Nadya Mihaylova - 5 January 2017

Strains on the EU’s immigration deal with Turkey could reach breaking point over the next few months, paving the way for an intensification of the refugee crisis. President Erdogan, angry over the denial of EU visas to Turkish travellers, has the capacity to make life very difficult for Angela Merkel ahead of German elections next autumn. Meanwhile, the Turkish economy is losing momentum, inflation is soaring and the currency is sliding. Is Turkey the next black swan?
2016 was a turbulent year for the Turkish economy, ranked 18th largest in the world by the OECD. Turkey’s economic dynamism has been sapped by a failed coup and the arrest of those who supported it, a series of deadly terror attacks that have deterred tourists and the ongoing civil war with the Kurdish militants. The number of foreign arrivals in the country fell by more than 20 percent year-on-year, to 1.35m in November 2016, on the back of security fears. The value of the Turkish lira slumped further, the more so against a resurgent US Dollar (figure 1). The Turkish lira hit a fresh low following Istanbul’s nightclub terrorist attack, which crushed optimism that the new year would bring relief to a fragile and troubled economy.  
Inflation, which surged to a rate of 8.5 percent at the end of last year, has also played a significant role in undermining consumer confidence and accelerating capital outflows. The rising price level put pressure on the Turkish central bank to raise interest rates in November 2016, marking the first hike in two years. The next meeting, expected later this month, will determine the future direction of monetary policy but I remain sceptical that rates will go up given the high risk of future insolvencies, the disappointing impact of the last rate hike and the President’s powerful wishes for a rate decrease instead.
Given that President Erdogan’s ambition is to implement a constitutional reform that will grant him an executive presidency and substantially increase his powers – a move that is highly opposed by the Kurdish People’s Democratic Party – the independence of any domestic institution is in doubt.

The next move in Turkish interest rates should be a matter of more than casual interest to the western world. A rate hike would signal that the central bank is still in charge and focused on a defence of monetary stability and currency credibility. An unchanged or reduced policy rate would suggest that politics has prevailed. The fate of the lira hangs in the balance, as international capital eyes the exits. A meltdown in the lira would add economic and financial turmoil to an already toxic mixture. And how receptive would the IMF be to an appeal for assistance?


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