The Turkish lira’s ongoing decline in the foreign exchange market, breaking the 23 barrier against the US dollar, has raised questions about the rapid decrease following the elections and the choices to be made by the new Minister of Treasury and Finance, Mehmet Simsek.
Since assuming his position, Simsek has indicated a shift towards a more conventional policy, diverging from the unconventional approach adopted over the past two years. While he has not provided extensive details regarding his future plans, he conveyed several messages and hints during his initial press conference.
Two days ago, Simsek stated that “Turkey has no choice but to return to rational foundations” and emphasized that a rules-based economy would be crucial in achieving long-awaited prosperity. He further stated that fiscal discipline, price stability, sustainable high growth, and reducing inflation to single digits are among the primary goals.
Economists and observers interpreted Simsek’s remarks, particularly the phrase “rational foundations,” as an indication of a departure from the unconventional policy of reducing interest rates to combat high inflation. This policy shift has had an impact on the current exchange rate of the lira, along with other factors predating the elections.
Bloomberg suggests that the record decline may signal a gradual liberalization of the exchange rate under the new economic administration led by Mehmet Simsek. With Simsek’s appointment, there are expectations in the markets that Turkey will adopt traditional policy tools employed worldwide to combat inflation, thereby restoring foreign investor confidence and meeting the need for external resources.
University professor and economic researcher Mukhles Al-Nazer commented that the Central Bank of Turkey has gradually reduced its interventions after the election period, possibly ceasing them permanently. This has affected the current value of the lira. Al-Nazer further explained that Simsek aims to liberalize and make the exchange rate more flexible, subject to the natural forces of supply and demand.
It is anticipated that the Turkish lira will continue to decline until it reaches an exchange rate that the central bank can defend without depleting its cash reserves. Al-Nazer noted that during the pre-election phase, the Turkish Central Bank injected $177 billion into the markets to prevent the current situation with the lira, ensuring it did not impact the electoral scene.
Turkey has been grappling with various economic challenges such as high inflation, unemployment, and the devaluation of the lira against foreign currencies. Since the beginning of the year, the lira has experienced a 13% devaluation, the highest decline since the currency crisis in 2021. As the economy becomes a prominent challenge for President Erdogan, attention is now focused on Simsek’s policies and their impact on the markets.
Another crucial aspect to consider is the appointment of the Central Bank governor, especially given reports suggesting Erdogan’s consideration of appointing Hafiza Jay Erkan, a young woman, to the position. Central banks worldwide are raising interest rates to combat inflation, while Erdogan has long advocated for low interest rates to stimulate growth, referring to high rates as the “mother and father of all evil” promoted by foreign interest groups.
In 2022, the Turkish government implemented an innovative economic model based on the unconventional notion that interest rates cause inflation, contrary to conventional economic theory. Under this approach, the Turkish Central Bank consistently reduced interest rates, fulfilling Erdogan’s promise to achieve single-digit rates. However, this strategy has had repercussions on the value of the Turkish lira, compounded by Erdogan’s dismissals of central bank governors and treasury and finance ministers.
It remains uncertain whether the new economic team, led by Simsek, will opt to raise interest rates in the next phase, particularly after emphasizing the importance of central bank independence. The Central Bank is scheduled to convene on June 22nd to determine its monetary policy.
Furthermore, the significant and sudden decline of the lira may be attributed to intense selling by Japanese currency investors seeking to minimize losses from previous decades. This selling movement has been observed alongside increased demand for transactions involving the lira and the Japanese yen.
According to Al-Nazer, raising interest rates in the next phase would not be beneficial for Turkey and could lead to an outcome similar to the Argentine scenario. He emphasized that controlling inflation poses a major challenge, requiring stringent austerity measures such as raising taxes and imposing restrictions on imports to address the current account deficit.
Simsek’s economic team faces difficult and precarious circumstances, where any missteps could have disastrous consequences. President Erdogan has prioritized solving the issue of rising prices caused by inflation in his election victory speech. While he pledged to harness all available resources to revive the economy and rehabilitate earthquake-affected areas, it remains unclear whether he will continue with his previous policies or adopt a different approach.
Simsek, following his appointment, conveyed messages that seemingly target foreign audiences more than domestic ones. He emphasized transparency, consistency, predictability, and adherence to international standards as guiding principles for the upcoming period. Simsek also stressed the importance of accelerating structural transformations to reduce the current account deficit.
Safar Levent, an economic journalist at the “Hurriyet” newspaper, noted that foreign investments, which have been overlooked recently, play a crucial role in Turkey’s economic growth. He highlighted the need for foreign direct investment and the potential benefits of attracting international funds.
Concerning the controversial policy of the “Turkish Lira Deposit Protected from Exchange Rate Fluctuations,” implemented in late 2021, it has become a matter of contention within the new economic administration. This financial mechanism shields depositors from exchange rate fluctuations, ensuring they receive the declared interest along with the difference in the dollar price at the time of deposit and withdrawal.
According to the economic newspaper “Dunya,” the rising exchange rate increases the cost of the deposit on the treasury, creating a new burden on public finances. The report indicates that assuming a 20% annual interest rate, the Ministry of Treasury bears a burden of approximately 200 billion Turkish liras due to a 10.3% increase in the dollar rate over the past ten days.
Economic circles eagerly await a solution to the deposit issue from the new minister, Simsek, and the economic administration, as reported by “Dunya.” Al-Nazer considers the deposit mechanism a disaster, emphasizing that the state will pay around 200 billion Turkish liras solely due to exchange rate differences over the past three months.
Former Minister of Finance and Treasury Noureddine Nabati previously recognized the positive impact of the protected deposit policy on the overall economic budget, attributing it to the growth of the national economy through investment, production, employment, exports, and decreased inflation.
In conclusion, the Turkish lira’s rapid decline, the new economic team’s policy choices, and the potential solutions to economic challenges have become crucial considerations. As Turkey navigates these complex circumstances, cautious and precise decision-making is essential to mitigate risks and steer the economy towards stability and growth.
