Time for Turkey to call in the IMF

The late Rudi Dornbusch, the renowned MIT economist, was fond of saying that economic crises generally took longer to occur than one might have expected. However, when they did finally happen, they occurred at a very much faster pace than one might have thought possible.

Turkish President Recep Erdogan is now finding out that Dornbusch’s dictum applies to Turkey. For many years Turkey somehow managed to avoid a full-blown economic crisis despite gross macroeconomic mismanagement and the embrace of highly unorthodox economic ideas. However, at the start of this year with the onset of the COVID-19 pandemic, the tide suddenly turned. Capital began flooding out of the country thereby depleting the country’s international reserves and leaving its currency in freefall. 

Turkey now finds itself in the most unenviable economic situation. Its tourism sector is being decimated by the pandemic, its central bank now has negative international reserves, its corporate sector has a $300 billion-dollar denominated debt and its banking system seems to have more foreign exchange liabilities than it has foreign exchange assets. More troubling yet, President Erdogan seems to have totally lost economic policy credibility both with domestic and foreign investors by his erratic and unconventional style of economic management.

One way in which Erdogan lost credibility was to appoint his ill qualified son-in-law as his finance minister. Another was to purge the central bank of its experienced and competent staff and to appoint a yes-man as the head of the central bank. More troubling yet was Erdogan’s profligate inclination toward public spending and his enthusiastic embrace of the harebrained notion that high interest rates caused rather than cured inflation.

Faced with a currency crisis that now appears to be spinning out of control, Erdogan has a basic choice. He can choose to have his country go it alone without seeking international assistance, with all of the risks that choice would entail. Alternatively, he can swallow his pride and call in the International Monetary Fund (IMF) for its balance of payments assistance, even though doing that would mean that he would have to go back on his oft-repeated pledge that Turkey’s IMF days were over. 

Choosing to go it alone at a time when the country has run out of international reserves is highly risky. It could mean that the country will soon need to impose capital controls to prevent the currency from spiraling ever downwards. That in turn would risk deepening the domestic economic recession and provoking a banking crisis by further damaging foreign and domestic investor confidence. 

Approaching the IMF for a large Standby Arrangement or an Extended Fund Facility loan would offer the country the possibility of a very much smoother adjustment path than would going it alone. Not only might the IMF help the country replenish its depleted international reserves and avoid the imposition of capital controls. It would also offer the country the opportunity of rapidly restoring its credibility in the markets through its seal of approval for the country’s economic policies. 

One big fly in the ointment for Erdogan to approach the IMF is that the IMF would attach strict conditions to its loan and would require that Erdogan abandon his wayward economic ways. In all probability, it would insist that Erdogan commit himself to restoring the central bank’s independence and to rebuilding the economic institutions that he has so badly damaged. More problematic yet for Erdogan would be that the IMF would require that he abandon his lavish pet public spending projects and that he agree to the aggressive use of interest rate policy to help support the currency.

Yet another big fly in the ointment for Erdogan is that to get an IMF loan he would also certainly need the support of the United States, the IMF’s largest shareholder. That in turn would require Erdogan to mend fences with the United States, a country that in the past he has seemed to go out of his way to antagonize.  

For Turkey’s sake, we must hope that Erdogan now puts his country above his personal pride and that he will reach out soon for an IMF lifeline. However, judging by Erdogan’s past economic blunders and by his highly nationalistic policy approach, Turkey’s economic crisis will probably have to deepen before Erdogan is forced to make an IMF U-turn.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.