ECONOMICS CONVENTION

JAI HIND COLLEGE

FEBRUARY 2020

THE IMPACT OF POLITICAL

INSTABILITY ON ECONOMIES
AUTHORITATIVE REGIMES AND IMPACTS

HARSH BALANI PAYAL DEVJANI AKSHAJ KHEMKA

harshbalani@icloud.com devjani.payal@gmail.com akshajkhemka@gmail.com

Word Count: 2456

 Table of Contents

Table of Contents ...................................................................................................................... 1

Abstract ..................................................................................................................................... 2
Introduction ..............................................................................................................................4
Research Methodology ............................................................................................................. 5
Objectives .............................................................................................................................. 5
Hypothesis ............................................................................................................................. 5
Sources ................................................................................................................................... 5
Limitations ................................................................................................................................ 5
The Political – Economy Analysis, Evaluation and Outcomes –............................................. 7
The Politically Instable Regimes .......................................................................................... 7
The Impact on the Macro Numbers and the Consequences on the Economy ...................9
Conclusion and Future Scope ................................................................................................. 14
Bibliography .............................................................................................................................15

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 Abstract

Political instability, mildly termed as volatility in electoral politics, is on the rise in

democracies and is showing no signs of abating. Granting the premise just for the
moment, why is this happening? Economic growth and political stability are deeply
interconnected. As the uncertainty associated with an unstable political environment
reduces investment and the pace of economic development, poor economic performance
leads to government collapse and political unrest.

This paper contributes to this developing empirical literature through analyzing the case
of debt-ridden Turkey, which is facing a crisis that threatens to plunge the arena's 19th-
largest economy right into an economic turmoil and cause contagion in rising markets
and Europe. It was characterized by the Turkish lira plunging in value, high inflation,
rising borrowing costs, and correspondingly rising loan defaults that led to the economic
crisis. Capital inflows, and the reversals thereof have dramatically affected the
mechanisms of economic growth and recession in Turkey. Turkey’s reliance on external
financing has made it vulnerable to minor changes in the terms and availability of credit.
The crisis was substantially caused by large amounts of private foreign-currency
denominated debt, in combination with President Erdogan’s increasing authoritarianism
and his unorthodox ideas about interest rate policy.

In many nations, including the US and EU states, the central bank is independent of
government and no one can tell it what to do with interest rates. This means it can keep
control of inflation by raising them when necessary. But in Turkey, Mr. Erdogan has
made sure he controls the reins

In the Indian context, the RBI has faced several interventions from the central
government who’s electoral and political motives promote a short term goal oriented
policy making. Contrary to this, Ex-Governor YV Reddy claimed his single agenda is to
protect the economy from the government. This apparent mismatch is worth giving a
thought.

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The cases on India and Turkey well define the interdependence of economic growth and
political instability as we interpreted that an authoritarian body with the perspective of
staying in power often influences the macros of an economy as well as how a
governments control of monetary rates can threaten global financial market. A mindset of
political power over contradicts the greater good of an economy with crossovers for short
and long term objectives.

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 Introduction

What is the nature of the relationship between political instability and economic growth
in a country? This question has been the subject of a long-standing debate among many
economists and political scientists. Economic growth and political stability are deeply
interconnected. With the uncertainty associating unstable political environment leading to
reduction in investment and economic development, political instability tends to be
persistent. Irrespective of political regimes, if a country does not need to worry about
conflicts and radical changes of regimes, the people can concentrate on working, saving,
and investing. In this paper, we look at the case of Turkey where Capital inflows, and
their pace and reversals have dramatically affected the mechanisms of economic growth
and recession along with President Erdogan’s moves toward authoritarianism. Changes in
the Turkish Constitution initiated by President Erdogan have also altered the balance of
power in the country by giving the president the power to appoint ministers and judges
without the approval of the parliament. This move weakens judicial independence and
threatens economic security.

President Erdogan has openly denounced the strategy of the Turkish Central Bank; he
criticized the raising of interest rates as a way to combat the devaluation of lira.
According to Dani Rodrik of Harvard University, Turkey’s growth has been a result of
globalization and cheap foreign capital, which allowed Turkey to borrow from countries
like France and the United States at low interest rates in order to fund infrastructure
projects and business ventures.

In India, Prime Minister Narendra Modi shares certain similar qualities with President
Erdogan, notably oratorical skills, appealing to populist basic instincts, and postured-
muscularity of governance that makes him popular amongst a vast section of the masses.
Both leaders are consummate politicians with a permanent eye on their respective cadres,
even at the cost of statesmanship or international criticism. We present some results
based on our specification focusing on the Turkish economy and measuring the
similarities in the political environment of Turkey and India.

