Erdogan’s New Economic Team: What to Expect

President Recep Tayyip Erdogan was asking Turkey’s new Minister of Treasury and Finance Mehmet Simsek to return to the government for over a year. Simsek refused Erdogan’s advances because he rejected any “window dressing” appointment that would make him look like an Erdogan puppet. Although he is celebrated by Western media as a champion of liberal values, Simsek is a deeply religious person. His religiosity takes the form of acting strictly in accordance with his beliefs, both in private and professional life. As a paradoxical expression of Turkish Islamism, Simsek’s religiosity has so far prevented him from becoming a “yes man” for Erdogan, and the same religiosity has enabled him to explicitly reject Erdogan’s intrusions. Since Simsek can express his opposition directly to Erdogan in religious terms – and in a way Erdogan understands – he gains a unique sort of immunity from presidential interference.

Simsek played a key role in guiding Turkey through the global financial crisis of 2008 and the European debt crisis of 2011-2012. He implemented several economic reforms aimed at improving fiscal discipline, boosting economic growth and attracting foreign investment. Simsek also focused on reducing the budget deficit, increasing tax revenues and implementing structural reforms in key sectors such as banking, energy and taxation.

This misinterpretation of Simsek’s beliefs and outlook owes to the fact that he likes to explain his decisions in great detail, in a way understandable by Western investors, using Western values, logic and analogies. This is precisely why the Gulf, Russian or Chinese investors also view Simsek as more aligned with their respective economic priorities; Simsek can see how foreign countries see Turkey very well and can explain Turkish positions to those countries from a viewpoint they can understand.

Simsek will ideally seek to return to economic orthodoxy, including structural changes, liberalization, and pro-market policies such as strengthening the rule of law, reducing judicial uncertainty and improving governance and transparency. Simsek was a key player during some of Turkey’s best years of foreign investment in 2007-2009. He will be partially focused on broadening healthy levels of investment beyond the real-estate sector, and significantly broaden manufacturing, export, high technology, and renewable energy investments in the country. But what do these mean in practice? In our view, the Simsek-Erkan team will try to bring about the following fiscal and monetary policy adjustments:

• End Erdogan’s low interest-rate policy. The pace and extent of the rate hikes might be managed to avoid excessive shocks but the rate will rise steadily. The Simsek-Erkan team will phase out government guarantees for exchange rate-protected bank deposit accounts (KKMs). This will cause considerable pain to AKP loyalist SMEs but Simsek appears to have got Erdogan’s plausible deniability to raise the rates to sustained higher levels, possibly reaching 25%. This is a short-term “carte blanche,” however. If the new economy team fails to bring in the investment that justifies their decision to hike rates to the extent that it causes Anatolian SMEs to go bankrupt, then Erdogan can use Simsek as the ideal fall guy. If Simsek and Erkan raise interest rates, allow SMEs to go bankrupt at the national scale, yet fail to convince foreign investors to broaden presence in Turkey, then Erdogan can discard them, and any future discussion of his policy intrusions, demonstrating that “Erdoganomics” is indeed the only logical way to pursue policy under Turkey’s unique realities.

• Free-floating lira exchange rate. Erdogan has, in the past, flipped from artificially supporting the value of the lira to an election-year courting of his pro-big business lobby, which favored a weak lira and maximized exports. Erkan will toe the middle line. Higher interest rates will be used to indirectly and gradually strengthen the lira, rather than direct government intervention. Erkan will only sparingly intervene to prevent sharp volatility. This has already caused immediate concern among Turkish importers and exporters, who now have to deal with a further weakened Lira, that has lost around 20% of its value since the appointment of the new team. Most exporters have already started to complain about the new economy team, and raw materials imports in all industries, including manufacturing, clothing, and construction have slowed down owing to high costs in Dollar and Euro terms.

• Gradual reduction of inflation. Simsek pragmatically aims to reduce inflation from the pre-election level of 44% to around 26% in two years. This is a much more modest rate of reduction than many opposition economists were promising (i.e., down to 10% in two years) but it takes into account ongoing government subsidies and social welfare support, which will offset the impact of higher interest rates. Erdogan is balancing the needs of the poorest segments of society and the industrialists who seek lower inflation as a means to bring down raw material and labor costs.

• Public borrowing. Some additional foreign and domestic borrowing will be utilized to service the fiscal deficit due to the earthquakes and pre-election wage increases. The technocratic core of the government and the potentially reduced role of the anti-loan Presidential Council on Economic Policy will allow greater borrowing.

• Tax increases. Simsek is the father of modern Turkish tax regulations and he can be expected to make new efforts to simplify the tax code and boost tax revenues. At a time when the broader public is struggling to meet the taxation increases from the previous economic administration, further tax increases will create nationwide austerity effects, and slow down consumption – a key driver of the Turkish economy.

• Limited fiscal austerity. Simsek will have to proceed very carefully and slowly to introduce more control over public spending, especially projects that are connected to the bloated presidential administration. Growth remains a priority for Erdogan and he will oppose policies that could intensify recession risks.

• Broader range of foreign investors. Simsek was last in government when Western investors were still the main game for Turkey, but today new types of investors (UAE, Qatar, China and fleeing Russian capital) are more important. Simsek will have to learn how to incorporate these types of investors and currency swappers into his system, factoring in the sanctions compliance risks they sometimes pose.

Looking Forward

While the technocratic cabinet suggests a move towards decentralization of power, it is important to consider President Erdogan’s continued influence over Turkish politics. Erdogan will retain a significant say in decision-making processes and has only temporarily put himself into the backseat to allow other members of his party to provide an alternative path.

With Erdogan reducing his involvement in economic matters, Turkey’s strong conservative SME ecosystem will likely use members of the parliament and media to pressure the new economy team. The degree to which cabinet members can shape policies and exert influence on Erdogan’s rule remains a subject of observation. Investors will closely monitor the government’s commitment to institutional reforms and the potential for dissenting voices within the cabinet.

Underperformance by the new Simsek-Erkan team could open the door for Erdogan’s old advisors to return. The SMEs that make up the heart of the AKP voter base will keep lobbying for lower interest rates. Former AKP officials will grow in influence again if the high-interest rates counseled by his new economic team crush too many domestic small businesses reliant on low-interest credit. Missteps by the Simsek-Erkan team will be seized upon by influential people on the Presidential Council on Economic Policy, such as Gulsum Azeri and Hakan Yurdakul. Erdogan might then revert back to his pre-election economic policy. Erkan is Turkey’s fifth central bank governor in four years. Interest rate increases have triggered the removal of previous governors.