Türkiye's shift in economic policy mitigated near-term risks, experts say

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 prospects, a senior analyst at Fitch Ratings and an economist at S&P Global Market Intelligence said.

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 Agency 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 December 15, with the bank on Thursday revealing the most recent $1.15 billion surge over the previous week.

In another historic move on the same day, the Turkish Central Bank held a Turkish lira deposit buying auction for the first time in the last 17 years, aiming to reduce excess liquidity in the market.

"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."

"A tight monetary policy stance will likely be necessary for an extended period to rebalance the economy," he said, adding that upcoming local elections in March could be challenging to maintain the current tightening cycle.

Worldwide challenges

The change in leadership at Türkiye's Central Bank has significantly 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 stabilise the currency to lean down on inflation and weaken domestic demand to bring down the imbalance on the current account," Wattret told Anadolu.

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

"I think the first thing to point out is that Türkiye has been struggling with some challenges that many other economies face," Wattret says, adding that the world has seen an inflation shock in the global economy, which it has 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."

'It will take some time'

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

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 maintained its main refinancing operations, marginal lending facility and deposit facility at 4.50%, 4.75% and 4.00%, respectively.

The full effects of the tightening monetary policy on economic activity are expected to manifest through 2024. However, Wattret said, the trend in inflation is expected to start to move downwards, stabilising the Turkish lira gradually.

"Hopefully, 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 stabilise inflation and to help stabilise 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."