On behalf of our Turkish authorities, we would like to thank Mr. Walsh and his team for the comprehensive and informative report and for the candid and fruitful engagement during the 2024 Article IV consultation.
Macroeconomic Context and Recent Developments
Türkiye’s economic performance after the pandemic was characterized by strong growth and employment recovery. GDP grew by an average of 8.5 percent in 2021 and 2022. Unemployment fell from 13.1 percent at end 2020 to 10.4 percent at end 2022. However, external uncertainties from geopolitical conflicts and pro-growth domestic policies increased vulnerabilities by reducing reserve buffers and increasing dollarization. Inflation reached last two decades highs. The devastating earthquakes in early 2023 have added to Türkiye’s economic strains, particularly on the budget, with significant resources allocated to relief efforts. Against this backdrop, presidential and parliamentary elections were held in May 2023.
After the elections, the new government, in close coordination with the Central Bank of the Republic of Türkiye (CBRT), started to implement a comprehensive policy program, mainly aimed at achieving price stability. The program consists of three main pillars: (i) monetary policy normalization and simplification of macroprudential measures, (ii) restoring fiscal health to support the CBRT’s efforts since inflation expectations have been de-anchored and to build buffers, and (iii) structural transformation to support more inclusive and sustainable long-term growth. The policy program has full political support, as achieving price stability and returning inflation back to low single digits are among the government’s top economic priorities.
The CBRT significantly tightened the monetary policy stance and unwound a number of pre-2023 regulations to achieve simplification. All securities maintenance regulations were abolished to improve the functioning of the market mechanism and macro-financial stability. FX surrender requirements for goods exports were eased. In addition, the CBRT took measures to support Turkish lira deposits and introduced new macroprudential measures to strengthen the monetary transmission mechanism. Over the same period, the CBRT has maintained effective communication with the markets that the tight monetary stance will be maintained until a significant and sustained decline in the underlying monthly inflation is observed, and inflation expectations converge to the projected forecast range.
On the fiscal front, the authorities introduced revenue enhancing measures to offset the stimulative effect of earthquake related spending. The increase in the corporate income tax (CIT) and value-added tax, the introduction of a minimum CIT for multinational corporations (will be put into effect in 2025), and the imposition of special consumption taxes on petroleum products are some of these measures. In addition, other measures, such as a freeze on public sector hiring and a freeze on new building/vehicle construction/purchases have been taken to ensure efficiency and control in public spending.
The authorities’ policy program is bearing fruits, and the rebalancing of the economy is becoming more pronounced. After reaching 75 percent in May 2024, inflation came down to 52 percent in August. The growth rate has started to slow down in the first quarter of 2024. Significant improvement has been observed in de-dollarization. The share of FX deposits, including the FX protected deposit schemes, in total deposits declined to 46.5 percent as of September 13, 2024 from a peak of 68.4 percent in August 2023. The 12-month rolling current account deficit (CAD), reaching USD 57 billion in May 2023, decreased to USD 19.1 billion as of July 2024. These developments are aligned with the broader strategy aiming for a more balanced external position and allowing the CBRT to increase its reserve buffers. Total official reserves and net international reserves, except all swaps, increased to USD 153.5 billion and USD 26.5 billion (highest level in almost 5 years) respectively as of September 13, 2024. The central government’s overall deficit was 5.2 percent of GDP at the end of 2023, lower than the Medium-Term Program (2024-26) projection of 6.4 percent of GDP, despite the significant earthquake-related expenditures. In addition, with the coordinated efforts of various ministries and institutions, Türkiye was removed from the Financial Action Task Force’s (FATF) grey list in June 2024. Against this backdrop, market sentiment has improved remarkably, CDS spreads have halved from their mid-2023 levels, and all major ratings agencies have upgraded Türkiye’s sovereign risk ratings.
Outlook: Medium-Term Program for 2025-2027
Based on a prudent, realistic, and consistent macroeconomic framework, the Medium-Term Program (MTP) unveiled in early September aims to further strengthen macroeconomic and financial stability, maintain fiscal discipline, and achieve price stability by reducing inflation to single digits in the medium term. Policies and structural reforms will be implemented in close coordination with relevant ministries and institutions, supporting the CBRT’s efforts to contain inflation. The objectives of the MTP also include improving R&D and innovation capacity, ensuring technological transformation with a focus on the transition to a green and digital economy, strengthening human capital, further activating the labor market, improving the business and investment environment, and reducing informality in the economy.
The authorities expect economic growth to be more robust than forecasted by staff as well as more positive developments in the overall fiscal balance, external deficit, and the inflation rate over the medium term. The authorities project growth to decline to 3.5 percent in 2024, in accordance with the implemented policies prioritizing disinflation, before rising to 4 percent and 4.5 percent in 2025 and 2026, respectively, on the back of estimated gains in total factor productivity through structural reforms, increased private sector competitiveness, improved investor confidence, and measures to strengthen the ease of doing business. In line with the expected growth developments, labor market reforms such as skill development and promotion of flexibility will support the employment outlook.
On the fiscal front, the authorities project the central government’s overall deficit to improve to 4.9 percent of GDP in 2024, slightly lower than staff’s projection, mainly due to the higher cost-saving impact of the expenditure control in May and the reduction of energy subsidies in July and August. The authorities will continue to pursue a prudent fiscal policy over the MTP period. The effects of revenue-enhancing measures will be fully felt in 2025, and declining earthquake-related expenditures will turn the fiscal impulse negative. As a result, the fiscal deficit is projected to improve to 3.1 percent and 2.8 percent in 2025 and 2026, respectively.
