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The Turkish Economy at the Crossroads: The Political Economy of the 2018 Financial Turbulence

In 2018, the Turkish economy suffered one of the most severe financial speculations in its 38-year open economy era. Some have tried to explain the causes of the financial turbulence solely by linking it to the deterioration in the macroeconomic indicators, such as the inflation rate and current account deficit. However, this approach cannot help us to understand the fundamental causes of the financial turbulence. This paper argues that internal and external shocks ranging from the coup attempt in 2016 to geopolitical risks hindered the designing and implementation process of the second-generation reforms Turkey needed to escape from its middle-income trap. As the reform process slowed down and the severity of shocks increased; uncertainties over economic performance and policies mounted. This uncertain environment paved the way for financial turbulence by providing opportunities for speculators to mislead the markets in line with their own interests.

The Turkish Economy at the Crossroads The Political Economy of
Employees work in their booths at the Borsa Istanbul SA stock exchange on January 1, 2019 in Istanbul, Turkey. AHMET BOLAT/AA Photo
 

In 2018, the Turkish economy underwent one of the most severe financial speculations of its history. The U.S. dollar/Turkish lira exchange rate climbed from 3.75 to 4.90 in the first five months of 2018, the lion’s share of the increase coming in May. The lira faced an even harsher depreciation in August as the exchange rate peaked at 7.22, before decreasing gradually below 6.00.

Although many posited that the currency shock emanated mainly from high levels of current account deficit and inflation, this “economic” explanation is clearly not enough, particularly for a country such as Turkey with its considerable economic strength and the level of its financial depth.1 In order to explain the sudden and severe volatility in the exchange rate, the following factors should also be taken into account: the constant crisis-mongering to create a perception that economic governance would be disrupted after Turkey’s transition to a presidential system, the manipulations with regard to foreign exchange markets, the banking sector, and the financial speculations fed by the then strained relations between Turkey, and the United States (U.S.).2

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