Turkey has suffered severely from the two major earthquakes on Feb. 6, 2023. The death toll is a record high, exceeding 45,000. Physical damage from the earthquakes will cost at least $20 billion, as the number of buildings destroyed has been steadily revised upwards. GDP growth will be 2.0-2.5% less than forecast before the disaster, adding nearly $20 billion to the cost. The combined economic losses due to damaged assets and slower growth expectations may end up being much higher than $40 billion when the government releases a detailed and reliable disaster loss report covering human resources. Outside figures already suggest the total will be even greater: A recent World Bank estimate put the cost of direct physical damage at almost $34.2 billion — the best and worst case scenarios are $28.7 billion and $40.8 billion respectively — and total reconstruction and recovery at nearly twice that.

Turkey was already in a weak economic situation when the quakes hit. In addition to repairing and replacing the damaged buildings and infrastructure, at least a million citizens will need to be supported financially and their accommodation, heating, and food expenses covered for six months or more. Civil society and business associations have launched major fundraising campaigns. The biggest was held by the government on Feb. 15; its 7-hour-long jointly broadcast TV program, “Turkey, One Heart,” took in donations of TL115.1 billion ($6.1 billion) to aid recovery and support programs.

Moving forward, the main pillars of the Erdoğan administration’s political strategy are threefold: emphasizing the unprecedented magnitude of the quake (which they have dubbed the “disaster of the century”), claiming that their initial response was better than that following the 1999 İzmit earthquake, and highlighting the government's financial and technical capabilities to rebuild the damaged areas. Thus, the total amount of donations received is critical. Moreover, these funds will be allocated to institutions under President Recep Tayyip Erdoğan’s control, such as the Disaster and Emergency Management Presidency (AFAD), which operates under the Ministry of Interior; the Turkish Red Crescent (Kızılay), the largest humanitarian organization and counterparty of the Red Cross; and the Housing Development Administration (TOKİ), the state’s main tendering agency.

Another major issue for the Erdoğan administration is growing public criticism over the use of the so-called “special communications tax,” intended to prevent earthquake-related damage. Introduced in 2000 as a temporary one-off measure to deal with the impact of the 1999 earthquake, the tax was made permanent in 2004. A total of $38.2 billion has been collected so far and none of it has been allocated to earthquake damage prevention. Adjusted for inflation, the total collected would come to $52.1 billion today, or 5.2% of 2022 GDP. Under Turkish law, governments have full control over the use of tax revenues unless the law specifically states that the revenue is for a special purpose and must be accumulated in a particular fund. Accounting for where the money has gone and explaining why it hasn’t been spent on earthquake damage prevention will be vital for the Erdoğan administration.

Breaking down the donation numbers

Of the TL115.1 billion in donations received, TL83 billion, or 72%, came from state institutions and entities whose main shareholder, either directly or indirectly, is the central government. The single biggest contributor was the Central Bank of the Republic of Turkey (CBRT) with TL30 billion. All state-owned enterprises transfer their profits as dividends to the Turkish Treasury. The Treasury also owns 55% of the CBRT; however, due to its regulations, the Treasury receives almost all of its dividends. That is to say, there is no need to make such a donation — the money would have ended up in the Treasury’s hands anyway. In addition, corporate tax on the CBRT’s net income is also paid to the Treasury.

There is another way of increasing the CBRT's profitability and enabling it to transfer additional funds for the recovery: monetary expansion. There are different ways of doing this. One is to print physical notes, although this is old fashioned and inefficient. Its impact is very limited when there are TL320 billion in notes in circulation, while the total money supply is even higher, at TL8.73 trillion. Another method is direct short-term lending from the CBRT to the Treasury. This was prohibited by law in 2001 to highlight the determination of the government at the time in its fight against inflation. In developed countries, quantitative easing is the main tool used; this is when a central bank purchases predetermined amounts of government bonds. Turkey, as an emerging market country, has been using a similar mechanism in a more rudimentary form. The CBRT has been increasing the amount of liquidity provided to banks and then forcing them to keep more government bonds on their balance sheet, thus lowering the cost and increasing the amount of government finance by borrowing. Despite the use of this tool, CBRT Governor Şahap Kavcıoğlu has claimed that the central bank’s donation is not related to monetary expansion. He said the central bank wanted the money to go directly to earthquake victims; if it had gone through the usual channel, he noted, the Treasury could have used it for something else. Despite the minor dispute between the CBRT and the Treasury, there will be no clash over the use of these resources. Even if there were a disagreement, President Erdoğan will ultimately decide in favor of spending to repair and rebuild damage caused by the earthquake due to the upcoming presidential and parliamentary elections, now expected to be held in May.

