Turkey’s economic woes catch up with Erdoğan
A cost of living crisis and social unrest are throwing the strongman leader’s plan to stay in power into jeopardy
John Paul Rathbone in Istanbul
© FT montage/Getty ImagesTarkan Özbudak is feeling glum.
For most of his life, he has made a good living in Istanbul’s Grand Bazaar.
But now, sitting outside his shop’s display of fine Iznik ceramics, he complains that business is “dismal”.
“Everyone is struggling,” says the 55-year-old, gesturing at the other stores that line the vaulted arcades of the over 500-year-old bazaar.
“The only companies making money are the big ones.”
Yet Turkey’s large businesses are doing no better.
Almost a third of the country’s 500 largest groups made an operating loss last year, according to the Istanbul Chamber of Industry.
Unemployment is rising nationally.
Bankruptcies are edging up.
Companies have warned of mounting distress across entire sectors.
Even some of the country’s mental health professionals have given up hope.
“I may emigrate,” says Gülsüme Oğuz, a clinical psychologist.
“My usual white-collar clients can’t afford regular sessions anymore, and I can’t afford the rent.”
The conclusion is obvious: Turkey’s economy, once tipped to repeat the success of South Korea’s transformation, is in a rut.
The proximate reason is a stabilisation programme put in place almost two years ago by finance minister Mehmet Şimşek, a former Merrill Lynch banker.
His mission has been to pull back Turkey’s $1.3tn economy from the brink of hyperinflation and a balance of payments crisis largely brought about by the ultra-low interest rate growth policies previously favoured by President Recep Tayyip Erdoğan.
As recently as February, the new approach seemed to be working.
Even Erdoğan appeared to be fully committed to the plan’s orthodox mix of ultra-high interest rates and tighter government spending, despite the toll it took on his popularity.
Inflation had almost halved to 40 per cent from 75 per cent a year ago.
Although still uncomfortably high, that drop had allowed the central bank to start cutting rates.
Adding to the sense of better times, Erdoğan’s international stature was growing.
He was being flattered by US President Donald Trump and courted by Europe for Turkey’s military might, which includes Nato’s second biggest army, as a bulwark against Russian revanchism and Middle East instability.
But then domestic politics intervened.
On March 19, the arrest on corruption charges of Erdoğan’s biggest political rival, Istanbul mayor and opposition presidential candidate Ekrem İmamoğlu, sparked mass street protests and a financial panic that forced the central bank to increase interest rates again and burn through foreign reserves to stabilise the currency.
The country is now struggling with the bitter aftermath of that episode.
Foreign companies have reconsidered investment plans.
Portfolio investors have headed for the exit.
The tough measures needed to stabilise markets and keep inflation down — commercial lending rates have risen to a historic high of 60 per cent — have set back economic recovery, prolonging Turkey’s cost of living crisis.
Israel’s 12-day war on Iran, which prompted fears of a massive influx of refugees from Turkey’s neighbour, was just the latest reminder of the region’s fragility.
Protesters in Istanbul rally against the arrest of Ekrem İmamoğlu. The presidential candidate’s detention sparked demonstrations and led to a financial panic that forced the central bank to increase interest rates and burn through foreign reserves to stabilise the lira © Kemal Aslan/AFP/Getty Images
Turkey’s economic doldrums have drained Erdoğan’s popular support, jeopardising his plans to remain in power, his geopolitical aspirations for the country, and ongoing peace talks with Kurdish militants that had been at war with the Turkish state for over 40 years.
According to most polls, Erdoğan would lose handily to İmamoğlu if an election — currently scheduled for 2028 — were held tomorrow.
Harder economic times have meanwhile led to periodic rumours that Erdoğan might abandon the reform programme and even fire Şimşek and the central bank’s new governor, Fatih Karahan, a former New York Federal Reserve economist.
If that happened Turkish markets would be in meltdown, economists say.
“Many people don’t think that Turkish domestic politics are very interesting.
Basically, they think that Erdoğan always wins, the opposition will lose, and a lot of complicated things happen in between,” says Selim Koru, an analyst at the Ankara-based think-tank Tepav and author of New Turkey and the Far Right.
“But if that’s your approach, you’re going to get blindsided at some point.”
It was in September 2023 that Erdoğan unveiled his government’s break from the unorthodox policies that he had long believed in.
The 71-year-old strongman president, who had previously called interest rates “the mother and father of evil”, announced to the country that “with the help of tight monetary policy, we will bring inflation back down to single digits”.
