All ammunition has already been used. Resorting to reserves is impossible because there are none. Selling out of required reserves or swap money – they are both liabilities, not assets – can only delay the problem. The rate cutting sequence has been initiated in an out-of-equilibrium belief universe. If anybody thinks people will invest or buy homes because banks can find cheap funding at 14% from the CBRT, well, this is wrong. Thus, things will have to change. This time around there has to be something real that needs be done and done swiftly.
There is talk about a new monetary policy framework. Because the policy rate, i.e. one –week repo rate, has been declared ineffective, even redundant, 3-6-12 month repo rates are set to become important. Open market funding is also down to 70% of the money base. Yet, this is all theory. In practice, the burning questions are: who will pay the political price for the massive exchange rate depreciation? USD/TRY was 7.37 on January 1, 2021; it stands at 13.40 today. Who will be held responsible for the reserves that are gone, for the very high and still rampant inflation, for the possible incoming stagnation, for the unemployment that has flown sky-high? This is about elections: winners will be either those who cleverly avoid being blamed for past calamities or those who convincingly promise better days.
INFLATION HASN’T PEAKED YET
Inflation truly matters now, perhaps more than it has at any point in the last decade or so. Because electoral research reveals that people care much more about jobs and income, i.e. growth, than inflation ahead of whatever elections loom on the horizon, governments tend to favor growth at the expense of inflation. Also, because inflation is only an index and various Gini groups may have different inflations depending on their spending patterns, whether the head-on CPI is 35% or 40% may not change approval ratings. However, when inflation climbs and escapes out of the ‘moderate inflation’ range, i.e. 15-20%, there is the risk that an inflationary spiral will form and you can face ‘runaway inflation’. Moderate inflation is notorious for tipping off either way in a short timespan. Moderate inflation is like a flat yield curve, so to speak. Currently, inflation is well-above the moderate range. Again, at 40-50%, inflationary pressures are being felt by households and cost-push inflation is still rampant. The 80% domestic producers’ price inflation to 36% CPI ‘scissor’ isn’t a normal pattern. I think 50% CPI in Q1 wouldn’t surprise anyone. That has already had a clear impact on all sorts of loan rates, although the economic administration thinks negative real loan rates are a good thing. Yes, they are negative, but they have gone up nominally. And they are negative because the link between interest rates and inflation is already broken. The 5-year CDS was 323 exactly a year ago but it is 556 today. The risk we are talking right now is a composite risk or country risk and it has all sorts of ingredients, from the market risk to credit risk to political risk to the risk of not having a plan.
WHAT SHOULD A NEW MONETARY GAME LOOK LIKE?
First, I would expect a steep rise in the policy rate, plain and simple. I would opt for 300 bps as a first step. Second I would also expect a complete reversal in many policies, domestic or international. If not, then we will have a problem. Other plans are likely to serve as delaying devices only, postponing a more severe financial crisis. Because the economic crisis is now felt deeply by at least ¾ of the population, the incumbent party can’t operate as usual, i.e. it can’t be in a state of denial and can’t call for early elections unless perceptions change. This is because even AKP voters think the economic outlook is bad. For perceptions to change, however, something really important should happen: one could call it a game changer. So, I predict that if nothing is done CHP, İYİP and the others – opposition tout court – will rise again. I don’t think non-economic arguments will win the day. Whether the opposition will win the elections or not is altogether a different matter, but currently the incumbent party is out of steam both ideologically and politically: this much is apparent. The general perception is one of economic management failure.
WHAT DOES THE PRODUCTION FUNCTION TELL US?
We know that unless total factor productivity doesn’t help significantly, over-reliance on a classical factor –such as capital – will end up with falling marginal productivity. Depending on the curvature of the production function – its degree and kind of concavity – sooner or later decreasing returns loom large on the horizon. In this particular case, too much reliance on a single factor meant over-investment in construction and real estate development. FDIs have been low; less than 2% of GDP over the last decade. There is virtually no innovation and the high-technology component of exports is always less than 3%. There are no efficiency gains and total factor productivity doesn’t help. Is this all due to the choice of a wrong growth model? The simple story that tells us that we can’t settle for an over-arching explanation: “there were billions of dollars on the sidewalk because there was a global savings glut in the early 2000s and then dollars were supplied at almost zero cost because of the Great Financial Crisis, and a small open economy has collected the money, accumulated debt, invested in buildings and such, and distributed rents through quasi-fiscal devices and such – so the incumbent party always wins”. It isn’t that simple.
INSTITUTIONAL FRAMEWORK MATTERS
There is another fundamental approach, a message conveyed by neoclassical/ neo-institutional political economics. It stresses the importance of institutions. The novelty in the recent works of Acemoglu & Robinson, for instance, compared to their older papers, lies in the proposition that geography, political legacy, and history are only conditioning variables. They don’t reduce the set of possibilities to a single point. Various outcomes based on similar backdrops have been possible as the society/ state mix varies and this very mix can be conducive to either extractive or inclusive institutions, weak states or despotic states, and suchlike. Admittedly, there are cases when the dead hand of the past weighs far too heavily on current generations so ‘Prometheus can’t be unbound’. There are also cases when there is enough degree of freedom so the game admits a solution leading to a ‘good’ equilibrium. In the face of deteriorating governance/institutional strength indicators, rule of law, freedom of press, accountability, and the like, it may be the case that the malaise is more deeply entrenched into the society/state mix than imagined before.
IS THE TURKISH ECONOMY GROWING?
This is debatable. Growth is value-added, not just production and spending. Even at zero growth there will be enough spending and enough production to sustain the population. Furthermore, even a high growth print isn’t necessarily a good omen, especially if it is driven by high-powered incentives, if it is based on credit, if it generates a high current account deficit and worsens the FX debt burden, if many large firms tend to restructure their debts, and if momentum is lost. You can’t grow at the expense of all other factors. The first quarter will look good and the H1 GDP growth will be in the vicinity of 4.5%. However, the second half will tell an entirely different story. Overall, achieving 3.5% yearly growth is possible. Nonetheless, 2022 relies on weak fundamentals. The automatic correction mechanism will drive the growth engine to work at a relaxed pace. The result is likely to be a secular fall in the potential growth rate. I personally can say that I don’t think the real growth rate is positive. There is no growth and has been no real growth over the last three years. There is only steady-state re-production with no value added.
PANEM ET CIRCENSES
Bread and circuses: this is what Paul Veyne reminded us decades ago in an unforgettable tour de force. Had the Credit Guarantee Fund not done the trick in 2017, a recession was in the making, even then. Had the EM rally that lasted 7 months not taken place, the Turkish economy would have faced a crisis in 2017. Just sheer luck, some would say. The upshot is there is a crucial election ahead, one that will seal the fate of generations to come. Will the logic of panem et circenses work its way out after two millennia? Are people that stupid?