Why Turkey is headed for Stagflation?

-  The views written in this post are strictly mine and doesn’t reflect the views of the institution I work for

After Turkey’s Central Bank (TCB) governor had tried to calm down the markets on Tuesday after lira traded record lows against US dollar and Euro, he unintentionally made the situation worse. Turkish lira slumped even more probably making the day “Black Tuesday” for Turkish market.

Başçı openly challenged the 4-trillion-a-day market openly while resisting an interest rate hike which left everyone scratching their heads. Turkish lira almost lost 763 basis points in 2 days despite his forecast of USD/TRY at 1,92 year’s end.

Turkey has a large trade and current account deficit. Most of the imports are comprised of energy commodities like oil or natural gas. Lira losing value makes these commodities more expensive for the domestic consumer. Oil prices rising due to Syrian conflict is not helping Turkey either.

It is obvious by now that TCB has shifted its focus to growth from inflation. Weak Turkish lira will force inflation to go higher due to large imports of Turkey. Central Bank should be hoping by resisting a rate hike which will keep the consumer credit rates at record low levels, the growth won’t be tapered.

Second, high energy prices will be a hurdle for growth as well as causing domestic prices to rise. Analyst expected Turkey to grow around 3 – 3.5% this year, a little higher compared to unimpressive 2012 growth rate of 2.2%.

The credit-pumped companies and foreign capital addicted banks will be shaken by the weak lira which will be difficult for them to grow, invest and hire employees.

Moreover the Syria situation gets more complicated for Turkey. As the government shows its willingness to interfere in Syria, it will be likely be an active player which makes things even more complicated for Turkey. If the conflict turns really sour for the region and Western powers unable to oust Esad quickly, Turkey will be a close target for the Esad regime, Islamist fundamentalists groups and likes of Hizbullah and Iran.

These economic and political risks are likely to cap the hiring in Turkey which then can cause the unemployment rate to rise.

As a result Turkey can be faced with high inflation and a high unemployment rate.