An economy in crisis: It’s time for Turkey to call in the IMF

If ever a country needed an International Monetary Fund (IMF)-supported economic adjustment program, it has to be Recep Tayyip Erdoğan’s Turkey.

It is not simply that his country has sky-high inflation, a gaping external current account deficit and a currency in seeming free fall. It is that the country’s foreign exchange reserves are depleted and Erdogan’s past economic policy mismanagement has left the country with a major investor confidence deficit.

The IMF could help the country’s president, who won reelection late last month, set his economy in order, not least by helping to prevent a full-blown foreign exchange crisis. It could do so by boosting confidence through provision of desperately needed external financial support and by giving its seal of approval to a credible economic adjustment program. At a political level, it could provide Erdoğan with a useful scape goat for the painful economic medicine that Turkey now has no real alternative but to take.

Turkey finds itself in dire economic straits at a challenging time for the global economy. Despite being artificially suppressed, inflation is still some 45 percent, while the external current account deficit has widened to 6 percent of GDP. Meanwhile, the central bank’s international reserves are dangerously low, interest rates are highly negative in inflation-adjusted terms and the government is on the hook for a mountain of bank deposits that it guaranteed against exchange rate depreciation. As if this were not enough reason for deep concern, the country’s currency has lost a further 20 percent of its value in the two weeks since the second round of the election.

In these circumstances, the last thing that Turkey needs is another half-baked economic adjustment program. To be sure, Erdogan’s recent appointment of Mehmet Simsek, a well-respected and experienced economist, as minister of finance is a welcome first step in restoring confidence. So too is the recent move to a more market determined exchange rate. However, if these moves have any hope of succeeding, those initial steps need to be followed by the more difficult task of pursuing an appropriate monetary and fiscal policy.

Contrary to what Erdoğan has espoused in the past, higher interest rates are an essential part of inflation’s cure. If he is to have any hope of stabilizing the exchange rate and bringing down inflation, he will have to allow his central bank to raise interest rates substantially to levels that might be at least positive in inflation-adjusted terms.

At the same time, if the external current account deficit is to be reduced to a sustainable level without adding to inflationary pressures, monetary policy will need to be supported by a more restrained budget policy. Such a policy would allow domestic demand to be reduced to make room for much needed external current account deficit without a further burst in inflation.

For Erdoğan to make an abrupt economic policy U-turn and go to the IMF will be a politically difficult pill to swallow. However, given his numerous past failed efforts in going it alone to adjust the economy, he would seem to have no realistic alternative but to go cap in hand to the IMF for its financial assistance and seal of approval.

Rudi Dornbusch, the late MIT economist, famously said that a currency crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought. He also is said to have likened the task of halting a currency crisis to that of a hunter with only one bullet in his rifle being faced by a charging tiger. If the hunter does not get his shot right the first time, he will not have a second chance.

Now that Erdoğan has been elected for another term, we have to hope he gets the present currency crisis under control the first time, by calling in the IMF for an economic adjustment program. However, given his past highly eccentric and erratic economic policy performance, I would not recommend betting the farm on his doing this.

American Enterprise Institute senior fellow Desmond Lachman was 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.