Few will envy Turkey’s next central bank president or finance minister. A shake-up in the country’s economic management this weekend that began with the replacement of the governor of the central bank and was followed by the resignation of Berat Albayrak, the finance minister and son-in-law of Prime Minister Recep Tayyip Erdogan, has been welcomed by investors. In response, the Turkish lira rallied on Monday by the most in two years.
The new occupants of these positions, however, will not only have to cope with a currency in crisis and the economic fallout from a pandemic but also the mercurial and authoritarian Mr Erdogan. There is little prospect of an independent monetary policy as long as he is determined to follow unorthodox economic policies.
The prime minister has long railed against what he calls “the interest rate lobby” — a shadowy group of financiers that he believes wish to raise rates solely for their own speculative gain. Mr Erdogan has instead advocated a radical theory that inflation is itself caused by tight monetary policy, in opposition to the orthodox line among economists that raising interest rates would be the appropriate way to combat Turkey’s chronically high inflation. Mr Erdogan sacked the previous central bank governor in 2019 as he “wouldn’t follow instructions”.
Mr Erdogan’s embrace of these economic theories partly reflects his increasing short-termism in the face of constant elections. Turkey’s economic growth since the 2008 financial crisis has partly depended on a construction boom supported by “hot money” as rich-country investors searched for yield. More long-term foreign direct investment to finance its current account deficit has been scared off by creeping authoritarianism.
The policy mix has left Turkey vulnerable. The hit to the country’s tourist sector — a crucial source of foreign currency — from the pandemic as well as a reversal in capital flows has contributed to a steep fall in the lira. Despite the rally on Monday, the currency has fallen against the dollar by about a quarter since the start of the year.
Mr Erdogan’s ambitions to restore Turkey to what he sees as its rightful place as a dominant regional power have not helped. Its gas exploration activities in Greek and Cypriot territorial waters, and earlier threats to unleash another migrant wave into Europe, have severely strained relations with the EU, by far its biggest market. Like Russia, it has become disruptive but it lacks the oil and gas riches and disciplined macroeconomic policy.
Investors hope the resignation of the finance minister Mr Albayrak and the appointment of a longtime critic of his policies to the position of central bank governor is an admission of defeat by Mr Erdogan. Attempts to shore up the value of the lira while keeping rates low have burnt through most of the central bank’s reserves and have done little to stop the fall. Only a return to more orthodox policy, raising interest rates and cutting back on spending, will restore faith in Turkey’s currency.
Eventually Turkey’s long-term prosperity will depend on attracting back FDI and further integration with the EU’s customs union. For the moment, however, the most important requirement for the next central bank governor and finance minister is providing competent economic management. That will be a struggle working alongside Mr Erdogan. Investors should be sceptical that the latest shake-up represents a fundamental change in policy. But for Turkey’s sake, as much as their own, they should hope it really does.