Prime Minister Recep Tayyip Erdogan had fingered what he called the "interest lobby” as the culprit behind his political problems arising from the Gezi Park protests and accused domestic and foreign financial institutions of fomenting unrest. But now to cope with the economic problems of the country, he had to allow the Central Bank to increase official interest rates in line with the demands of the financial institutions he had been blaming.
On July 14, Erdogan held a long summit meeting with his ministers involved with the economy. On July 15, when the markets opened, the statement by Erdem Basci, president of the Central bank, revealed the decision taken at the summit. Basci said the interest rate increase will be on the agenda of the Monetary Policy Council, which will meet on July 23. That statement was meant to be perceived by the markets as a sure indication of the upcoming interest-rate increase, and market performance duly improved. Interest rates of treasury bonds that were about to reach double digits eased back by one point, and the parities began to go down while stock shares went up.
In April, Erdogan was unhappy with interest rates that had gone down to about 5%; he wanted an even lower rate. At that time, the exchange rate was 1.75 Turkish lira to the dollar. But because of global developments and the Gezi Park protests in June, interest rates climbed close to double digits and the exchange rate went up to 1.95 Turkish lira to the dollar.
Following the declarations of the US Federal Reserve at the end of May, the outflow of short-term capital from developing countries also affected Turkey, and the markets began to deteriorate. In early June, when global capital movements usually pick up pace, protests at Taksim Square and Gezi Park had begun and rapidly spread across the entire country. The spread of protests accelerated the negative trends in the markets, but how much of this was because of global capital movements and how much of it could be attributed to the protests could not be properly measured. Parallel developments occurred in all developing countries, but Turkey went above the average. In the second week of July, when expectations in global markets were restored and improvements were registered in developing countries, a continuation of negative trends in domestic markets worried the Turkish economic leadership.
Warnings by foreign banks that the Central Bank had to decide on increasing interest rates or else foreign capital outflow would increase caused even more disturbance in the economic echelons of the state. This is why economy managers called on Erdogan to hold an economic summit, because it was time to decide on increasing interests rates, or else increasing worries in the market would cause even more negative consequences. A general statement was made after the summit, but the message that was noticed was the one by Basci on the morning of July 15. The improvements registered after that statement vindicated the economic management of the country.
Market improvement not yet permanent
Whether the positive indicators of the market will continue depends above all on developments in the global markets. Of course, the context of the interest rate increase decision and the ratio of increase will also impact the markets. Market experts say that “foreign fund owners expect at least a one-point increase.
Market experts, contacted by Al-Monitor, say that foreign fund owners expect at least a one-point increase. These experts note that Basci’s reference to a "proportionate” increase wasn’t understood and they say if the ratio is below market expectations than a return to negative trends is likely.
In the meantime, Erdogan's unchanging narrative will continue to affect the markets. Deputy Prime Minister Ali Babacan, who is responsible for economic affairs, says that market negative trends are mostly due to global developments and the Gezi Park protests had a minimal share in them. However, Erdogan persists on accusing local and foreign financial institutions he derides as the "interest lobby." It is obvious that Erdogan's narratives rattle the market and particularly worry foreign investors. Some bankers, however, say although Erdogan doesn’t change his language easily he nevertheless does what is needed for the economy. In other words, they are saying, "Don’t look at what Erdogan says, and look at what he does." In comments to Al-Monitor, some bankers noted that Erdogan uses the vague notion of "interests lobby" to create politics, but they expected him to agree to the needed steps — even if he doesn’t want to.
It is known that Erdogan — in harmony with his "interest lobby” propaganda — has instructed the Stock Market Council and the Banking Regulatory and Supervision Agency to investigate suspicious market transactions during the days of economic downturn. The launch of investigations is seen as "police action” and demands for detailed data and information is another factor disturbing the markets. Such investigations known to be detrimental to the market economy's performance are having a negative bearing on foreign capital’s evaluation of the Turkish economy. Economic managers, seen to be supporting Erdogan, say the investigations are only looking for "manipulative" transactions that could harm “a regulated market economy,” according to banking sources who spoke to Al-Monitor.
But knowing that such investigations are worrying foreign investors — just when they are needed the most — they would like to urgently remove the investigations from the agenda.
Increasing economic risks
Thus, we are entering a period of growing risk for the Turkish economy. Topping the risks are decisions primarily by the Fed to limit the global liquidity surplus. Return of liquidity to developed countries beginning next year will signal a start of a normalization period. In this process, all developing countries such as Turkey which attract short-term funds will be deeply affected. It is very likely that we will enter a period when interest rates will climb and growth will be restricted.
Of course, the Turkish economy will be affected by this process. It will be burdened by economic and political developments specific to Turkey. The Turkish economy — whose current deficit is higher than that of other developing countries — cannot avoid being affected by an outflow of capital. That means lower economic growth. A reduction of growth in the coming year and a half — in which three elections are scheduled, starting in March 2014 — is not to be desired. This brings with it the danger of disrupting the financial discipline that had prevailed until now.
Although the domestic political conflicts that started with the Gezi Park protests seem to have cooled down a bit in recent days, there are fears that they may escalate in September, when universities reopen and people return from the summer holidays. Erdogan’s tendency to resort to his traditional combative ways of polarization and the like — instead of reconciliation or developing democracy to deal with this growing societal opposition — compound the fears. His continuing search of internal and foreign plots behind events not only affects his political moves but also magnifies the risks of preserving the economic stability in such a critical global change atmosphere.
Erdal Saglam is an economics writer for Hurriyet and a consultant for Radikal and produces programs on several TV channels. He was previously a lecturer on economics journalism at Istanbul University and worked for Dunya newspaper.