Mustafa Sönmez

Turkey’s consumer inflation overshot expectations in October, climbing 2.67% and bringing year-on-year inflation to 25.2%, much to the chagrin of Treasury and Finance Minister Berat Albayrak, the president’s son-in-law, who had declared an “all-out fight against inflation” in mid-September.

The details of the inflation data, released Nov. 5, show that food prices shot up nearly 30% from October last year. In the subcategory of fresh fruits and vegetables, the increase was even more staggering, hitting 50%.

For Turkey, such inflation is unprecedented since 2004. The sharp increases in food prices hit low-income groups especially hard, as they spend a significant part of their budget on food. According to official statistics for 2017, the largest item in household spending was housing and rent at 24.7% of total spending, followed by food at 19.7%. The lower the income, the larger the share spent on food. Impoverished households in the bottom 20% on the income scale spent 29% of their budgets on food.

Coupled with economic contraction and increasing unemployment, the surging inflation owes much to a structural setback, namely an insufficient supply in agricultural products or a food deficit. The concerned authorities, including the Central Bank, agree that Turkey will struggle to get rid of double-digit inflation unless these problems are resolved.

In its inflation report for the third quarter, the Central Bank said, “Occasional supply shortages in unprocessed food products in Turkey that lead to sudden and sharp price increases mainly stem from structural factors. Here, the inability to make an efficient and dynamic agricultural production plan is considered to be a significant structural problem. Developing a production plan requires strengthening of agricultural statistics, yield estimation and early warning system infrastructure.”

Yet the Central Bank failed to delve further into the core of the problem, focusing instead on the role of middlemen. “Another structural problem causing cyclical supply shortages is the mismanagement of the field-greenhouse-field transition, particularly in fresh vegetable products,” the report says. “Despite being short-lived, these transitions lead to supply shortages and enable the intermediaries who dominate the market to speculate on prices and achieve excessive gains.”

No doubt, speculative profits by middlemen should be prevented, but the primary problem that needs to be highlighted is that the agricultural sector is losing producers and its share in the gross domestic product is rapidly falling. Agriculture accounted for 6% of GDP in 2017, down from 10% in 1998.

In recent years, Turkey has become a net importer of food despite its abundant agricultural potential and recent classification as self-sufficient and safe from food security risks. In the 2016-2017 market term, for instance, the rate of domestic output meeting domestic demand in cereal products was 97.2%. In other words, the locally produced crops such as lentils, chickpeas, haricots, barley and sunflower were not enough to meet domestic demand.

The factors behind the decline of Turkish agriculture can be traced back to ill-advised policies in the 1980s and 1990s. Public enterprises that significantly propped up the sector prior to 1980 were privatized on the grounds they were a burden on the treasury. Similarly, subsidies were reduced on the grounds that agricultural support purchases contributed to central budget deficits. An agriculture law adopted in April 2006 appeared to legally guarantee support to farmers, but that was not the case on the ground. According to the law, funds of at least 1% of GDP must be allocated to supporting farmers, but according to Turkey’s Agricultural Chambers Union, the amount of support has remained at only 0.56% of GDP.

The decreased support condemned agricultural output to trail behind industry, which in turn meant that agriculture ceased to be a source of livelihood for a significant portion of the populace. In 2000, Turkey’s agricultural sector employed 7.7 million people, or nearly 36% of an overall 21.5 million people. In 2018, the overall figure was up at 29.2 million people, but the share of agriculture was down at 19.5%. The number of people employed in agriculturehas decreased by 2 million to 5.7 million in 17 years.

Farmers have been grappling with high input costs to sustain production. They often take losses, unable to sell at prices justifying the production cost, driving them to quit the sector.

The decline in agricultural activity and the aging population in rural areas have left vast farmlands uncultivated. Many agricultural fields in proximity to urban centers have become plots for housing projects and commercial buildings. According to data by the Turkish Statistical Institute, the country’s farmlands shrank to 38 million hectares in 2017 from 41 million in 2001, a remarkable 7.3% shrinkage. That only a third of the fields enjoy access to irrigation is another important problem of the sector.

Last but not least, Turkish farmers rely heavily on imported inputs both in crop cultivation and husbandry, another factor that drives them away from the sector. On the crop side, this reliance includes basic materials such as diesel fuel, fertilizers, seeds and pesticides. And because of the depreciation of the Turkish lira, the cost of imports keeps rising, coupled with hefty taxes.

