Turkey's Economic Woes: Inflation, Interest Rates and a Depreciating Lira

 Turkey's Economic Woes:  Inflation, Interest Rates and a Depreciating Lira

(Jahanzaib khan/ published 30 Aug 2023)

Ever wonder why prices keep going up in Turkey but your salary stays the same? You're not alone. Turkey's been dealing with some major economic troubles recently. Inflation is rising fast, the Turkish lira has lost a ton of value, and interest rates are through the roof. If you're living in Turkey, your cost of living has probably skyrocketed.

Understanding Turkey's Soaring Inflation and Interest Rates

If you've been following the news, you know Turkey’s economy has seen better days. Inflation and interest rates are soaring while the lira continues to lose value. What’s behind these troublesome economic woes?

Understanding Inflation

Inflation means prices are rising, and your money buys less. Turkey’s inflation rate topped 40% this month, among the highest in the world. Several factors drive inflation in Turkey:

• Demand-pull inflation: Strong economic growth leads to higher demand and pushes prices up. Turkey’s economy grew over 11% in 2021,5% in 2022 and 3% in 2023 fueling demand-pull inflation.

• Cost-push inflation: Higher costs of production, like wages and raw materials, force companies to raise prices. Turkey imports most of its energy and raw materials, so a weak lira makes these more expensive. Companies pass on the higher costs to consumers through price hikes.

• Deficit spending: The government spends more than it earns from taxes, so it prints money to fund the deficit. This expands the money supply and devalues the currency, driving up inflation.

To curb inflation, Turkey’s central bank raised interest rates. Higher rates make it more expensive for businesses and consumers to borrow money. This slows down economic activity and demand, putting downward pressure on prices. However, higher rates also attract foreign investors, strengthening the lira. A stronger lira makes imports cheaper, helping lower inflation.

Controlling inflation and stabilizing its currency will require Turkey to tighten government spending. Taming inflation and interest rates won’t be easy, but it’s necessary to get Turkey’s economy back on track.

Causes of the Turkish Lira's Depreciation

The Turkish lira has been in a steady decline for years now, losing almost 100% of its value against the dollar since 2018. There are a few reasons behind the lira's troubles.

High Inflation

In Turkey, inflation has been rising rapidly, up to 30% recently. When the cost of goods and services rises quickly, the purchasing power of the lira drops. People need more liras to buy the same items, so the currency is worth less. Compared to Pakistan's inflation averaging around 20% in recent years, Turkey's high inflation severely weakens its currency.

Political Uncertainty

Investors don't like uncertainty. President Erdogan's unconventional economic policies and the political turmoil in Turkey have made investors nervous. When investors pull their money out of Turkey, the lira declines in value. 

High Interest Rates

To curb inflation and prop up the lira, Turkey's central bank has raised interest rates. But higher rates also slow down economic growth. This Catch-22 makes it hard to stabilize the currency.

Over-reliance on Foreign Debt

Turkey relies heavily on debt from foreign investors and governments to fund economic growth. But when the lira drops, it becomes more expensive for Turkey to repay its foreign currency-denominated debt. This further weakens the currency. 

How Government Policies Impacted the Turkish Economy

The Turkish government has made several policy decisions in recent years that have significantly impacted the country’s economy.

Interest Rates

In an effort to curb rising inflation and support the Turkish lira, the central bank has raised interest rates. Higher interest rates make it more expensive for businesses and individuals to borrow money. While this can slow down economic growth in the short term, lower inflation often leads to lower interest rates and stronger economic growth over the long run.

Government Spending

The Turkish government has increased spending on major infrastructure projects, social programs, and the military. This spending, combined with lower tax revenues, has led to larger budget deficits. To finance these deficits, the government has borrowed money by issuing bonds. More government borrowing can drive up interest rates and weaken the currency.

