The time bomb of the Turkish economy: explosion and fallout

(To Andrea Gaspardo, Paolo Silvagni)
22/12/21

In our previous analysis entitled: "The time bomb of the Turkish economy", published in Difesa Online on August 18, 2020 (v.articolo), we have described the latent ailments that have accumulated in the Turkish economy in the last 15-20 years, in particular the excessive use of the practice of "post-dated checks", describing in detail how this peculiarity of the Turkish economy has benefited the country-system until 2015-2016, while it began to create problems in the last five years, when the Turkish lira accelerated its progressive depreciation against the main world currencies (primarily the dollar and the euro).

We also argued that this situation has tied the Turkish government hand and foot to the impossibility of letting the Turkish Central Bank implement the only strategy capable of countering the progressive depreciation of the country's currency; that is, raising interest rates to a level sufficient to stabilize the currency.

Finally, in our previous analysis we analyzed four possible scenarios available to Erdoğan's government to deal with the storm, correctly discarding the first three, that is the request for direct aid to the International Monetary Fund, the possibility of a "state to state" loan to other world powers, and the blocking of the international convertibility of the Turkish lira. In fact, none of these three scenarios materialized. On the other hand, the forecasts relating to the fourth scenario turned out to be correct, consisting of an increasing diplomatic and military assertiveness at international level in all geopolitical scenarios in which Turkey has a national interest, combined with an increasing use of reckless financial operations.

Well, on the geopolitical front already starting from 27 September 2020 the whole world has witnessed the outbreak of a real war between Armenia and Azerbaijan for the control of the Nagorno-Karabakh region (Artsakh for the Armenians), a war that in 44 days was resolved with a full victory for the Azeris thanks to the decisive logistical and military support of Turkey.

Furthermore, on October 18, 2020 in the second round of the presidential elections in the Turkish Republic of Northern Cyprus (an entity recognized only by the Republic of Turkey), challenger Ersin Tatar defeated outgoing president Mustafa Akıncı. The electoral campaign was marked by several complaints by the outgoing president Akıncı of having received threats from the Turkish side, as well as by not too veiled initiatives by subjects attributable to the Ankara government to have actively supported Tatar. The new Turkish Cypriot president is in fact a staunch supporter of the so-called "two-state solution" for Cyprus, a position that Turkey likes but is opposed by the European Union, the United Nations and international diplomacy in general.

Turkey has also accelerated its strategy aimed at guaranteeing a military and geopolitical projection far beyond simple regional contexts, so much so that today the Ankara military has established, or is about to establish, stable bases in no less than 10 countries : Syria, Iraq, Qatar, Azerbaijan, Libya, Somalia, Cyprus, Kosovo, Albania and Bosnia-Herzegovina. It should be noted that while the Turkish presence in some of the countries mentioned above takes place in a perfectly legal manner, that in Syria, Iraq, Libya and Cyprus it is completely illegal under any rule of international law (as far as international law may actually be valid in the complicated historical era in which we are living).

We also point out that, filtering the Turkish geopolitical and military strategy through the exclusive prism of our country's national interests, the Turkish presence in Somalia, Libya, Cyprus, Kosovo, Bosnia-Herzegovina and, above all, Albania, represents a concrete threat to national security. of the Italian Republic.

However, this Turkish activism in the various geopolitical scenarios in which the Anatolian state believes it has a national interest to defend may have served to galvanize the support of the electoral base that supports Erdoğan's government, but certainly could not solve the real problems of the Turkish economy, which instead continued to worsen. On the economic-monetary side, in fact, from summer 2020 until today, President Erdoğan could not help but continue to exert very strong pressure on the Turkish Central Bank (Türkiye Cumhuriyet Merkez Bankası - TCMB) so that it could continue to faithfully implement its desired, even with sudden changes at the top if necessary.

If in most countries of the world it is absolutely normal for a Governor of the Central Bank (an institution normally independent of political power, as opposed to what happens in the Anatolian country) to remain in office for a period of at least 4 years or more, in Turkey the president-sultan changed 4 Governors in 3 years: on 6 July 2019 the 22nd Governor of the Turkish Central Bank, Murat Çetinkaya, was sacked in favor of Murat Uysal, who then had to give his place to Naci Ağbal on the 7th November 2020, in turn "fired" on March 20, 2021 in favor of Şahap Kavcıoğlu.

