Turkey - you got to have faith

Interesting piece by Ragip Soylu in Middle East Eye.

https://www.middleeasteye.net/news/erdogan-reveals-he-didnt-change-his-mind-interest-rates

Obviously some people might freak out by this, taking this as a warning that Erdogan might flip back to the unorthodox view on policy rates, firing Simsek.

Actually I don’t view it that way as it was always clear to me that Erdogan had not changed his view on policy rates when he hired Simsek back in mid 2023 to carry out a policy 180 degree turn to begin hiking policy rates.

Important here to understand where Erdogan gets those long held views that high policy rates cause inflation and the inversion to interest rates as a policy tool.

First, it’s a faith based view, that in Islam usury is fundamentally wrong. Nothing wrong with that, entirely understandable.

Second, it’s a small shopkeepers view and AKP is still a party of small shop keepers. Herein interest rates are seen as a cost of doing business. Lower interest rates reduce costs and in Erdogan’s thinking this can be passed on to consumers in lower prices.

Third, its recognition that in the past low interest rates have been an election winner. Low rates fuel credit growth, employment growth and this has generated votes for the AKP. At least up to the last elections.

So if Erdogan’s views were so strongly held, why the move to hire Simsek, allow the policy 180, and is Simsek still safe?

Well the change of tack in 2023 I think was driven first by Erdogan’s increasing reliance/confidence in a new, younger group of trusted advisers who were more technocratic in outlook. Their message to Erdogan was that the low interest rate policies simply were not working and would have resulted in systemic crisis in H223 if they had been continued. And ultimately that would have resulted in election defeat. That ultimately was the message given at the March 2024 local elections - that the population cared more about inflation than say credit growth/jobs. Inflation hurts everyone in society, whereas whether real GDP growth is 3% or 4% impacts a smaller subset of society those in/out of jobs. The point I think was also made that the prior low rate policy was deeply unfair and some were exploiting it - some were getting rich by borrowing cheaply in lira (those with access to cheap credit) then buying FX. But for the bulk of the population without access to such channels they were being devastated by inflation.

Herein I think Erdogan was getting a near consistent message from his own closest circle of advisers, Simsek et al, plus business in mid 2023 - and still is - that the country needs an orthodox approach to tackle inflation.

Second, as ever, Erdogan showed his pragmatic side. He has done it many times. Despite his own long held views I think he accepted the overwhelming message from those around him, and the political reality.

Third, not sure it was the starting point for the turn in policy in mid 2023, but I think it has helped sustain the change. But around mid 2023 the Erdogan administration began a reach out to the Gulf for financial support. And note there the change in Gulf financial support to struggling friends whether it is in Bahrain, Oman, Tunisia, Pakistan, Egypt or Turkey - we give support but our money is an investment and we want to be paid back with a return. We demand good macro policy as the requirement for investment to generate a return. So I think that was the message from the Gulf to Erdogan and team - we will invest but we need policy orthodoxy. And I assume that was a condition of the $51 billion from UAE, and had already been from monies from Qatar and perhaps monies still to come from Saudi Arabia and Kuwait. I think all this helped Simsek in his push for an orthodox policy adjustment and I think still helps anchor him in position.

So is Simsek safe?

Well, never say never.

But the close advisors around Erdogan selling the orthodox policy adjustment have not changed - arguably they have been augmented while the unorthodox crew have lost the president’s ear.

The adjustment is being seen to work now - with the lira stabilising, FX reserves rising, and market confidence rising. The sense of never ending economic crisis around Turkey is dissipating. And we should see high base period effects help inflation begin to moderate over the next few months, albeit still staying in the 30-35% range by year end.

And that Gulf messaging remains.

Erdogan certainly still holds his own personal views but I think accepts the need to delegate on the economy to those who are competent and trusted by the markets. It helps I think that Simsek has a long association with Erdogan - he is loyal - but who I think has also been more than willing to tell truth to power, that the low interest rate course simply was not working.

The concern obviously is that the high interest rate policies, and tightening of policy thru other means (macro prudential and fiscal tightening) are hurting the economy but in the end we know that to fight inflation there has to be a growth trade off - no other options. And the now strong lira is hurting exports. But there is simply no alternative to short term pain for long term gain. And therein Erdogan is the ultimate political operator - he knows he still has 3-4 years until the next elections, and upfront economic adjustment can still deliver lower inflation and potential salvation at the polls. But he just has to stick with Simsek. That’s the hope at least.