Republic of Türkiye: 2024 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Türkiye
Author:
International Monetary Fund. European Dept.
Search for other papers by International Monetary Fund. European Dept. in
Current site
Google Scholar Close
Publication Date:
11 Oct 2024
eISBN:
9798400290848
Language:
English
Keywords:
inflation expectation; FX liquidity risk; sequential inflation; carry trade; CBRT credibility; Inflation; Global
Download PDF (1.9 MB)

1. Economic imbalances and crisis risks were high in spring 2023. As inflation rose in 2021, the CBRT repeatedly cut policy rates, pushing inflation above 80 percent before a large real appreciation in early 2023 pulled it down to around 40 percent. The resulting negative real interest rates encouraged borrowing in lira and capital flight. The authorities responded with financial repression to maintain exchange rate and financial stability and to keep government bond yields artificially low. Monetary policy at that time was the main driver of inflation. But in early 2023, fiscal policy was also substantially loosened, due to reconstruction and relief efforts after the February earthquake as well as energy subsidy, pension, and public sector wage increases. As a result, the economy overheated and the current account deficit (CAD) widened to 7.0 percent of H1/2023 GDP. Gold imports increased as households hedged against inflation, and inflation expectations unmoored. Despite financial repression, the CBRT lost around US$30 billion in international reserves between January and May 2023.

Context

1. Economic imbalances and crisis risks were high in spring 2023. As inflation rose in 2021, the CBRT repeatedly cut policy rates, pushing inflation above 80 percent before a large real appreciation in early 2023 pulled it down to around 40 percent. The resulting negative real interest rates encouraged borrowing in lira and capital flight. The authorities responded with financial repression to maintain exchange rate and financial stability and to keep government bond yields artificially low. Monetary policy at that time was the main driver of inflation. But in early 2023, fiscal policy was also substantially loosened, due to reconstruction and relief efforts after the February earthquake as well as energy subsidy, pension, and public sector wage increases. As a result, the economy overheated and the current account deficit (CAD) widened to 7.0 percent of H1/2023 GDP. Gold imports increased as households hedged against inflation, and inflation expectations unmoored. Despite financial repression, the CBRT lost around US$30 billion in international reserves between January and May 2023.

2. A policy turnaround since last summer has reduced imbalances and risks. Fiscal measures reduced, but did not fully reverse, overall stimulative policies. Monetary policies have been tightened and many financial repression measures have been unwound in line with the September Medium Term Program (MTP) and some of staff’s advice (Annexes I and II). The economy is showing clear signs of cooling and inflation has started to ease. Market sentiment has also improved markedly, with all the major ratings agencies upgrading Türkiye’s sovereign risk ratings and CDS spreads at half their mid-2023 levels. However, the current policy stance appears insufficiently tight to reach the midpoint of the authorities’ forecast range, and financial and external risks remain.

The Setting

3. Growth is starting to slow. The economy grew by 5.1 percent in 2023, led by strong domestic demand. Despite monetary tightening since 2023:H2, sequential GDP growth (q/q, seasonally adjusted) accelerated from 0.2 percent in 2023:Q3 to 1.4 percent in 2024:Q1, partly buoyed by strong external demand. Activity is now cooling markedly: sequential GDP growth in 2024:Q2 was 0.1 percent; retail sales are falling steadily; industrial production has been shrinking; and vehicle sales have fallen by around a third. The unemployment rate, at 9.2 percent in June, has begun to rise from recent lows.

4. Inflation has recently begun to fall but remains high and sticky. Inflation was pushed to 75 percent in May 2024 by a large mid-2023 depreciation, stimulative incomes policies through early 2024, and tax increases. Base effects and tightening brought it down to 52 percent (50.9 percent core) in August. Sequential inflation has also slowed, particularly when adjusted for administered price changes, but still averaged around 2.4 percent in recent months.

5. The monetary policy rate has been in positive real territory since December 2023. The policy rate rose gradually from 8½ percent in May 2023 to 50 percent in March 2024—with falling inflation expectations, the ex-ante real rate now stands at 20 percent.1 Monthly caps on credit growth to most sectors of 2 percent monthly for lira exposures and (since mid-July) 1.5 percent monthly for FX have also contributed to suppress demand (Annex III).2 However, as credit demand has weakened, caps on lira loans appear non-binding for an increasing number of lending institutions. Liquidity forecasting and management have improved and better CBRT communication has provided explicit guidance about where monthly inflation and expectations need to converge before policy easing begins.

6. The authorities have largely unwound pre-2023 regulatory distortions. Interest rate caps on loans, required holdings of government bonds at below-market rates, and most other repressive measures have been abolished. Limits on offshore swaps and export surrender requirements—both capital flow management measures (CFMs)—are still used to contain pressures on the lira and strengthen international reserves. Also exports and investment are excluded from credit growth caps, favoring them over imports and consumption.

7. Monetary policy transmission has improved and dollarization is falling. Deposit and lending rates have broadly tracked the policy rate. CBRT requirements that banks reduce their share of FX-protected deposits (KKMs) boosted rates on lira deposits. By end-July, sight deposit rates were around 54 percent, or around 24 percent in ex-ante real terms, high enough to encourage depositors to move from FX into lira. The CBRT absorbed resulting increased lira liquidity including via higher reserve requirements (RRs), raising banks’ costs.3

8. Credit is rapidly falling as a share of GDP. Higher RRs and rising deposit rates have forced up lending rates, with new consumer loan rates above 70 percent and corporate rates around 60 percent. With caps on credit growth since March 2024, banks’ appetite for liquidity has been limited, pushing some longer-term deposit rates below the policy rate in recent months. From an average m/m growth rate of 4.7 percent in 2023:H1, credit is now growing at around 1.3 percent m/m, well below inflation and recently below even the growth caps. The composition of credit has also shifted to FX-denominated loans since March 2024 as capital inflows increased.

9. Private banks have adapted well to the new environment and systemic risks have receded since the last Article IV consultation, but state-owned banks (SOBs) are in a weaker position. Policy rate increases led to fair-value losses on domestic lira securities at all banks. However, private banks held more CPI-linked securities and their higher funding costs have been compensated by interest rate liberalization, leading to marginally higher profitability and CARs around 17.5 percent,4 comfortably above the 12 percent target ratio.5 SOBs—45 percent of the system’s assets—had larger and longer-dated bond portfolios, and are more exposed to weaker sectors, such as SMEs, yielding lower CARs of around 16.2 percent. Overall, the financial sector has shrunk: banking sector assets in 2023 were 89 percent of GDP, down from 103 percent in 2018. Systemic risks have been reduced since last year, though liquidity risks in lira arising from dedollarization and in FX from inflows and the recent increase in the FX share of lending should be closely monitored.

10. Despite major tightening since mid-2023, fiscal policy this year is projected to be stimulative. In the first half of 2023, a large increase in the wage bill, pensions, and subsidies raised spending by over 3 percent of GDP. In mid-year, VAT rates, special consumption taxes on petroleum and motor vehicles, and CIT rates were increased, adding around 2¼ percent of GDP to fiscal revenue (on an annualized basis). Together with earthquake recovery spending of 1 percent of GDP, this implied an annual cash stimulus of around 0.7 percent of GDP. In 2024, the authorities tightened other current and non-earthquake capital expenditure; in August introduced minimum corporate taxation; and in July began to reduce energy subsidies—together amounting to net savings of around 0.5 percent of GDP. However, with a wage bill of 7.2 percent of GDP—a 10–year high—and continued earthquake spending, fiscal policies will remain stimulative (Box 1).

