increase in trade exports.

However, this runs the risk of causing demand-pull inflation as aggregate demand is increased. In the case of Turkey, due to the economy experiencing a recession, the devaluation of the Lira may be insufficient enough in boosting export demand. The growth is weak, and hence there will be less of an increase in demand for exports and therefore the country’s GDP shouldn’t increase too significantly.

Current Account deficit

In January 2023, Turkey’s balance of payments hit an all time high as the trade deficit widened by 38% to $14.24bn. Since June, its trade deficit decreased by 35% as both imports and exports declined as President Erdogan’s adopted more orthodox economic policies.

Despite this, it does indicate that Turkey’s goods and services are uncompetitive which could cause major issues such as an increasing level of unemployment. If the economy experiences high unemployment, it causes consumer expenditure to decrease which hinders investment by firms as they face falling sales, revenues and profits. Therefore, a reduction in consumption will lead to a fall in the rate of economic growth.

The government is negatively impacted as well due to welfare payments increasing as more people claim benefits which causes burdens on its national debt and taxpayers – both direct and indirect taxation will need to be increased in order to stabilise the government’s budget deficit. The government will also receive less through tax revenues as less people are incentivised to work and therefore revenue from both income tax and corporation tax will be less as firms’ profits will also be lowered.

Recent events of the slowdown in inflation, the fall in trade deficit and the appreciation of the currency – suggests that Turkey is slowly rebuilding its economy.

Although there are signs of promising results since Erdogan’s re-election and his shift in economic policy, Turkey still has a long road ahead in recovering the economy and reducing the impact of the cost of living crisis.