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Turkey’s Economy Under the Justice and Development Party

At the start of the 21st century, the Justice and Development Party (AKP) in Turkey rose to power on the promise of economic stability and re-alignment with Western democracies and financial institutions.

The February 2001 financial crisis—arguably the biggest economic downturn in Turkish history—began as a banking crisis and led to the closure of thousands of businesses, with millions of Turkish citizens unemployed. Then Deputy Prime Minister responsible for the Economy, Kemal Dervis, implemented an economic program that called for tight monetary policy and structural regulations to reduce inflation. Dervis established fiscal discipline, secured the support of the World Bank and IMF, and introduced reforms that secured the independence of the Turkish central bank from political developments.

From 2002 to 2013, the Turkish economy grew rapidly: inflation decreased from 30% to 6%, and billions of dollars of foreign capital flowed into the country. During this time, Turkish institutions grew closer to the European Union, and the resulting economic stability and opportunity caused the country’s economy to grow at an annual rate of 7.2% between 2002 and 2007, weathering the 2008 financial crisis, and returning to growth again 2010. During Dervis’ stabilization period, per capita income rose from 3,581 dollars to 12,480 dollars. Dollarization rates—the rates at which people in Turkey protect their savings by purchasing foreign currency and gold—fell to 29.7%, the lowest the country had seen in 20 years.

By contrast, as of September 2022, the dollarization rate in Turkey has reached 70%–the highest in the country’s history.

These dollarization rates—which began to rise again in 2015, a year after Erdoğan became president—represent a larger economic decline that has marked the second half of Erdoğan’s time in power. In 2013, Turkey had a gross national product of 951 billion dollars. The IMF predicts that this number will have shrunk to 692 billion dollars by the end of 2022. 1 The consequences of this downturn are serious: for the first time, Turkey’s place in the G-20 is at risk.

Erdoğan’s volatile presidency has discouraged foreign direct investment for a number of reasons: his party’s lack of oversight for financial crimes, and the extremely corrupt nature of Turkey’s economy has led to Turkey’s placement on the Financial Action Task Force’s “grey list” of countries who are particularly risky because of rampant money laundering and terrorist financing with little to no oversight or enforcement.

The End of the Central Bank’s Independence

The single most urgent issue facing Turkish citizens, however, is Erdoğan’s unprecedented and complete control of the Central Bank. As inflation soars, the Bank continues to cut rates as it follows Erdoğan’s cues. According to official figures, inflation reached 83.45% in September.2 The Bank nevertheless lowered the policy rate by 100 basis points to 13% in August, and then again to 12% in September.

On September 28, Erdoğan made a public statement: “The interest rate has decreased to 12 percent and will go down from now on.” 3 The public has every reason to believe that this will result in even more rate cuts, and ever higher inflation, because the Central Bank has ceased to function as an independent body.

Between 1931 when it was established and 2016, Turkey’s Central Bank was managed by 21 different presidents with an average tenure of 3.9 years. During Erdoğan’s time as prime minister (2003-2014), two men served as president of the central bank. During Erdoğan’s tenure as president, five men have held the position. Erdem Başçı, who took office in 2011, completed his term in April 2016. After Başçı, 4 different men–Murat Çetinkaya, Murat Uysal, Naci Ağbal, and Şahap Kavcıoğlu–have been appointed to this position in the last 6 years. Kavcıoğlu, who was appointed in March 2021, defends Erdoğan’s unorthodox interest rate theories and has remained in office.

Although Central Bank Law has not been changed and the bank maintains its autonomous structure on paper, President Erdoğan has effectively taken over the bank’s management. This has been facilitated by the aftermath of the 2016 coup attempt, during which Erdoğan purged most of Turkish civil society. With the help of intelligence and security forces, the Turkish president eviscerated Turkey’s free press and independent judiciary, but he also took aim at economic freedom. Shortly after the coup, Erdoğan accused the Central Bank’s employees of “terrorism” and a “coup plot.”4 Hundreds of economists from Turkey’s best universities were subsequently fired and then arbitrarily arrested.

To further cement his economic rule and legitimize his unorthodox economic theories, Turkey’s president has also taken control of the country’s traditional economic institutions. Erdoğan has changed the president of the Turkish Statistical Institute four times in the last three years. 5 Furthermore, the Institute has altered its calculation method several times in the last six years, resulting in a false picture of falling unemployment, a growing economy, and inflation rates that are actually lower than they are in reality. As a result, 94% of the Turkish people do not believe the data announced by the Turkish Statistical Institute. 6 For this reason, independent economists have established an organization called the Inflation Research Group (ENAG) in order to share accurate information with the public. According to the Turkish Statistical Institute data, September inflation was 83.45%, but ENAG experts calculated it as 186%. 7 Several economists who reported on these issues—including the head of ENAG—have been investigated and faced disciplinary action at their places of work.

As President Erdoğan’s corrosive executive branch silences dissent and lies to the public about the country’s economic reality, the Turkish Central Bank has lost nearly all credibility. Press conferences, meeting minutes, and statements by the money market board are no longer considered important by investors. This is because Erdoğan’s presidency—and especially the new presidential system he has implemented—has transformed central bank bureaucracy into an operator that implements the President’s orders.

