I visited Turkey last week meeting with the usual suspects - policy makers, industrialists, bankers, analysts, journalists and tech types. I included tech guys this time around as I visited Teknofest in Izmir - the big take out there is the fact that so many young Turks are inspired by all things tech. Note therein Elon Musk’s offer to visit Teknofest next year. Fortunately Turkish kids generally don’t want to be bankers or economists but the next Elon Musk or better, the Turkish version, Bayraktar. And tech played a big part in the elections earlier this year - Erdogan playing up Turkey’s new found prowess in drones, a helicopter carrier, electric car et al. Tech and innovation is hence a new theme that resonates in Turkey. It seems to help unify a very polarised nation.
A few thoughts herein.
Politics/elections - the opposition are in total disarray after their “surprise” but nonetheless devastating defeat in the national elections in May. Unfortunately for them in-fighting, rather than soul searching, is the order of the day and Erdogan’s AKP look well set to sweep many municipalities including Istanbul, likely Ankara and some even suggested that the secular citadel of Izmir could be breached.
The above might suggest that Erdogan has more space to ease up on lamb barrelling in the run up to the local vote - giving Simsek et al more scope to undertake the now much needed economic policy tightening. But Erdogan likely wants nothing better than to further cement his own domination of domestic politics than by drubbing the opposition in the local elections. So likely Simsek et al will be somewhat constrained until at least after the local elections.
I know there has been much talk of succession - partly I have banged that drum - but Erdogan looks reinvigorated in politics after his national win and the only constraint is the current two term constitutional limit. That though ends in 2028 - some talk there of perhaps deals with opposition groups (Babacan et al) to change the constitution again to reset Erdogan’s term limits . But this is still a long way off. That said I think if you look at the recent cabinet changes the ousting of likely rivals for succession - Akar and Soylu - opens the way for “friendlier faces” nearer to home. I think therein Erdogan is keeping options open but securing the Erdogan family name and legacy surely has to be paramount. An anointment, if it comes nearer to 28’, will surely be from the close circle. A lot of focus had been on Berat Albayrak but his star seems to have faded in recent years and some HR changes in the telecom sector over the past week seemed to reinforce that view.
And obviously a big focus for the trip was whether the new economic policy team - Simsek, Erkan et al can turn the economy around and prevent Turkey from falling into a systemic crisis.
Important herein for me to state that I think Turkey was heading into a systemic crisis to rival the last one in 00/01, if there was n’t a 180 turn in policy from the frankly crazy and highly damaging unorthodox low interest rate policies run into the May elections. Loose policies spurred a devaluation-inflation spiral that threatened a BOP crisis which would have eventually seen a run on banks and then a sovereign debt crisis. Read my lips DEFAULT. Turkey was that close. And I think recognition as to how difficult things had got meant that key officials told hard truths to power and Erdogan seemed to listen. I think a salient point here was the message that low interest rate policies were not really helping the poor but generating windfall profits for a few lucky connected speculators who could access cheap loans and buy real assets as inflation hedges - real estate and stocks which rocketed in price. But high double digit inflation was devastating the poor/poorest. I think this finally resonated with Erdogan and hence the pivot to Simsek/Erkan et al.
The new economy team is superb. No doubts. The likes of Simsek, Akcay and Hatice Karahan are well known by the market and orthodox thinkers - great thinkers. Erkan and Fatih Karahan have great CVS. It’s a very rounded and well balanced team and more strong hires are likely in the works.
I know the Agbal factor weighs here but a few things make me more confident that Simsek et al are here to stay: a) First, as above, I think Erdogan was finally persuaded by people he trusts that existing policies were doing much more harm than good. b) I think advisers in the presidential palace have changed or at least more orthodox thinkers have his ear; c) safety in numbers, as while Agbal was pretty isolated the current team is just that, a team, and it’s growing which makes it that much more difficult to take a spur of the minute decision to fire them all - of course he still can, but more players are now involved, and a change would be far more disruptive.
In addressing the risks of crisis Turkey needs a credible team, a plan and then financing.
It has the credible team - tick.
The plan?
The team is more than capable of coming up with a plan. And to some extent if the team and plan are in place I think financing will follow.
In terms of the plan, it’s not rocket science. Policy needs to be tightened and short term growth needs to be sacrificed for lower longer term inflation which will then help deliver longer term growth.