Earthquake Spending and the Fiscal Stance

The February 2023 earthquakes had large humanitarian and infrastructure impacts, but less so on growth. Over 45,000 people appear to have lost their lives. The World Bank estimated damage and losses of around 9.0 percent of GDP; around 80 percent was concentrated on residential and non-residential building, with the remaining damage to infrastructure. The impact on 2023 growth was likely below one percent of GDP as the affected region only contributes a small share of GDP. The large loss of housing stock likely exacerbated pre-existing pressures on rents.

The authorities allocated almost 7 percent of GDP in earthquake-related expenditures to the medium-term budget. Four fifths of the spending was allocated to investment mostly to rebuild housing stock. The remainder was to support the emergency response to vulnerable households.

Earthquake-related cash spending in 2023 was less than what reported in the accrual fiscal accounts. Expenditure statistics are recorded on an accrual, rather than cash, basis. Around 1.0 of the 3.6 percent of GDP in the reported 2023 accrual spending occurred in cash terms (the accrual exceeded the budget target, primarily from larger transfers to the disaster response agency (AFAD)). Additional accrued spending (2.6 percent of GDP) reflects a combination of allocated and committed expenditure rather than expenditure that occurred but is not yet paid; it will not expire. The authorities noted that there are no arrears. Cash spending related to earthquake reconstruction is expected to accelerate this year as reconstruction efforts are ramped up, though spending is likely to remain below the full allocation in the 2024 budget.

There are thus large differences in measuring the fiscal impulse on an accrual or cash basis. Measured as the change in the accrual primary balance, the fiscal impulse was 3.6 percent in 2023 with a contraction of 1 percent in 2024. On a cash basis, which is relevant to measure the impact of fiscal policies on demand in this instance, the 2023 impulse was 0.7 percent, while the 2024 impulse is estimated at 1.2 percent.

11. Public debt remains at sustainable levels (Annex IV). Inflation contributed to a fall in debt from 40 percent of GDP at end-2021 to below 30 percent at end-2023. However, the average cost of new domestic fixed-rate borrowing in June was 36 percent, up from 10 percent at the beginning of 2023 when financial repression suppressed interest rates. Maturities have also shortened, reflecting higher borrowing costs. Nonetheless, the immediate impact of the higher borrowing cost on the fiscal position is limited as a significant portion of domestic fixed-interest domestic debt is around five years and much of the stock is in FX. However, the large exposure to foreign currency debt implies exchange rate risks. Furthermore, the overall fiscal position is also exposed to risks from quasi-fiscal activities and contingent liabilities (¶45 and Box 2).6

12. Incomes policies are now more aligned with the disinflation program. Public sector wage and ad hoc salary increases, along with a 34 percent minimum wage hike in July 2023, added strongly to inflation pressures last year (Box 3). Another increase of 49 percent in January 2024 further slowed disinflation. In early 2024, the authorities stated that they would return to annual minimum wage adjustments.

Fiscal Risks

Beyond recent expansionary measures, Türkiye’s fiscal position is exposed to contingent liabilities from Public-Private Partnerships (PPPs), losses at SOEs, and recent changes to pension eligibility.

Türkiye‘s large PPP portfolio presents numerous contingent liabilities. There were 198 PPP projects during 2003–23, with a total investment of US$74 billion.1 The government provides guarantee mechanisms, including the Treasury’s debt assumption commitments amounting to 1.5 percent of GDP (cumulative up to 2024 covering eight PPP projects); repayment guarantees amounting to 1.4 percent of GDP at end-2023; and minimum revenue guarantees or indexation to the nominal exchange rate, estimated at a cost of 0.4 percent of GDP in 2023. Information on the size, structure, and risk composition of the overall PPP portfolio is relatively limited, as no single agency is responsible for monitoring and managing the fiscal costs and risks of the overall portfolio. A PPP law, currently in draft, is expected to address some of these limitations.

Financial information on SOEs suggests rising fiscal costs, mainly related to subsidized energy bills. While the budget covers 20 SOEs (text chart on costs), there are over 400 SOEs.2 Some large public enterprises, including Turkish Airlines, Turkish Post, and the Housing Development Administration of Türkiye (TOKI) are not included, as well as other SOEs within the Turkish Wealth Fund portfolio. SOBs have been recapitalized in recent years through the issuance of non-cash debt securities; in 2023 the central government issued 112 billion lira securities that were then on-lent to the banks and as of June 2024 there were 190 billion lira (0.4 percent of GDP) outstanding debt securities for the recapitalization. In addition, the government lends to nonfinancial SOEs and compensates various utilities and other firms for duty losses. There is no one document that consolidates all SOE activities. An updated SOE law aims to address these concerns, although the timeline and the content of the law remain unclear.

The 2023 early retirement scheme is another fiscal risk. The law allows for early retirement, provided workers were registered prior to 1999. The authorities estimate that this increased the pensionable population by 4.1 million people, of which around 2.1 million people have already taken advantage of the change at an annualized cost of around 1 percent of GDP. Some cost might be mitigated as those that retired early continue to work and contribute to premium revenues of the fund while drawing a pension. Still, the scheme increases overall pension costs in the short term (though it does not affect the long-term actuarial viability of the pension fund as there were no permanent changes to other parameters).

1/ Around 70 percent of 2017 public sector investments are estimated to be from PPPs. Includes only investment cost, and not fees associated with the PPP. 2/ The budget covers these SOEs subject to Decree Law 233. The Decree does not apply to the SOBs, enterprises owned by local governments, or to other SOEs that operate under separate laws (statutory corporations).

Minimum Wage and Inflation

Minimum wage adjustments play an important role in wage setting. Around 43 percent of formal workers in nonagricultural sectors currently earn salaries at or below the minimum wage. More broadly, economy-wide nominal wage increases can be largely explained by minimum wage adjustments and past inflation (CBRT 2023), with the elasticity of average hourly earnings to minimum wage at around 1. The impact is also fast, with most of the passthrough completed within the same quarter (CBRT 2021).

The impact on employment is less clear. Studies on the impact of the minimum wage on the labor market have shown mixed results (IMF 2016). Since firms can make minimum wage hikes less binding by shifting workers to the large informal sector, the level of employment may be largely unaffected.

Minimum wage adjustments have increased in size and frequency in recent years. After hovering below 20 percent for most of the past two decades, minimum wage hikes have picked up sharply since 2022. The frequency of adjustments, which had previously fallen, has also increased. These adjustments have minimized real wage cuts as inflation reached multi-year highs. Still income inequality has been rising.

Pass-through from minimum wage hikes to inflation is fast and substantial. Minimum wage earners have a high marginal propensity to consume. With earnings close to subsistence levels and a near-binding budget constraint, they spend a high fraction of any extra lira they receive. CBRT estimates for 2005–20 show that a 1 percent increase in the minimum wage typically raised CPI inflation by around 0.06 to 0.08 points within two quarters, with the estimated impact being twice as large when broader wage effects are included (CBRT 2021). The passthrough to inflation appears to have increased in recent years (CBRT 2023). Staff also estimates that minimum wage hikes have added around 20 and 10 percentage points to 2023 and 2024 CPI inflation, respectively.

Minimum wage adjustments also complicated disinflation. These adjustments have been backward-looking, that is, based on previous-year inflation, adding to inflation inertia and slowing progress toward re-anchoring inflation expectations. Second round effects are also likely larger when demand remains strong, making it easier for companies to pass on the higher wage costs to their prices instead of reducing profit margins.

