Turkey Inflation and how was it managed

From The Economist Article

How has Turkey’s economy kept growing despite raging inflation?Many Turkish businesses are struggling to cope

Jul 21st 2022 | GAZIANTEP AND ISTANBUL

On the wall of Savas Mahsereci’s office is a black-and-white photograph of his father and grandfather making shoe soles from recycled tractor tyres. The room is upstairs from his factory on the outskirts of Gaziantep, a city of 2m people in south-eastern Turkey, close to the border with Syria. Like his forebears, Mr Mahsereci is in the recycling business. His family firm, mtm Plastik, makes refuse bags, disposable gloves and pellets for use in moulded products. The business has grown rapidly. It now occupies 20 times as much factory space as it did in 2004, and started exporting in 2016. Supply bottlenecks in China are “a big opportunity for us”, he says. Other industrial firms in Gaziantep are benefiting. The city enjoyed record exports last year, says Mr Mahsereci

than 72 hours, says Mr Mahsereci, compared with a minimum of a month from China. And supply is more reliable. Turkey can also export via the Aegean or the Black Sea.

Yet accelerating inflation poses big challenges for even the most agile business. One is pricing strategy. It is tricky to judge where to pitch prices. Too high, and you risk losing market share to rivals; too low, and you may find you do not cover replacement cost. Hard decisions seem to multiply. “You have to be ready to negotiate with all of your customers and all of your suppliers all of the time,” says a businessman. “It is very, very tiring.” Some prices are slow to adjust. A large share of mobile-phone subscribers have 12-month contracts. Many are still on last year’s prices.

Businesses must protect themselves from inflation to survive. This often means that the cost is pushed onto others. That creates tensions—between landlords and tenants, shops and customers, and firms and their suppliers. No business can afford to defer the settlement of its customers’ bills for very long. “Payment terms of three to six months are down to zero to three months,” says an Istanbul-based investor. And there are other pressure points. Turkey’s external deficit has not gone away. In principle, devaluation is a remedy. It works by stimulating exports and crushing demand for imports. The export fillip is working, but strong consumer demand has kept imports high.

Against the flow

Turkey must either attract fresh foreign capital or draw on its existing reserves of foreign currency. Both are becoming harder. The quality of capital inflows to Turkey has steadily degraded over the past 20 years. Foreign direct investment (fdi), the “stickiest” form of capital inflow, has not matched the levels of the mid-2000s, when Turkey followed more orthodox policies (see chart 5).

Some European bosses now see Turkey as a potential alternative to China as they seek to shorten and diversify their supply chains. Last year ikea said it would move production of some of its furniture from Asia to Turkey. Hugo Boss, a clothing firm, said it would add capacity to its factory in Izmir to reduce reliance on Asia. But Turkey’s monetary instability—and a deterioration in governance and the rule of law—is a bar to another fdi boom. Portfolio flows into Turkish bonds and shares have evaporated. That leaves Turkey ever more reliant on short-term syndicated loans extended to local banks. As interest rates go up worldwide, these are harder to come by.

The situation for reserves is also perilous. Turkey’s central bank has burned through tens of billions of dollars trying to prop up the lira. Official reserves of foreign currency are negative if swaps with local banks are taken into account. (The central bank still has holdings of gold.) Meanwhile private-sector demand for dollars and euros has risen. At their peak last year, two-thirds of bank deposits were held in foreign currency. The growing illiquidity in currency markets means exporters have every incentive to hoard dollars and euros from their overseas sales.

The authorities are striving to curb this creeping dollarisation and to stop the lira from falling further. A scheme has been in place since December which indemnifies deposits switched out of dollars or euros and into lira from exchange-rate losses. In January Turkish exporters were ordered to hand over 25% of their hard-currency earnings to the central bank. That figure was raised to 40% in April. Complaints from corporate treasurers that they needed a float of dollars and euros to pay for vital imports or to service debts had no effect.

In a sign of growing desperation, the authorities went further. On June 24th Turkey’s bank regulator said it would ban loans to firms that cling to significant hard-currency holdings. This measure was to stop companies borrowing lira on the cheap to speculate in dollars. The initial reaction in Istanbul was shock. Suddenly the main concern of corporate Turkey was not inflation but a potential credit crunch.

If the regulation is strictly enforced, says one executive, banks will be unwilling to lend and firms will be forced to cut back on non-essential spending. Some may struggle even to get enough trade credit to finance their working capital. It may not come to that. Noises from Ankara are that the banks will not bear the burden of verifying whether borrowers are complying with the new regulation.

Still, companies are turning cautious and big investments are being put on hold. “Everybody is waiting for the elections,” says an investment banker. Mr Erdogan’s ak Party is clearly behind an alliance of six opposition parties in opinion polls. He trails in polls against the plausible opposition candidates for the presidency. His defeat would probably mean a return to monetary orthodoxy.

Taming inflation would be a big and painful job, but Turkey’s experience after 2001 shows that, with the right policies, it can be done. fdi could rebound to take advantage of Turkey’s position as a low-cost manufacturing hub on Europe’s doorstep. A rally in the stockmarket is plausible, given how cheap Turkish shares have become. Yet electoral defeat for Mr Erdogan is far from certain. He has jailed political opponents, bullied the media, sought to suppress free speech and could resort to all manner of chicanery to cling to office. Many of the people interviewed for this article did not want to be named.

And before then, the exchange-rate crisis might enter a new, more combustible phase. Once the summer is gone, and the boost to hard-currency earnings from tourism starts to fade, things could get dicey. A tranche of protected lira deposits matures at the end of August. The state has $6bn of external debt payments due in the second half of this year, according to Morgan Stanley, a bank; big companies and banks have $23bn coming due. It seems unlikely that all these debts will be fully rolled over. Yet somehow the diminishing stock of foreign exchange must be augmented—or husbanded. In a worst-case scenario, limits might be placed on withdrawals of householders’ dollar deposits.

Perhaps the economy will somehow muddle through until the elections. As strange as Mr Erdogan’s approach to monetary policy has been, his fiscal policy has been quite conservative. The public debt-to-gdp ratio was 41.6% of gdp last year. This is comfortably below the debt burden of Turkey’s emerging-market peers. Given the country’s low solvency risk, perhaps its friends in the Gulf might stump up some of their petrodollars.

Turkey has withstood some remarkable strains. Now, more than ever, Turkish businesses are focused on survival. Inflation breeds uncertainty and uncertainty breeds caution. The things you must do, you keep doing, says a businessman. The rest can wait. “You live another day.” ■

This article appeared in the Briefing section of the print edition under the headline "Inflation nation"