Jonathan Spicer and Orhan Coskun by Nevzat devranoglu

ANKARA (Reuters), – Turkey’s President Tayyip Erdoan believes that a sudden interest rate reduction will boost the economy in Turkey ahead of election. However, hot inflation and a lira sale are likely to stall economic growth.

According to Reuters, sources close to Erdogan’s presidency said that Erdogan pressed the central bank publicly and privately for several months to provide the monetary stimulus to increase lending, employment and exports despite soaring inflation.

On Sept. 23, the bank delivered, unexpectedly lowering its policy rate https://tmsnrt.rs/3CJiJXv by 100 basis points to 18% – sending the lira currency to all-time lows.

Investors dumped Turkish bonds and said the move marked the latest blow https://www.reuters.com/business/turkish-central-bank-surprises-with-rate-cut-sought-by-erdogan-2021-09-23 to the central bank’s tattered credibility, given inflation had jumped above 19% amid global price pressures that leave emerging markets like Turkey uniquely vulnerable.

According to data released Monday, September saw a 19.6% increase in consumer prices over the same month in 2017. This is the greatest rate of growth in 2 1/2 years.

Interviews with Turkish economists revealed that the rate reduction was a serious error and would lead to economic hardship for Turks ahead of mid-2023 elections.

Refet Gurkaynak in Ankara, who is the chair of Bilkent University’s Economics department said that “the sense of gloom and the exchange rate are exposing how economic governance is corrupt.”

Erdogan, who is currently sliding in opinion polls, had become impatient for a cut to the rate after installing a new chief central bank officer earlier this year. He was also surprised by how much inflation has risen, according two Turkish officials.

However, a close aide to the President said that the rate cuts were worth the risk and the inevitable criticisms.

    “This decision was necessary to increase exports, to generate employment and to open the way for new investments,” the person said, requesting anonymity. While there are possible negative side effects, the decision had to be made… in order to realize these benefits.

President’s Office did not comment immediately on whether or not it had pushed for the rate reduction and why. Erdogan’s pressure was not a topic that the central bank addressed.

Erdogan is a self-described enemy to interest rates and said that on Friday inflation would drop to the single digits. However, he didn’t address the issue of the interest rate cuts.

The government of Erdogan has accused supermarkets of unfair practices. However, Erdogan pledged to open new 1,000 markets throughout the country on Sunday to ensure “suitable prices” for goods.

FALSE ASSUMPTIONS

According to the central bank, easing is needed because inflation is temporary and core measures have dipped and lending has suffered six months after the policy rate was held at 19% for the longest time – the most high in the world.

Turkey’s relative low foreign reserves, imports heavy and an “real” inflation adjusted interest rate that is becoming less negative all raise concerns about the currency. To make matters worse, inflation is driven higher by lira decline.

This, along with the high level of foreign debt companies have, makes it difficult for exports to benefit from rates cuts. Private banks, however, would prefer shrinking credit than expanding credit again according Gurkaynak (an ex-economist at U.S. Federal Reserve Board).

“If policy changes are based on false beliefs that they will improve economic activity, then there are false assumptions,” said he.

Selva Demiralp is the director of Koc University-TUSIAD Economic Research Forum. He said that Turkey’s current “trial-and-error” approach to economic research was reckless considering the Fed and other central banks moving to tighten their policy to stop inflation. This includes the recent shock to the energy-price.

She said that the rest of the globe correctly analyzed the Fed’s guidance, but the decision would cause severe economic damage in Turkey.

The Fed has pulled cash from Turkey in the past as a result of tightening its policy.

The yields on benchmark debt rose after the rate reduction, indicating little confidence that the central banks can reduce inflation. However, traders anticipate more cuts to the money market before the policy rates return to 18%-18.5% within a year.

SLIDING POOLS

In five years after the 2018 currency crisis, and subsequent smaller selling events, the Turkish lira fell two-thirds in value. It has also been reducing the income of Turks who faced high inflation most of those five-years.

Erdogan’s conservative AK Party has ruled over Turkey for 19 year on a track record of high economic growth, household wealth and stability.

But that reputation has somewhat rusted https://www.reuters.com/world/middle-east/when-erdogans-turkish-economic-miracle-began-failing-2021-07-15.

According to polls, the party is now 31%-33% popular. This compares with 42.6% support in 2018. The party’s alliance with the MHP, a nationalist group, has also declined. This suggests Erdogan could lose control over parliament during a vote.

Erdogan is now a dominant figure at the central banking after it fired three of its governors for policy differences. In June, Erdogan escalated the tension when he claimed he talked to Sahap Kavioglu about the need to cut the rate after August.

Reuters, citing participants, reported that Kavcioglu started giving dovish signals to investors on September 1st, even though inflation rose to 19.25% last August. In a speech on September 8, he reiterated that statement, citing participants.

According to another source, Erdogan was informed that the cut would be made in July or august. According to another source, Erdogan had a “serious expectation” that the rates would be reduced even though it wasn’t.

Erinc Yeldan is the acting dean for Bilkent’s economics faculty. He stated that the AK Party wants to create a new story of economic growth “whatever it costs” before the elections.

He said, “It is evident that the outcome of these efforts would be even more instability and an ever-deepening forex crise.”