What’s happening in the Turkish economy as key local elections approach?

In the run-up to significant local elections this month, Türkiye stands at a critical juncture, requiring not only short-term measures to combat inflation, but also a comprehensive re-evaluation of its economic structure, technological landscape and social equity.

As Türkiye approaches the crucial local elections scheduled for 31 March 2024, the nation finds itself at a significant juncture, with the economy continuing to be a focal point of attention. This article assesses the main challenges for the Turkish economy.

Robust growth, the minimum wage conundrum and persistent poverty

The Turkish economy grew substantially in 2023, surpassing expectations with an estimated year-on-year GDP increase of 4.5% (see Figure 1). This growth was fuelled by stimulus measures implemented ahead of the May 2023 elections, including wage and pension hikes. But a minimum wage, though relatively high, has failed to alleviate widespread poverty, especially in urban centres like Ankara and Istanbul, exposing flaws in the country’s economic system.

Taking a closer look at the industrial scene reveals a situation characterised by low productivity and efficiency. The problems include weak institutions, low investment in technology, and a shortage of skilled workers, all contributing to an economic system that is struggling to make substantial progress. This emphasises the urgent requirement for comprehensive reforms and strategic investments to rejuvenate the whole industrial sector.

Figure 1: Türkiye has to balance promoting economic growth and keeping monetary policy tight to reduce inflation

Source: Refinitiv, IMF, author’s calculations

Orthodox economic policy implementation in the middle of continuing turmoil

After the elections of May 2023, a new economic management team took charge in Türkiye, marking a significant shift towards tighter monetary and fiscal policies. The central bank responded with substantial interest rate hikes, more than quadrupling borrowing costs, and scaling back interventions to defend the currency (see Figure 1). Despite these efforts, challenges persist as interest rate adjustments have not yet achieved positive real interest rates (that is, once adjusted for high inflation, the rate of interest remains negative).

The most recent policy rate increase to 45% reflects a relentless effort to combat inflation and stabilise the currency. But the focus on inflation alone will not address Türkiye’s more fundamental problems, which are deeply systemic and impede the nation’s development opportunities.

The economic outlook, growth dilemmas and risk mitigation

Estimates suggest a growth rate of 4.5% for 2023, while the government projects a growth rate of 4.4% for the year ahead. But according to the International Monetary Fund (IMF), growth is expected to slow down to 3.25% in 2024, presenting challenges in balancing macroeconomic stability.

The Turkish authorities are grappling with the challenging responsibility of promoting economic growth in the face of numerous obstacles. High inflation and interest rates are hampering private consumption, and the call for fiscal discipline presents challenges for public spending and investment.

For example, to align with the objectives of reducing inflation, the 2024 budget deficit should be lower than the forecast outlined in the government’s Medium-Term Program for 2024-26. Further, private investment faces barriers such as a high cost of borrowing (high interest rates) and various other structural issues, including concerns about policy uncertainty and the rule of law. The combination of high borrowing costs and an unstable economic environment makes Türkiye an unfavourable investment location. This is likely to hamper future growth.

Risk mitigation and evolving economic policies

Meanwhile, the risk of a sudden reversal of the current turn towards orthodox economic policy is diminishing. Positive messages from the president expressing support for the new economic team and Türkiye’s Medium-Term Program indicate a commitment to stability and reform.

But actions speak louder than words. While the sentiment from the Turkish authorities is promising, reforms are needed to facilitate the stable economic environment that is so essential for the country to make meaningful progress.

Links with Russia, sanctions and global dynamics

A significant aspect influencing Türkiye’s economic landscape is its intricate relationship with Russia. In 2022, Russia emerged as the country’s largest trading partner, with bilateral trade doubling to $68.2 billion (see Figure 2).

This trend is anticipated to have persisted into 2023, leading to sanctions on Turkish companies involved in supplying technology, goods and services to Russia. As global political shocks continue to shape economic outcomes, Türkiye keeps its important commercial partnerships while adapting to evolving geopolitical challenges. But in any case, the country’s trade prospects are tied in part to sanctions imposed on Russia. This situation is uncertain by nature.

Figure 2. Trade with Russia surged after 2022 but has since declined

Source: Refinitiv, IMF, author’s calculations

Brain drain

In the context of the current Turkish landscape, the escalating brain drain is also a critical concern for the nation’s future. The growing departure of Türkiye’s brightest minds, driven by heightened restrictions on freedoms and a pessimistic outlook for the country, raises significant apprehensions. Without skilled employees on home soil, meaningful domestic economic growth is hard to achieve.

The potential consequences of this brain drain are likely to be profound. As the exodus of intellectual capital gains momentum, it underscores the urgent need for comprehensive measures to retain and foster the talents that could contribute significantly to Türkiye’s development.

This could feed into other structural issues discussed above. Without human capital feeding into economic growth, Turkish policy-makers will remain under severe pressure. There is only so much that fiscal and monetary interventions can achieve in terms of supporting growth. The right people trained to the right level living in the right places are crucial too.

To sum up, in the run-up to the local elections, Türkiye stands at a critical juncture, requiring not only short-term measures to combat inflation but a comprehensive re-evaluation of its economic structure, technological landscape and social equity. Only through systemic change can the country chart a sustainable path towards economic stability, harnessing the opportunities presented by growth while addressing the deep-rooted challenges that persist.