Public banks were major contributors to the government’s donation campaign as well. Ziraat Bank, fully owned by the Turkey Wealth Fund (TWF), made a TL20 billion donation. VakıfBank (85.4% state ownership) and Halkbank (87.7% state ownership) contributed TL12 billion and TL7 billion respectively. There are fresh rumors that both of these banks will raise TL20 billion in new capital from the TWF to shore up their financial soundness. If this happens, then these donations will be a clear example of monetary expansion as the TWF also does not have the cash to directly inject. The Treasury will probably support them by providing newly-issued government bonds as capital. This would increase the TWF’s share in Halkbank and VakıfBank to more than 90%. Half of the credit market in Turkey is currently controlled by state banks.

The Turkish Savings Deposit Insurance Fund (TMSF), the state governing body that handles insurance in the banking system as well as trusteeship operations for Gulenist Movement (FETÖ-affiliated) companies, also made a TL2 billion donation. Other TWF subsidiaries, such as Borsa Istanbul, Türkiye Sigorta, Türk Telecom, and Turkish Airlines, each donated TL2 billion, while Turkcell and the Defense Industry Agency — directly controlled by the state — donated TL3.5 billion.

Another group of donors are close associates of Erdoğan’s family, party, and government. Kalyon Holding, Limak Holding, and Cengiz Holding — all members of the so-called “Gang of 5” major contractors for government tenders, according to the main opposition party — promised to donate TL950 million, TL100 million, and TL3 billion respectively. Other business groups close to the ruling party, such as Turkuvaz Medya, Doğuş Holding, and Demirören Holding, made considerable donations as well. Baykar, one of the largest privately owned defense industry companies, owned by the family of Erdoğan’s son-in-law, and the manufacturer of the Bayraktar armed drones, donated TL2 billion. Fettah Tamince and Cihan Kamer, prominent businessmen that allegedly have close relations with the Gulenist Movement (FETÖ), were also contributors. SOCAR Turkey, fully owned by the national oil company of Azerbaijan, SOCAR, donated TL3.5 billion too. President Ilham Aliyev and Erdoğan are close friends. Moreover, Turkey privatized its main petrochemical industry company Petkim and sold it to SOCAR. This group has invested in the multibillion-dollar Star oil refinery, gained maritime port operations rights for Petkim, and became the main contractor for the Trans-Anatolian gas pipeline (TANAP).

Reconstruction and inflation

The Turkish economy has been hit hard by this disaster. While for most people the main concern has been the earthquakes’ humanitarian consequences, the Erdoğan administration has been mostly focused on how to change the narrative and improve the adverse perception of the government. The destruction cannot be undone, but reconstruction can easily be promised. This is a strong message to persuade people affected by the earthquakes. The associated financial burden presents a major challenge, but these campaigns may convince people that the government will rapidly reconstruct brand-new buildings and infrastructure.

There is one significant side effect of all these promises and sincere efforts, however — inflation. More government spending is necessary, not only for political purposes related to the elections, but also for the recovery of the region hit by the earthquakes. However, given Turkey’s limited production capacity and weak competitive power due to the expensive lira, the main consequence of these policies will be higher inflation. The CBRT’s target for year-end 2023 inflation is 22.3% while a less reliable market participant survey compiled by the CBRT forecasts 35.8%. Despite the lack of trust in Turkstat, the state statistics agency, broader expectations are hovering at around 50%. Any attempt to repair both the physical damage in the region and restore the government's lost approval at the national level can only be accomplished through more government spending. The single-month inflation rate in January 2023 was 6.7%. Therefore, it should come as no surprise if the inflation rate begins to accelerate once again in the coming months.

Higher inflation is a hidden way of sharing the costs of the disaster with the whole of society. This is understandable in a country where national solidarity is highly valued. This unconventional mechanism was widely used during the world wars or the COVID-19 pandemic to lower the indebtedness of central governments in developed countries. In Turkey’s case, however, the inflation rate is already too high, the government has lost its credibility in the fight against inflation, and pricing decisions taken in light of a perceived inflationary spiral and a new foreign exchange (FX) crisis may result in the inflation rate peaking in the triple digits.

2022 was a year when Erdoğan’s government chose high inflation for the sake of stronger economic growth. 2023 may not be that virtuous as high inflation will not bring growth; instead, low growth, stagnation, or a recession are more likely. Long years of inflation eventually lead to a sudden stop: a sharp slowdown in global capital inflows triggering FX shocks or a credit crunch, an abrupt reduction in the general availability of domestic loans, and a rapid and dramatic deceleration in economic activity. Erdoğan’s choices, the public response, and global financial conditions will all determine where Turkey’s economic model and disaster recovery efforts are heading and what they mean for the future of the country.


M. Murat Kubilay is an independent financial advisor on the Turkish economy and a non-resident scholar with MEI’s Turkey Program.

Photo by YASIN AKGUL/AFP via Getty Images

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