It can certainly be argued that each of these changes was made with the aim of replacing competent personalities at the top of the monetary authority with others increasingly prone to carry out the will of the president, which is not to increase interest rates on the Turkish lira at levels adequate to maintain currency and price stability, not even in the face of scenarios of ever more rapid depreciation and increasing inflation.

If at 31 December 2018 to buy 1 euro you needed 6,05 Turkish lira, and at 31 December 2019 you needed 6,66, at 31 December 2020 you needed 9,09. The depreciation accelerated further this year as the exchange rate reached 10,39 as of June 30 and 11,44 as of November 15 (Bloomberg data). (A small note from the authors: although the world of international finance is used to tracking the exchange of any currency in the world - including the Turkish lira - against the US dollar, those who write prefer to monitor the exchange rate of the lira against the euro, since European countries account for the lion's share of Turkey's international trade).

While it can be argued that the depreciation of the lira is a secondary problem for Erdoğan, given that it still improves the competitiveness of the manufacturing exports of the “Sublime Porte”, the same cannot be said for inflation. In fact, excessive inflation (where excessive is understood to be higher than nominal interest rates) represents a mortal danger for the Ankara banking system, as it could induce citizens and businesses to pour the uncontrolled mountain of post-consumer checks into banks. dated that we talked about in our previous analysis. If in the three golden years of the "Anatolian tiger", ie from 2004 to 2016 inclusive, annual inflation in Turkey has always remained stable and between 6% and 10% (except in 2008, when it settled to 10.44% due to the surge in the international price of oil), from 2017 to 2020 inclusive it increased and settled every year in a range between 11% and 16% (World Bank data).

Although higher, in the last four years inflation has certainly worried those, among the officials of the Turkish government and Central Bank, who have long advocated a more orthodox approach to monetary policy, but certainly not President Erdoğan, who has imposed the substantial maintenance of the route.

However, in the course of 2021, inflation also underwent an indigestible surge for the president, going from 14,97% in January 2021, to 17,53% in June, to 19,89% in October until 21,31. % of November (Turkish Central Bank data, comparison with the same month of the previous year).

Having exceeded the psychological threshold of 20%, the president-sultan must have understood that it was no longer possible to maintain the line as if nothing had happened, and he decided that it was time to do something.

And here in the last month, our prediction according to which Erdoğan would continue "To use the already consumed mix of propaganda shots and reckless financial operations" it confirmed itself beyond our imaginations.

The salient events of the last month can be summarized as follows:

- December 2 2021 Finance Minister Lutfi Elvan, considered the last supporter in the chambers of Turkish power of a minimally "orthodox" economic policy, resigned and was replaced by Nureddin Nebati, a staunch supporter of the policy of low interest rates. After taking office, Nebati stated on his Twitter profile that while the pursuit of a low rate policy has met with strong opposition in the past, "This time we are determined to implement it";

- December 8 2021, after a meeting of the presidential cabinet, Erdoğan released a statement on the new course in economics during which he said: “We know what we are doing. We know how to do it. We know where we are going. We know what we will get ". Interesting from this point of view is the parallelism that economic historians could draw with the words spoken in 1928 by António de Oliveira Salazar when he took power in Portugal ("I know very well what I am doing and where I am going") . However, Salazar was one of the greatest economists of his time and, to stabilize the Portuguese currency, he used all the tools of classical monetary economic policy (drastic reduction of wages, massive cut in public spending and increase in taxes). One wonders what he would look like today at the thought of what Erdoğan is doing;

- December 16 2021 President Erdoğan announces a further cut in interest rates by 100 basis points, together with a 50% increase in the minimum wage in Turkey starting January 2022, 50, the highest increase in the last 30 years. In memory of the authors, the only country in the world that tried to do such a thing, at least in the last 2009 years, was North Korea with its clumsy reform of the North Korean Won which caused a brief but potentially devastating situation of chaos in North Korea in XNUMX.

It can therefore be understood - especially from the double move on Thursday 16 December - how the president-sultan wanted to take the bull by the horns, and address all the economic problems of his country, which have accumulated over the course of 20 years, in the most unscrupulous of ways. : intentionally causing an "explosion" of an inflation-devaluation spiral that can no longer be controlled.

To understand why President Erdoğan wanted to implement a policy that at first sight may seem crazy, at the cost of boring the reader, it is necessary to make a brief digression and recall some fundamental changes that have occurred in the economy and in global trade as a consequence of the COVID-19 pandemic.

