Focusing on the dynamics behind price, exchange rate, CDS, current account (CA), interest rate volatilities; rising income inequality, huge interest payments and means to resolve these nominal volatilities.

The DS version:

https://www.dailysabah.com/opinion/op-ed/further-strengthening-of-the-turkish-economy

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Original text (with links):

Just to recapitulate an essential point here: Although the real economic outlook is not dire, indeed, nominal variables are rather challenging in Türkiye. More specifically, unemployment, growth rate, industrial production, export and even fiscal budget balances are usually positive.

Monetary and financial figures, on the other hand, are still noticeable poor issues to contemplate. Hence, the post-election policies had better focus on these weaknesses. And this would, of course, include inflation, exchange-rate, credit default swap (CDS), current-account (CA) deficit, interest rates and other nominal macro-financial figures.

Key weaknesses

Therefore, financial, monetary and nominal variables have recently been rather tedious in Türkiye. They are the key issues the country could excel more in. In particular the chronic CA deficit, inflation, exchange-rate volatility, financial stability (as in rising household debts, exchange-rate instability and the CA deficit) or the worrisome financial issues in general have been problematic.

On the other hand, the targets (as in low CA deficit, low interest rate and higher exports) are correct, in essence. President Erdoğan has indeed always had a very clear stance against high interest rates, for example. However, the problem was probably practice or inception. More specifically, institutions-wise implementation process was not that clear. The central bank and the Ministry of Finance (for instance) might not have been ready enough for the policies they implemented.

Although these vast financial volatilities are not a critical issue only in Türkiye, they are relatively higher at home. After all, inflation has also reached 40-year highs in the US, the UK and even Canada. It further reached 30-year highs in Europe and 28-year highs in Türkiye. Yet, it was at over 85% in Türkiye. Huge exchange-rate volatility stood at over 100%, especially in 2021.

Moreover, Türkiye has opted for growth and more employment, at the cost of higher inflation. It has preferred inflation to the recession. That is, despite the rising inflation, growth and rising employment were preferred. Expansionary monetary and fiscal policy, lower interest rates, liquidity and credit abundance were effectively used to increase investment, production, employment and higher demand to keep the economic activity afloat.

CA deficit (at above 50 billion USD) is mostly due to gold imports, energy needs of growing Türkiye, rising energy prices, and also the intermediate good-service imports of a growing economy. High CA deficit leaves Türkiye exposed to international price movements, the pass-through effect over the exchange rate movements. The CA deficit (and external finance needs) should thus be resolved and not left out as a structural issue.

The decreasing labor share of national income (down from 36,5% to 26,5%) in the past 6 years is another critical issue to bear in mind. A new course of price stability, growth, rising wages and social policies are required to solve this issue. Yet, it is still much better than the mid-1990s. The post 2001 period has been a gradual improvement era, except the past few years. Minimum wage hikes, especially in the past 1 year, are a good head start.

Huge interest payments, at over a few hundred billion TL (311 billion TL in 2022, and 566 billion TL expt. for 2023) are also worthy of notice. They are mostly due to global contractionary monetary, financial and credit crunch conjuncture. Rising domestic savings, liralization strategies and decreasing the external finance needs are therefore fateful.

That is indeed why Türkiye is rightly targeting domestic production, savings (including its exchange-rate protected accounts, gold accounts etc.), even higher reserves, and encouraging TL deposits and savings. However, for that to succeed, less price volatility, less uncertainty and reasonable real interest rates are needed. Creating new employment opportunities is also critical.

High inflation and rising living costs decreases purchasing power and the real economic value of income and savings. It further increases uncertainties, disproportionally affects the rich and the poor, and leads to falling real wages and improper pricing mechanisms.

Persistent high inflation

Türkiye has opted for growth and more employment, at the cost of higher inflation, especially in 2022. It has preferred inflation to the recession, as underlined earlier. But, the high and volatile inflation rate is a global phenomenon as well. And high global inflation figures also mean changing expectations regarding the prices in Türkiye and the direct impact on local prices over the trade relations.

External factors including the inflationary trends in the West should, thus, be taken into consideration. The sources and dynamics (fundamentals) of the inflationary trends are as crucial. International factors such as the pandemic related supply and demand imbalances, commodity price volatility, broken supply chains, chip shortage, slowdown in global growth engine (China), energy and food crisis have all surely led to this global inflationary trend.

