As Turkey grapples with deficit, Erdogan pins his hopes on Gulf funds during visit

ISTANBUL — A huge budget deficit is among the main issues that Turkish President Recep Tayyip Erdogan and his party face after their election victory in May, but not even an extra budget is likely to remedy the government’s financial woes, aggravated by its election-centered policies. 

With a budget deficit on course to reach 10% of gross domestic product by year-end, this week the parliament passed a supplementary budget, allowing for additional spending of 1.1 trillion Turkish liras ($42 billion). Though that sum falls short of the needs, the government can ill afford to ask for more because of a legal obligation to equally increase revenues. Instead, the ruling party passed another bill that would allow Erdogan to allocate funds to public entities and expand his borrowing limits in a move that the opposition say is unconstitutional. 

Budget deficits are a major factor underlying Turkey’s unruly inflation, which stands at 38.2% after prices rose nearly 4% on a monthly basis in June. The government may be speaking of tackling inflation, but with local elections looming in March 2024, it has been reluctant to go for a full-fledged employment of anti-inflation measures to cool the economy, curb public spending, slow income increases and raise borrowing costs. Signs are growing that such unpopular steps would be considered only after the polls. 

As prices continue to rise, Ankara has sought to placate the electorate with pay hikes, vowing to “not let inflation crush the people.” This, however, is a recipe for a vicious cycle that only deepens economic fragilities. 

The original 2023 budget envisioned spending 4.5 trillion liras ($172 billion) and a deficit of 661 billion liras ($25.3 billion). But the government’s election-focused spending resulted in a budget meltdown, exacerbated by the two giant earthquakes that devastated vast southern regions in February. The budget deficit exceeded 263 billion liras ($10 billion) in the first five months of the year, amounting to 40% of the gap that Ankara had projected for the whole year, according to official figures. The disaster, which claimed more than 50,000 lives and destroyed about 650,000 buildings, made the need for a supplementary budget inevitable, especially given the spending required for housing needs. According to the additional budget bill, 44% of the additional funds will go to earthquake-related programs. 

The slump of the lira since the May elections has also contributed to the growing budget gap. Under a deposit scheme designed to curb dollarization and encourage lira deposits, the treasury and the central bank have been compensating depositors for the depreciation of the currency in addition to the interests paid by banks. The lira has lost 23% of its value since late May, aggravating the cost of the scheme. The new bill will let the central bank pay all compensations and relieve the budget from the heavy charge of the scheme.

Nevertheless, the government still appears in need of an extra 2 trillion liras ($76 billion) to spend by year-end. Under Turkish law, a supplementary budget requires the government to outline equivalent revenues of 2 trillion liras and stick to the original budget deficit of 661 billion liras. Unable to commit itself to collecting that much revenue despite hiking an array of taxes and fees last week, the government made do with a supplementary budget proposal of 1.1 trillion liras ($42 billion), hoping to bridge the gap through other means. The omnibus bill passed by parliament this week includes provisions authorizing Erdogan to disburse funds to public entities and raising the presidency’s borrowing limits. Accordingly, Erdogan would be able to meet allocations of 794 billion liras ($30 billion) through borrowing. The opposition has raised loud objections to the bill on the grounds that it infringes on the parliament’s budget-making authority. The legislation is likely to end up at the Constitutional Court.

With the bitter pills postponed, inflation is likely to reach 56% by the year-end, according to pundits. In Turkey’s import-reliant economy, rising foreign exchange prices represent a major driver of inflation. As export and tourism revenues fall short of covering imports, the country’s current account deficit widened to nearly $8 billion in May and $60 billion over 12 months. 

To cover the gap, Turkey needs to attract foreign funds. But despite the appointment of a new economy chief and a new central bank governor after the elections, Ankara has so far failed to inspire confidence in Western investors and seems to pin hope on the United Arab Emirates and other wealthy Gulf monarchies. Treasury and Finance Minister Mehmet Simsek held talks in Saudi Arabia, Qatar and the UAE over the past weeks, paving the way for a visit by Erdogan to those their capitals, as part of a regional tour that will include all three countries from Monday to Wednesday. 

Ankara has yet to clarify what economic deals are in the pipe, but according to unnamed officials quoted by Bloomberg last week, the government aims to attract $25 billion in investments from the Gulf through various means, including privatization and acquisitions. 

But if Turkey limits its efforts to the Gulf, it will have to contend with a growing foreign currency crunch and rising foreign exchange prices in the near future. 

The lira remains under pressure amid the foreign currency needs of importers, the country’s short-term external debt liabilities and a trend among locals to flee the lira. The currency's continuing slump means that the cost of import-based materials, chief among them fuel, is constantly rising, fueling cost inflation. In an alarming signal, producer prices rose 6.5% on a monthly basis in June, with the 12-month moving average topping 86.5%.