Turkey, a country with the potential to connect the riches of the Middle East to the economic prosperity of Europe, has recently been subject to extremely high levels of inflation. The country, whose major tourism industry fueled its massive economic growth between 2000 and the mid-2010s, is now undergoing severe economic and political mismanagement – unraveling all the progress the country has made in the past two decades. A depreciating currency and questionable monetary policies have significantly damaged the country’s major industries and made foreign financial institutions think twice before lending money. This article will examine the factors that lead to the Lira’s fall and the implications for inflation. Interest rate policy under the Turkish president’s drive to prioritize exports - despite opposition from Turkish central bankers - has led to Turkey’s annual inflation soaring to almost 50 percent.

Reaching 14 to the dollar, Turkey’s Lira fell to a record low – falling 40 percent since the central bank embarked on its policy to consistently cut interest rates under President Erdogan’s orders. Economists warn that cutting rates will come at a cost, intensifying inflation and hurting living standards - particularly for Turkey’s youth and working-class population. In a country that is heavily dependent upon its tourism industry, the same economists are bullish on Turkey’s path towards financial instability. Looking at the past two decades, the country is no stranger to inflation and economic instability.

 Turkey underwent high levels of inflation in the 1980s and 1990s – as high as 140 percent – caused by the country loading up on foreign debt in order to fuel rapid growth during the 1970s. The Turkish government ran massive deficits as the idea was to have the currency devalued so the country could become a giant exporter of goods. This proved unsuccessful with the economy overheating due to the country’s heavy dependence on imported oil during the oil crisis of the 1970s. To counter this crisis, the government implemented stimulus measures that devalued the Lira. As most of their debt was to be repaid in foreign currencies, it became more difficult for the Turkish government to pay back these loans with domestic money. The government was borrowing money in foreign currencies which meant these loans needed to be repaid in the same foreign currency. With a weakening Lira, Turkey was inevitably going to endure high levels of inflation. The country continued to struggle with high levels of inflation every day that passed – hovering around 60 percent – before establishing new mandates for the central bank in 2001. Prior to these mandates, the central bank was directed by the Turkish federal government. After the reform, the central bank was tasked with maintaining price stability in the country and assisting the government with growth and employment.

In addition, it is important to note that the United States treasury raises money by purchasing government-issued bonds in primary markets: this practice was forbidden to the Turkish central bank after the status-quo change in 2001. The central bank had to turn to investors if it wanted to raise money – the latter being more cautious about lending as they do not have the power to print more money. This meant that the central bank was also warier about the policies it implements to stabilize prices. The central bank proceeded to hike interest rates to as high as 100 percent to curb double-digit inflation for a brief period. Despite this, inflation was still rampant in Turkey – decades of high inflation meant the confidence in the Lira depreciated around the world. To fight this issue, Turkey released a new Lira in 2005 which was exchangeable for the old Lira at a rate of 1 to 1 million. This prompted relative monetary stability.

The combined monetary and relative political stability in the region helped the nation accelerate its economic growth in the past two decades. Turkey’s geographical proximity to Europe and the Middle East, being a natural hub for tourism due to strong touristic and travel infrastructure, beautiful historic sites, and natural beauty helped the country become the tourist hotspot the world sees it as. Turkey is a country that built its economy on sustainable growth instead of using resources that deplete such as oil and gas. The government had also successfully overseen the country’s growth by avoiding debt; since the 2000s, Turkish national debt has stayed below 50 percent of GDP. So, what contributed to the downfall of the Turkish economy?

It is difficult to talk about the country’s inflation problem and its interest rate policy without invoking Erdogan’s ideology and politics. A firm believer in Islamic finance, Erdogan has insisted for years that low-interest rates reduce inflation, in defiance of basic economics. Elected on a platform of conservative populism in 2014, Erdogan has used Islamic finance - a method of raising capital in accordance with Islamic law - as a vehicle to keep interest rates low. Islamic finance sees money differently from the West: money should not have any value in itself, it is only a means to exchange goods and services that are valuable. With this logic, it is wrong to make money with money. As interest-bearing assets are deemed by the faith’s as usury, it circumvents this problem through Islamic banks that set up savings accounts where depositors share the profits of the bank, and borrowers rent the assets they want to purchase. Subsequently, Erdogan has deemed hikes in interest rates to be contrary to the teachings of Islam. 

In the past, Turkey’s private sector had been taking more debt from foreign institutions relative to the government. Though it created a lot of wealth, it also meant Turkey became deeply indebted and over-leveraged to countries like Germany. The over-leverage would prove to be costly when Turkey’s bid to enter the E.U. as a fully-fledged member state was denied due to concerns about human rights concerns centered around Erdogan. This meant foreign institutions were more skeptical about lending money to Turkey, especially considering Erdogan’s government had seized the assets of those who were believed to be involved in the 2016 coup attempt, even when their ties were attenuated. Erdogan did not take the concerns posed by foreign institutions about the lack of political stability seriously. Tourists were less likely to feel safe, thereby reducing tourism velocity in the country. These factors induced low confidence in the Lira, making Turkey’s private sector debt more expensive. The government proceeded to raise interest rates and introduce austerity measures to mitigate the Lira’s depreciation. This worked, but at the cost of the everyday Turk: the unemployment rate rose to 14 percent.

Erdogan’s view on the central bank’s interest rate policy contradicts conventional economics. Turkish central bankers have recommended - as conventional economics does - to raise interest rates. Raising interest rates makes borrowing more expensive, limiting growth in money supply and curtailing investment and spending. From the president’s perspective, a weaker Lira is good for the Turkish economy as exports will increase, facilitating the recovery from global lockdowns and supply chain issues. This train of thought is not unprecedented; countries like Japan and China have purposefully kept the value of their currency low to boost their exports. However, Turkey is a country that is very reliant on imports such as fuel, food, and fertilizers. 

The rise in the price of food and energy has hit the most vulnerable and poorest Turks the hardest. With the instability of the Turkish Lira, most people do not have the confidence to hold their savings in the currency. As a result, wealthy Turks opt to hold their money in foreign currencies such as the dollar. This means it is the working-class and small businesses that feel most of the pain in this crisis. According to the Economist, two in three Turks have to take out loans to meet their basic needs.

Turkey is very quickly losing its monetary autonomy to a president putting his ideology and worldview over the needs of everyday Turks. A depreciating Lira and losses in its tourism industry have contributed to high levels of inflation in the country. By invoking the Islamic faith to keep interest rates low - despite conventional economists saying otherwise - Erdogan has opted to play the virtue-signaling pious ruler who rules in accordance with God’s will.