More pressure on Erdogan as Turkey’s economy deteriorates

A major factor in pushing Turkish President Erdogan’s government towards rapprochement with Russia rarely gets discussed.  This is the rapidly deteriorating state of the Turkish economy.

At a superficial level this deterioration is reflected in the performance of Turkey’s currency, the lira.  It lost 17% of its value in 2016, and a further 12% of its value in January of this year.

The underlying problem is that under President Erdogan the key driver of the Turkish economy’s rapid growth has been high capital inflow masking high deficits in the budget and the current account.  Much of this capital inflow has gone into funding a construction boom and high consumer spending, which whilst it has provided Turkey with high growth rates has left it with limited leeway if he capital inflow stops or reverses.

This is precisely what is now happening as the Turkish economy is battered by a loss of confidence caused the rising security crisis, the fallout from the July coup, and growing external pressure with the rises in interest rates in the US.

The situation urgently calls for an increase in Turkish interest rates to strengthen the lira and to avoid a further run down of Turkey’s dwindling reserves.  However President Erdogan – mindful of the heavy burden of debt carried by Turkish companies and committed to a policy of growth at any cost – is resisting this, and following the collapse in authority of Turkey’s institutions following the July coup attempt the Turkish Central Bank is in no position to stand up to him.  The result is that interest rates are failing to rise as quickly as they should, making the position of the economy worse.

Latest figures show that the Turkish economy contracted by 1.6% in the final quarter of 2016, whilst as a result of the lira’s deprecation inflation has risen above an annualised rate of 8% and is probably still rising.  With no obvious relief for the economy head there is a serious risk of a severe fall into recession and even of a crash.

Given the politically fragile situation in Turkey, it is not surprising in the circumstances if President Erdogan is unwilling to cross Russia, which is rapidly emerging as Turkey’s key trading partner and major energy supplier.  With Erdogan’s reputation closely linked to the economic boom Turkey has experienced in the decade of his rule, the last thing he needs is a rift with Russia that can only make Turkey’s already precarious economic situation worse.