The backward Rudi Dornbusch, MIT’s leading economist, liked to say that economic crises sometimes took longer than expected. However, when it all happened, they happened at a much faster rate than one might imagine.
Turkish President Recep Erdogan is now discovering that Dornbusch’s saying applies to Turkey. For many years, Turkey has controlled to avert an economic crisis in its own right despite great macroeconomic mismanagement and the adoption of very unorthodox economic ideas. However, earlier this year, with the onset of the COVID-19 pandemic, the tide suddenly changed. Capital began to flow out of the country, depleting the country’s foreign reserves and leaving its currency in freefall.
Turkey is now in the maximum economic situation that is unenviable. Its tourism sector is decimated by the pandemic, its central bank now has negative foreign reserves, its business sector has a debt denominated in $300 billion, and its banking formula turns out to have more foreign currency commitments than foreign currency assets. Even more worrying, it turns out that President Erdogan has completely lost his credibility in economic policy to domestic and foreign investors because of his erratic and unconventional style of economic control.
One of the tactics Erdogan has lost credibility has been to appoint his under-qualified father-in-law as his finance minister. Another was to purge the central bank of its experienced and competent staff and appoint a yes-man to lead the central bank. Even more troubling was Erdogan’s disproportionate tilt to public spending and his enthusiastic adherence to the implausible perception that higher interest rates were causing it to cure inflation.
In the face of a currency crisis that is now out of control, Erdogan has a fundamental selection. He would probably let his country pass alone without seeking foreign aid, with all the dangers that this selection would entail. Otherwise, he can swallow his pride and appeal to the International Monetary Fund (IMF) for his balance-of-payments assistance, even if that would mean he would have to keep his repeated promise that Turkey’s days at the IMF were over.
Choosing to go it alone at a time when the country has run out of international reserves is highly risky. It could mean that the country will soon need to impose capital controls to prevent the currency from spiraling ever downwards. That in turn would risk deepening the domestic economic recession and provoking a banking crisis by further damaging foreign and domestic investor confidence.
Approaching the IMF for a large-scale confirmation agreement or loan from the Fund’s Extended Facility would give the country the option of a much smoother adjustment path than alone. The IMF can not only help the country fill its depleted foreign reserves and the imposition of capital controls. It would also provide the country with the opportunity to temporarily repair its credibility in markets through its seal of approval of the country’s economic policies.
A major blow to Erdogan’s IMF technique is that the IMF would impose strict situations on its lending and ask Erdogan to abandon its capricious economic paths. In all likelihood, he will insist that Erdogan be dedicated to restoring the central bank’s independence and rebuilding the economic establishments it has damaged so much. Even more problematic for Erdogan would be that the IMF would ask it to abandon its lavish public spending plans and settle for the competitive use of interest rate policy to help the currency.
Another big challenge for Erdogan is that to get a loan from the IMF, I would actually want the help of the United States, the IMF’s largest shareholder. This in turn would force Erdogan to fix barriers with the United States, a country that in the afterlife seemed to do everything imaginable to oppose.
In Turkey’s interest, we will have to expect Erdogan to now place his country above his non-public pride and soon seek an IMF lifeline. However, judging by Erdogan’s economic errors and his highly nationalist political approach, Turkey’s economic crisis is likely to worsen before Erdogan is forced to turn the IMF around.
Desmond Lachman is a resident of the American Enterprise Institute. In the past, he was Deputy Director of the Policy Review and Development Department of the International Monetary Fund and Chief Emerging Market Economics Strata at Salomon Smith Barney.
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