13. The lira has remained strong. The lira was allowed to depreciate by around 30 percent between end-May and end-July 2023. Since then, the CBRT has noted that interventions would only smooth volatility, though communications have emphasized the importance of real exchange rate appreciation for reducing inflation. For 2023, the external position is assessed to be weaker than the level implied by medium-term fundamentals and desirable policies. Based on the EBA CA model the implied REER overvaluation is in the range of 8.7–13.3 percent, with a midpoint of 11.0 percent (Annex V). As this assessment averages the 2023:H1 overvaluation with a depreciation and as substantial rebalancing of the current account took place in 2023:H2, some of this overvaluation may have been corrected. This year, the lira has been weakening at an average monthly rate of around 1.8 percent, pushing up its real value by about 12.3 percent by August 2024, partly due to improved terms of trade.

14. The current account has strengthened and reserves increased. Falling prices for imported fuel, lower demand for gold, and macro policies aimed at external rebalancing brought the CAD down from 5.1 percent in 2022 to around 2.8 percent in 2024:H1. Since March, domestic depositors, speculative carry trade investors, and portfolio managers have shifted into lira assets. “Core” net reserves—net reserves excluding off-balance sheet swaps with banks and Treasury FX deposits—had fallen to -US$75 billion in March, but rose to US$9 billion by September 9; gross reserves are at slightly above 100 percent of the ARA metric.

Outlook and Risks

A. Slow Disinflation and a Subdued Medium-Term Outlook

15. The outlook assumes macroeconomic policies broadly in line with announced and observed policies.

  • Monetary policy is expected to tighten into 2025 as the gap between a constant nominal rate and falling inflation expectations widens. As sequential inflation falls, the authorities are expected first to lift credit growth caps, and then to gradually lower the policy rate. Improvements to the CBRT’s liquidity management toolkits, and continued efforts to improve communications, are expected to gradually enhance monetary policy effectiveness in 2025. Financial policies that favor investment and exports would remain in place.

  • On fiscal policy, no further measures are assumed for 2024, while revenue and spending would stay in line with trends observed so far. Overall, the cash fiscal impulse is estimated to remain around 1.2 percent of GDP, partly because some of the unspent earthquake-related overhang from 2023 is expected to be used. In 2025, the main assumption is a freeze in civil service hiring and full revenue impact of the May tax package together with waning earthquake spending (under capital transfers). On a cash basis, there would be a negative fiscal impulse of 0.9 percent. Over the medium term, the deficit would converge to the authorities’ announced 3 percent target. Debt is expected to stay stable at around 26 percent in 2029.

Central Government Fiscal Accounts

(Percent of GDP)

article image
1/ The MTP figures are presented on the IMF definition of the deficit where information is available. These are based on published numbers and IMF staff calculations.

  • On incomes policy, the forecast assumes minimum wage increases each January will be mainly backward-looking.

16. Growth would start to recover in 2025:Q1. Falling credit and eroding real incomes would, despite the expansionary fiscal stance, lead to sequential contractions for Q3–4, reducing annual growth to 3 percent in 2024. A modest recovery would keep 2025 growth at around 2.7 percent. Over the medium term, growth would increase to 3.5–4 percent with a larger contribution from stronger external demand. This is well below Türkiye’s average historical performance of around 5 percent, reflecting distorted capital allocations from a prolonged high inflation environment and a now smaller financial sector.

17. Inflation would continue to fall but remain above the CBRT forecast range. Tight financial conditions would further dampen sequential inflation, with end-2024 headline around 43 percent. With continued tight policies and moderate capital inflows, inflation would fall slowly into the mid-20s by end-2025 and, with continued rebuilding of confidence, further in the medium term.

18. The current account is expected to improve further, and the reserves position to strengthen. The CAD is estimated at -2.2 percent of GDP in 2024, reflecting the slowdown in economic activity, low global energy prices, continued strong goods and services exports, and lower gold imports. Foreign investors would continue to invest in Turkish equities and bonds and gross international reserves rise slightly above the ARA metrics of 100 at end-2024. In the medium term, falling inflation and high rates will attract more inflows, and the combination of financial policies supporting exports with stable global growth would result in a further CAD contraction and reserves staying above the ARA metric.

Selected Economic Indicators

article image
1/ CBRT projections differ from that of the Finance Ministry. Projection is midpoint of forecast range. 2/ Based on the authorities definition of the deficit and differs due to to the inclusion of one-off revenue items. 3/ Change in cash primary balance Sources: CBRT; MoTF; and IMF staff calculations.

B. Lower Risks but Tilted to the Downside

19. The authorities’ approach to fighting inflation bears significant downside risks. The gradual policy tightening prolongs the period during which shocks, such as commodity price volatility or the intensification of the Gaza/Israel conflict and Russia’s war in Ukraine, might derail disinflation (Annex V). While domestic demand is slowing, policies may still be insufficiently tight to firmly reduce wage pressures and pricing power given sticky expectations. Further, any reversal of policies or wage adjustment above targeted inflation ranges could further unmoor expectations. A sharp deceleration in activity could impact the financial health of NFCs, leading to higher NPLs and potential insolvencies, and tighten credit conditions, exacerbating the slowdown. On the other hand, should falling headline inflation improve confidence faster, capital inflows could accelerate, leading to a real appreciation that would push down inflation, or pricing power may weaken faster than expected, pushing sequential inflation down more quickly.

20. Financial and external risks remain. Credit risks could rise with tighter monetary policy, especially if growth declines, and higher policy rates could drag down asset prices. The CBRT’s transition from quantity measures to a decisively binding policy rate will need to be carefully managed. Banks have taken advantage of demand for Turkish risk by increasing FX bond issuance, exposing banks to FX conversion and funding risks in the event of deposit withdrawal. While NFC’s net FX positions have improved substantially and they hold substantial short-term FX assets, positions did worsen in late 2023 and 2024:H1, and remain vulnerable to lira volatility. Finally, geopolitical developments or a loss of confidence could trigger foreign investors to unwind their lira positions, corporates and banks would find it harder to roll over debt, and—most significantly—domestic savers could liquidate lira deposits to buy FX. While core NIR has improved significantly, the current level remains low relative to standard metrics.

Authorities’ Views

21. For this year, authorities project growth similar to staff, but lower inflation. They also expect growth to bottom out toward end-2024, and gradually rebound thereafter to a level above staff’s forecast in 2025. They forecast rebalanced demand and real exchange rate appreciation bringing down inflation against tailwinds from inflation inertia. The authorities highlighted that rebalancing growth and contained demand for gold will contribute to moderating imports, and thus expect a CAD below 2 percent of GDP over 2024–25. In this regard, they underscored the importance of a lower CAD to sustainably accumulate international reserves. For 2025, they noted both upside and downside risks to growth, as strengthened policy credibility can reduce the growth costs of disinflation but acknowledged the negative impact of the expected contractionary fiscal stance. They acknowledged risks around the inflation outlook, especially related to services inflation and global factors.

