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Can Erdogan's New Powers Help Fix Turkey's Economy?

September 26, 2018 Topic: Security Region: Middle East Blog Brand: Middle East Watch Tags: TurkeyEconomyErdoganPolicyNational Security

Can Erdogan's New Powers Help Fix Turkey's Economy?

Smart policies and quick decisions are needed in Ankara.

Additionally, the new constitution allows for more effective fiscal reforms. Under Turkey’s presidential system, the government budget is drafted by the president (instead of the parliament) and submitted to the parliament for approval. The parliament can no longer impose its own budget law on the executive branch, and if it does not approve the president’s proposed budget, the government is not shut down (which is the case in America). Instead, the government will continue to function under the approved budget of the previous year with an appropriate adjustment for inflation. In the current inflationary environment of Turkey, this new arrangement can have positive consequences if President Erdoğan decides to shrink the budget or increase taxes to reduce the fiscal deficit.

The new presidential system will also give President Erdoğan more power to control the country's massive government bureaucracy. Some budget reduction measures might face resistance not only from ordinary citizens and voters but also from the powerful civil servant and bureaucratic organizations. The military and the civilian government organizations have already experienced a major purge after the failed July 2016 military coup and Erdoğan supporters now fill all key bureaucratic positions. Cutting back the benefits and privileges of civil servants and public enterprise employees will be easier and more effective under the new presidential system. These steps might include a temporary wage and promotion freeze for current government employees and an end to subsidies on goods and services that were exclusively available to employees of some government institutions.

Overall, if President Erdoğan and his team decide to implement any difficult and unpopular measures in response to the current economic crisis, they will have more power to enforce these measures under the new Presidential system in comparison to the previous parliamentary system.

Early Evidence of the Potency of the Presidential System

After waiting for several weeks (since August 10) the Turkish government has finally taken some crucial steps to address the economic crisis. The most significant development was the sharp increase in interest rates by the Turkish Central Bank. On September 14, the Central Bank increased its short-term interest rate from 17.75 percent per year to 24 percent. This 6.25 percent increase was larger than most analysts were anticipating and it caused an immediate 2 percent appreciation in the value of lira against the U.S. dollar.

President Erdoğan reacted negatively to this decision and insisted on his old argument that high-interest rates will not be effective against inflation. He further claimed that this is one of the negative consequences of the Turkish Central Bank’s independence. This comment was meant to assure the president’s base that he does not support this unpopular step and remains consistent in his opposition to high-interest rates.

However, for Turkey’s domestic and foreign investors and creditors, this statement had a mixed message. On the one hand, it was worrisome that the president expressed opposition to a policy that all experts consider an important first step for restoring confidence in Turkey's national currency. On the other hand, it was meant to reassure them that Turkish Central Bank enjoyed significant independence and had no difficulty with defying the President Erdoğan's advice.

But in light of the new Erdoğan’s unprecedented executive power, it is false to interpret the interest rate increase as an indication of Central Bank’s independence and its ability to defy the president. If anything, Erdoğan now has more control over all government agencies that are responsible for economic policy. Only a day before this announcement, for example, President Erdoğan took full control of the country’s sovereign wealth fund by announcing himself as the general director and his son-in-law and finance minister, Berat Albayrak, as the deputy director of the fund. While the central bank enjoyed some degree of independence before the presidential system went into effect, its independence after June 2018 is a result of President Erdoğan's deliberate decision to let it maintain a posture of independence. Furthermore, the behavior of the Central Bank in its previous (July 24) policy meeting, however, demonstrated that it acted in full sensitivity to the priorities of President Erdoğan. For instance, ahead of that meeting, most experts anticipated that the central bank would raise the short-term interest rates to combat the weakening of lira. To everyone’s surprise, the bank left the rate unchanged, and this inaction let to a further weakening of lira in the days that followed.