In husbandry, many inputs are also import-reliant, including breeding animals for dairy farming and stocks bred for meat. Amid shrinking pasture areas, the sector has largely adopted manufactured fodder, and more than 50% of those raw materials are also imported. Even in the production of barley and corn, two key inputs for the fodder industry, the self-sufficiency rates have fallen to 89% and 88%, respectively.

In sum, agricultural and trade policies over the years have served to boost imports rather than agricultural output. As a result, the supply deficits in agricultural products and food have increased and so have their prices. Unless structural problems are resolved, Turkey’s food inflation is clearly bound to continue.

Turkey’s construction sector, the backbone of Ankara’s growth policies for the past decade and half, stands out among the earliest victims of the country’s economic crisis, rapidly contracting and threatening to drag others down with it.

The sector, including realty, accounted for 15.7% of Turkey’s $851.5 billion in gross domestic product (GDP) last year, almost on par with the manufacturing sector, which accounted for 18.5% of GDP. After impressive expansion, sales are now shrinking rapidly for homes and offices, leaving builders with swelling stocks. Housing demand, in particular, has fallen sharply, hit by the slump of the Turkish lira and the ensuing increase in interest rates. Building companies are struggling to decrease stocks and repay bank loans. Despite government incentives, including tax cuts and cheaper loan campaigns, the sector remains in turmoil, and the circle appears to be tightening.

In the first nine months of the year, home sales decreased 2.7% compared to the same period last year. Mortgaged home sales, meanwhile, were down 29.4%, largely the result of the increase in interest rates. The rate on home loans hit 25.2% in September, up from 12.9% in September 2017, before climbing further to 29% in October.

The overstock problem has also strained the government’s Housing Development Administration (TOKI) and its affiliated Emlak Konut, the country’s biggest real estate investment trust. Founded in 1984 to develop land with infrastructure and provide loan support to mass housing builders, TOKI turned to high-profit housing after the Justice and Development Party (AKP) came to power in 2002. Since 2008, it has also focused on the construction of public buildings, including hospitals and schools. As of June, TOKI had 142,000 homes for sale. Since 2003, it has sold about 696,000 of the nearly 838,000 homes it built, but it is now struggling to attract buyers, and the number of its new projects has visibly decreased.

Sales figures in branded projects developed by Emlak Konut also indicate a slow down. Nearly half of Emlak Konut homes, offices and shops remained for sale during the first half of 2018, according to a company activity report released on the Public Disclosure Platform.

Shrinking demand has also led to tangible drops in home prices. As a result, the annual increase in housing prices has fallen well behind the increases in overall consumer and producer prices. As of August, the 12-month increase in housing prices stood at only 3.8% in Istanbul, 8.6% in Ankara and 15.7% in Izmir, according to central bank data. Producer inflation was 32% for the same period, a striking sign of how the increase in housing prices was not even half of the inflation rate.

Hardship in selling or renting finished homes and offices has forced an abrupt halt in new investments. Another major factor is the spike in construction material prices amid the rapid increase in foreign exchange prices and interest rates over the past several months. The construction cost index by the Turkish Statistical Institute indicates that the prices of construction materials soared 44% over the last 12 months, with overall producer inflation reaching 46% in the same period. In 2016 and 2017, the increase in construction material prices stood at 13% and 27%, respectively. The soaring costs have not only discouraged new investments but have also dealt a heavy blow to ongoing projects.

A sharp downturn is seen for infrastructure as well. Public construction investments have rapidly slowed, and the so-called megaprojects, launched as public-private partnerships (PPP), have also fallen into crisis. PPP projects, including airports, highways, bridges and hospital campuses, many of them in and around Istanbul, have been hit by foreign currency losses due to the meltdown of the Turkish lira, which has aggravated the debt burden stemming from the foreign loans acquired. The increasing costs are hard to cope with for those projects as well.

Dozens of construction companies have already thrown in the towel, lining up for bankruptcy protection in commercial courts. The hardest blows, however, are being felt by the sector’s workers, from blue-collar laborers to architects and engineers. Employment figures in the sector are on a downtick. Moreover, the increase in labor coststrails well behind consumer inflation, indicating a meltdown in the real income of construction workers. As of July, the 12-month increase in labor costs stood at 17%, compared to a nearly 20% increase in consumer prices for the same period.