Policy Discussions

22. With growth cooling, inflation is likely to subside, but a tighter policy stance would more swiftly and sustainably bring it down. Cross country experience suggests that despite short-term costs and risks associated to weaker economic activity, faster disinflations deliver higher long-run growth and stability.7 Tighter policy would reduce wage and price pressures more firmly, bringing down inflation expectations faster and thus further reducing price pressures. The authorities have also made important progress in improving their policy toolkit—e.g., improved central bank communications, simplification of financial regulations—to manage shocks. More decisively contractionary fiscal policy would produce a more coherent policy mix, which with forward-looking incomes policies, and tight financial conditions supported by prudent exchange rate policy would reduce risks, support external rebalancing, and boost medium-term growth (“Staff scenario,” Box 4).

Staff Scenario—A More Secure Disinflation

Staff’s proposed policy mix has three pillars: front-loaded fiscal consolidation, forward-looking incomes policy, and proactive monetary tightening.

  • With monetary policy having long and variable lags, contractionary fiscal policies are the linchpin. With multipliers estimated at around 0.4–0.5, fiscal measures of 2.5 percent of GDP would substantially reverse the 2024 fiscal stimulus and make fiscal policies decisively contractionary in 2025. The strong signaling effect of this tightening, in a context of tighter monetary conditions, would reduce inflation expectations and weigh on aggregate demand. The net effect of these measures on inflation could be 3–5 percentage points, arguing for strong policy coordination.1

  • Setting wages and contracts based on forward-looking inflation expectations would tackle inflation inertia.

  • While monetary policy must remain data dependent, policy tightening should ensure sufficiently contractionary real ex-ante policy rates to put sequential inflation on a downward path consistent with the CBRT’s mid-point forecast for end-2025 and high enough to attract more capital inflows and help rebuild reserve buffers.

Inflation would fall toward the CBRT’s central point forecast in 2025. A rapid fall in inflation would be driven by weaker aggregate demand, less inertia from eliminating backward indexation, a real exchange rate appreciation, and lower inflation expectations as a result of the tighter policy stance. Inflation would fall to 14 percent at end-2025 and be in single digits from 2027.

  • Growth would stall in 2025. In 2025, still-tight financial conditions would induce more savings and further cool credit growth, particularly for investment and exports, as incentives to support lending in those sectors is reduced. Fiscal consolidation would directly reduce incomes, and a significantly more negative impulse would weigh heavily on growth, widening the output gap. As backward-looking wage indexation is eliminated, initially high inflation would also erode real earnings and further bring down aggregate demand. Growth would fall below one percent in 2025. With interest rates higher and inflation falling faster than the baseline, foreign inflows would increase and reserves be built more quickly, stemming depreciation pressures. Real appreciation in the near term would boost imports, but the effect would be offset by lower aggregate demand, leaving the CAD broadly unchanged.

  • A more frontloaded consolidation has a greater chance of reaching the authorities’ central forecast. While weaker economic activity poses risks for corporates and banks, the slow transition so far has given them time and space to adjust, and little stress has so far been visible. A more abrupt slowdown would constrain firms’ pricing power, easing demand for higher wage increases. With wage inertia a central challenge for disinflation, this would help bring expectations down, further reducing pressures on prices and wages while further strengthening CBRT credibility.

  • Soon after macro stabilization would pave the way for higher and more sustainable growth. With inflation under control, reduced economic uncertainty and regained confidence would boost consumption and investment, engendering a recovery in 2026. Growth in 2027 would rise to 4 percent. Faster disinflation would increase confidence while faster removal of remaining financial distortions and higher inflows would improve capital allocation in the medium term, raising productivity growth and increasing potential output growth to around 4–5 percent.

Selected Economic Indicators

article image
Sources: Turkish authorities; and IMF staff estimates and projections.
1/ The estimated fiscal multipliers in Türkiye are usually small. For example, Sen and Kaya (2020) estimate that the tax multipliers range from -0.83 to -0.27 and spending multipliers from 0.02 to 0.98, depending on the fiscal instruments.

A. Bringing Inflation Down

Fiscal Policy: Supporting Disinflation

23. Further fiscal restraint in 2024 would help dampen demand. While admittedly difficult to enact in the last quarter, measures would signal the policy direction for next year and some could reduce the cash impulse. Staff recommends rationalizing tax expenditure (estimated at 5.3 percent of GDP in 2024) and possibly unifying VAT rates. While earthquake expenditure needs to be protected, further limiting spending on non-essential capital projects and postponing those that have not yet started would also reduce demand. Close monitoring of earthquake spending and published quarterly fiscal targets would provide early feedback on the cyclical stance.

Recommended Fiscal Policy Measures

(Percent of GDP)

article image

24. Additional measures next year would improve tax structure and efficiency. Measures to unify the VAT rate and revenue administration reforms would boost revenue; a broad tax policy diagnostic would be useful before implementing such reforms.8 Non-earthquake capital spending can be further held back as long as reconstruction continues. Backward-looking indexation in wage contracts should be replaced with forward-looking expectations. Remaining energy subsidies should be phased out, while supporting vulnerable households through targeted cash transfers.9 A two-year phasing-out would not compromise disinflation efforts as the effect of price increases would be counterbalanced by the impact of limited disposable income on demand.

25. The shift toward tighter income and price-setting policies should continue. The minimum wage has increased in real terms and is a key determinant of both inflation expectations and aggregate demand. The authorities should continue annual adjustments, with increases in line with inflation expectations to reduce wage-price feedback and also being mindful of competitiveness. More broadly, backward-looking indexation should be minimized or discontinued. For administered prices, one-off adjustments might be needed and future increases should be aligned with production and/or maintenance costs.

Authorities’ Views

26. The authorities expect fiscal policy to be neutral in 2024 and contractionary in 2025. They signaled their commitment to continue strengthening tax policy and expenditure management. They noted that ongoing efforts to control expenditures in the context of the revised MTP will lead to a smaller fiscal impulse than projected by staff in 2024 and agreed that as earthquake relief spending declines, the fiscal stance will turn contractionary in 2025. They see space to raise revenues given large tax expenditures and informality. In this regard, they emphasized that tackling informality is a key priority. The authorities expect ongoing and future policy actions to strengthen tax collections and highlighted that possible changes in tax measures will need to consider their inflationary impact. In this regard, they highlighted the importance of policy coordination to tackle inflation. They agreed that untargeted energy subsidies are costly but argued that a full subsidy overhaul would only be implemented after a safety net protecting disadvantaged households is in place. Wages will be raised as mandated by law, via contracts renegotiated every other year. The authorities noted that with inflation declining, they will continue annual minimum wage adjustments.

Monetary Policy: Tighter For Longer

27. Reaching the midpoint of the end-2025 CBRT forecast band will require tighter financial conditions, which will partly come from falling inflation expectations. With domestic demand falling, credit growing below the caps, and sequential inflation entering the band consistent with reaching the end-2025 forecast, financial conditions are quite restrictive at the moment. Reaching the end-2025 midpoint of the authorities’ inflation forecast range, however, will require further tightening to ensure real ex-ante rates remain sufficiently contractionary. Future changes should be data-dependent, and some tightening is likely to occur organically through falling inflation expectations; this would add to an envisaged tighter fiscal stance. But should sequential monthly inflation not continue to fall to the 1.1 percent average path needed to reach 14 percent (midpoint of the 2025 CBRT forecast range), further policy tightening would be called for.

