Turkish Interest Rate rise- the start of a new economic chapter?

Nathan Wiesheu (30 September 2020)

On the 24th of September, President Erdogan of Turkey, announced a surprising rise in the central bank interest rate, from 8.25% to 10.25%. This comes following sharp decreases since Erdogan took de facto control over the central bank and no interest rate rises in two years. 

Following the switch in central bank leadership, President Erdogan had focused heavily on reducing interest rates. The cheap credit on offer was beneficial in helping Turkey to bounce back from the Covid-19 pandemic; making it easier for individuals and firms to gain access to affordable loans. As a result, they were more likely to spend money, lifting the economy out of turmoil caused by a lack of consumption. However, it has placed severe pressure on the Lira, causing it to fall by more than 20% against the USD in the past year with its lowest at 7.7 Lira against the United States Dollar. The interest-rate cuts had been used to revive the fast, credit-led growth that had earlier proved beneficial for Turkey. The decision to increase rates comes as a shock as President Erdogan for many years has been an opponent to higher interest rates affirming that they hinder the fast growth that he and his government have embraced so heavily during their tenure. Despite repeated attempts in the past by opposition government officials and economists to convince President Erdogan to raise interest rates to no avail, something on this occasion has altered for him and his government to make this decision.

In August 2020, inflation in Turkey reached 11.7%, providing a real worry of a future economic collapse on the cards with evidence of such price instability. With President Erdogan falling third in the presidential polls behind the mayors of Ankara and Istanbul, the increase in interest rates may have political motivations. With the idea that if he made a more popular economic decision, he may gain more support from members of his populous. This move may have worked, with President Erdogan gaining many plaudits for his surprise decision which showed some rational thinking in an attempt to prevent inflation levels reaching an unsustainable rate by disincentivising spending through the raising of interest rates. This move illustrates that the government may have learned from the mistakes of its 2018 currency crisis which will provide hope to many political onlookers that the president and his government are willing to protect the currency despite going against their long-term monetary policy strategy.

Despite all of this, there is still worry that the government has not gone far enough to stem the crisis. The reasoning is that despite the rise in interest rate to 10.25%, because inflation is higher than 10.25%, at around 11%, there is still a real negative interest rate in the economy. This means there is still an incentive to spend and loan rather than save, meaning the rise in interest rates may not have been large enough to counteract the inflation problem it was supposed to fix effectively.

The effects of such a raise will take weeks to fully expose themselves, but it appears to be a welcomed move by the government which looks to increase stability surrounding the Lira. However, whether the increase is large enough is yet to be determined, and only time will tell the effectiveness of the policy.

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