A home-made crisis is possible

There is a smell of economic crisis in the air. This weekend, Economy Minister Nihat Zeybekçi declared that “there will be no crisis.” When does an economy minister declare that there will be no crisis? The answer is straightforward: This is the case when crisis expectations are rising among economic actors. And this is the case at the moment.

Let's begin with the most recent news: Inflation in July, revealed yesterday, has been very disappointing. While the Central Bank of Turkey has been expecting a decrease in headline inflation, we actually saw an increase. The yearly consumer price index (CPI) rose from 9.2 percent to 9.3 percent. The real bad news is that the two core inflation indexes are still rising and they reached 10.4 and 9.8 percent, respectively, in July. Rising inflation is driven mainly by service prices, signaling the presence of demand pressure.

Recently, when the central bank's Monetary Policy Committee (PPK) decided to cut its policy rate for the third time, this time by 50 basis points, I wrote in this column that low interest rates may cause an excessive revival in domestic demand -- something that the committee has disregarded. I concluded that the central bank is too optimistic about inflation. I am afraid that I was right.

One must conclude that the fact that inflation is outpacing the central bank's forecasts is not a sufficient factor to conclude that there will be an economic crisis. However, a radical change in the macroeconomic framework in place could do this. This will probably be the case if Prime Minister Recep Tayyip Erdoğan is elected president of the Turkish Republic this Sunday.

It is well known that Mr. Erdoğan disagrees profoundly with the current monetary policy and the macroeconomic framework that tries to maintain balanced growth -- a continuation of the decrease in the current account deficit while trying to get inflation closer to its target of 5 percent in the medium term. Nevertheless, this balanced growth requires a strict control of domestic demand, which results in rather low growth.

The critical point lies here. Mr. Erdoğan believes firmly that it is possible to have a revival in domestic demand through radical interest rate cuts without jeopardizing either inflation or the current account deficit. Many times he has declared that high interest rates are the cause of high inflation and that the central bank is following the wrong monetary policy. So, we must expect the implementation of a new economic policy along with the nomination of a new government after the election of the president of the republic, supposing that this will be Mr. Erdoğan. I am almost sure that Ali Babacan, the deputy prime minister in charge of the economy, who is the main builder of the balanced growth regime, will not be present in the new Cabinet. With the departure of Babacan, the central bank management will lose its main defender in the government. I do not think that Turkish Central Bank Governor Erdem Başçı will resist the political pressure that will be exerted by the president of the republic, recently elected by universal suffrage and who does not mince his words, as you know.

Under these circumstances, what kind of events should we expect in the Turkish economy? As soon as interest rates are cut, inflation and exchange rate expectations will be worsened. Let me mention that the current market interest rate for two-year maturity Treasury bonds is at 9 percent, while the policy interest rate of the central bank is 8.25 percent. For a few months we may witness a boom in domestic demand, thanks to negative real interest rates, but a sudden stop in capital inflows will not be lasting. This will fuel even further the depreciation of the Turkish lira and push inflation up again. In sum, the “new monetary policy” will backfire, pushing the Turkish economy into recession. Believe me, this is neither a fantasy nor wishful thinking.