When the AKP come to power in early elections in November 2002, it was handed a rehabilitated economy on a silver platter, while the three outgoing coalition partners were ousted from parliament, paying the penalty for the International Monetary Fund-backed austerity measures that put the economy back on track after a severe crisis in 2001. Drawing on this precious inheritance, the AKP government was able to attract an extraordinary inflow of foreign funds, including in the aftermath of the 2008 global crisis, until 2014. Thanks to those foreign funds, obtained mostly through borrowing, it achieved high rates of economic growth, which relied largely on the domestic market and was heavily driven by construction. The government paid no mind that construction was not generating much-needed foreign exchange, enjoying the political returns of the building frenzy.

Turks were impressed by the grandiose airports, bridges and buildings springing up before their eyes, rewarding the AKP at the ballot boxes. In further electoral gains for the party, the construction boom meant jobs for the most unqualified and neediest breadwinners, while part of the foreign funds flowing into the country became housing loans to make large numbers of Turks homeowners.

Another reason to opt for construction-centered growth was to create the AKP’s own bourgeois, with the building spree proceeding along with nepotistic construction permits and public land allocations by local administrations and the central government. As such, the construction sector provided the funds to build a party state through the control of crony business people of varying caliber.

This wheel, which relied on foreign funds to continue spinning, began to slow as money became more expensive after 2014 before hitting a downturn and then crisis. Due to its links with many industrial subsectors and service sectors, among them financing, real estate marketing and advertising, the crisis-hit construction sector has begun to drag the entire economy down.

A fresh takeoff can be achieved only with the revival of domestic demand, which, in turn, requires reducing inflation to single digits, getting loan interests to reasonable rates, restoring foreign investor confidence in Turkey and the flow of external funds and dispelling the general fog of economic uncertainty. In short, it all depends on seeing a light at the end of the tunnel, which is likely to take several seasons. Before anything else, however, the AKP government needs a clear roadmap to begin climbing out of the hole. Some may claim the worst is now behind, but the truth is, Turkey has not hit bottom in the current crisis.

Turkey is grappling with soaring inflation, the highest since 2003, which was the first full year in power of the Justice and Development Party (AKP). In September, year-on-year inflation reached 24.5% in consumer prices and 46% in producer prices. The inflation dynamics indicate that the year-end figures could climb to between 30% and 35% in consumer prices and between 50% and 60% in producer prices.

Consumer inflation had been in single digits since 2003, excluding last year, when it reached 11.9%. The current surge is a new situation that makes wage earners and pensioners relatively poorer as they fail to increase their incomes in line with price increases. The biggest fear of working people, however, is that they could end up with no income at all if the slowing economy spawns a new wave of layoffs. For those indebted to banks, the reasons to worry are even bigger.

Faced with an inflation unseen in the last 15 years, Turks are primarily incensed over the increase in food prices, which owes heavily to the ill-advised policies of the AKP. For years, the AKP encouraged construction-centered growth, neglecting agriculture, as a result of which Turkey is now facing supply shortages and has become a net importer of food.

The main factor fueling inflation, however, is the dramatic depreciation of the Turkish lira or, in other words, the huge increase in foreign exchange prices. At the end of September, the price of the dollar was up 82% from the same period last year. In the first 10 years of AKP rule, the price of the greenback had increased only 27%, which made possible the single-digit inflation rates. With the currency crisis this year, imports became much more expensive and the costs of producers shot up, hence the 46% producer inflation in September.

The big gap between producer and consumer inflation indicates that retailers have refrained from hiking their prices at the rate of producers. Yet despite the threat of sharp declines in domestic demand, consumer prices have already soared 24.5%. No doubt the global increase in the prices of energy and commodities such as wheat, iron ore and copper has also played a role in the growing cost burden for producers.

