Is Erdogan ready to run Turkey’s economy too?

The Turkish president is meddling in the central bank for short term political gains, writes Joseph Dana.

The Ottoman era Dolmabahce Palace was the scene of a standoff between president Erdogan and the central bank governor. Murad Sezer / Reuters
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Monetary policy has always been fertile ground for political manipulation. While many countries try to maintain a strict separation between political calculations and central banks, several in emerging markets fail to strike the right balance.

In Turkey, Recep Tayyip Erdogan’s Justice and Development Party (AKP) rose to power on a platform of social conservatism and neoliberal economic aggressiveness. His party was able to kick-start the Turkish economy at a time when most countries were in the throes of the global financial crisis.

Having survived every political challenger who has arisen, Mr Erdogan’s grip on power appears unshakable. But it was the Turkish central bank that arose as an unlikely check on his power.

Now that the bank’s influence and independence has all but evaporated, its experience is instructive for other similar economies grappling with issues of unchecked political power and monetary policy.

Under the AKP, Turkey took advantage of historically low interest rates in the United States to borrow large amounts of cheap money. Capital was invested in mega-infrastructure projects such as the tunnel connecting the Asian and European continents in Istanbul. Turkish Airlines, the national carrier, went from a small regional airline to the world’s most connected thanks to rapid expansion into Africa and Central Asia spurred by heavy government investment.

As with similar emerging market economies, Turkey ran a high current account deficit during this period of growth, and a majority of Turks facilitated their consumerist lifestyle primarily on debt. But then the American economy started to get stronger and the era of cheap money seemed to be coming to a close.

Turkey’s former central bank governor Erdem Basci, whose term ended this month, took on most of the burden when the US federal reserve decided to scale back monetary stimulus and raise interest rates last year.

Mr Basci responded by raising borrowing costs to stabilise the Turkish lira and rein in inflation as part of a multi-interest rate policy that the former governor designed. Benchmark interest rates remained high to safeguard the Turkish lira but the method deeply angered Mr Erdogan. He eventually suggested that the governor was a traitor for not cutting rates more aggressively.

Mr Basci was reportedly called to private meetings with Mr Erdogan at Istanbul’s Dolmabahce Palace in which the president informed the central bank chief that interest rates must be cut. Such a meeting would be unthinkable in many advanced economies because of the appearance of undermining the independence of the central bank.

For Mr Erdogan, a consummate politician in the middle of a historic reformulation of power in Turkey, raising interest rates would be felt by the majority of the country’s citizens whose lives were consumed by debt. And that proved unacceptable in an election year.

By nearly all accounts outside Turkey, raising interest rates was a prudent and unavoidable measure to safeguard the overall health of the economy and protect the Turkish lira. But Mr Erdogan was vehemently opposed. Mr Basci found himself in an impossible situation: Mr Erdogan accused him of halting economic expansion by keeping rates high, while foreign investors, who own nearly $82 billion (Dh 302bn) in Turkish stocks and bonds, said the governor was losing control over inflation.

Underneath this battle for economic policy was a fight over the independence of the central bank. And Mr Basci ultimately lost. Murat Cetinkaya, the former deputy governor, took over the central bank last week. At the first opportunity, Mr Cetinkaya cut Turkey’s overnight lending rate to 10 per cent from 10.5 per cent.

According to many analysts in Turkey and unnamed officials inside the central bank, the new governor lacks the backbone to stand up to Ankara. There are several other factors that could bolster Mr Erdogan’s plans for short-term economic recovery. The US will advance interest rate hikes slower than expected, the lira is performing better against the dollar, and March inflation was down to 7.5 per cent.

Moreover, investors are encouraged that Mr Cetinkaya avoided cutting rates by as much as Ankara was demanding. But uncertainty about the central bank’s independence casts a shadow on Turkey’s long-term economic health.

Mr Erdogan is free to continue running virtually all aspects of the country with little oversight. As we have seen in South Africa and other emerging markets, the economy needs a respectable measure of freedom from political influence to meet the challenges of the global marketplace.

While Mr Erdogan will get his way when it comes to short-term economic dividends translating into votes, he is probably creating long-term economic obstacles for his country.

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