Türkiye's economic policy shift mitigating near-term stability risks, necessary mechanisms in place

By Nuran Erkul

LONDON (AA) - With a major shift in economic policy since elections earlier this year, Türkiye has been reducing its near-term macro-financial stability risks and balance of payment pressures, improving future prospects, a senior analyst at Fitch Ratings and an economist at S&P Global Market Intelligence told Anadolu.

After getting reelected in May, President Recep Tayyip Erdogan's administration brought in a new economy team, overseeing a tightening in monetary policy as the Central Bank gradually raised its interest rate from a mid-year low of 8.5% to 42.5% as of Thursday.

"The monetary tightening, including not only the increase in the monetary policy rate since June 2023, but also selective credit and quantitative tightening has been larger and faster than our previous expectations," Erich Arispe Morales, a senior director in Fitch Ratings' sovereigns group and primary Türkiye analyst told Anadolu exclusively.

"It is contributing to the cooling of domestic demand, easing pressures on the lira (currency) and thus supporting the recovery in international reserves and arresting the previous deterioration in inflation expectations."

The course change also saw the Central Bank's international reserves hit an all-time-high of $142.53 billion as of Dec. 15, with the bank on Thursday revealing the most recent $1.15 billion surge over the previous week.

"We believe that Türkiye’s post-election policy shift has reduced near-term macro-financial stability risks and balance of payment pressures," Morales said. "Moreover, President Recep Tayyip Erdogan has publicly endorsed the new policy direction and frontloaded monetary policy adjustment."

Tighter monetary policy and weak growth in Türkiye's main trading partners, particularly the eurozone, will also lead the Turkish economy to decelerate, according to him.

Fitch Ratings expects the Turkish economy to grow 2.5% in 2024, down from projected growth of 4.1% in 2023.

Morales also took note of significant policy challenges, including substantial macroeconomic imbalances, annual inflation expected to peak at over 70% in the second quarter of 2024, and a year-to-date current account deficit of $41 billion.

"A tight monetary policy stance will likely be necessary for an extended period of time to rebalance the economy," he said, adding that upcoming local elections in March could test the government's commitment and political space to maintain the current tightening cycle and avoid electoral stimulus measures that undermine the policy shift.

- Difficult year ahead, but steps taken necessary to bring down inflation

The change in leadership at Türkiye's Central Bank has significant changed its approach, according to Ken Wattret, vice president for global economics at S&P Global Market Intelligence.

"The intention is to raise interest rates to stabilize the currency to lean down on inflation and weaken domestic demand to bring down the imbalance on the current account," said Wattret told Anadolu.

Explaining that the combination of these factors will work to slow economic activity in the near term, he said that both Türkiye and the rest of the globe could face a "pretty challenging economic situation" through 2024.

"But it is a necessary condition to try and stabilize inflation and also to prevent the currency from continuing to depreciate, which of course leads to more imported inflation and creates a vicious cycle," he said.

"We need to be realistic. We have seen this with other central banks, it takes time to squeeze inflation out of the system. It does not happen immediately when interest rates go up."

Major central banks have been increasing rates for over two years to tackle rising inflation. Last week, the US Federal Reserve kept its policy rate unchanged, in line with expectations, at a 22-year high range of 5.25%-5.50%.

The Bank of England also kept its policy rate at 5.25%, while the European Central Bank, too, maintained its main refinancing operations, marginal lending facility and the deposit facility at 4.50%, 4.75% and 4.00%, respectively.

But the central banks' response to the initial inflation shock in 2021 and 2022 was quite late and their credibility has been challenged, according to Wattret.

"I think the first thing to point out is that Türkiye has been struggling with some challenges that many other economies face. We have seen an inflation shock to the global economy, which we have not seen for decades.

"Central banks around the world have had to cope with that inflation shock and shift their monetary policy stance accordingly. Türkiye is doing the same."

The full effects of the tightening monetary policy on economic activity, which tends to appear with significant lag, is expected to manifest through 2024.

However, Wattret said, the trend in inflation is expected to gradually start to move downwards, stabilizing the Turkish lira. "Hopefully again as we progress through the year, the economic outlook will start to improve and the subsequent year will be much more positive."

"I think the key thing is to establish some credibility in tackling the inflation problem and some credibility in terms of the external imbalance and current account and also provide some support to the currency. It looks as if the change of direction in monetary policy is leading us to a more stable environment," he said.

"It looks as if the mechanisms are now in place to stabilize inflation and to help stabilize the currency but it will take some time. It is important the (Turkish) Central Bank sticks to the plan and maintains a degree of restriction in monetary policy in the same way that we have seen central banks around the globe."