First, the abrupt closure of China in early 2020, which was followed by the closure of virtually the rest of the world in the spring of that year, completely engulfed the ocean-going commercial shipping sector as 2 years now there is a chronic shortage of empty containers "at the right port at the right time" and there is total uncertainty about the routes of transoceanic ships and the ports in which they will be able to call. As a result, the cost of a container for a one-way Asia-Europe journey has now increased tenfold compared to pre-COVID times (source: The Economist). Furthermore, the timing of this trip has at least doubled, and is characterized by absolute uncertainty.

Secondly, the "zero COVID" policy pursued by the Chinese authorities (and to a lesser extent by other Asian manufacturing powers such as Vietnam) has effectively resulted in the hermetic closure of the borders of the People's Republic of China (and some other Asian nations) to all foreign visitors for two years now, as well as the drastic and unpredictable implementation of lockdown as extensive as they are indefinite in duration, even if only for an officially very small number of infections.

A few weeks ago the Chinese government also clarified that both the "zero COVID" policy and the closure of the borders will continue at least throughout 2022. As a result, all businessmen, technicians and workers who until 2019 regularly went to I work in the country that for over 20 years has represented the true “factory of the world”, for the third consecutive year they will be physically unable to supervise their own productions. Furthermore, for the third consecutive year, Chinese and other Asian export production will most likely be subject to absolutely unpredictable production and delivery delays.

The result of both the phenomena described is that an increasing number of European and American companies from every manufacturing sector are now seriously working to shorten their production supply chain geographically. In particular, for European companies this means replacing production in China and the Far East with supplies in countries characterized by low labor costs located geographically closer to Europe, which essentially means North Africa, Eastern Europe and (see case !!) Turkey.

Once we have clarified these epochal changes that are taking place in global trade, we can now try to understand what is the "expected fallout" from President Erdoğan with respect to this "intentional explosion" of the inflation-devaluation spiral:

- the Turkish lira, which was on the edge of the ravine a month ago, has taken the step forward. If (as already mentioned) on 15 November it changed to 11,44 against the euro, at the close of last Friday 17 December 2021 the exchange rate stood at 18,68 which means a loss of about a third of the value in just one month. (and half in less than a year). Everything suggests that this is only the beginning of a very deep abyss;

- the cost of living is destined to get out of hand, both due to the devaluation and the colossal increase in minimum wages. Already in the coming weeks, Turkey will be in a situation of hyperinflation;

- devaluation and hyperinflation will waste paper from the mountain of post-dated checks denominated in Turkish lira and accumulated at all levels of the economy over the past 20 years, solving the problem once and for all;

- Turkish companies will stay afloat, as they will take advantage of the collapse in wages in real terms, and for some months they have been flooded with rivers of orders and orders from European customers who have to replace Asian productions. Furthermore, in order to operate in this context, Turkish companies must necessarily require their customers (international or Turkish) to pay in advance and in foreign currency;

- this will lead to a brutal consolidation of the balance sheets of Turkish companies, especially as regards working capital, given that very long payments and post-dated checks of a very short time ago suddenly switch to advance payments and in foreign currency;

- the salaried population and pensioners will be the real victims of this situation, given that they will suffer a vertical collapse of purchasing power and therefore a general impoverishment. The government will count on being able to keep the population at bay with increases in salaries and pensions that are as frequent as they are generous, but which will not fully compensate for the loss of purchasing power.

- the productive bourgeoisie and the elites will not suffer that much, since they are already used to keeping a considerable share of their savings in hard currency (primarily US dollars and euros).

It is of fundamental importance to note that the "anti-atomic refuge" on which the Erdoğan government truly relies in anticipation of events is the solidity of the banking system, or the belief that the "de facto dollarization" of the Turkish economy just described (or "Heurisation" if the reader of Defense Online allows us this neologism) will not lead to a flight of capital from Turkish banks to foreign countries. The hope is that the production system, which given the context will immediately have to operate only in dollars or euros, will keep the dollars and euros deposited with Turkish banks. Alternatively, it is expected that those foreign currency deposits that a part of the productive bourgeoisie will want to move to other shores for safety will be more than offset by the incoming hard currency flows, expected for example by all those European investors, but above all Russian, who for a few weeks they have already set their sights on villas and apartments in all Turkish holiday resorts, now on sale at discount prices.

