Turkey puts projects on hold in battle against inflation

Turkish President Tayyip Erdogan wants to slow spending on infrastructure projects to rein in inflation. But in the fight, he is still opposed to central bank measures after a massive interest rate hike on Thursday.

In a speech to officials from his AK Party on Friday, Erdogan said ministries were reviewing their plans for big new public investments, with some of them postponed or even cancelled.

Read more: Opinion: Only Erdogan can help Turkey

The Turkish president said the government would complete projects that are "90 percent, 80 percent, 70 percent complete" under updated government investment plans.

"We are not considering brand new investments. We will complete the ongoing investments. We will not harm the building contractors," he said.

Erdogan's announcement comes as Turkey is battling double-digit inflation — at about 18 percent in August — as a result of an economic boom fueled by rising government debt.

In recent months, however, the Turkish currency has come under mounting pressure, slumping nearly 40 percent this year amid growing investor concern for Turkey's ability to pay off its mostly US dollar-denominated debt.

Read more: Emerging economies under pressure amid Turkish crisis

Therefore, the scaling back of infrastructure plans would be welcomed by investors, who have repeatedly warned about surging costs of new hospitals, bridges and roads that are mostly built in private-public partnerships.

However, the Turkish president is still reluctant to let go of any of his 'mega projects,' which are intended to celebrate the Turkish republic's centenary this year. In addition, he continues to detest monetary policy measures, such as higher interest rates, to stem the slide of the lira.

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The big picture

Turkey is in the throes of a full-blown currency crisis, with the Turkish lira losing nearly 45 percent of its value since the start of the year. The currency crisis threatens to plunge the world's 18th-largest economy into a financial crisis and trigger contagion in emerging markets and Europe.

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Search for yield

Turkey has traditionally suffered from a large current account deficit. This difference between import and export of goods and services has been filled through external borrowing in foreign currency. A decade of easy money and low interest rates in the United States and EU following the 2008 financial crisis led to investors searching for higher yields to emerging markets like Turkey.

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Credit-fueled growth

The external funds entered the Turkish economy to finance deficits, massive government spending and company borrowing. Credit-fueled growth helped the Turkish economy grow and boosted the government’s popularity through increased consumption and major construction projects. Here, road paint reads: "Slow down."

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Reducing exposure to emerging markets

Investors have pulled back money from emerging markets in recent months as the US Federal Reserve has steadily raised interest rates and is cutting back on easy money policies in response to a robust American economy. This has caused the dollar to increase, the lira to fall, and Turkish bond yields to rise.

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Loss of confidence in Erdogan's strong hand

The pressure on Turkey is reflective of broader trends in emerging markets, although the lira is by far the worst performer. That's because investors have lost confidence in management of the economy under President Recep Tayyip Erdogan, who believes in unorthodox economic policy, demands low interest rates and constantly assails "the interest rate lobby." Inflation is at 16 percent a year.

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Trump's tweet shakes markets

On August 10, US President Donald Trump announced higher tariffs on Turkish imports of steel and aluminum. The tariffs themselves are minor and impact around $1 billion (€875 million) in trade, but they weighed on market confidence in the vulnerable Turkish economy. Even more, Trump’s direct reference to the Turkish lira sent the currency tumbling.

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Frenemies

The imprisonment of US pastor Andrew Brunson has weighed heavily on relations, leading to a series of escalations. Ties between the two NATO allies have also nosedived over US support for Syrian Kurdish forces, Ankara's plans to buy a Russian missile system and Turkey's demand that Washington extradite US-based Islamic cleric Fethullah Gulen, whom Erdogan blames for the failed July 2016 coup bid.

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One man show

Poor relations between Washington and Ankara have added to Turkey's economic woes, but given broader fundamentals it is only a proximate cause of the market mayhem. More than 30 percent of the lira’s loss has come since June, when Erdogan took over the office with new sweeping powers. Erdogan's authoritarian hand has distanced the country from traditional Western allies and hit confidence.

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Albayrak: the son-in-law

After winning a June election, Erdogan spooked markets when he tightened his control over the central bank. Instead of appointing technocrats, Erdogan appointed his son-in-law Berat Albayrak (pictured) to lead the newly empowered Finance Ministry. This has raised concerns over the central bank's independence given the president’s repeated statements against raising interest rates.

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'Economic war'

Erdogan has not inspired confidence in responding to the lira meltdown. He speaks of "economic war" and a "campaign" waged by external powers designed to weaken Turkey. Instead of taking drastic action to shore up confidence, such as raising interest rates or going to the International Monetary Fund (IMF), the government is couching itself in nationalistic rhetoric of sacrifice.

Limits to patience

On Thursday, the Turkish central bank surprised markets with a higher-than-expected interest rate hike, lifting Turkey's benchmark rate by more than 600 percentage points to 24 percent.

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Read more: Turkish interest rate rise brings Erdoganomics down to earth

The move, which shored up the lira by about 5 percent, roiled Erdogan, who had described higher rates as a "tool of exploitation" just hours before the central bank's decision.

In his first comments on the decision, the Turkish president on Friday described the rate hike as "very high," but added that the central bank was independent in its policy.

"They say independence, there you go independence. Now we will see the result of independence. Right now personally I am at my phase of patience. But this patience is to a certain extent. Because we can't say OK to a lever of exploitation," he said.

Read more: IMF bailouts — roads to stability or recipes for disaster?

Investors said they were now expecting the Turkish government to draw up a clear fiscal plan about how it wants to bring its budget deficit down below 2 percent — the government's target to be achieved under its medium-term economic program. Moreover, they have urged Erdogan to resolve Turkey's disputes with the United States that triggered the currency crisis in the summer.

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The two sides of the Turkish crisis

uhe/tr (Reuters, AFP)