According to government officials, however, the soaring inflation is essentially the work of malevolent actors such as greedy middlemen and speculators who have to be disciplined through forceful measures, including the mobilization of municipal police. In an Oct. 2 speech, for instance, President Recep Tayyip Erdogan said, “I’d like to appeal to my dear nation: You are the ones who inspect the prices most closely at supermarkets and elsewhere. If you spot products with extraordinary price differences, report them immediately to the municipal police. I am also calling on mayors to encourage more attention on the issue among the municipal police. It is our duty to do what is necessary if there are fluctuations in prices and to raid stocks if there are hoarders.”

Treasury and Finance Minister Berat Albayrak, who is also the president’s son-in-law, followed suit. In a television interview the following day, he said citizens were reporting “speculative” price hikes on a consumer line set up by the government. “Citizens and [government] are both in action,” he said.

Interior Minister Suleyman Soylu, for his part, instructed governors across the country to tighten measures against hoarding and price gouging and slap fines on transgressors.

In short, Ankara has refused to acknowledge the real dynamics of inflation and draw up measures accordingly. True to style, it has instead pointed an accusing finger at “villains,” who, in this case, are hoarders and opportunists.

For those familiar with the AKP, this strategy is hardly a surprise. Blaming setbacks and problems on external factors, conspiracies or instigators has been an AKP hallmark for years. According to this thinking, the surging inflation cannot be the result of Ankara’s mismanagement, so it must be the work of greedy actors in the market, against whom the victimized populace has to be protected.

Then, at an Oct. 9 meeting attended by leading business people, Albayrak announced an “all-out fight against inflation.” As part of the campaign, which is perhaps unprecedented in the world, the private sector promised 10% discounts to consumers by the end of the year. Another measure envisaged a freeze on the prices of gas and electricity, again by the end of the year. Banks, for their part, would contribute a 10% cut in the interest rates of already issued loans.

The Turkish Statistical Institute (TUIK) calculates consumer inflation on the basis of more than 400 products and services, which are provided by tens of thousands of companies in the market. Participation in the campaign was not obligatory, but the business community was asked to promise discounts. Of course, no one publicly raised objections, but many could not conceal sardonic smiles. With consumer prices already up by more than 24% and further cost-related hikes already factored into producer prices, discounts of 10% will make little difference.

The increased prices, meanwhile, have led to a drop in domestic sales. According to TUIK, retail sales were down 3% in August in terms of inflation-adjusted value. The drop is likely to have worsened since then, given the decreasing real income of consumers. The shrinking demand has already forced companies to make markdowns, with many shops advertising discounts of up to 50%. This again raises the question of what difference the 10%-discount campaign can make.

So, what is the government’s actual purpose with the campaign? Is it another attempt to shirk responsibility by portraying inflation as an external calamity against which a fierce struggle is waged? Or is the government laying the ground for looming negotiations with trade unions to determine the hike in the minimum wage, which is the principal income of millions of Turks? By claiming a sincere struggle against an externally inflicted setback, Ankara might be planning to press its interlocutors to make their own sacrifice in the “all-out fight” and acquiesce to a low pay hike. This perhaps is the calculus behind the AKP-style fight against inflation.

Turkish President Recep Tayyip Erdogan has quickly returned to anti-American ranting after conciliatory messages to Washington and Berlin two weeks ago that seemed to herald a bid to mend fences with the West. In an Oct. 6 speech heavily peppered with anti-American rhetoric, Erdogan nixed a consultancy deal with the US company McKinsey that Finance Minister Berat Albayrak had recently announced as part of efforts to fix the ailing economy. Turkey can manage it by itself, Erdogan asserted, only days after Albayrak, who happens to be his son-in-law, said that those opposed to collaboration with McKinsey were “either ignorant or traitors.”

Such zigzagging in Ankara reflects how economically and politically squeezed Erdogan’s government has become. On the economic front, it faces a hefty debt stock, a badly weakened currency, an inflation rate of nearly 25%, a serious unemployment problem and stagnation, which are causing loud grumbling among the electorate, including long-time voters for Erdogan’s Justice and Development Party (AKP). With municipal elections looming in March, the circle around Ankara tightens by the day.

The International Monetary Fund (IMF) appears to be the only source of much-needed recovery funds — in return for an austerity program, of course — but Erdogan has bluntly rejected that option, maligning past IMF-backed programs as an “IMF yoke.”