Therefore, the Central Bank’s September 14 decision to sharply increase interest rates represents a significant shift in President Erdoğan’s policy priorities. It appears that in light of the severity of the crisis he has finally accepted that fighting inflationary expectations and restoring investor confidence in Turkish Lira must take priority over any concerns about preserving economic growth.

The credit for changing President Erdoğan’s mind about interest rates goes to his son-in-law, Mr. Albayrak. Recent statements by Albayrak, who is the head of president’s economic team, indicate his strong commitment to a robust anti-inflationary response. It now appears that he has finally convinced Erdoğan that raising interest rates and taking other strong measures against inflation and fiscal deficits, is the only viable option for avoiding an economic meltdown and must take priority over other economic objectives.

Bold Fiscal Steps

In addition to raising interest rates, the Turkish government has announced several necessary steps in recent weeks to show its commitment to restoring the fiscal balance. President Erdoğan who has developed a reputation for initiation a large number of public sector mega-projects, issued a decree on September 14 to freeze all public sector investment projects that are less than 70 percent complete. This will allow the government to achieve considerable fiscal savings by freezing many projects that are in early stages of implementation. Further cost-saving steps include a reduction in public organizations’ car-transport budget and a significant decrease in their occupancy of rental properties.

Albayrak has also provided some early information on the government’s medium-term economic program, which is scheduled for release in late September. Based on his comments there will be a substantial shift toward reduction of government expenditures and budget deficit. Furthermore, to stabilize the economy, the most substantial fiscal saving steps are scheduled for 2019 with a deficit target of under 1.5 percent of GDP. Since the government announced a similar program last year—which did not lead to economic stability—many observers might be skeptical about the government's ability and commitment to this updated program. However, this updated program has a better chance of being implemented because there seems to be a consensus among President Erdoğan and his economic team about the severity of the current crisis, and he now has sufficient executive power to implement deep reforms.

It is in the implementation phase of these spending cuts that the vast powers of the presidency and the executive branch will become crucial. The government is likely to face considerable populist pressure against these measures in the near term. Furthermore, unless the burden of these economic sacrifices is distributed in a fair and transparent manner, perceptions of corruption and nepotism could cause resentment and social unrest.

As significant as these fiscal steps are the Turkish government is yet to announce how it is going to prevent a default on Turkish firms’ large external debt in the next twelve months. There is no guarantee that the monetary and fiscal steps that have been initiated in recent weeks will be sufficient to restore confidence in Turkey’s ability to service its debt. The inevitable economic recession in 2019 will also reduce the revenue potential of may heavily-indebted firms. Consequently, it is likely that Turkey might have to ask the International Monetary Fund for assistance—something that President Erdoğan and Mr. Albayrak have so far firmly rejected. Yet even in any potential negotiations with the IMF, the new executive powers of President Erdoğan will make a crucial difference. If it turns out that Turkey needs substantial short-term assistance—perhaps in the range of $50 to $100 billion—then it is likely the IMF will demand even deeper fiscal and monetary reforms than what Turkish government has announced in recent weeks. In this case, the Turkish government will find it easier to withstand the strong domestic criticism and resistance that implementations of IMF demands are likely to cause.

A Word of Caution

While the new presidential system will make the Turkish government more effective in dealing with the current economic crisis, democratic freedoms—particularly freedom of information, journalism, speech, and debate—are also essential. These freedoms allow people and experts to detect the shortcomings and abuses of the stabilization program. They also provide a channel for opposition parties and independent experts to communicate their suggestions and concerns about economic policies to the government and the citizens.

The adherence of the Turkish government to these freedoms and other democratic institutions would also be reassuring to international and domestic investors about the transparency of the economic and financial systems. They also play a crucial role in preventing corruption and crony capitalism, which have frequently undermined economic reforms in emerging market countries. For instance, the vital role of democracy and the rule of law for the long-term economic progress of Turkey were articulated recently by the prominent economist Daron Acemoglu.