28. The CBRT should continue to improve the functioning of monetary policy. Credit growth caps and still-high dollarization have diminished the effectiveness of the policy rate (Box 5). Once inflation is on a clear downward path, and before reducing the rate, credit growth caps should be removed. Meanwhile, with RRs quite high, the CBRT should further develop deposit auctions and gradually lengthen deposits’ terms as a more market-friendly way to absorb surplus liquidity. Should inflows accelerate further, potentially adding to future external financing needs, additional financial stability policies would help mitigate their macroeconomic impact and build buffers against systemic risks (Annex VIII). In turn, the recent reserve accumulation, thanks to increased inflows in 2024:H1 and benign CAD dynamics, is building much-needed buffers in case the external position weakens again.

29. Policies to strengthen central bank independence and monetary policy communication would complement these efforts. Clearer communications about how targets will be reached and the CBRT’s response function would help address sticky expectations. Transparent arrangements for senior CBRT appointments and dismissals would strengthen central bank independence and support monetary policy credibility.

Tightening Monetary Policy

The CBRT’s one-week repo rate is its main policy rate, but caps on credit growth introduced in March 2024 and tightened in July have brought to the fore challenging tradeoffs between disinflation and financial stability.

Caps have complemented policy rate hikes in slowing credit growth. In early 2024, transmission from the policy rate to credit growth and aggregate demand was weak because of still-negative real policy rates. In response, the CBRT moved in March 2024 to control monetary aggregates not just by increasing the rate and broadening the base for required reserves, but also more directly via growth caps on loans.1 These caps cover most but not all bank lending, and with the lira lending rates now broadly following the policy rate, credit has fallen rapidly in real terms, likely contributing to cooling aggregate demand in Q2.

The use of the policy rate and credit caps is weakening the transmission of monetary policy by influencing both the price and quantity of credit. As the caps limited the growth of banks’ balance sheets, they reduced bank demand for lira funding. With lower lira funding costs, lending rates also rose less. These caps thus undermine the role of the policy rate as the main policy instrument and blur the monetary stance. They are also more difficult to incorporate into central bank communications and forward guidance.

The need to manage excess liquidity in the wake of inflows further complicates monetary policy and adds to financial stability risks. The move in 2024:Q2 of domestic depositors and carry trade investors into lira, and the CBRT’s need to prevent excessive appreciation, led to reserves accumulation, which in turn caused a sharp rise in lira liquidity. Liquidity was absorbed largely by raising RRs and unwinding swaps, reducing quasi-fiscal revenues, and further lowering net liquidity absorption despite a decline in KKM payouts. These changes were triggered by higher policy rates and a relatively stable lira, but by injecting liquidity into the system, they complicate monetary policy. The CBRT managed the liquidity surge by raising RRs, but these are now approaching a level that could undermine bank profitability at a time when funding costs have risen with the policy rate and opportunities for lending are constrained by growth targets.

1/ Initially the ceiling was 2 percent on lira lending. A 2 percent ceiling was added in May 2024 for FX lending, and reduced to 1.5 percent in July.

Exchange Rate Policy: Smoothing Volatility and Rebuilding Buffers

30. Exchange rate intervention should focus on smoothing potentially destabilizing exchange rate movements that could dislodge inflation expectations. Intervention should not be used to substitute for warranted adjustment of macro policies, including appropriate monetary and fiscal policy settings. But it can be useful when large shocks interact with frictions – such as high dollarization and strong inflation passthrough - to generate sharp increases in external financing premia or a jump in inflation expectations that can undermine price stability. Moreover, Türkiye’s FX market is shallow, and, until confidence in the lira has further increased, external shocks could be misinterpreted as permanent, leading to a disorderly and destabilizing jump in FX demand. Hence, to avoid destabilizing inflation expectations during policy normalization, intervention to smooth sharp changes in the exchange rate is warranted. In this context, the CBRT’s responses to capital outflows in 2024:Q1 and the subsequent strong reversal in Q2, are commendable. Until sequential inflation is on a sustainable downward trend, the CBRT should continue to prioritize smoothing exchange rate movements in a manner consistent with disinflation and without undue real appreciation. The CBRT should avoid intervening against persistent shocks, which could lead to an unsustainable appreciation followed by a correction. Such shocks should be addressed more sustainably through tighter policies and by allowing the currency to find a floor. Excessive real appreciation would first be visible in trade data and the financial performance of externally-exposed corporates; these should be monitored closely. The CBRT should continue to replenish reserves buffers opportunistically.

31. When sequential inflation has declined, interventions should be scaled back. Lower inflation, inflation expectations close to the CBRT range, and more comfortable reserve buffers will improve confidence in the lira. Similarly, disinflation will encourage capital inflows, reducing frictions in the FX market and lessening the need to smooth exchange rate volatility. Further relaxation of the export surrender requirement or reducing minimum FX-protected deposits rollover rates would support greater liquidity and price discovery in the market.

32. Measures to limit FX outflows are being dismantled. Türkiye retains two CFMs: surrender requirements for goods exports (relaxed in June from 40 to 30 percent) and measures that limit the scale of offshore derivative transactions aimed at limiting swaps. Surrender requirements should continue to be gradually discontinued. Lira short selling should continue to be banned until financial liberalization is largely achieved.

Financial Policies: Improving Efficiency

33. Financial liberalization should focus on reinforcing policy tightening and improving transmission. The 2023 FSAP noted that dismantling complex and distorting repression measures should be carefully sequenced, to avoid jeopardizing financial stability. Many of these measures have now been removed, and the banking system appears to operate more smoothly with risks broadly contained. Nevertheless, the CBRT should continue to improve liquidity forecasting and management, including by moving toward targeting the overnight rather than one-week rate to smooth adjustments. The FSAP suggested simplifying collateral and haircut rules to improve access to CBRT funding; developing a unified master repo agreement in line with the ISDA standard, and removing individual banks’ limits on participation.

Authorities’ Views

34. The authorities strongly believe the current stance will bring inflation into the CBRT’s forecast range. Consistent with current guidance, they reiterated that the CBRT will keep the tight monetary stance until a significant and sustained decline in the underlying trend of monthly inflation is observed, and inflation expectations converge to their target range. The CBRT highlighted three disinflation channels: domestic demand moderation; real exchange rate appreciation; and reanchoring inflation expectations. The authorities expect further improvements in inflation expectations but noted that these may remain high for households and sticky for corporates. They remain ready to tighten further if inflation and inflation expectations do not converge to the target range. They agree that interventions should be fully sterilized and emphasized that improvements to systemic liquidity management, including the development of deposit auctions, are ongoing.

35. The authorities consider that low exchange rate volatility contributes to anchoring expectations and reiterated that the CBRT does neither target an exchange rate level or a pace of depreciation. The CBRT explained that the real exchange rate appreciation is a natural consequence of the tight policy stance and policy credibility. As market conditions permit, they plan to bring down the stock of FX-protected deposits at a faster pace.

36. The authorities highlighted the significant progress in financial liberalization and noted that further liberalization would be taken as market conditions allow. On the policy toolkit, the CBRT explained that credit growth caps transmit faster and more directly to domestic demand, and so allow for a swifter tightening of the policy stance, especially in light of imperfect monetary transmission. They noted that credit growth caps on FX loans helped extend tight financial conditions from lira to FX markets. Nevertheless, the CBRT stated that the macroprudential policy framework will be viewed as complementary to the policy rate. They emphasized that they will continue simplifying the macroprudential framework and introduced new tools to improve transmission, including swap facilities and deposit auctions.