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 Research Methodology

OBJECTIVES
 To analyze the correlation between political instability and economies
 To understand how political leaders’ impact the macro numbers and key
economic indicators with their leadership regime, mindset, political party
agendas and strategy

HYPOTHESIS
 Political instability widely affects an array of economic indicators and at
large, the social status and monetary ideologies of the Central banks.

SOURCES
Secondary Sources: The secondary research done was done with several online sources
and websites that had instances relating to the topic. They will not seem accredited and
highly claim worthy as a variety of economic data and opinions were collected to study
how the senses at a lesser magnitude were experienced. Other sourced were research
journals, studies by journalist via the people of the country and economists as well as
blogs

Limitations

The following limitations were analysed:

 Lack of reputed studies made open to the world

 Lack of statistical data to cross verify the observations
 The articles published can be biased towards certain economies, present skew facts
and figures. The reviews and opinions cannot be completely relied on as they are
of anonymous individuals or collected by media sources; hence trusted websites
for reviews are essential

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 Reports and websites should be reputed and known as many fake/politically
sponsored websites offer economic opinion, research and data about leaders and
their agendas.

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 The Political – Economy Analysis, Evaluation and Outcomes –

THE POLITICALLY INSTABLE REGIMES

The President of Turkey, Recep Tayyip Erdogan has been recognized as key role player in
the 2018 Economic crisis of Turkey that was vastly subjected to his leadership as well as
the ruling party’s influence on the Central bank and trade relations with their counterparts.

In contrast with Turkey, a similar example can be viewed in India, wherein the Central
bank, RBI has often criticized the central governments motive to be electoral and short
term in nature, hampering the far sighted goals set by the RBI for the Indian Economy.
Speaking for this, Deputy RBI Governor in 2018, Viral Acharya spoke about the
government’s involvement in interfering with the autonomy of the institutions policies for
NPA’s, NBFC’s and banking provisions. Currently these issues have risen to be very
prominent that makes it clear that his statement had merit and authoritarian regimes by the
Modi government hindered the financial sector by an attributable margin.

Erdogan assumed office in 2014 with bare majority margin and what led to Turkey’s
economic meltdown was a combination of the restraining forces by the Presidents’
authoritarian leadership regime and inconsistency in managing foreign trade relation. He
won a controversial referendum in 2017 that turned Turkey from a Parliamentary
Democracy to a Presidential Republic marking the beginning of his controlling leadership
that sparked by a rogue operation of rebels – condemning the Presidents motives. This was
the earliest evidence of a political instability in his rule termed as – “ERDOGANISM”. To
analyse the impact of Erdogan’s political motive on the aforementioned crisis in Turkey,
the restraining factors can be vividly described.

The Leadership Style

 Erdogan’s initial electoral promises of integral prosperity has led to a strengthening

in the Erdogan personality alternative – to the point where it now serves as a
substitute for achievement. He has himself taken to portraying each failure as proof

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 of his greatness, claiming that they are all products of immoral conspiracies by his
domestic critics and scheming Western powers to try to prevent Turkey’s otherwise
inexorable rise to global pre-eminence under his leadership, a rather unorthodox
take on criticism.
 Secondly, the President has been reluctant to groom a successor for fear that she/he
may launch an early bid for power and refused to introduce much-needed structural
reforms

 The president with his authoritative regimes claimed the exclusive power to appoint
members of the bank’s rate setting board and firing the bank’s governor, Murat
Cetinkaya, after pressuring it to restrain borrowing costs while bought his Son – in
– law to lead the Finance Ministry.

 In what can be termed a pro-monarchy, his thinking lies about the fact that his
successor may come from within the Turkish Islamist movement, she/he is unlikely
to be an Erdogan loyalist or to be drawn from his inner circle but, given that his
successor is unlikely to be able to match Erdogan’s monopoly of political power,
there would likely be at least a partial re-strengthening of Turkey’s institutions.
Hence a quality, that can detrimental for an economy’s development

The Interest Rate Perspective

Turkey suffers from chronically high inflation and is reliant on foreign funding. Lowering
interest rates reduces the return on investing in Turkish assets, and the local currency tends
to weaken relative to others when foreigners decide to put their money elsewhere. That
increases the cost of imported goods in liras and results in higher prices, or more inflation

 In theory and evidence when a central bank increases rates, banks are less able to
borrow to maintain mandatory reserves and tend to lend at their own elevated rates.
This makes loans for businesses rarer and more expensive and so can slow the
economy.

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  However, Erdogan’s notion -- that elevated interest rates cause prices to rise --
contradicts conventional economic theories. They hold that when rates increase,
borrowing decreases, leading consumers to spend less and curbing inflation
 His economic knowledge is partly based on his experience running businesses,
mostly in the food industry, before his career as a politician took off.

