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Improved Policy Consistency Key for Effectiveness of Turkiye’s Monetary Tightening

Fri 26 Apr, 2024 - 9:01 AM ET

ֳ-London-26 April 2024: Expected post-election fiscal tightening would strengthen the effectiveness of Turkiye’s monetary policy, in the context of weakened transmission channels, ֳ says. If sustained, this improvement in policy consistency should support lower inflation, a narrower current account deficit and a recovery in international reserves.

ֳ believes the economic policy mix implemented since June 2023 will be maintained despite the opposition CHP winning the largest share of the vote in Turkiye’s local elections at the end of March. We therefore continue to expect a significant decline in inflation and easing of external vulnerabilities. This assessment was a key factor underpinning our upgrade of Turkiye’s rating to ‘B+’ with a Positive Outlook on 8 March.

Turkiye has demonstrated commitment to fighting inflation under the new policy mix. Continued political backing was reflected after the local elections when President Recep Tayyip Erdogan restated his support for the programme of the economic team led by Finance Minister Mehmet Şimşek.

In a move that was not widely expected, the Central Bank of the Republic of Turkiye (CBRT) raised its policy rate by 500bp to 50% shortly before the local elections. The rate was maintained at the 25 April MPC meeting. This is consistent with our early March expectation of a peak rate of 50% and our view that the central bank will keep financial conditions tight, aided by targeted bank regulations.

To bring inflation down further, the authorities face a challenge in rebuilding the effectiveness of monetary policy. Monetary policy transmission channels have weakened due to the prolonged period of artificially low interest rates, high financial dollarisation, distortionary regulatory measures introduced in 2022 and 1H23, and high inflation and exchange-rate depreciation expectations.

Strengthening the consistency and coherence of the macro policy mix would help boost monetary policy effectiveness, in our view. In the run-up to the local elections, fiscal spending accelerated leading to a widening of the budget deficit. On a four-quarter rolling basis, ֳ estimates that the central government budget deficit reached 5.2% of GDP in 1Q24 with the primary deficit at 2.6% (3.7% programme definition).

We believe the government will reduce the fiscal deficit in the rest of 2024 by slowing spending growth, especially that which is not related to earthquake reconstruction. This would be consistent with comments by Minister Şimşek. The choice of revenue measures is likely to take into consideration their potential inflationary impact. In ֳ’s view, though, the result of March’s local elections could influence the pace and magnitude of the fiscal adjustment and which budget areas are most affected. Fiscal consolidation would support monetary policy in helping to cool domestic demand and the central bank’s objective of sterilising excess liquidity.

Improved policy consistency should support lower inflation, a narrower current account deficit and a recovery in international reserves. Inflationary pressures have eased (month-on-month inflation dropped to 3.2% in March from 6% in January) and we forecast annual inflation to decline to 40% by end-2024 from 68.5% in March.

The 12-month rolling current account deficit narrowed to USD32 billion in February from USD60 billion in May 2023. As local election-related uncertainty and an associated build-up of depreciation expectations dissipated, international reserves and the central bank’s net foreign asset position have also improved.

Contacts:

Erich Arispe
Senior Director, Sovereigns

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Paul Gamble
Senior Director, Sovereigns

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Mark Brown
Senior Director, ֳ Wire

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Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@thefitchgroup.com

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