B. Safeguarding Stability and Boosting Medium-Term Growth

Financial Stability During and After Disinflation

37. Risk management and dealing with problem assets should be further improved. The FSAP noted that bank regulations were not fully in line with Basel standards and that insufficient resources and intrusiveness at the Banking Regulation and Supervision Agency (BRSA) undermined supervision. Changes to the supervisory approach, such as the new Supervisory Review and Evaluation Process, are welcome. Going forward, measures such as further improving loan quality reporting practices and risk management would bring the supervisory framework closer in line with Basel, mitigate credit risks related to the slowing economy, and improve capital allocation. Regulatory forbearance that obscures asset quality transparency should be phased out. In addition, the CBRT’s emergency liquidity assistance framework should be modified to eliminate any overlap with liquidity provision in the event of financial stress, and deposit insurance regulations be brought in line with FSB Key Attributes.

38. Macroprudential policies should focus on systemic liquidity and credit risks. Lira RRs continue to be used to support preferred sectors, tighten financial conditions, and support liraization targets. They should be simplified and focused on managing systemic liquidity. With FX liquidity risks still high, FX RRs (as well as risk weights on FX-denominated securities) should be set commensurate with FX liquidity risks. Measures such as differential growth caps, complex risk weights, and RRs that divert credit toward export, investment, and other preferred sectors, should be lifted.

39. Dedollarization should take second priority to disinflation. FX-protected deposits present quasi-fiscal risks in the event of a major depreciation and undermine market discipline by shifting FX risk away from the private sector. As inflation falls and the FX reserves position improves, these should be slowly made less generous and further unwound. In the meantime, tolerating dollarization while bringing inflation down will likely raise the likelihood of success for both policies, and systemic FX liquidity risk can be managed with macroprudential policy.

Authorities’ Views

40. The authorities stressed that banks have adequate capital and liquidity buffers and highlighted efforts to simplify the macroprudential policy framework. They noted that regulatory changes (in line with FSAP recommendations) are contributing to strong bank lending portfolios, effective NPL workouts, and diminishing impact of declining loan portfolio growth on NPL ratios. They noted that the BRSA requires banks to comply with leverage ratio standards not subject to forbearance. They explained that the debt servicing capacity of both households and corporates has not been significantly affected by policy rate increases, given plentiful cash buffers and moderate leverage. On the macroprudential framework, they highlighted the elimination of the securities maintenance requirement and of loan rate caps. They emphasized that tight monetary policy has contributed to declining dollarization, while restrictions on FX loans to unhedged borrowers have limited systemic FX liquidity risks. They noted that while the stability of FX inflows is uncertain, FX liquidity risks are mitigated by banks not being exposed to FX maturity transformation risks as FX inflows are either sold to the CBRT or invested into liquid FX-denominated assets.

Ensuring Fiscal Sustainability and Reducing Risks

41. The authorities’ medium-term deficit target is appropriate to manage sizable fiscal risks. The 3-percent target is transparent and easily communicated. With some fiscal space still available, this would allow further spending on health and toward climate mitigation. Public debt would stay at low levels (Annex IV) and is robust to shocks, while gross financing needs (GFN) are manageable. Under macro stress scenarios, GFN would rise to around 8 percent in the medium term, (against 6 percent of GDP in the baseline) while contingent liability shocks on top of macro stress would raise the GFN to a peak of over 13 percent of GDP in the year of the shock, falling to an annual average of around 9 percent. Debt would increase to 32 percent of GDP by end-2029 against the baseline of 26 percent. Possible risks stem from policy normalization, which will increase debt service. Also, cumulative PPP investment is over 8 percent of GDP, recapitalization of SOEs could prove necessary, and more citizens could avail themselves of the 2023 early retirement scheme (Box 2). And a large increase in commodity prices would increase costs while energy subsidies remain in place exposing the government to commodity risk.10 Lastly, natural disasters, including earthquakes and climate-related losses, consistently add to fiscal costs.

42. Modernizing fiscal policy would help guard against risks:

  • Revenue administration. Estimating tax potential, improved institutional structures at revenue administration agencies, and implementing compliance risk plans should be key first steps.

  • Fiscal governance reforms, including the oversight and management of PPPs, should be accelerated. Timely publication of SOE financial statements and comprehensive and consolidated information on their quasi-fiscal operations would improve the assessment of risks. New guarantees should ideally be eschewed or costed transparently and systematically.

  • Pensions. Ad-hoc increases to pensions and the enactment of early retirement schemes should be avoided. A review of the pension system would ensure that the most vulnerable are protected, while ensuring the long-term fiscal viability of the system.

43. Public spending should become more efficient, transparent, and accountable. An assessment of public financial management through an updated Fiscal Transparency Evaluation (FTE) would support such efforts. While certain public officials must submit an interest declaration, there is limited information on the monitoring and enforcement of compliance with conflict-of-interest regulations.11 Türkiye has an asset declaration system for public officials, but both interest and asset declarations are not made publicly accessible. There is also no centralized body to collect and verify these declarations following a decentralized approach. Finally, the efficiency, integrity, and value for money of post-earthquake spending should be assessed through a performance audit by the independent Public Procurement Authority.

Authorities’ Views

44. The authorities are committed to a 3 percent of GDP deficit anchor in the medium term and agreed with staff that public debt would remain sustainable under a variety of shocks. They acknowledged fiscal risks from SOEs and PPPs, while noting that they are transparently reported, manageable, and sufficiently safeguarded. PPP-related demand guarantees that have been called are budgeted annually and included in the budget targets. Treasury debt assumption commitments for PPPs are reported monthly, and these commitments have never been triggered. Moreover, the size of new annual Treasury debt assumption commitments is limited by law. The authorities are committed to modernizing the legal frameworks for both PPPs and SOEs and corresponding laws are currently under consideration. The new framework for SOEs will aim to expand coverage of their reporting and monitoring beyond the limited subset currently included. The authorities noted that allocations for earthquake relief cannot be diverted to other purposes and that are subject to the same audit process as other expenditure categories.

Structural Reforms to Support Growth

Climate Mitigation and National Energy Plan

45. Türkiye is developing plans to reduce greenhouse gas (GHG) emissions. It was the world’s 14th largest GHG emitter in 2022, though its per-capita emissions are below the EU average. Its energy efficiency, measured as total emissions relative to production, has improved at a slower pace than most of its peers with many Turkish companies not operating at the energy efficiency frontier (Annex IX). The share of fossil resources is expected to decline to 70 percent by 2035 (from 83 percent in 2020) as the National Energy Plan (NEP) aims to increase renewables in primary energy consumption to about one quarter by 2035. However, there are no plans to reduce power generation through coal plants before 2050.

46. Existing mitigation policies are helping to limit emissions’ growth, but further efforts are needed to achieve Türkiye’s net zero emissions target of 2053. Existing policies include promotion of renewables through feed-in tariffs, net metering and tendering; tax incentives for EVs; vehicle registration fees by vehicle size and the Zero Carbon Buildings for All initiative which aims for the decarbonization of new buildings by 2030 and all buildings by 2050. In its Nationally Determined Contribution (NDC), updated in 2023, Türkiye committed to reducing emissions by 41 percent through 2030 compared to a Business as Usual (BAU) scenario. The CPAT tool estimates that this NDC is non-binding.12 However, additional policies are needed to achieve carbon neutrality as planned in 2053. First, the power sector should be decarbonized by scaling up renewable energy and retiring most existing coal power plants and mines before 2050, while compensating affected workers. Second, energy efficiency can be improved by making building standards and codes more stringent and well-enforced, perhaps alongside improving earthquake-resilience. Promoting more energy-efficient modes of transportation, national schemes to support energy efficiency in factories, and a coordinated shift toward industrial electrification would also help, with an important role for carbon pricing. Third, adopting sustainable forest management to grow carbon-absorbing areas would maximize Türkiye’s considerable carbon sequestration potential.