Policy rates have already been hiked from 8.5% to 30%. But with inflation currently in the high 50s and expected to peak next May likely in the 70s rates just have to go higher. Where to? Officials will argue that macro prudential policies and tighter fiscal can help moderate the scale of rate hikes. They would also argue that a seismic up front rate hike could shock the system and create more problems throughout the system - and risks of such have surely increased due to the Frankenstein monster of macro prudential regs created before the elections to hold the lira, and to try and stall dollarisation while keeping policy rates low.
Notwithstanding these points I don’t think there is a global example where when faced with a high inflation, devaluation driven spiral that gradualism works. Well it can eventually work but the costs are more entrenched inflation, slower disinflation and ultimately likely higher and longer held terminal rates - ultimately more damaging for growth. Gradualism is suboptimal economically albeit I get the political math - local elections.
The brakes need to be slammed on sooner rather than later and all the evidence is that plain vanilla monetary policy - rate hikes - are just more effective than fiscal and macro prudential policies at anchoring inflationary expectations lower sooner. The latter are useful additional tools but should not do the heavy lifting.
Local elections are also a constraint.
Blank piece of paper I think with inflation heading to 70%+, policy rates need to be jacked up to 40-50%, at least - true that deposit and lending rates are already getting there. But policy rates are the best signalling force to more quickly anchor inflationary expectations lower - and important on the financing front to bring foreign inflows in to create the virtual circle.
Macro data still suggest not much of a growth slowdown so import demand will remain elevated - not helped by energy prices heading higher again. Exports are being constrained by real FX appreciation again plus also week export demand in Europe as the cost of living crisis hurts. The BOP crisis is not helped by still high inflation expectations which means that goods imports and gold are being used as inflation hedges. Tourism has helped buoy the lira in the short term but the season is ebbing and the current account will move back into a hefty deficit thru the winter. The CBRT also needs to rebuild FX reserves as part of its own rebuilding credibility exercise. It has succeeded since May in taking gross reserves from below $100bn to nearer to $125bn but there is talk of the new team looking to up this to $150bn. That needs either a bigger deflation of domestic demand (higher rates, tighter fiscal) or short term foreign financing - at least to bridge to local elections after which the political reality will then allow much tighter monetary and fiscal policy.
Good news has recently come with evidence of reduced dollarisation via conversion from FX and FX protected accounts - helped by higher deposit rates. It feels a bit like a turning point and perhaps a few more big rate hikes (3 x 500bps) could turn the flow to lira into a rush. But again it’s a rates versus inflation and FX trade off. Higher inflation means people need higher rates to compensate for devaluation risk and it’s a vicious circle still - it can turn virtuous with higher rates.
Gulf financing can buy time and get the team through to local elections on the gradual path then for a step on the accelerator of adjustment. Talk still of the promised $8.5bn in earthquake bonds - hope/necessity they come before local elections.
One key point on Gulf financing which links back to the team and the plan. Gulf financing is no longer a free lunch but UAE, and Saudi now only lend on the assumption a) they get their money back; b) earn a decent investment return. Hence they are looking for bankable projects but to ensure the latter they demand good, orthodox macro policies - prudent fiscal and monetary policies and a competitive exchange rate. That helps Simsek sell them and their plan back to Erdogan. And I think Gulf advice, with financing pledges but fewer ESG tags/lecturing attached will better resonate in the Presidential palace.
In summary, encouraging signs for sure. Systemic crisis avoided for the time being and if the current course is maintained likely Turkey can put such risks long behind it. But difficult choices/compromises could ultimately delay recovery and impose higher longer term costs on the economy. Simsek et al would likely argue its “political economy” not just “economy” hence compromises are needed to deliver what is possible.
One final takeaway was a quote from a banker we met who quipped “we voted for the wrong party”, meaning while they might have voted for the opposition, actually the policy mix they have got is more similar to what they expected with the opposition.
This is an excellent summary and agrees well with what I hear and read. Erdogan lost none of his authoritarian instincts but he seems to have relented on the unorthodox economic policies of the past. Authoritianism and rational economics are not incompatible. Finally, you left out Azerbaijan and Armenia conflict and the implications for Turkey. I think they are as significant as the relations with the Gulf states.