Photo by Omid Armin on Unsplash

Freshly re-elected Turkish President Recep Tayyip Erdoğan appointed a new finance minister, Mehmet Şimşek, on Saturday. Şimşek began his tenure with a promise to return the nation to “rational” policies, following years of unorthodox monetary and fiscal moves which have served to crush the lira, the currency shedding two thirds of its value in less than three years. 

Thus far, the market is not buying the claim. The lira (USD/TRY) hit an all-time low last week off the back of Erdoğan’s win, and has fallen further despite Şimşek’s promise. It now takes 21.45 liras to purchase one dollar – a further 6% fall from before his appointment. 

What are Turkey’s policies?

Şimşek has plenty to change if he is to stick to his promise of instilling “rational” policy. Around the world, central banks have been raising rates over the last 16 months to combat a global inflation crisis that has sprung up. Turkey, however, has bucked the trend. Under Erdoğan’s previous regime, the president and Şimşek’s predecessor, Nureddin Nebati, had been cutting interest rates. The below chart contrasts the approach with the Federal Reserve in the US. 

Against this backdrop, Şimşek has sworn to flip Turkey’s approach. “Transparency, consistency, predictability, and compliance with international norms will be our basic principles in achieving the goal of raising social welfare,” he said on Sunday as formally took the role. 

 

Turkey has no choice but to return to a rational basis. We will prioritise macro financial stability.

Mehmet Şimşek

The unconventional policy comes despite Turkey suffering from a particularly acute inflation problem, even by the standards seen internationally over the last year. The most recent number has inflation running at 43%, and as high as 85% in October. 

A few days prior to Şimşek’s appointment, Erdoğan was defiant that inflation could be beaten, although made no reference to rates tightening. If anything, he hinted at the opposite, saying last Monday that the central bank interest rate “has now been reduced to 8.5% and you’ll see inflation continue to fall”. He further swore that, in relation the battle to tame inflation, “if anyone can do this, I can do it”, 

Şimşek previously served as finance minister before leaving government in 2018. Since then, the lira is down 77% and the crisis has mushroomed. For lack of a better expression, the gig appears to be up in Turkey, with the piper coming home to be paid. The Financial Times reported that Erdoğan had reduced foreign currency and gold reserves by $17 billion in the six weeks running up to the general election, a decline of 15%. That $17 billion is split between a $9.5 billion drawdown of foreign currency and $7.5 billion of gold (Turkey held 572 tonnes of gold at the start of the year). Updated numbers put the decline in total reserves at around $27 billion, constituting a fall of 24%. 

Turkey’s government finances are under pressure

Obviously, this cannot continue indefinitely, something Şimşek evidently realises. While capital controls have been introduced to restrict foreign currency access for citizens, as well as the suspension of gold imports following the earthquake in February when retail demand jumped, the scale of the outflow of government reserves is too large. 

The issues are exacerbated by the existence of special savings accounts, which pay out a greater interest rate if the lira depreciates, the idea being to encourage citizens to hold lira (they were part of a wider project under Nebati, known as “lira-isation”, to bolster lira demand). These accounts have thus far cost the government $4.7 billion, according to Şimşek’s predecessor Nebati. This further heightens the risk of a depreciating lira, as government finances are tethered to the currency, given they must make up the shortfall if the lira falls. 

What next for the lira?

So, with all this weakening and concern, what next for the lira? Are Şimşek’s promises of a new monetary regime a sign that the lira’s great decline could be about to slow? 

“Reducing inflation to single digits in the medium term . . . and accelerating the structural transformation that will reduce the current account deficit are of vital importance for our country,” Şimşek went on to say on Sunday. 

If listening to him, one one would be tempted to conclude that the lira may in fact finally see some respite. The only issue is, the president remains Recep Tayyip Erdoğan, a man who is notoriously stubborn and has never allowed the central bank much autonomy. Nor has he allowed his finance ministers to operate freely – Şimşek left his prior role as deputy prime minister in 2018 when Erdoğan appointed his son-in-law, Berat Albayrak, as finance minister. 

So while Şimşek may be talking the talk that foreign investors – and Turkish nationals – will want to hear, whether it results in action remains to be seen. They say the market never lies, after all, and the lira did nothing but fall further in the aftermath of Şimşek’s comments. 

Erdoğan has hardly been shy about his unwavering faith in low interest rates. “Please do follow me in the aftermath of the elections, and you will see that inflation will be going down along with interest rates,” he told CNN ahead of the election in May. Pushed further on whether that meant there would be no change in economic policy, he replied emphatically, “Yes. Absolutely.”

That sums up the problem. If Turkey were trying its best to reverse this crisis, as Şimşek promises it will, it would be a tough order. But Erdoğan’s presence and determination to pursue loose policy turns what is already a challenging job nearly impossible. That makes something else also impossible to formulate: a convincing argument to buy the lira right now.  

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