Macroeconomic indicators from Turkey's institutions show the delicate financial situation in which the country finds itself. From the beginning of 2020 until the end of May there has been a sharp increase in public debt, which now stands at around $240 billion. Inflation is out of control and consumer prices are soaring. The population is having more and more trouble getting its hands on basic foodstuffs. Inflation in June was 12.62%, according to the latest data from the Turkish Statistics Authority collected by the Al-Ain News website.
Industrial production also fell sharply in May, falling 23% and 31% in April, according to Reuters. Turkish President Recep Tayyip Erdogan explained that he expects the economy to overcome the downturn it is going through during the second half of the year.
The lack of foreign currency in the Central Bank and the increase in inflation are again putting downward pressure on the Turkish lira. Some economists are concerned that the widening current account deficit and rising inflation could lead to further weakness of the Turkish lira, which fell to a record low of 7.269 per dollar in early May. The widening of the current account deficit in mid-2018 helped to trigger a currency crisis that plunged the economy into a recession.
The Central Bank of Turkey, which has spent tens of billions of dollars of its foreign exchange reserves to support the lira, has cut interest rates to help the government boost economic activity. Its lending rate currently stands at 8.25%, well below inflation. Monetary policymakers may be forced to increase their year-end inflation estimate of 7.4% after reducing it from 8.2% in April.
The central bank has been losing currency for four months in an effort to shore up the currency and protect it from market swings. Although this policy did not prevent the historical collapse of the currency, in the last two months it has managed to recover. Despite this, Moody's analysts expect the currency to continue to lose value in the future.
Lower reserves, higher inflation, rising debt and a devaluation of the currency all portend that the economy may collapse worse than it did in the spring. The only way out of this situation is to raise interest rates, but the Turkish regulator and the president have been reluctant to pursue this kind of policy in recent months.
Erdogan has opted to reduce interest rates to boost growth and spending to stimulate the economy, especially after the outbreak of the coronavirus in the country. The Central Bank kept its reference rate unchanged at 8.25% during the last rate review at the end of June, after nine consecutive reductions from a peak of 24% during the first half of 2019.
Against this background, Moody's has indicated that it expects the economy to contract by 5% in 2020, with the slowdown concentrated in the first half of the year, followed by a relatively slow recovery of around 3.5% in 2021. The International Monetary Fund has also predicted a 5% contraction this year, after a pyrrhic growth of 0.9% in 2019.
The difficulty of receiving external financing remains one of Turkey's main weaknesses, Fitch said in a report last week. "The fall in foreign exchange reserves since the end of February, added to the weak credibility of monetary policy and negative real interest rates, increase the risks of new external pressures," the document states.
Due to the low level of reserves, Fitch analysts predict that there will be no further cuts in interest rates and that the new debt issue by the government will have a "stabilizing effect". Even so, economists warn that Erdogan's approach is unpredictable and do not rule out a hardening of the Central Bank's policy. "There is still a risk of further interest rate cuts," they have warned.