Turkey elections: Erdogan has a chance to solve the lira crisis, but will he take it?

Turkey’s presidential contest has ended with the re-election of Recep Tayyip Erdogan, who will lead the country for another five years.

In light of this outcome, it is worth considering how the Turkish economy will be impacted. Will there be a shift in Erdogan's economic policy, or will he stick with his unorthodox monetary policy to treat chronic inflation and the continuous plummeting of the Turkish lira?

Erdogan's economic inclinations and policies have traditionally relied on unconventional tenets, primarily within the domain of monetary policy. Consequently, this has led to the resignation or dismissal of several governors of the Central Bank of Turkey in recent years.

In general, the Turkish economy is considered robust, maintaining a high growth rate and edging closer to joining the trillion-dollar club, with GDP currently at around $900bn. On the individual level, median per-capita income is healthy, according to the World Bank, surpassing $10,000.

However, even with the upward trajectory of GDP, the Turkish economy faces various problems, with extremely high inflation not corrected by a substantial devaluation of the Turkish lira against major currencies.

Erdogan believes that the depreciation of the lira serves as a mechanism to bolster Turkish exports, with importing nations taking advantage. This is theoretically right - but with limits.

Here it is useful to recall the currency wars between the United States and Japan in the 1990s and the ongoing dispute between the US and China due to Beijing's refusal to increase the value of its currency due to supply and demand factors.

Record inflation

However, there are internationally accepted limits to currency exchange rate fluctuations, and what is happening with the Turkish lira is not within this category. The exchange rate of the lira against the US dollar has declined by more than 70 percent since the beginning of 2019.

This was accompanied by a record inflation rate, which reached its peak at the end of 2022 at 85 percent. Currently, it stands at around 44 percent, which is very high according to international economic norms. The economy should ideally have an annual inflation rate of only 2-2.5 percent, although in most countries this rate is exceeded.

Foreign investors would be expected to flood into Turkey, bringing major currencies that will help raise and stabilise the value of the Turkish lira

Traditional monetary policy relies primarily on raising interest rates to address inflation. This is a strategy industrialised countries have been adopting for over a year in order to deal with their high rates, which have exceeded nine percent in the United Kingdom and the US.

However, the central banks of these industrialised countries have been sequentially raising interest rates for more than a year. The US Federal Reserve has raised interest rates approximately 11 times over the period, because raising interest rates traditionally increases savings and, at the same time, restrains spending and reduces investment.

Therefore, Erdogan fears the application of traditional monetary policy. The economic goals of his administration, as stated in his election campaign, consist primarily of increasing the country's GDP to $1.5tn during his next presidential term - chiefly by increasing foreign trade to $1tn, and also by increasing tourism income, an essential component of the Turkish economy, to $100bn.

As for inflation, Erdogan aims to hit single digits. As such, western experts and major global banks expect the continuous decline of the lira exchange rate, especially in the short term.

Optimists, especially in the investment sector in the West, believe that the trading atmosphere might improve and are preparing to enter the Turkish market. Their optimism stems from the fact that Erdogan has begun to lean towards adopting traditional monetary policy, even if only partially.

Highly respected

Erdogan has already held more than one meeting with Mehmet Simsek, economic expert and former finance minister in the Justice and Development Party governments, to try to convince him to join the team, pledging to hand over the state's economic file.

Although Simsek rejected Erdogan's offer, due to his many other international commitments, he expressed his readiness to cooperate with the government on the economy.

Simsek has worked extensively in the West. Early in his career, he joined the US embassy in Ankara as an economic adviser, before moving to New York to work for the Swiss banking group UBS.

He has also worked in Deutsche Bank AG, in Istanbul. However, his most important position was serving as managing director for the International Monetary Fund and the World Bank in Turkey.

Simsek is highly respected in the West, both by governments and investors.

If he were to be entrusted with Turkey's economic portfolio, it is expected that monetary policy would change. Accordingly, Simsek would likely raise interest rates - but not excessively, as happened in the US, in order to avoid causing a recession.

Turkey elections: Has the country reached an economic breaking point?

Lire

Raising interest rates can reduce high inflation, and it is possible that the president's single-digit goal within the next five years could be achieved.

Also, due to the strong trust in Simsek among the international financial community, foreign investors would be expected to flood into Turkey, bringing major currencies that will help raise and stabilise the value of the Turkish lira.

So, there is plenty to be optimistic about regarding the Turkish economy, but much depends on the willingness of Erdogan to adopt Simsek's financial prescriptions.

If Erdogan continues on his current course, it will be difficult to solve the problem of inflation and the lira in the short term, except through cooperation and project agreements at government level.

The president reportedly has plans to reduce disputes with global and regional powers, and there have already been signs of that, culminating in the Saudis depositing $5bn into the Turkish central bank.

Such an influx of currency could greatly help in solving the lira problem.

The views expressed in this article belong to the author and do not necessarily reflect the editorial policy of Middle East Eye.