A situation of limited importance but which gives the idea is the incredible reversal of the parts from Dante's circle that has been taking place for a few days along the Bulgarian-Turkish border. In fact, for a few days now the inhabitants of the normally impoverished regions of south-east Bulgaria have been keeping the fortunes of the shopkeepers and shopkeepers in the city of Edirne rosy, making purchases (in Turkish lira) regardless of expenses.

However, we must not think that more properly economic-financial actions represent the only "weapons" that Erdoğan will use in his "Jihad" for the survival of his regime. As already happened in the past, all the initiatives of the "Reis" were anticipated by the usual media drum for internal use and consumption aimed at representing Turkey for the umpteenth time as a "victim of an international conspiracy" caused by the inevitable Americans, Europeans, Russians, Jews and Freemasons and the need on the part of the nation to make a square around the "sacred defense of the fatherland".

On the geopolitical front, rumors have been running for weeks about the beginning of a new Turkish offensive in Syrian soil that would target both the Kurdish militias allied to the West and the forces loyal to President Assad. It is interesting to note that while at the beginning of the crisis the parties in the field gave the start of the Turkish operation as imminent, and the preparations on the ground were clearly taking place in front of the telecoms from all over the world, it seems that now the Turks are niching and postponing the start of their "next shot". The reason could be the possible outbreak of the much feared war between Russia and Ukraine, which has also been prominent in this last period on the pages of the media all over the world. If such a catastrophic confrontation were to take place, it would be a boon for Ankara because it would guarantee them the possibility of supporting Kiev in the light of day and being able to intervene with impunity in Syria without either Russia or the West being able to do anything.

In the same period, the Turkish air forces, in particular the drones, were particularly involved in Iraq and carried out a series of high-profile targeted killings against some political and military leaders not only of the PKK but also of the "Êzîdxan Protection Force ", the" Sinjar Resistance Units "and the" Êzîdxan Women's Units ", all military formations of the Iraqi Yazidis accused by Ankara of being nothing more than the" emanations of the PKK "and which have the" sin "of defending the territory of the yazidi located on Mount Sinjar, a strategic importance that has been tempting the geopolitical ambitions of Ankara for a long time.

We must not forget the latest shocks of the troubled internal Libyan events, with the recent cancellation of the presidential elections scheduled for the end of 2021 due to the umpteenth act of force of the militias supported in a hidden or open way by Turkey, which would have everything to lose if the winner of the electoral round were to be Saif al-Islam Muammar al-Gaddafi son of the late dictator Muammar Muhammad Abu Minyar al-Gaddafi killed in the course of the civil war that broke out in the country in 2011 and is still ongoing.

On balance, therefore, it is very likely that Turkey will be pushed to engineer another of its "blows" in one of the aforementioned geopolitical theaters in the course of 2022, perhaps already in the first months.

In conclusion, we can say that if Erdoğan's government got it wrong, and in the coming months we will see a loss of confidence in the banking system by Turkish economic operators with consequent flight of capital from national banks to foreign countries, then the spiral of inflation -devaluation will convert to one system crisis with outcomes as devastating as they are unpredictable both on the front of the internal political stability of the Republic of Turkey and on the front of the international financial markets. Given the relative strength of Turkish banks, as well as the degree of control that the president-sultan exercises over the main ganglia of the economy, this scenario is currently unlikely.

If, on the other hand, Erdoğan's government has guessed its unscrupulous bet, it is easy to hypothesize that within a few years the Turkish lira will be reformed as after the 2001 crisis, the zeros that must be eliminated will be eliminated and an orthodox monetary policy will return. . European companies looking for low-cost industrial supplies close to home, faced with the instability of North Africa, the shortage of labor in Central-Eastern European countries and endemic corruption in the former Soviet countries, will instead find in Turkey a country with relatively low taxation and a young and large workforce at a very low cost of labor and above all, 48 hours of land transport from Western Europe. The economy will start running again, and it is not excluded that someone will speak of "awakening the Anatolian tiger".

The result? A more industrialized Turkey, an increasingly essential link in the industrial supply chains of Europe, and consequently stronger also on a political and diplomatic level.

We therefore traced two possible developments for Turkey, one negative (in the event of a banking crisis) and one positive (in the absence of it). How will things really go in the coming months and years? We would like to foresee, as always, a middle ground between the two extreme scenarios. In medio stat virtus.

Photo: Türk Silahlı Kuvvetleri / AZERTAC / presidency of the republic of Turkey / web / Xinhua / Online Defense