Turkey inflation tests patience with Erdogan’s policy U-turn

Turkey inflation tests patience with Erdogan's policy U-turn

Turks Brace for Soaring Cost of Living as Inflation Hits New Highs

Turkey Currency

Ankara, Aug 10 – Turks are bracing themselves for an even higher cost of living this summer as experts predict prices to surge by as much as 8.5% in August. This persistent inflationary pressure, driven by a drop in the lira and tax hikes, presents a formidable challenge for President Tayyip Erdogan as his government embarks on a path towards more orthodox policies.

The sustained increase in prices comes as Erdogan’s new finance minister and central bank chief orchestrate a policy U-turn, including interest rate hikes aimed at curbing domestic demand. After years of aggressive rate cuts, this monetary tightening is expected to cool down inflation by mid-2024. However, in the meantime, the U-turn has hammered the currency and left Turkish households feeling the pinch.

In July, consumer prices skyrocketed nearly 10% due to tax hikes and a lira crash. And the forecast for this month is equally grim, with experts predicting a rise between 5.5% and 8.5%, with the fallout from mid-July tax hikes expected to linger into August. The recent tax hike on fuel, implemented to fund a budget increase of 1.12 trillion lira ($42.2 billion) after the earthquakes in February and the May elections, will further drive up food prices.

As a result of the tax rise, petrol prices have surged by 45% to 36 lira per litre. Additionally, public transportation and taxi fares in Istanbul, Turkey’s largest city, have been raised by 51%, with short-distance taxi fares soaring by 75%. These measures, although necessary to address the economic challenges Turkey faces, have put additional strain on already-stretched households.

Erdogan’s previous drive to slash interest rates caused annual inflation to reach a 25-year high of more than 85% last year, and also heavily influenced the state-managed lira. However, since his re-election in May, faced with an unstable economy and depleted reserves, Erdogan has made a U-turn and appointed a new cabinet to reverse policy. The central bank, under new Governor Hafize Gaye Erkan, has since raised rates by 900 basis points, resulting in a 26% plunge in the lira, which is now freer to float.

Despite Erdogan’s past opposition to high rates, Erkan has vowed to continue the tightening process gradually. However, due to currency depreciation, the central bank expects annual inflation to continue rising until the second quarter of 2024, peaking above 60%, which will further exacerbate the cost-of-living strains for Turks.

Erdogan publicly supports the objective of lowering inflation to single digits. Nonetheless, he recently emphasized that the government will never compromise on employment and economic growth. Analysts have raised concerns about how far he is willing to allow rates to rise and growth to slow, especially with nationwide local elections approaching in March. To address these concerns, Finance Minister Mehmet Simsek has stressed that he has Erdogan’s full support.

According to a Turkish official familiar with the matter, the gradual tightening aims to preserve growth and avoid shocks to employment and the economy. Moody’s has indicated that it could raise Turkey’s credit ratings if the shift to orthodox policies is sustained. Nevertheless, the agency highlights the challenge of balancing the need for decisive action to address economic concerns while maintaining robust economic growth, which is politically imperative.

One significant development since Simsek and Erkan assumed their positions two months ago is the improved quality of price measurements published by the Turkish Statistical Institute (TUIK). The July inflation reading of 9.5% accurately reflected the tax and fuel changes, indicating a marked improvement in data quality compared to previous readings this year. This improvement in data transparency and accuracy is particularly significant considering the criticism TUIK faced in recent years for data diverging from street prices.

The central bank’s decision last month to revise its end-2023 annual inflation forecast from 22.3% to 58.0% is another positive step towards aligning market expectations, after years of divergence.

In conclusion, while Turks brace for a significant rise in living costs this summer, driven by currency depreciation and tax hikes, there is a cautious optimism that the policy U-turn and gradual tightening by Erdogan’s government will eventually lead to a more stable and robust economy. The challenge lies in striking a balance between tackling inflation and ensuring sustained economic growth, while also addressing the political imperative of maintaining employment and social stability. The improved quality of economic data and transparency, coupled with the continued support from international ratings agencies, brings hope for a more prosperous future for Turkey.