Foreign Exchange Intervention

The Turkish central bank has sold foreign currency reserves, like U.S. dollars, to buy Turkish lira. This props up the lira but depletes the country’s reserves of foreign currency. With fewer reserves, the central bank has less ability to support the lira in the future. A weaker currency, like the lira, can lead to higher inflation by making foreign goods and raw materials more expensive.

The economic troubles in Turkey point to the challenges of balancing government policies. Steps to curb inflation and support the currency, like higher interest rates, can slow growth. Policies to boost growth, like increased government spending, can drive up inflation and weaken the currency. There are no easy fixes, but most economists agree Turkey would benefit from reducing deficits, limiting foreign exchange intervention, and allowing interest rates to reflect market conditions. With prudent economic management, Turkey can get back to a path of stable growth with low inflation.

Comparing Turkey and Pakistan's Economic Situations

Comparing Turkey and Pakistan’s economic situations, causes which are fueling their troubles are almost same. In Turkey, inflation and interest rates have been soaring to new highs same is the case in Pakistan.

In Turkey, inflation has skyrocketed to over 80% this year, a 20-year high. When the cost of goods and services rise rapidly, it diminishes people’s purchasing power and standard of living. To try and curb inflation, Turkey’s central bank has raised interest rates. However, higher interest rates make it more expensive for businesses and consumers to borrow money, which can slow down economic growth. It’s a double-edged sword.

Same is happening in Pakistan which is also facing a balance of payments crisis where more money is flowing out of the country than in. This has caused Pakistan’s currency, the rupee, to plunge in value. A weak currency makes a country’s imports more expensive and reduces the value of foreign debt obligations and remittances. However, it also makes exports cheaper and can boost tourism. The rupee has dropped over 180% against the US dollar in the past year. Pakistan’s government is seeking loans from allies like China and Saudi Arabia to shore up its foreign reserves.

While Turkey and Pakistan are both witnessing economic turmoil, the primary drivers are same. Inflation and interest rates are Turkey’s main concerns like Pakistan. 

Potential Solutions for Turkey's Economic Problems

To help get Turkey’s economy back on track, several solutions could be considered:

Reducing Inflation

Bringing down inflation should be a top priority. The central bank policy of raising interest rates to make it more expensive for businesses and consumers to borrow money is failed in Turkey and in Pakistan. This can slow the economy and reduce demand-pull inflation. The government should cut spending to reduce the budget deficit, lowering cost-push inflation.

Stabilizing the Lira

The Turkish lira has lost a lot of value relative to other currencies like the US dollar. To strengthen the lira, the central bank has raised interest rates which makes it more attractive for foreign investors to buy lira-denominated assets like government bonds. The central bank has also sold off its foreign exchange reserves to buy lira, increasing its value. Restricting imports and promoting exports can improve Turkey’s balance of payments and support the lira.

Reforming the Economy

Long-term reforms are needed to address underlying economic issues. Reducing red tape, barriers to trade and corruption can improve the business environment. Investing in education and infrastructure will boost productivity. Privatizing state-owned enterprises and opening up markets to more competition can increase efficiency. Strengthening institutions and the rule of law will make Turkey's economy more transparent and attractive to foreign investors.

Economic problems often develop gradually but solving them requires decisive action. By addressing inflation, stabilizing the currency, lowering interest rates responsibly and implementing reforms, Turkey can overcome its current challenges and get back to a path of sustainable growth. The solutions may not be easy but are necessary to secure a prosperous future.

Conclusion

At the end of the day, Turkey has some tough economic challenges ahead. While the government has taken some steps to address inflation and support the lira, more substantial policy changes are still needed to turn things around in a sustainable way. The good news is Turkey has a lot of economic potential, with a large, youthful population and proximity to major markets in Europe and the Middle East. With the right reforms and policies enacted, there's still hope Turkey can get back on track to stronger economic growth and prosperity. But for now, all eyes will remain on inflation, interest rates and the lira to see if the government can regain investors' confidence and steer the economy into calmer waters. The road ahead won't be easy, but for the sake of Turkey's citizens, let's hope policymakers are up to the task.