Turkey’s Central Bank: The AKP’s Next Target?

Jessica Atlas and Preston Feinberg contributed to this post.

Turkey’s ruling Justice and Development Party (AKP), led by Prime Minister Recep Tayyip Erdoğan, came to power more than a decade ago and, under their leadership, took Turkey from a struggling economy to the seventeenth largest in the world. While the AKP earned success and legitimacy from the rapid growth of the Turkish economy, Turkey has recently been beset by economic difficulties that, as Turkey approaches a series of pivotal elections, could pose a threat to the AKP’s continued rule. Turkey’s Central Bank has taken action to ameliorate economic strain and restore investor confidence, but its actions, running counter to Erdoğan’s stated economic policy, could make it a political target.

Turkey’s rapid growth, which averaged between eight  and nine percent annually during the early years of AKP rule, was heavily financed by short-term capital flows from abroad and heavy borrowing by the government. Recently, however, its economic growth has slowed to a near halt and the value of currency, the lira, has plummeted. This is the result of several factors.

First, exogenous forces, primarily expected cuts in the U.S. Federal Reserve’s stimulus program, are hurting emerging markets around the world. Turkey, which is among the states identified by Morgan Stanley as the “Fragile Five” for their dependence on foreign investment, has been hit especially hard.

Second, measures that helped promote Turkey’s growth in the short-term are proving not to be sustainable in the long-term. Much of its economic development over the last decade was led by domestic demand instead of exports of Turkish products and much of that demand was purchased with credit, leading to a current account deficit of seven percent of gross domestic product, 80 percent of which is financed by short-term loans, and a low domestic savings rate. These imbalances now imperil future growth.

Third, and foremost in slowing Turkey’s economy, has been recent political uncertainty– the Gezi Park protests and recent corruption allegations. This summer’s unrest and the government’s heavy-handed response – including politically-motivated raids on Doğan Group and Koç Holdings, large and influential Turkish conglomerates – decreased investor confidence in Turkey. That confidence has taken a further hit as the government attacks alleged foreign and domestic conspirators and undermines the independence of Turkish institutions and rule of law in response to ongoing corruption investigations against the government.

While the government predicts four percent growth for 2014, other analysts such as Ozgur Altug at BGC Partners project growth of only 1.9 percent. Economist Ian Brenner, in response to Turkey’s ongoing economic crises, asserted that “Turkey is not an emerging market right now, in the sense that it is not developing. They’ve had decades of actually putting their political institutions together, making them more consolidated. They’re now stripping them apart. They’re taking legitimacy out of the judiciary, out of the police forces and it’s making it much more uncertain an environment for investors to want to be in.”

Investors’ rush out of Turkey as a result of the political turmoil has had a dire effect on the lira, which has fallen some twenty percent since December, hitting record lows. Despite both international and domestic pressure to shore up the currency, Prime Minister Erdoğan, who decried raising interest rates as caving to an “interest-rate lobby” of foreign investors and actors seeking to undermine Turkey’s economy for their own profit. Also opposed to raising interest rates on religious grounds, Erdoğan has argued that Turkey should have a real interest rate of zero and, contrary to economic theory, has contended that higher interest rates lead to higher inflation. But faced with the rapid downward slide of its currency, Turkey’s Central Bank finally acted. Last week, it convened a midnight emergency session and more than doubled its main weekly repurchasing rate to 10 percent from 4.5 percent, and raised its overnight lending rate to twelve percent from 7.75 percent.

Raising interest rates against Erdoğan’s explicit wishes is more than just a much-needed adjustment in Turkey’s economic policy, it is indicative of how the current corruption scandal has weakened, at least somewhat, Erdoğan’s stranglehold on Turkey’s economic policy. In response to the Central Bank’s decision, Erdoğan has so far adopted a wait-and-see strategy, saying “it falls on me to be patient for awhile,” and asserting that “the Central Bank is obviously an independent institution. We have long said that we don’t interfere in this and we don’t have any direct connection.” But Erdoğan has also warned that, in the aftermath of its decision, he will hold the Central Bank accountable for any economic consequences.

While the lira rallied somewhat in the aftermath of the Central Bank’s decision, it hasn’t made steady increases, and economists worry that the Central Bank’s efforts may not be sufficient to overcome Turkey’s economic struggles. If the rate increases don’t alleviate the lira’s slide, the Central Bank and its leaders may find themselves the next target of the AKP government’s purges and restructuring efforts. The government has already sought to subordinate the High Council of Judges and Prosecutors (HSYK) to executive control, if displeased with the Central Bank it might seek to intervene in much the same way.

The economy has been one of the main bastions of the AKP’s success, and with the party and its leaders under fire from wide-ranging allegations of corruption that reach into the highest levels of government, the need to insure some measure of economic stability in the lead-up to local and presidential elections is of vital importance to the AKP.