47. Plans for an emission trading system (ETS) are to be aligned with the EU. An ETS would substantially help Türkiye in reaching its mitigation targets, while phasing out energy subsidies would help getting carbon prices right. The EU’s carbon border adjustment mechanism (CBAM), which will be phased in from 2026, will levy charges on the carbon content of imported steel, aluminum, cement, fertilizers, and electricity. Aligning Türkiye’s ETS, both in coverage and pricing, will avoid charges. ETS coverage should include the industrial and power sectors and introduce binding ceilings on emissions consistent with Türkiye’s mitigation goals. Ideally, emission allocations should be auctioned off, with the carbon price increased in a predictable and gradual manner through consistently declining emission caps. Including a price floor would further reduce uncertainty about ETS pricing and thus help businesses. Such a set-up would also raise revenue which could support economic activity and strengthen social safety nets.

National Employment Strategy

48. Labor market reforms should focus on reducing informality and increasing flexibility and female participation. Despite recent improvements, informality remains high and female labor force participation extremely low, while labor mobility continues to be impaired by burdensome procedures and a lack of fixed-term contracts. Reform priorities to increase female participation include increasing the supply of affordable and well-targeted public childcare services, better targeting subsidies and allowances for childcare for low-income workers, and building on recent tax measures which increased labor supply incentives for women (Annex X).

49. On informality and flexibility,13 priorities include: reassessing severance pay reform, making formal fixed-term and temporary work contracts more flexible, and reducing administrative, regulatory, and the tax burden on SMEs, among which informality is most prevalent. Taken together, these would boost medium-term growth and make it more inclusive, facilitate business efficiency, improve tax collection, and better protect workers.

Legal Reforms

50. A robust governance framework could further build investor confidence. The 12th Development Plan (2024–26) establishes strategic objectives to strengthen bureaucratic and legal predictability in the business and investment environment to make the economy more competitive; reform measures include improving the quality and quantity of judges and prosecutors and streamlining judicial processes. A new anti-corruption strategy document is also under preparation and will be published. In the absence of a dedicated anti-corruption agency, robust coordination through the Ministry of Justice among relevant public institutions is critical for the effectiveness of anti-corruption efforts. Türkiye is undertaking its 2nd Review Cycle under the United Nations Convention against Corruption, and is encouraged to timely implement the recommendations.

Financial Issues

51. Türkiye was removed from the Financial Action Task Force (FATF) “Gray list” of jurisdictions with strategic anti-money laundering and combatting the financing of terrorism (AML/CFT) deficiencies in June. The authorities have been recognized as implementing all of the action plan items agreed upon with the FATF, the international standard setter for AML/CFT purposes. Notably, the authorities made important legal and regulatory updates, including addressing shortcomings related to politically exposed persons. The authorities also amended AML/CFT legislation in 2021 to bring virtual asset service providers (VASPs) into the AML/CFT regulatory regime and enacted a new virtual assets (VA) regulation that now requires registration of VA Service Providers (VASP), of which there are around 80 in Türkiye.14 The authorities have also updated the national money laundering and terrorism financing risk assessment.

52. The CBRT is developing a central bank digital currency (CBDC). The authorities have completed the first phase of their CBDC pilot, focusing on, among other things, digital transactions and identification. In the second phase, the CBRT will focus on introducing a digital lira to the payments infrastructure as well as interoperability.

Authorities’ Views

53. The authorities assess potential growth to be higher than assumed by staff and conveyed their commitment to policies to make growth greener and more evenly distributed. In this regard, they

  • Noted that they are on track to meet their updated NDC, consistent with net zero emissions in 2053. They emphasized that the design of a domestic ETS is underway, that it will cover the main sectors included in the EU’s CBAM and that a pilot phase is planned for 2025. While there are no plans to close existing coal plants, coal’s share in energy production is projected to gradually fall, in accordance with the NEP.

  • Acknowledged that employment reforms remain important. They emphasized that while informality remains high, it has declined. They highlighted ongoing work to improve labor market flexibility, including cooperation with ILO to bring women into the labor force, part-time contracts for home workers, and grant schemes for SMEs to promote entrepreneurship. They are working on tailored programs to deal with informality in sectors with high informality, such as agriculture and construction. The authorities consider increasing female labor force participation as a priority, but acknowledged the need to further increase targeted public spending for childcare services.

  • Noted that they continue to work towards improving the governance framework. While there is no dedicated anti-corruption agency, a coordination mechanism by the Ministry of Justice is already in place. So far, no recommendations have been issued for the review of the implementation of United Nations Convention against Corruption.

  • Noted that risks from digital finance are contained. The new crypto law will help gather more information and address future risks. Development of a retail CBDC is being undertaken in various independent stages to minimize risks to the financial system.

Staff Appraisal

54. A bold policy shift since mid-2023 has reduced economic imbalances and crisis risks. The CBRT significantly tightened monetary policy while gradually dismantling financial distortions. Substantial tax and expenditure measures helped dampen an expansionary fiscal impulse, which partly reflected critical earthquake-related spending. Minimum wage indexation now takes place once a year, down from semiannual adjustments. This policy shift generated a remarkable revival in market sentiment since the spring and net international reserves have strengthened significantly. The financial and corporate sectors have so far weathered the policy tightening and financial liberalization.

55. As the economy is cooling, inflation is now moderating from high levels. Although fiscal policies will move to contractionary territory only in 2025, the policy mix will continue to weigh on demand. After peaking at 75 percent (y/y) in May 2024, inflation is projected to gradually decrease to about 25 percent in 2025. Growth would decline to 3.0 percent in 2024, further to 2.7 percent in 2025, and recover to its potential thereafter. The external position in 2023 is assessed to be weaker than the level implied by medium-term fundamentals and desirable policies. However, the CAD is projected to fall from 4.0 of GDP in 2023 to 2.2 percent in 2024 with reserves increasing to above 100 percent of the reserve adequacy metric.

56. The authorities’ gradual approach to fighting inflation bears significant downside risks. In particular, gradual fiscal tightening will prolong the period during which adverse shocks might materialize and runs the risk of failing to bring down sequential inflation. A reversal of confidence or capital flows, higher global energy prices, or rising geopolitical tensions could further complicate disinflation efforts. Also, a growth slowdown needed to curb inflation may raise credit risks in the financial system, while FX borrowing and carry trade flows have added to potential FX liquidity risks. Nevertheless, tighter policies could create a virtuous cycle under which reduced pricing power at firms eases wage pressures, lowering inflation inertia and thus further reducing wage and price pressures.

57. A tighter policy stance would result in more rapid and more sustainable disinflation, though at some cost for short-term growth. More decisively contractionary fiscal policies over 2024–25, forward-looking incomes policies, and tighter financial conditions, supported by prudent exchange rate policy, would lower risks, support rebalancing, and boost medium-term growth.

58. A larger and more front-loaded fiscal consolidation would cool down demand faster. Measures of 2½ percent of GDP, frontloaded to the extent possible, would move the fiscal impulse in 2025 into significantly contractionary territory, reversing fiscal stimulus from previous years. Policies should include rationalizing tax expenditures, broadening the tax base, energy subsidy reforms, and limiting spending to essential capital projects as long as earthquake reconstruction continues.