All in all, Ankara seems bent on deferring the bitter pills the crisis calls for, which involves enacting serious measures. Instead, its course of action until elections appears to be based on buying time by distracting the electorate, sweeping the dirt under the rug of the Treasury and foisting corporate debt woes onto banks, especially when it comes to companies in the good graces of the AKP.

Erdogan is averse to calling the turmoil a “crisis,” instead often describing it as “manipulations” or a foreign conspiracy against Turkey. The IMF, however, sees a Turkey in the grips of crisis.

The IMF’s “World Economic Outlook 2018,” released Oct. 8, prescribes tighter monetary policies for Turkey to curb “unanchored inflation expectations” amid the lira’s sharp depreciation. Pointing to “significant stress … emerging in bank and corporate balance sheets,” the fund calls for “strengthening bank supervision and enhancing the crisis management framework.”

The IMF expects a sharp decline in Turkey’s economic growth, projecting the rate to drop to 0.4% in 2019, from 3.5% this year. By implication, this means that the economy would shrink by 1-2% between the last quarter of 2018 and the third quarter of 2019. High inflation and economic contraction, coupled with increasing unemployment, make for the particularly vicious type of crisis called stagflation. Instead of acknowledging reality, however, Ankara is pursuing measures that deny the crisis while producing little in terms of results.

In mid-2018, Turkey’s external debt stock stood at $457 billion. Over the next 12 months, the country will need $181 billion to roll over maturing debts. The financing of the current account deficit requires another $40 billion, at the least, though the gap has begun to decrease under the impact of the economic downturn.

In total, Turkey needs a minimum of $220 billion over the next 12 months, or roughly $18 billion a month, but it has become a high-risk country for creditors. Its risk premium, reflected in credit default swaps, has decoupled from those of other emerging economies, hovering above 400 basis points despite occasional drops. In sum, borrowing has become more expensive for Turkey.

Under pressure from Erdogan, the central bank had dragged its feet in hiking interest rates to prop up the melting lira before announcing a massive hike of 625 basis points in mid-September. With inflation hitting 24.52% last month, however, the hike has quickly become irrelevant. Anticipation is now building for another hike of up to 300 basis points at the bank’s next meeting, on Oct. 25. Increased interest rates on the Turkish lira have had limited effect in shoring up the currency. The price of a dollar remains at about 6 liras, and although the lira’s free fall has stopped, the exchange rate appears prone to fluctuation.

Ankara’s zigzagging on economic policies is fueling the perception of risk. Albayrak’s deal with McKinsey was aimed at providing some international credibility to Ankara’s economic management and restoring confidence among fleeing foreign investors. In less than a week, Erdogan rebuffed the deal. This flip-flopping has of course stoked foreign creditors’ and investors’ mistrust.

Consumer inflation is widely expected to climb further in the coming months under the pressure of producer inflation, which stood at a staggering 46% in September. In the eyes of the AKP, however, malicious forces are again to be blamed.

Ankara is telling the nation that opportunists, speculators and hoarders are fueling the inflation. In an unprecedented move, it has mobilized municipal police to inspect supermarkets to hunt for price gougers. Furthermore, Albayrak asked businesses this week to grant customers 10% discounts by the end of the year as part of an “all-out struggle” against inflation.

Fighting inflation with discount pledges from sellers is nothing but fantasy, yet Ankara’s efforts appear aimed at producing an argument against inflation-indexed pay rises at the end of the year. When the time comes for pay and pension hikes in December, Ankara is likely to argue that its measures will bring inflation down to 16-17% next year, so the hikes should be fixed accordingly, not in line with the current rate. Such a fiat would affect some 19 million working people and about 10 million pensioners, threatening political fallout for the AKP in the March polls.

The problem does not end with the real income loss caused by inflation. Unemployment is on the rise as well, and no measures are being discussed to stem layoffs. Moreover, the assets of the Unemployment Insurance Fund, amounting to 125 billion liras (about $21 billion), have been put in use to shore up the gaps of public banks, adding to popular discontent. Many among the electorate are also struggling to repay bank debts.

Hundreds of indebted companies, big and small alike, are in a financial bottleneck and pressing banks to make sacrifices. The banking system itself needs safeguarding.

In sum, the challenges are many, but Ankara’s means are limited. As the government scrambles for solutions, budget deficits and other, less visible gaps in public finances are widening, and Ankara’s room to maneuver is shrinking.