Analysis: Second COVID-19 wave tests Turkey’s commitment to austerity, higher rates

ISTANBUL – A surge in COVID-19 infections and the prospect of another economic downturn could sorely test Turkish President Tayyip Erdogan’s reluctant acceptance of much higher interest rates and the need for greater austerity.

Already, record COVID-19 infections and deaths have led to new curfews and shorter business hours, hitting Turkey’s large hospitality sector and many others struggling with double-digit inflation, and raising fears of a winter recession.

Erdogan is also facing serious geopolitical headwinds, with the European Union and the United States both weighing economic sanctions, respectively over a gas drilling dispute and Turkey’s purchase of Russian missile defences.

“It remains to be seen if the government will really stick to the recent tightening in economic policy if growth decelerates markedly,” said Yesenn El-Radhi, senior sovereign analyst at Capital Intelligence Ratings.

Last month, Erdogan’s newly installed central bank governor jacked up the policy rate by 475 points to 15%, cheering foreign investors. The currency rallied but more tightening is expected, given the lira is still down 24% this year versus the dollar.

New Finance Minister Lutfi Elvan has promised fiscal policies that support macroeconomic and price stability

The government has aggressively reined in credit growth to below 10% from 50% in the summer. A burst of state-driven cheap credit had triggered a sharp rebound in the third quarter but the pivot towards what Erdogan calls a new economic era with “bitter pills” could now lead to a technical recession on a sequential basis through the first quarter of 2021.

STAYING THE COURSE?

Some analysts believe Erdogan and his economic team will stay the course, while hoping – like governments around the world – for a swift rollout of anti-COVID vaccines in coming weeks that could lead to an economic rebound by April.

Deutsche Bank (DE:) has predicted rate rises this month and early next year to 17.5%.

Others, however, fear a repeat of 2018, when Erdogan – who long resisted tighter monetary policy, arguing against economic orthodoxy that it causes inflation – backed a rate hike to 24% only to criticise it once the currency crisis started to fade.

His past performance, said Wolfango Piccoli of consultancy Teneo, has “significantly undermined confidence in the government’s ability to manage the intertwined public health and economic crisis”.

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Annual inflation was 14% last month and the lira remains among the worst performing currencies in emerging markets (EMs) after shedding half its value since mid-2018.

Calls for a change of course are likely to get louder.

While wage supports and a layoff ban remain in place, shopkeepers say they need more tax and rent relief to survive.

For individual Turks, borrowing costs have nearly doubled to 20% since the summer and banks are extending far less credit.

“The situation is awful,” said Nurten Karagoz, 43, whose Istanbul restaurant has been restricted to takeaway service due to the pandemic just as she started repaying a loan that had kept it afloat during the initial spring lockdowns.

“We have debts that we can’t pay and they are building up. Even if I shut down, we still have to pay rent,” she said.

The lockdowns in the first wave of coronavirus lopped nearly 10% off Turkey’s economy.

Government officials told Reuters they expected only a mild slowdown this time round because most of the economy, including manufacturing and trade, will remain open.

An economy official said the new restrictions would “be predominantly seen at shopping malls and in the service sector”.

On Monday, Turkey reported a record 203 new coronavirus deaths, pushing the total death toll above 15,000.

Turkey has signed a contract to buy 50 million doses of COVID-19 vaccine from China’s Sinovac Biotech Ltd and aims to start vaccinations this month.