Interest hike aimed to address persistent monetary crisis but unlikely to prevent Turkey’s economic slow-down

This section is an extract from Le Beck's Weekly Security Brief that provides in-depth insight on more strategic issues affecting the MENA region.

Following months of anticipation and disappointment among foreign investors who expected the Turkish Central Bank to finally increase interest rates in response to the growing devaluation of the Lira, the financial institution finally did so, raising interest rates from 17.75% to 24% and leading to a notable increase in the value of the Lira against the US Dollar (USD). Still, concerns regarding the long-term ability of the Central Bank to fend off growing political pressure by President Recep Tayyip Erdogan were highlighted by a slight decrease in value during a speech by the Turkish leader, during which he highlighted his continued opposition to high interests rates and despite his claim that the Central Bank was acting independently.

Indeed, while the Lira did rally in the wake of the interest rate hike, the move is unlikely to fully dissipate these broader concerns over the Central Bank’s ability to act independently and disregard Erdogan’s calls to maintain lower interest rates (despite the fact that such hikes are a standard practice by any other country when in a similar situation). Doubts as to the sustainability of the growth rates and other monetary factors have already affected multiple emerging economies, including Argentina, Russia, and South Africa, yet additional Turkey-specific factors have contributed to growing concerns regarding the country’s economic stability and ability to tackle its increasing monetary instability. On multiple occasions, interest rate hikes were expected yet failed to materialise, in a development seen as the consequence of Erdogan’s opposition to the move and tighter grip on all of the country’s public bodies.

In this context, higher interest rates go against Erdogan’s overall growth strategy that is based on low-interest rate growth fueling multiple large-scale development projects, particularly in the real-estate sector. Over the past years, dozens of new real-estate projects, including modern high-rises, were fast-tracked largely due to the ability to receive loans at low interest rates. The increase in this rate, therefore, is sure to undermine such a model, while other factors are also playing a significant role in slowing down the pace of Turkish economic growth.

These factors, which meant that an economic slowdown was likely to occur regardless of interest rates, along with the diplomatic row between Turkey and the US that has exacerbated the existing economic crisis, may, in fact, have pushed Erdogan to finally allow the Central Bank take action despite his opposition to such a move. Economically, the interest rate hike may have been deemed inevitable, given the collapse of the Lira and the fact that Turkey explored multiple other options in vain. Politically, Erdogan can also still claim that the Central Bank is independent, which serves two potential purposes: One, to reassure foreign markets (although they are liable to remain sceptical) and two, to blame the Central Bank, purported to still be acting independently, for any alleged consequences of the interest rate hike.