With the noticeable move to loosen government controls on foreign currency, combined with some uncertainty, the Turkish lira tumbled to record lows against the dollar, and one dollar skyrocketed to 23.22 on the evening of June 7. However, the rate had been just under 20 liras on the last working day before the election, while the benchmark rate determined in the interbank foreign exchange market had been 19.97. The Turkish lira has weakened by 16.3 percent in 8 days against the dollar. What is happening?
Let me start with a comprehensive introduction. In my last article, published on June 2, I once again underlined that an economic program that would lift the Turkish economy and increase the potential growth rate in the long term; in other words, a return to the rational program should have three pillars: Measures towards stability, changes in the institutional structure of the economy, and changes in the institutional structure in areas outside the economy.
Our experience tells us we should not be hopeful for the last two.
Contented to remain in the second league
In this case, we are almost sure to remain in the ‘high-middle-income countries’ league, that is, in the second league, according to the World Bank’s classification of countries. It can be a relief that we are not in the third and fourth leagues; nonetheless, we should not be pleased. Under what conditions we stay in the second league is also vital. With high inflation, volatile growth, high-risk premium, and high unemployment level compared to most major league countries, will we ‘go through the motions’ in this league, or will we have a more stable economy?
What is anticipated in the new period is that, for at least a return to reasonableness, the stability-oriented part of the three-pronged program will be implemented. I concluded my earlier article with these sentences: “…who will implement this program? Names are crucial, at least in order to provide some initial credibility to the program. Nevertheless, it is not just about the name(s). Will that name(s) be at least allowed to implement the stabilization leg of the return to “reasonable”? For what duration? Will there be any interference in their subjects during this time? The recent Ağbal-Elvan experience, unfortunately, prevents us from being optimistic in this respect. Could it be the other way around this time? We will see.”
How likely is it to “return to reasonable” with Şimşek?
At the time of the publication of that article, who would take the helm of the economy was not defined. Recently announced: Mehmet Şimşek.
His statement at the Ministry of Treasury and Finance handover ceremony was unfavorable for those who had designed and implemented the economic program until the elections. He signaled the likelihood of pursuing a rational program to stabilize the economy: “Turkey has no choice but to return to the rational ground.”
According to the Turkish Language Institution dictionary, the Turkish equivalent of rational, a word of French origin, is as follows: “logically, based on the rules of reason, moderate, measured.” It is unlikely to be precise when the ‘unreasonable’ economic policy was put into effect; however, let me take September 2021 as a milestone – even though that policy had started earlier- and continue comparing some indicators:
The dollar rate, which had been 8.4 in mid-September, reached 23.2 on the evening of June 7. In other words, it has increased 2.76 times (176 percent) in twenty months.
Unsound economic conditions
According to the index published by the Turkish Statistical Institute, consumer prices increased 2.3 times in the same period. In other words, a commodity bought for 1000 liras can recently be purchased for 2300 liras; the one bought for 10 thousand liras is 23 thousand liras. These values mean that the entire twenty-month inflation rate is 130 percent.
What happened in September 2021? The Central Bank (CBRT) started to lower the policy rate; from 19 percent to 18 percent in the first stage and then 14 percent in December. It is currently 8.5 percent. On the contrary, the three-month deposit interest rate, 19 percent in September 2021, was 30-35% recently. Loan rates are even higher.
Did the unemployment rate decrease? Not at all. The broad uneployment rate -idle workforce rate- was 22.1 percent in the third quarter of 2021 and 22.9 percent in the first three months of 2022.
Exchange rate and risk premium
There are other negative indicators: for example, the current account deficit problem has deepened. On the other hand, the growth rate increased by 5.4 percent between the third quarter of 2021 and the first quarter of 2023. Regrettably, it is not sustainable (see, for example, the continuously and sharply depreciating lira), and the share of the workforce in the generated income has decreased.
In short, Mehmet Şimşek is accurate: “Turkey has no choice but to return to a rational basis.” So, why is the exchange rate increasing so rapidly, despite the positive atmosphere since the outbreak of the possibility of his appointment as the minister?
Not to throw prudence to the winds
First, Turkey’s risk premium (five-year CDS) jumped to 702 basis points right after the election. It fell under 500 basis points after Mr. Şimşek was appointed minister. Under normal circumstances, we would expect the exchange rate to rise when the CDS is bouncing, whereas to fall when the CDS is declining significantly. However, there is a reverse situation: As the exchange rate increases, the risk premium decreases.
Depressurize the accumulated vulnerability
Why so? What is most likely to happen is this: It is anticipated that a stabilization program will be implemented that would restore macro balances in the economy. In other words, a program is expected to include at least the first leg of the return to the rational program that I have underlined above. The name Mehmet Şimşek and his words at the handover ceremony reflect this expectation. Consequently, CDS is falling.
The increase in the exchange rate is attributed to the opening of the lid of the pressure cooker before the new program so that it does not explode, which is also considered indispensable. So the increase is tolerated even if it gets ‘hastily.’ In this context, it is interpreted that the exchange rate is going towards equilibrium. If a ‘reasonable’ economic program is to be implemented, it is appropriate to spot the optimum exchange rate before the program’s announcement because such sharp moves after the new program’s announcement can spoil the new program’s reputation.
It is probable to interpret the upsurge in the exchange rate as the risk premium decreases.
Possibility of fire getting out of control
Nonetheless, ‘equilibrium’ is a vague concept. It will be altered if at least a reasonable stabilization program is to be pursued in the current conditions and it is believed that it will not be interrupted, or if there is an opinion that the program can be interrupted, or if the program is to be implemented is slightly reasonable. Moreover, the ‘equilibrium’ that will emerge in the second and third cases may also be quite volatile and constantly directed upwards.
In this context, announcing the new program and the staff implementing it as soon as possible would be favorable. Nevertheless, Mehmet Şimşek’s tweet in English on June 7 confused us: “Our priority is to strengthen our team and design a reliable program.”
Or is the program not ready yet? I hope it was a typo. Moreover, the agenda does not end with the announcement of the program. The markets need to be convinced that ‘Ağbal-Elvan syndrome’ will not be repeated. All of them are challenging; nevertheless, it seems that the most challenging part is to persuade.
Note: In the early hours of June 9, we learned that Erdoğan appointed Hafize Gaye Erkan to lead the CBRT, while the former governor Şahap Kavcıoğlu became the head of the Banking Regulation and Supervision Agency. Unfortunately, this is a mixed message for the markets. While the first appointment reflects a move towards rationality as promised, the second one reflects a desire to keep the status quo intact.