A critical question at this point is if the inflation we face in Türkiye, nowadays, is a demand-driven or rather supply-driven inflation (due to the cost of production). Energy and food prices, other real shocks such as the broken supply chains and slowdown in China have all surely led to negative supply-side impacts. Therefore, more structural challenges (the same as that in imports and CA deficit dynamics) exist here.

Inflation (and exchange rate volatility) is hence mainly a global problem, to begin with. But why is it particularly awful in Türkiye? More specifically, all world economies faced the inflation problem, and the US dollar was rising against almost all currencies. However, these volatilities were much higher in Türkiye. Türkiye had additional internal dynamics.

In addition to all other post pandemic, supply-chain related issues, food and energy price surges, and even the unprecedented QE policies, Türkiye had its own issues. More specifically, in Türkiye, continuous cycles of higher inflation expectations (just as in the self-fulfilling prophecy), exchange rate volatilities, relatively huge demand (due to the young population, external demand and migration waves), but most essentially insufficient supply were all top-line issues.

Relatively strong demand is another significant issue, as supply is not fulfilling the needs of this excessive demand. Weak supply leads to domestic supply shortages. However, the Turkish inflation overall is more due to the former supply shocks or the cost related external factors such as energy prices, broken supply chains and food prices, as well as the exchange-rate movements. The same goes for the exchange-rate volatility as well, indeed.

Exchange-rate volatility

Most of the above-mentioned factors are true for external inflation, the exchange-rate volatility, as well. Of course, part of the reason was rising USD, against almost everything else (especially in 2022). But other internal factors should also be considered. For instance, policy-makers were not able to manage expectations, the negative perceptions or deal with the financial speculation or manipulations.

Global financial risk factors are, again, the first thing to take into account here. Monetary policy divergence across the globe (both between the emerging-markets and the developing-economies, and also amongst the developing-economies), strong US dollar (the dollar index was at its 20-year highs) were all major issues.

Meanwhile, pandemic related supply and demand imbalances, and the related external finance needs, energy and food price surges, the war in Ukraine have all altered the global risk perceptions. All these factors were affecting relatively more fragile economies (in terms of exposure to speculative attacks, manipulative actions, and financial shocks), and those that need external finances the most.

That being so, energy imports (CA deficits) are the main weakness or shortfall of the Turkish economy. But Türkiye has also focused on extensive gold imports and the rising intermediary good needs of growing Turkish economy. Other pitfalls included rising chip, other critical imports and the rising cost of these imports.

This trend of rising prices (of the post-pandemic era in particular), in general, has even turned into a self-fulfilling prophecy. But, unfortunately, part of it is also sometimes overshooting and undershooting. After all, financial markets are notorious for their overshooting and undershooting behavior in the face of unexpected negative information.

The political pressure, speculative and manipulative reports, internal notes or comments from local and leading international financial intermediaries have all caused a cyclical volatility. Part of the story is also (hence) cyclical, speculative, political process and direct external influence. The experiences Türkiye went through in 2018 are a good case study at this point.

CA deficit and external finance needs also lead to fragility. Uncertainties (policy-wise, political and financial) have been higher. Unconventional or unorthodox policies (implemented starting in late 2021) were not communicated very well. There was too much uncertainty and concern in the markets.

Election manifesto

The problem in Türkiye, overall, seems rather to be about communication, signals and the expectations management. Communication of the new heterodox policies was a critical issue. Most importantly management of these expectations has been a challenge. Hence, it should probably be more prioritized. CA deficit and external finance needs are another huge upward pressure here. The rising prices has even turned into a self-fulfilling prophecy.

Meanwhile, a more just and inclusive development should also be ensured. Industrial and structural transformation, energy and infrastructure investments, defense and manufacturing advances, chip production, national electric vehicle, housing sector initiatives, and falling commodity dependence are all helping Türkiye transform into a more stable economy. They will also help increase economic independence.

Decreasing external dependence, on the other hand, will help increase resilience to external shocks, as well. Meanwhile, the costs, so far (due to a new economy model and accruing costs of the unconventional stance), should also not be in vain. The policies so far should pay off from now on. Ak Party’s new term economic policy measures and the election manifesto also seems to be based upon the new model, better known as Türkiye Economy Model (TEM), and a vision to expand beyond the current trade and economic connections.

Accordingly, policymakers also aim to increase production, investment, employment and exports via lower interest-rates. With the help of these types of (mostly) supply-side policies, Türkiye aims to bring down (better, even topsy-turvy) the chronic CA deficit and decrease inflation to single digits again.

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