An overview of basic problems of Turkish economy and remedies suggested

Turkey, a country surrounded by seas on 3 sides and with educated young population, as well as qualified labor force and immense natural resources. A country that would be expected to have taken its place among most developed economies in Europe and the World… However when we look at the real picture we unluckily see this huge country has been experiencing major uninterrupted problems in economy such as high inflation, high interest rates, unemployment problem and devaluation of domestic currency against foreign currencies.

Consequently, these negativities reflect on the economy of citizens and Turkish people cannot improve their life standards. It is no secret that Turks are not happy with the performance of the current administration at all, owing to reasons mentioned above.

(below text is excerpted and translated from article by Mr. Mahfi Eğilmez)

The problem of high inflation and high interest rates

Turkey has had a problem with high inflation for a very long time. The presence of high inflation also leads to high interest rates. The inflation problem is at the top of the economy, unresolved, due to different reasons depending on the period. The main reason for inflation in the last few years is that the TL has experienced a high external depreciation. A significant part of the inputs used in Turkey’s production (capital goods such as raw materials, intermediate goods and machinery equipment) are imported. Therefore, the depreciation of TL against foreign currencies has a negative impact on the cost of these inputs and therefore to the increase of production costs. As production costs rise, these increases are reflected in prices and cause inflation. As the depreciation of the TL shows continuity, inflation also shows continuity. As inflation rises, interest rates rise is inevitable.

The first way to solve this problem would be to prevent the depreciation of the TL. Turkey achieved this in the period 2003-2010, as part of banking reform, ensuring public financial discipline and negotiating full membership with the EU reduced risks and its credit rating rose, the CDS premium fell, the whole economy recovered, the depreciation of the TL was stopped, inflation fell, interest rates fell.

Unemployment Problem

One of the main problems of the Turkish economy after the 2001 crisis was high unemployment. The unemployment rate, which was between 7 and 8 percent until the 2001 crisis, rose to two digits with the crisis and never decelerated to its previous level, moving at the level of 12 to 13 percent. Actually, we’re talking about the official unemployment rate, here. If we consider those not applying for a job for several reasons (just as loss of hopes etc.) we find a rate called the broad unemployment rate, which is about 27 percent. This definition is best suited to the realities of Turkey, that is, the real unemployment rate is 27 percent. This is a very high rate and this problem needs to be solved.

The solution to this problem is to reduce risks and increase production and exports by attracting foreign direct investment to Turkey.

The Problem Of Not Being Able To Grow Without A Deficit

Another long-term problem of the Turkish economy is not being able to grow without a deficit. The Turkish economy can grow by either a budget deficit or a current account deficit. Until the 2001 crisis, the preference was to grow by giving the budget deficit. The preferred choice was leading the growth of the economy by spending more than the public sector income (and borrowing the difference). At that time, budget deficits were about 10 percent of GDP. After the 2001 crisis, action was taken to reduce budget deficits within the framework of public fiscal discipline, and the budget deficits were significantly reduced. In contrast, this time the private sector gave a deficit and began to borrow and the current account deficit rose. As of the end of 2020, Turkey’s budget deficit is 3.5 percent and its current account deficit is 5 percent. In other words, both of the twin deficits have risen above smoothly manageable rates.

This problem is largely caused by the covid-19 outbreak in 2020. However, it seems that this problem will continue at least in the first half of 2021.

High Risk Issue

Turkey is a high-risk country not only economically but also socially and politically. There are two measures that we use to measure the height of risks: the first is the country’s credit valuation, which credit measurement organizations make, and the notes they give accordingly. Turkey is considered a high-risk country in all three institutions as a credit rating.

The second measure is the CDS premium. Turkey’s CDS premium has been over 300 for a long time. Countries with CDS premium under 100 are considered to have low-risk, whereas countries with between 100 to 200 are treated as medium-risk. However countries with 200 – 300 are accepted as high-risk countries and those with over 300 are defined as countries with excessively high risk.

The CDS premium determines the cost of the country’s borrowing papers. The higher the risk, the higher the interest rate turns out to be.

Suggested remedies

So far, Turkey has made attempts to solve these problems by trying to lower inflation, even interest rates, focusing on results as the starting point.. In return for these attempts, sometimes the administrations seemed to get good answers in the short term, and those in charge were mistaken thinking the problem could be solved, this way. This is not a new misconception. Although administrators have changed, the same misconception has been repeated for many years. This misconception stems from the inability of administrators to accept that risk-creating approaches are born out of their own decisions. A short-term decrease in inflation occurred with an approach to go from result to solution, instead of cause. However, these positive results disappeared when the maturity extended. In other words, Turkey could not maintain this positive mood. Because the risks did not disappear or they could not be reduced and in fact they even increased. In other words, it was not possible to solve the cause by going from the result, and the risks were increased.

In an environment where you can’t eliminate or at least reduce risks, solutions are always destined to be temporary. For this reason, Turkey must take steps to remove or reduce risks based on the reason, not the result, in order to achieve a final solution. The way to do this, in turn, can be achieved by steps such as trying to solve problems with neighbors (even making an effort on this path may be enough), improving democracy, and implementing the rule of law. It is very likely that if these steps can be taken, Turkey’s CDS risk premium will seriously decrease. If the risk premium falls, the rapid depreciation of the TL against foreign currencies can be prevented, and therefore inflation can also be controlled. As inflation begins to fall, interest rates also fall.

In a nutshell, most of today’s economic problems are actually caused by an increase in risk caused by non-economic causes. So the solution has to start there.

Editor’s note: A large part of this article was taken from an article published by one of the most reputable economists in Turkey, Mr. Mahfi EGILMEZ. We sincerely thank dearest EGILMEZ for having explained the issue so clearly and painting a very realistic picture of the Turkish economy currently. Original source: mahfiegilmez.com/2021/01/turkiye-ekonomisinin-temel-sorunlar-ve.html