Turkey hikes interest rates as Erdogan stages economic U-turn

Turkey has hiked its main interest rate from 8.5% to 15%, reversing one of President Recep Tayyip Erdogan’s unorthodox economic policies.

The 6.5-point rise was far lower than economists were expecting, but it marked a major shift in policy by his new economic team brought in to tackle rampant inflation.

Turkey’s leader has until now insisted on keeping interest rates down.

Inflation is almost 40% and Turks are in the grip of a cost-of-living crisis.

The head of Turkey’s central bank, Hafize Gaye Erkan, 44, was only recruited from the US this month in the wake of Mr Erdogan’s re-election as president.

Her decision marks the first rise in interest rates since December 2020, after a turbulent period in which three central bank governors were fired in less than two years, as they sought to stick to orthodox economics.

Although the increase almost doubles Turkey’s policy rate to 15%, it is far less than many economists had forecast. US-based investment bank Morgan Stanley had suggested it would go up to 20%, while Goldman Sachs said it could hit 40%.

In its statement the bank’s monetary policy committee made clear that Thursday’s move was the start of a gradual process, with the target of bringing inflation down to 5%.

Its members said they had “decided to begin the monetary tightening process in order to establish the disinflation course as soon as possible… and to control the deterioration in pricing behaviour”.

President Erdogan’s problem is that Turkey’s inflation rate remains stubbornly high and its central bank’s reserves have fallen to critically low levels, after it spent billions of dollars trying to prop up the lira.

Interest rates have come down from 19% two years ago to 8.5% in recent months and the change in direction will have repercussions for a country already in economic crisis.

“It is a risk, but it’s a difficult circle to square,” says Ozge Zihnioglu, senior politics lecturer at the University of Liverpool.

Erdogan “has to do something for the economy, but a clear shift to orthodox economic policies would hit a large section of society and he wouldn’t want to have that impact on local elections” next year.

Turkey’s economy grew dramatically in the early years of President Erdogan’s leadership. But in recent years, he has ditched traditional economic wisdom by blaming high inflation on high borrowing costs and seeking to stimulate economic growth.

In the past five years, the Turkish currency has lost more than 80% of its value and foreign investment has plummeted. Turks are now trying to move foreign cash out of local banks.

Mehmet Kerem Coban of Kadir Has University said Turkey’s economic model needed capital to survive because its reserves had melted away.

Although the rate hike was intended to stabilise the Turkish lira, investors appeared unimpressed and it continued to slide against the dollar.

Mr Erdogan has been in power in Turkey for more than 20 years. He defeated his opposition rival last month in elections that international observers said suffered from an “unlevel playing field” that gave the incumbent president an unjustified advantage.

During the election campaign, he maintained his mantra that interest rates would stay low as long as he was in power, guaranteeing that there would be no change in economic policy. The opposition promised to reverse his focus on low interest rates.

And yet within days of his re-election, he signalled a change.

First, he appointed former banker and economist Mehmet Simsek as finance minister. Although a former member of Erdogan’s government, Mr Simsek has made clear Turkey’s only economic choice is to return to “rational ground” and “compliance with international norms”.

Next, he appointed Hafize Gaye Erkan, as the central bank’s first female governor. A well-known figure on Wall Street, she has never had a role in Turkey before and was chief executive of US bank First Republic, leaving around a year before it collapsed.

Mr Erdogan said last week that his position on interest rates had not changed, but “we accepted that [Mr Simsek] should take the necessary steps rapidly and effortlessly with the central bank”.

Emerging markets specialist Timothy Ash warned ahead of the decision that if Ms Erkan did not “front-load rate hikes”, she risked “always playing catch-up with the market and waiting in the ante-room of the presidential palace to plead for rate hikes”.

Bartosz Sawicki, an analyst at Conotoxia fintech, said that in the short term Turkish households would suffer from a steep increase in loan instalments and a more conservative fiscal policy, but there was no other way to “extinguish the inflationary fire in two to three years”.