Turkey: An Interest Rate Hike Stops the Bleeding — For Now

What Happened

Turkey’s central bank has hiked its benchmark interest rate from 17.75 percent to 24 percent, bringing a measure of relief to markets after the country’s currency crashed over the summer. President Recep Tayyip Erdogan had preceded the lender’s announcement with a speech that slammed interest rates — a frequent bugbear of his — briefly spurring speculation that the bank would not move to arrest the slide of the currency and prevent the potential spread of Turkey’s currency woes to other emerging economies.

Erdogan also issued a decree in the country’s Official Gazette stipulating that transactions for property sale, rental, business and service contracts must be conducted in Turkish lira, rather than in foreign currencies. The decree also forbade signatories from indexing their transactions to foreign currencies, while ordering existing contracts in other currencies to be switched to the lira by Oct. 12.

Both actions came after Erdogan named himself the head of the country’s nascent sovereign wealth fund on Sept. 11, giving himself even more control over the country’s slowing economy.

Why It Matters

The decision to raise interest rates appears to underline the bank’s independence, but Erdogan’s preceding speech denouncing interest will loom over the markets, sowing worry that he will soon exert his already outsized influence on the country’s economy once more. Inflation ran at 17.9 percent in August, but the latest rate hike — while substantial for Turkey, especially under Erdogan — is too limited to counter such a figure. To rein in inflation, the central bank would need to raise the interest rate level to 23-28 percent, but that might be a level too far for the central bank under the current administration.

As part of Turkey’s medium-term economic program, which Finance Minister (and Erdogan son-in-law) Berat Albayrak is scheduled to release this month, officials are expected to give a clearer indication as to how the country intends to escape from its plight of high private debt, slipping currency, high inflation and large current account deficit. The current rate hikes are largely palliative, and markets are watching intently to see if Erdogan and his finance minister will take more comprehensive steps to right the ship.

Background

Erdogan faces a number of challenges going ahead. Turkey’s economy is projected to slow even further as the year ends. It is largely public spending and government-backed construction that accounts for much of the country’s current economic activity. Erdogan’s struggle to stabilize the Turkish economy and preserve his political legitimacy — all while holding steadfast to his firmly held beliefs on issues such as the evils of interest rates — is far from over.

Beyond Turkey’s borders, Erdogan is facing military and diplomatic challenges in Syria, where his army is attempting to hold back a potential assault by Syria’s government on Idlib province, which abuts Turkey’s border. A sustained assault would put Turkish troops in harm’s way and could drive up to 3.5 million refugees into Turkey, straining the country’s economy even further. In the face of such a challenge, Erdogan needs as much political legitimacy at home as possible.

And then there’s the squabble with the United States, where interest groups within the Republican Party continue to lobby President Donald Trump to force Ankara to release pastor Andrew Brunson, who is under arrest on terrorism charges. Trump’s sanctions on Turkey, as well as on its justice and interior ministers, may have been symbolic in dollar amounts, but they have raised more doubts that Turkey can extract itself from its deep economic hole. Against such a backdrop, the central bank’s latest interest rate hikes have stanched the bleeding, but they’re not enough to heal the patient.