 In Erdogan’s view, higher interest rates result in higher prices because businesses
have no choice but to pass increased costs on to their customers. This framework
makes assumptions that orthodox economists challenge, such as that interest rates
make up a significant part of companies’ costs and that producers have sufficient
pricing power to impose their will on consumers.

THE IMPACT ON THE MACRO NUMBERS AND THE CONSEQUENCES ON THE ECONOMY

 The impact of his political instability widely reflected on the Macro numbers and
the economy as a whole after a roaring growth in early 2018 growth had slowed,
the Turkish economy has become heavily dependent on domestic demand, which –
given the country’s low savings rate – has been largely financed by borrowing from
abroad, particularly in US dollars. As a result, Turkey is now highly vulnerable to
any downturn in foreign lender confidence at a time when faltering domestic
consumer confidence and then it crashed suffering a classic run on its currency
which has nosedived and has lost more than 34% of its value against the dollar as
cited in Image 1 and a brutal credit crunch.

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 Image 1 – Currency losing value – Bloomberg

Economic War, Credit Crunch and fall of the Lira

 Turkish companies were expanding their horizons—and piling on debt Turkish

companies were expanding their horizons—and piling on debt and struggled to
repay loans in dollars and euros, as the weakened lira means there is now more to
pay back from the construction boom taken place as cited in Image 2 as relation in
to falling government debt and soaring private credit

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Image 2 – Debts – World Bank, IMF

 Turkey has traditionally suffered from a large current account deficit. This
difference between import and export of goods and services has been filled
through external borrowing in foreign currency. A decade of easy money and low
interest rates in the United States and EU following the 2008 financial crisis led to
investors searching for higher yields to emerging markets like Turkey.

 The lower rates the president is pushing will produce a weaker lira and higher
inflation. There’s also a risk that investors in Turkish debt will be turned off by the
drop in interest. The Turkish debt market is one of the biggest among emerging
markets; worth around $223 billion. Because Turkey suffers from a savings
shortage, it relies on these investors to finance economic expansion. A retreat by
them could undercut cheaper money’s positive effects on growth.

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  The stress on Turkey is thoughtful of larger trends in emerging markets, although
the lira is by far the worst performer. That's because investors have lost
confidence in management of the economy under President Recep Tayyip
Erdogan as cited in Image 4, who believes in unorthodox economic policy,
demands low interest rates and constantly assails "the interest rate lobby."
Inflation is at 16 percent a year.
 On August 10, US President Donald Trump announced higher tariffs on Turkish
imports of steel and aluminum. The tariffs themselves are minor and impact
around $1 billion (€875 million) in trade, but they weighed on market confidence
in the vulnerable Turkish economy. Even more, Trump’s direct reference to the
Turkish lira sent the currency tumbling and can be seen in solvency crisis and FX
shortfall data as cited in Image 3.

Image 3 – FX Shortfall and Solvency Crisis – Central Bank of Turkey

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  All in all linking the economic troubles to failed leadership, political turmoil and
inefficiency in taking decisions for his economy, stumbling onto instability and
crisis and being dreadfully harming the confidence outlook in Turkey, a key
indicator for positive animal spirits in the economy as cited in Image 4.

Image 4 – Confidence Crisis – Turkstat

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 Conclusion and Future Scope

When political stability comes with having one party or a coalition of parties in office for
a long time, it may eventually be detrimental. Other aspects of the society might suffer
because of complacency, lack of competition, international trade boundaries and opacity
and it is a cause for concern about the country’s monetary policy. This highlights the
need for an outside council.

Consequently, stable governments do not necessarily lead to higher economic growth.

India is another case in point. This is in direct linkage with a struggling authoritarian
regime and can be seen Ex-Governor Raghuram Rajan’s Statement "One of the problems,
and I have said this very strongly, suppressing criticism means you don't hear feedback”
that criticizes the need for the central government and most important the ruling party
BJP, to work on a feedback mechanism

Not all forms of political stability are equally development friendly; much depends on the
extent to which stability translates into good governance.

The case in point does provides evidence that political instability had unfavorable
economic instances for the aforementioned traits and policies in Turkey. Firms,
consumers and the government faced plunging values both in monetary and non –
monetary terms which has a linkage with the Authoritarian regimes of President Erdogan.

Turkey should look towards other ways of stimulating economic growth such as
increasing productivity and developing new technologies. This would allow them to
boost their GDP and then repay the debts instead of having to increasing their debt ratio
even more.

PAGE 14
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https://www.bloomberg.com/news/features/2018-12-09/how-turkey-created-a-debt-crisis

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https://www.epreview.org/international/2018/9/23/the-turkish-lira-crisis-explained

https://www.imf.org/en/About/effectiveness-of-imf-lending

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