59. Tackling backward-looking indexation would more swiftly re-anchor inflation expectations. The decision to return to annual minimum wage adjustments is welcome, as their frequency and magnitude are a signal on the desired speed of disinflation. In general, backward indexation should be eliminated. Administered prices adjustments should also be aligned with production and/or maintenance costs.

60. Falling inflation expectations may not be sufficient to bring the end-2025 inflation forecast within reach. Monetary policy should remain data-dependent and ex-ante real rates sufficiently contractionary to ensure sequential inflation is on a downward trend aligned with the CBRT’s end-2025 midpoint forecast. As inflation expectations fall, the real policy rate will rise, but if inflation stays outside the envelope consistent with the end-2025 forecast, nominal increases would also be called for. Credit growth caps should be discontinued before nominal easing. Inflows should be fully sterilized, and systemic liquidity forecasting and management improved. Additional clarity on the CBRT’s reaction function to shocks would help re-anchor inflation expectations. Macroprudential policies can focus on mitigating systemic financial risks. CFMs should be discontinued gradually as FX liquidity risk recedes and inflation falls.

61. Policies to strengthen central bank independence and communication would help improve monetary policy efficacy and credibility. It is important that measures to tighten the policy stance and re-anchor expectations be complemented with policies to strengthen central bank independence and communication of monetary policy.

62. Exchange rate policy should focus on smoothing destabilizing exchange rate movements. Given strong passthrough and high dollarization, a sharp lira depreciation can push up prices, potentially undermining inflation expectations and hindering price stability. FX intervention to smooth such exchange rate volatility is thus warranted while policies normalize, but intervening against persistent shocks could lead to an unsustainable real appreciation followed by a correction. As sequential inflation falls, intervention can be scaled back. Reserves accumulation should be opportunistic.

63. Maintaining financial stability in a context of higher rates and lower growth and preserving financial integrity in the face of emerging risks will require continued vigilance and further reform. The authorities should continue to bring the supervisory framework more closely in line with Basel, notably for risk management and reporting practices. The CBRT’s emergency liquidity assistance policies should be strengthened. Recent improvements to the AML/CFT framework are commendable, and work in this area should be continued. The authorities should continue efforts to understand and mitigate money laundering and terrorism risks, particularly those related to the virtual asset sector. Going forward, regulation and oversight of VAs activity should be strengthened.

64. While public debt is sustainable under a range of policy shocks, there is scope for structural fiscal reforms. The authorities should continue to address tax compliance gaps, improve tax administration, reduce tax expenditures, and review their transparency policies and public financial management framework. Risk monitoring would be enhanced by a PPP law in line with best international practice, defining roles, responsibilities, and procedures for contract management of PPPs, and reporting requirements for contingent liabilities arising from SOEs and PPPs in primary legislation, as well as timely SOE financial statements.

65. Accelerating structural reforms will enhance medium-term growth and make it more inclusive and greener. Investing in the transition to a low-carbon economy, including through further decarbonizing the power sector, would help Türkiye achieve its carbon emission reduction objectives. ETS implementation in line with the EU’s would preserve competitiveness. Labor market reforms should aim to boost female labor force participation, reduce informality, and increase labor market flexibility.

66. It is recommended that the next Article IV consultation with Türkiye be held on the standard 12-month cycle.

Figure 1.
Figure 1.

Türkiye: Real Sector Developments

Citation: IMF Staff Country Reports 2024, 312; 10.5089/9798400290848.002.A001

Sources: Bloomberg Financial Markets L.P.; CBRT; Consensus Forecast; European Commission; Turkstat; and IMF staff calculations.1/ Ratio of the sum of time-related underemployment and unemployed people to the labor force.2/ Ratio of the sum of unemployed and potential labor force to the sum of labor force and potential labor force.3/ Ratio of the sum of unemployed, time-related underemployment, and potential labor force to the sum of labor force and potential labor force.
Figure 2.
Figure 2.

Türkiye: Inflation Developments

Citation: IMF Staff Country Reports 2024, 312; 10.5089/9798400290848.002.A001

Sources: Central Bank of the Republic of Türkiye; Consensus Forecasts; Country authorities; Eurostat; Haver Analytics; Turkstat; and IMF staff calculations.
Figure 3.
Figure 3.

Türkiye: Financial Markets

Citation: IMF Staff Country Reports 2024, 312; 10.5089/9798400290848.002.A001

Sources: Bloomberg Finance L.P.; Haver Analytics; and IMF staff estimates.1/ Excludes Russia.
Figure 4.
Figure 4.

Türkiye: Financial Sector

Citation: IMF Staff Country Reports 2024, 312; 10.5089/9798400290848.002.A001

Sources: BRSA; CBRT; and IMF staff calculations.
Figure 5.
Figure 5.

Türkiye: Credit Growth Developments

Citation: IMF Staff Country Reports 2024, 312; 10.5089/9798400290848.002.A001

Figure 6.
Figure 6.

Türkiye: Fiscal Stance

Citation: IMF Staff Country Reports 2024, 312; 10.5089/9798400290848.002.A001

Sources: Ministry of Treasury and Finance and IMF staff calculations.
Figure 7.
Figure 7.

Türkiye: External Sector

Citation: IMF Staff Country Reports 2024, 312; 10.5089/9798400290848.002.A001

1/ Data refers to 2024Q1.2/ Excludes changes in reserve assets.3/ As of July 26, 2024.Sources: CBRT; MOTF; and IMF staff calculations.
Figure 8.
Figure 8.

Türkiye: Climate Change

Citation: IMF Staff Country Reports 2024, 312; 10.5089/9798400290848.002.A001

Table 1.

Türkiye: Selected Economic Indicators, 2019–29

article image
Sources: Turkish authorities; and IMF staff estimates and projections. 1/ Staff estimates. 2/ Authorities national definition of the fiscal balance, which includes one-off revenues, expenditures and financing items removed from IMF staff defintion. 3/ The external debt ratio is calculated by dividing external debt in US$ by staff-estimated GDP in US$. GDP in US$ is calculated as GDP in TL divided by the annual average exchange rate.
Table 2a.

Türkiye: Summary of Balance of Payments, 2019–29

(Billions of U.S. dollars, unless otherwise noted)

article image
Sources: Turkish authorities; and IMF staff estimates and projections.
Table 2b.

Türkiye: Summary of Balance of Payments, 2019–29

(Percent of GDP, unless otherwise noted)

article image
Sources: Turkish authorities; and IMF staff estimates and projections.
Table 3.

Türkiye: External Financing Requirements and Sources, 2019–29

(Billions of U.S. dollars, unless otherwise noted)

article image
Sources: Turkish authorities; and IMF staff estimates and projections. 1/ Includes CBRT and the general government, excluding eurobonds issuance. 2/ The increase in government amortization in 2021 largely reflects swaps held by the CBRT, which are assumed to be rolled over. 3/ Includes sales and purchases of portfolio assets by the government, banks, and other private sectors; and sale of assets classified under Other Investments. 4/ Includes currency and deposits of non-residents.
Table 4.

Türkiye: Public Sector Finances, 2019–29

(Percent of GDP)

article image
Sources: Turkish authorities; and IMF staff estimates and projections. 1/ IMF program definition which excludes several items from non-tax revenue and the primary balance, including privatization proceeds, transfers from CBRT, dividend payments from Ziraat Bank and interest receipts. 2/ Headline or authorities' definition which includes items excluded from the IMF 'program' definition.