The enemy of interest strikes again: Erdogan causes the lira to fall

Hyper-inflation in Turkey threatens to spiral out of control.

The enemy of interest strikes again: Erdogan causes the lira to fall

Hyper-inflation in Turkey threatens to spiral out of control. President Erdogan nevertheless announces interest rate cuts. The currency is therefore rushing into the basement.

The Turkish currency is in free fall. There are now around 17 lira for one dollar. Since the beginning of the year, the currency has lost almost a quarter of its value. In the past year, it had already lost more than 40 percent. The reason for the current price slide: President Recep Tayyip Erdogan has announced that the central bank will lower interest rates even further.

This is remarkable because Erdogan is not the president of the central bank, but of the country. And formally, the central bank is independent. But Erdogan made the central bank obedient by firing three heads in succession and finally found a governor in Sahap Kavcioglu who will fulfill the head of state's wishes.

The head of state wants namely low interest rates. That's not necessarily a good idea given hyper-inflation, though. Because according to economic theory, low interest rates ensure that inflation continues to gain momentum. It is currently more than 70 percent in Turkey and thus higher than it has been since 1998.

In addition, low interest rates contribute to the fact that the domestic currency loses value. This makes it less attractive to invest in Turkey and not elsewhere where interest rates are higher. In addition, investors there have to take into account that the money they invest there quickly loses value. A vicious circle: Inflation contributes to money flowing into currency areas with a more stable currency and higher interest rates. This is helping to put further pressure on the lira, thereby accelerating inflation.

But Erdogan still wants low interest rates at all costs. The self-declared enemy of interest rates calls it the "mother of all evils" and insists that high interest rates cause high inflation and low interest rates cause low inflation. The key interest rate in Turkey is currently 14 percent. In March last year it was 19 percent.

The reason for Erdogan's unorthodox stance: Higher interest rates result in the economy growing more slowly. And Erdogan wants to avoid that at all costs. Presidential elections are planned for June next year in Turkey, and he wants to score points with strong economic growth. In fact, the Turkish economy started the year with strong growth. It increased by 7.3 percent in the first three months of the year.

Erdogan is betting that high inflation will soon come down and the current consequences are only temporary collateral damage. But that can go wrong. An ever-depreciating lira and high inflation rates could affect the entire economy. Turks can afford less and less. Vital imports such as energy and raw materials are becoming even more expensive as a result of the currency collapse.

"We assume that economic growth in Turkey will only be sluggish in the further course of this year," according to the analysis company Capital Economics. "The fallout from the war in Ukraine and the continued weakness of the lira means inflation is likely to hover around 70-80 percent by the end of the year."

In addition, inflation in Turkey may be even higher than officially stated. Erdogan fired the head of the national statistics agency in February, accusing him of exaggerating the extent of the crisis in Turkey. Under the new boss, the authority no longer publishes average prices for individual items, but only for product groups. That makes economists and opposition politicians suspicious.

But even the official numbers are tough. Prices in the transport sector - which includes petrol, for example - were more than twice as high in May as they were a year earlier. Groceries cost almost twice as much as in May 2021.

The government, meanwhile, has insisted that inflation will come down on its new economic program and will peak in June. A central element of the plan: In order to stimulate exports, interest rates are to be lowered even further. This corresponds to Erdogan's economic ideas and suggests that prices in Turkey will continue to rise sharply.

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