The Effects of Central Bank Policies on the Turkish Economy

In the fall of 2021, after Erdoğan’s statements, the Central Bank cut interest rates by 500 basis points from 19% to 14%. Following this decision, the lira depreciated by 44% – the second most depreciated currency in the world last year after the Argentine peso. In 2022, after the 200 basis point rate cuts, the Turkish lira became the fifth most devalued currency in the world, with inflation reaching its highest levels—even by the government’s inaccurate figures—in 25 years.

At the start of the Russia-Ukraine War, most central banks around the world increased interest rates to reduce inflation. The Fed, for example, raised interest rates by 300 basis points to 3.25% this year. In the same period, the European Central Bank increased the interest rates by 125 basis points to 1.25. The British and Swiss Central Banks followed suit, raising interest rates to 2.25 and 0.50, respectively.

In an atmosphere where the US Federal Reserve (Fed) and the European Central Bank (ECB) are aggressively raising interest rates to combat inflation, Turkey’s Central Bank makes decisions according to Erdoğan’s orders and directives, not according to market conditions.

The Turkish central bank is the only central bank in the world that has lowered interest rates despite having negative reserves, and it has announced that it will continue to do so. After more rate cuts throughout 2022, the Turkish lira has become the 5th most rapidly deprecating currency in the world, and some economists list it among the countries at the highest risk of bankruptcy. 8

The Currency Board Solution

A currency board is the only way to protect Turkey’s currency from Turkey’s president.

Steve Hanke, economist at Johns Hopkins University and a proponent of currency boards in Turkey as well as several other countries, has described the process by which a currency board can function independently of a country’s government:

An orthodox currency board issues notes and coins convertible on demand into a foreign anchor currency at a fixed rate of exchange. As reserves, it holds low-risk, interest-bearing bonds denominated in the anchor currency and typically some gold. The reserve levels (both floors and ceilings) are set by law and are equal to 100%, or slightly more, of its monetary liabilities (notes, coins, and, if permitted, deposits).

By design, a currency board has no discretionary monetary powers and cannot engage in the fiduciary issue of money. It has an exchange rate policy (the exchange rate is fixed) but no monetary policy. A currency board’s operations are passive and automatic. The sole function of a currency board is to exchange the domestic currency it issues for an anchor currency at a fixed rate. Consequently, the amount of domestic currency in circulation is determined solely by market forces, namely the demand for domestic currency. Since the domestic currency issued via a currency board is a clone of its anchor currency, a currency board country is part of an anchor currency country’s unified currency area. 9

Currency boards have been effective in countries where the central bank lacks independence, has extremely low credibility, and/or does not work effectively. They have been implemented in Hong Kong, Argentina, Estonia, Lithuania, Bosnia-Herzegovina, Bulgaria, and several other countries with generally positive results. In fact, the only currency board in history that has failed was instituted in Argentina at the turn of the 21st century, and Argentina’s system was not an orthodox currency board because it had the authority to engage in discretionary monetary policy.

The aggressive use of monetary policy for political gain is precisely the problem in Turkey, and a currency board would give the Turkish lira much needed economic independence from the meddling of the executive branch. It is the most efficient and effective way to overcome Turkey’s inflation problem.

Furthermore, per Steve Hanke, “A currency board requires no preconditions and can be installed rapidly. Government finances, state-owned enterprises, and trade need not be reformed before a currency board can issue money.” 10

Source: Hanke (2002), “Currency Boards,” The Annals for the American Academy

The lessons of the 2001 Financial Crisis will make the Turkish people open to the potential reforms made possible by an orthodox currency board. After suffering under high inflation throughout the 90s and culminating in the 2001 crisis, Turks saw the positive effects of apolitical economic reform. On becoming Deputy Prime Minister in Charge of the Economy, Kemal Dervis assumed a supra-political position to implement reforms—and brought inflation down from 70% to 30%. Erdoğan and the AKP themselves followed this prescription until 2012, and with it they saw serious success.

Given the country’s current volatile political climate, if a currency board must make its aims clear to the public—namely that it exists to fight inflation and will focus on that goal only—we believe that it will garner huge support from voters. Politicians should outline the many potential benefits of instituting a currency board, and the board itself should make it clear that it is above politics, that it does not focus on any interests other than the interests of the country, that it will act within its purview as determined by law, and that its main purpose is to create a set of rules.

Ultimately, Turkey has a strong banking system that will provide a great advantage to the currency board system. Asset size and structure, as well as capital adequacy, are of great importance to the currency board system. The total size of the Turkish banking sector is 694 billion dollars, which corresponds to 121% of the GDP. 11 The capital structure of Turkish banks is strong and their profitability ratio is high. Banks made a net profit of 14 billion dollars in the first 8 months of this year and doubled their profits in dollar terms. 12

If Turkey could solve the myriad economic problems caused by exchange rate uncertainty, it would increase international trade. It would also increase credibility, which could lead to a decrease in inflation rates and a convergence of the interest rate level to the reserve country’s level. The decrease in interest rates would also lead to an increase in domestic savings and private investments, leading to greater economic growth overall.

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