Ankara goes on risky quest to cut interest rates
Bent on lowering interest rates, Turkey’s president took the extreme step of ousting the central bank governor, but his insistence on rate cuts is fraught with risks that could fan fresh economic turmoil.
In a memorable interview in May 2018, Turkish President Recep Tayyip Erdogan advocated low interest rates as a way to reduce inflation, defying conventional economic theory. “When we look at the cause and effect relationship, interest rates are the cause and inflation is the result," Erdogan told Bloomberg during a visit to London. "The lower the interest rates, the lower the inflation. Once we lower interest rates, all cost expenses will go down."
In the same interview, which dumbfounded financial actors, Erdogan raised the specter of greater government pressure on the central bank once the new executive presidency system took effect after the June 2018 elections. “The central bank is, of course, independent," he said. "Yet it cannot use this independence to set aside the signals from the president, who is the head of the executive."
The way Erdogan’s remarks rattled foreign investors — just five weeks ahead of presidential and parliamentary polls — was hardly beneficial for Turkey’s economy and its dire need of external funds. Though Erdogan won the elections with 52% of the vote, assuming sweeping powers under the new system, foreigners shied away from putting money in Turkey, causing hard currency prices to increase. In August, under the added impact of political turmoil with the United States, the Turkish lira nosedived to record lows against skyrocketing foreign exchange prices. As a result, Erdogan’s government had to acquiesce to a massive rate hike of 6.25 percentage points in September to pull the lira from the brink.
Hence, in the very prelude to his new regime, Erdogan faced a benchmark interest rate of 24%, along with a consumer inflation rate of 25% and a badly battered currency. The turbulence plunged the economy into stagnation and then into contraction, which has continued in 2019. In the first quarter of the year, the economy shrank nearly 3%, with leading indicators signaling a similar contraction rate in the second quarter.