It was a late switch to orthodoxy by Erdoğan, a pious Muslim whose economic beliefs are grounded in the 1970s when Turkey was a closed economy.
Then, many believed that the best way to beat inflation was to increase the supply of goods by boosting investment via cheap credit.
For many years, Erdoğanomics delivered on that premise.
Real interest rates, which subtract inflation from central bank policy rates, have been negative for a remarkable 13 of the 22 years that Erdoğan has been in power, according to FT research.
This helped spur growth, boost incomes and sustain a construction boom.
It also laid the foundation for an economic crisis.
By late 2022, real rates had fallen to minus 75 per cent.
By mid-2023, fuelled by high government spending following a devastating earthquake and pre-election fiscal splurge, the economy was overheating. Inflation was running at 60 per cent, the lira was in freefall and Turkey had a current account deficit equivalent to almost 6 per cent of GDP but had negative net reserves of about minus $60bn.
Adding to the problems was a huge monetary booby trap: about $140bn of lira deposits that paid out a government guarantee whenever the lira depreciated.
The scheme, called KKM, was supposed to support the currency but also generated a huge contingent liability that amounted to as much as $100bn, around 10 per cent of GDP, in 2023.
Solving the crisis appeared to be a financial “mission impossible”, as Turkey’s economic reformers have since described the challenge.
Yet by this March, the worst had seemingly passed.
High interest rates quashed domestic demand, helping to close the current account deficit and bring inflation below 40 per cent.
Hard currency inflows rebuilt net central bank reserves to more than $50bn.
KKM deposits shrank to a fraction of what they had been.
“It’s a small miracle that Simsek managed to pay down the KKM scheme and accumulate reserves at the same time,” says Tim Ash, a longtime Turkey watcher and senior strategist at UK-based BlueBay Asset Management.
But then came the politico-economic rupture of the March 19 arrest of İmamoğlu, and the subsequent arrest of dozens of other members of the opposition.
To critics, this confirmed their worst fears that Erdoğan was using a politicised judiciary to consolidate power, much as Vladimir Putin has in Russia or Alexander Lukashenko in Belarus.
The government insists the country’s courts are independent, but polls show most Turks believe the arrests are unwarranted.
A street vendor sells corn in Istanbul. The tough measures needed to stabilise markets and keep inflation down have set back economic recovery, prolonging Turkey’s cost of living crisis © Ozan Kose/AFP/Getty ImagesThe crackdown is “part of Turkey’s ongoing and deeply rooted shift towards authoritarianism, and . . . [Erdoğan’s efforts] to secure indefinite personal rule,” says Wolfango Piccoli, co-president of Teneo, a New York-based global advisory firm.
It also brought stiff economic costs.
To calm markets, the central bank spent about $50bn, cut roughly between March 19 and April 11, to defend the lira.
To quell inflation, it also raised interest rates again, thereby delaying recovery and deepening the slowdown.
Almost a thousand domestic companies have now filed for bankruptcy in the first five months of the year, according to bankruptcy tracking websites, nearly double last year’s rate.
GlobalSourcePartners, a consultancy, points out this is only a fraction of Turkey’s more than 2mn registered companies.
Even so, worse may come soon, given that real interest rates are punishingly high at 20 per cent and as many as a fifth of Turkish companies are in a “zombie” state, requiring them to have fiscal handouts, cheap credit or other financial help to survive, according to a 2023 IMF study.
“Don’t assume this disinflation [process] will be costless,” Osman Cevdet Akçay, deputy central bank governor, told a conference in May.
“It could be low cost, or it could be very costly.
We don’t know.”
Real exchange rate appreciation, fuelled by inflation outstripping the lira’s rate of depreciation, has only added to the pain.
Visitors to Istanbul are often shocked by how expensive it is, with restaurant and other service prices akin to those in Paris, London or New York.
The strong exchange rate policy has particularly hurt exporters, especially in the textile sector, which employs almost 1mn workers and accounts for 10 per cent of Turkey’s $360bn of annual exports.
Turkey is no longer “suitable for low-cost textile production,” Ahmet Fikret Kileci, head of a textiles and Turkish exporters federation, warned last month, adding in a newspaper interview that EU countries such as Bulgaria and Poland now have lower labour costs than Turkey.
Meanwhile, the political crackdown has dented animal spirits.
Even before İmamoğlu’s arrest, two top executives in Turkey’s biggest business association TÜSİAD were arrested for “publicly disseminating false information” after they criticised the government’s economic policies.
“We can live with high inflation but our biggest disincentive to invest is the lack of the rule of law,” says another business executive, who declined to be named out of fear of reprisal.
