Turkey’s elections could be defined as setting the course of the country in terms of its political model (democracy versus autocracy), economic outlook (stop-go cycles versus more stable development), and geopolitical orientation (East versus West).

On the economy, Recep Tayyip Erdoğan’s more than 20 years in office presents a very mixed report card. 

The first decade was characterized by high growth, lower inflation, a stable and indeed strong lira, productivity improvements, rising living standards, reduced poverty and close to 700,000 jobs created a year, record inward investment and rating upgrades to investment grade status. 

The second decade was marked by stop-go economic cycles, high double digit inflation, an almost constantly depreciating lira — to the point that it lost close to 90% of its value in the decade to 2022 — the exit of foreign investors and net foreign direct investment (FDI) dropping to a fraction of the prior peak, stagnant productivity growth and declining living standards with increased inequality.

Why the difference?

Primarily the loss of checks and balances on President Erdoğan. 

The first decade Turkey was anchored, initially at least, by an IMF program, the expectation of European Union (EU) accession, and — until 2011 at least — a fully independent central bank. The ruling AKP’s economic policy was in this period the result of a broader consensus, with orthodox reform policymakers such as former President Abdullah Gül, and former deputy prime minister, Ali Babacan, still having considerable sway. After 2011 though, there was a steady move to concentrate power around Erdoğan and the side-lining, and eventual departure from government, of the likes of Gül, Babacan, and many more who had previously moderated his economic excesses.

Unchained by the departures, Erdoğan now controls economic policy settings, with his unorthodox approach to monetary policies dominating. Turkey’s president believes that high-interest rates cause inflation. So, over the past decad, he has endeavored to keep them low — indeed rates are now massively negative in real terms. This has in effect overstimulated demand, with growth prioritized over fighting inflation. The value of the lira has been debased and Turkey has been in an almost perennial balance of payments crisis.

Get the Latest
Sign up to receive regular emails and stay informed about CEPA's work.

Turks see little value in the lira and have sought the shelter of foreign currency, which has been in short supply. To anchor the currency, Erdoğan has begged abroad for loans from autocratic powers in the Gulf and Russia. This has plugged gaps, but left the central bank, with a large negative international reserve of close to $60bn. This causes doubts about the solvency of the central bank itself, with fears there may be a wholesale loss of confidence not only in the lira but the country’s banks. This anyway is the risk if the current policy mix continues. 

If 69-year-old Erdoğan wins in May (assuming his health holds up after an April 25 scare on live television), he will likely be soon tested, with accelerated capital flight, perhaps accentuated by the threats of Western sanctions unless some resolution can be reached around issues such as Sweden’s stalled NATO membership bid. Unless he can find more dollars offshore — from his friends in Russia or the Gulf — he will have to either hike policy rates, devalue the lira again and risk yet more inflation, impose capital controls and perhaps even go to the IMF. His aversion to rate hikes limits his options. 

An opposition win promises a return to economic orthodoxy and would offer hope of avoiding a more systemic crisis. The opposition has promised a clear-out of political appointees at the central bank and other government economic departments and a return to meritocratic appointments. The independence of the central bank will be restored. Monetary policy will return to orthodoxy, with strong hints that policy rates will have to increase very substantially from the current single-digit level to perhaps as much as 40%. 

The adjustment will be painful, even with the opposition assuming power, as economic distortions across the system are very significant. 

There are, for example, concerns around the balance sheets of state-owned banks which may have been forced to lend to politically related projects or borrowers. 

And the necessary higher interest rates to bite off inflation will mean a period of lower growth for the Turkish economy which will likely impose costs on the budget, with lower nominal GDP growth, higher budget deficits resulting, and also on the banking sector with likely an upturn in non-performing loans. 

But ultimately, the longer-term gain will be lower inflation, higher and more sustainable growth, and improved productivity throughout the economy, delivering jobs and improved living standards, with higher investment and hopefully relative lira stability, or at least a domestic currency that has value.

Timothy Ash is a Senior Emerging Markets Sovereign Strategist at RBC BlueBay Asset Management. He is an Associate Fellow at Chatham House on their Russia and Eurasian program.   

The opinions in this article are those of the author.  

Europe’s Edge is CEPA’s online journal covering critical topics on the foreign policy docket across Europe and North America. All opinions are those of the author and do not necessarily represent the position or views of the institutions they represent or the Center for European Policy Analysis.

Europe's Edge
CEPA’s online journal covering critical topics on the foreign policy docket across Europe and North America.
Read More