DURING TURKEY’S constitutional upheavals in 2016-17, when President Recep Tayyip Erdogan faced down an attempted coup and gathered up new political powers (and prisoners), the country’s economic reformers remembered better days. They talked wistfully of an imminent return to “factory settings”. Turkey, they believed, had a default set of successful policies, from which it had recently deviated and to which it could quickly revert, undoing any mistakes in between.
Instead the economy suffered something closer to a system crash. Excessive lending, some of it guaranteed by the government, contributed to rising inflation and a widening current-account deficit. The central bank’s ability to restore order was stymied by Mr Erdogan’s hostility to orthodox monetary policy (he compared interest rates to tools of terrorism). When the government fell out with President Donald Trump over the arrest of an American pastor working in Anatolia, foreign investors (and many Turkish depositors) lost their nerve. Turkey’s currency, the lira, fell by 40% against the dollar in the first eight months of 2018.
That drop was excruciating for the many companies that had borrowed in euros or dollars: foreign-currency corporate debt amounted to over 35% of GDP in 2018. Hundreds of firms have since defaulted or applied for konkordato, a court-approved rescheduling of debt that allows them to avoid declaring bankruptcy. Their number includes the Turkish franchises of Gloria Jean’s Coffees owned by Haci Sayid, a cafeteria chain founded by two brothers who have been making baklava since 1968.
The full extent of the damage became clearer on March 11th, when Turkey reported its latest GDP figures. They showed that the economy shrank by 3% in the fourth quarter of 2018 compared with a year earlier (see chart). That was an even sharper fall than expected. But if anything, it understates the suffering. An unusually large share of this diminished output was exported to foreigners, rather than enjoyed at home. Household consumption, a better measure of pleasure and pain, shrank by almost 9%.
The crisis has, however, forced the government to reset its reckless macroeconomic policies. The appointment in July of Berat Albayrak, the president’s son-in-law, as finance minister did not bode well. But for the moment the family dynamic seems to be working in the economy’s favour, helping to reconcile Mr Erdogan to the need for monetary and fiscal restraint. The central bank was belatedly permitted to unholster its terrorist tools and raise interest rates. The government has also set itself ambitious fiscal targets that will require cutting pensions and postponing investment to narrow the budget deficit.
The flow of credit has been sharply curtailed, imports have collapsed and exports have boomed. The current account even swung into surplus for four months in a row from August to November, as Turkey welcomed more foreign tourists and fewer foreign goods. This rebalancing has helped to revive the lira, which rose by 28% from the end of August to the end of January.
But how long will it take for stability to translate into growth? An economy, unfortunately, cannot be reset as easily as a smartphone. Past mismanagement tends to become embedded in the circuits. The Turkish public, for example, will not quickly forget last year’s erosion in the value of the lira. They now hold nearly half of their deposits in foreign currency. And the central bank will have to keep interest rates high for some time to convince people that it can conquer inflation, which remains at almost 20%. In its impatience, the government has resorted to opening subsidised food stalls in big cities to dampen the rise in the price of groceries, which Mr Albayrak has branded “food terrorism”.
Inflation should fall further later in the year, as the effects of the lira’s decline wear off. Credit is already beginning to revive, led by state banks. And some early indicators for 2019 suggest that the pace of economic contraction is starting to ease. BBVA, a bank, believes growth will return in the second half of the year, leaving the economy 1% bigger this year than last.
A cyclical recovery will not, however, resolve questions about Turkey’s longer-term future. It is hard now to argue that the market-friendly policies embraced by Mr Erdogan’s party from 2002 to 2011 represent the economy’s default mode. After all, the populism and cronyism of more recent years is hardly new in Turkey. A similar kind of mismanagement reared its head many times before the financial crisis of 2001 and the promise of European Union membership motivated a decade of reform. Perhaps populism, not liberalism, represents Turkey’s factory settings, to which it has returned after all.