“Unless you are totally aligned with the government, they can just come after you.”
Some foreign businesses have also been reconsidering their investment plans.
Paradoxically, some say, this is precisely because of the geopolitical free pass that western governments have given Erdoğan.
Despite his democratic backsliding, none have issued public rebukes.
“Turkey has made itself an indispensable partner on matters of regional security,” says Jay Truesdale, chief executive of TD International, a Washington based consultancy.
“But the question foreign businesses are now asking themselves is: if Turkey’s economy takes a dramatic turn for the worse — in extremis, say, leading to capital controls or mandated wage increases — would other governments have any leverage to fight on investors’ behalf?”
It all makes for a grim economic outlook. According to one recent survey, 45 per cent of voters who support Erdoğan’s Justice and Development party believe the economy is “bad” or “very bad”, while over half of all Turkish respondents think the economy is getting worse.
“Erdoğan has been very patient with the reform programme, so far.
But for him to keep on saying to his team, ‘Keep rates up!
I am OK haemorrhaging popular support!’ — I just don’t see it,” says Roger Kelly, the former lead Turkey economist at the European Bank for Reconstruction and Development, who is writing a book about Erdoğanomics.
“He’s treading a very fine line between keeping markets and his supporters happy.”
President Recep Tayyip Erdoğan with finance minister Mehmet Şimşek. Harder economic times have led to rumours that Erdoğan might fire Şimşek and the central bank governor. If that happened Turkish markets would be in meltdown, economists say © TUR Presidency/Murat Cetinmuhurdar/Anadolu/Getty ImagesIn the worst case, Erdoğan might abandon the reforms to get interest rates down again — even firing his economic team, having already replaced four central bank governors over the past five years, and three finance ministers.
That, in turn, could prompt Turkish savers to rush out of the lira and into dollars, precipitating a currency crisis that could return the stabilisation programme to square one.
With about 40 per cent of Turkish deposits currently held in dollars, a near 10-year low, it is also a real risk to be watched, economists have warned.
In many ways, Turkey’s experience under Erdoğan mirrors that of other big emerging economies this century, such as Brazil.
Both countries had charismatic leaders, whose popularity derived in part from a credit-driven construction boom, which lifted the fortunes of the poor and reduced inequality — but has now run its course.
Like Brazil — “the country of the future, and it always will be”, as Charles de Gaulle is said to have quipped — Turkey enjoys an enviable strategic position.
It has a diverse manufacturing base, well capitalised banks and a dynamic entrepreneurial sector.
It has a high share of services in its exports, especially tourism, meaning it may be less affected by a global tariff war.
Şimşek has said that the prospect of successful peace talks with the militant Kurdistan Workers’ party (PKK) could also free the Turkish state from a conflict that he says has cost the country an estimated $1.8tn, including in lost opportunities and economic gains.
Reconstruction work in Syria is another lucrative prospect that Turkish construction companies are eyeing.
Turkey’s relatively young population should also be a boon for future growth.
But to fully realise that vision requires going beyond the current macroeconomic stabilisation and taking on difficult structural reforms, economists say.
Last year, for example, Turkey attracted foreign investment equivalent to only 1 per cent of GDP, according to the World Bank, a fraction of that achieved by comparable middle-income countries such as Bulgaria, Romania, Kazakhstan, Mexico or Chile.
One way to attract more, business leaders say, is to improve the rule of law in a country that last year, according to the World Justice Project, ranked 117 out of 142 countries, sandwiched between Russia and Nigeria.
Instead, Turkey has been moving in the opposite direction: over the past decade, it has dropped by 37 places.
In the meantime, the political and economic risks that Erdoğan faces are mounting.
Tough economic times at home are complicating the already difficult political alliances that Erdoğan needs should he stand, as many expect, for a third presidential election beyond the two terms in power currently allowed by the constitution.
He is juggling peace talks with the PKK, but these have been undermined by his crackdown on the opposition as it has sown distrust among the potential Kurdish voters he would need to be re-elected.
The opposition is still successfully organising mass rallies around the country, while young voters are increasingly disenchanted with the government.
Combined with the government’s decline in the polls, that makes another bout of market volatility highly likely this year, analysts say.
That is especially so as the economic status quo that Erdoğan has long presided over no longer holds, and his government can no longer resort to the policies it used before to boost popular support.
“In the past, the government could tee-up credit growth, spur a construction boom and get people to spend,” says Kelly, the former EBRD economist.
“But that model is now exhausted. Turkey’s credit-driven model can no longer do it.”
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