As underlined by staff, the monetary policy stance has been contractionary since March 2024, and measures are in place to contain credit growth. The slowdown in domestic demand amid tight financial conditions contributes to mitigating inflation. The MTP year-end inflation projections are 41.5 percent in 2024, 17.5 percent in 2025, and 9.7 percent in 2026. Incomes policies have played an important role in reducing inflation in 2024, as the government has returned to annual wage adjustments for the minimum wage and refrained from excessive pension increases for retirees. The authorities are committed to maintaining this practice. On the other hand, while the authorities fully recognize the inflationary impact of the backward-looking indexation of wage adjustments, the social support will not be sufficient to shift to a forward-looking incomes policy, as backward-looking indexation has been the longstanding practice and helps ensure that workers maintain their purchasing power, especially during periods of high and volatile inflation, while reducing the risk of social unrest. Gradually reducing inflation expectations and aligning wages could be a more sustainable strategy in the long term.
On the external sector, prudent macroeconomic policies and measures, favorable energy prices, normalization in gold trade and robust tourism receipts contribute to a better-than-expected current account performance. The authorities project a significantly better CAD to GDP ratio than staff of around 1.7 percent at end-2024. Given the uncertain external environment and increased fragmentation, the authorities are committed to maintaining the current account deficit at sustainable levels to avoid vulnerabilities and to keep the external financing needs at reasonable levels. Capital inflows continued to increase, with the highest monthly inflow of USD 15.8 billion in July 2024, allowing the CBRT to build up international reserves to more comfortable levels. These inflows also helped to stabilize the exchange rate, which has historically fueled inflation. The CBRT has been successful in sterilizing these inflows. The capital inflows are expected to continue through 2024, further strengthening Türkiye’s reserves and stabilizing its financial position. Against this background, and contrary to staff's assessment of a weaker external position in 2023 than the level implied by mediumterm fundamentals and desirable policies, Türkiye’s external position improved significantly in 2024.
Monetary and Exchange Rate Policy
The CBRT is committed to maintaining the tight monetary stance until a significant and sustained decline in the underlying trend of monthly inflation is observed and inflation expectations converge to the projected forecast ranges. Domestic demand’s contribution has been declining and the rebalancing of demand is expected to strengthen further. The composition of growth has become more balanced in the second quarter. In this period, the contribution of final domestic demand to growth declined significantly on an annual basis, while net exports continued to make a positive contribution to growth. Leading indicators from both production and expenditure side for the third quarter suggest that the deceleration of growth is continuing. According to the CBRT, the output gap is expected to become negative in the third quarter and will remain in negative territory for the rest of the year. To manage inflation expectations, the CBRT has strengthened its communication on its restrictive monetary policy stance and will continue to take the necessary steps by carefully assessing the totality of the data, their implications for the outlook, and the balance of risks. Moreover, the CBRT demonstrates a strong commitment to price stability which anchors inflation expectations and restores confidence in the economy.
The CBRT does not have a nominal or real exchange rate target and does not engineer a certain degree of real exchange rate appreciation. The increased attractiveness of Turkish lira financial assets as a result of tight monetary policy leads to a real appreciation of the lira, which supports disinflation. Achieving price stability will address macroeconomic imbalances and facilitate sustainable, long-term reserve accumulation. In the face of the increasing capital inflows, the CBRT has significantly increased its reserve buffers. In line with this, the CBRT has eliminated swaps with domestic banks and is now reviewing deposit arrangements with international counterparties to reduce foreign exchange liabilities. The CBRT closely monitors and assesses liquidity conditions and effectively sterilizes temporary excess liquidity through reserve requirements, Turkish lira deposit purchase auctions, and overnight transactions in the Borsa Istanbul repo and the interbank money markets.
Macroprudential measures are being implemented to enhance the effectiveness of monetary transmission. Monthly growth limits for certain Turkish lira and FX loans have been introduced to tighten financial conditions. As a result of the limits and weaker loan demand, consumer and commercial loan growth has moderated since the second quarter. The gradual approach allows the CBRT to assess the economy’s reaction at each stage and adjust its strategy accordingly. Recent developments in loan growth confirm that financial conditions are tight enough to support the disinflation process. The targets for the renewal and conversion of FX-protected accounts have been changed and the minimum interest rate has been lowered, accelerating the decline in FX-protected account balances. The CBRT expects the share of Turkish lira deposits to increase further as a result of these measures.
Fiscal Policy
Fiscal discipline will remain the linchpin of the macroeconomic policy. Prudent fiscal policies have improved fiscal buffers over the years, and public debt levels are among the lowest among the G20, with the debt-to-GDP ratio remaining below 30 percent. While the average cost of domestic fixed-rate borrowing has increased, the authorities have shortened the maturity of new issues to limit their impact on the debt stock. In addition, the improvement in credit spreads on external borrowing contributed positively to the debt stock. Overall, the authorities are less concerned than staff about the exchange rate risk of the debt stock, as the central government debt stock denominated in foreign currency was 16.3 percent of GDP in 2023 and 13.4 percent of GDP as of the second quarter of 2024. On the other hand, the central government deficit has widened, mainly due to the earthquake relief spending in 2023, despite the introduction of several revenue-enhancing measures to limit their stimulative effect. While the central government deficit is expected to improve in 2024 compared to the previous year, it is still high by historical standards. However, the authorities see this as temporary and expect a gradual reduction of the budget deficit in their policy program period (2025-2027) from 3.1 percent to 2.5 percent.
The support of fiscal policy to monetary policy in disinflation will be more visible in 2025. The authorities are mindful of a gradual fiscal consolidation that would leave longer periods to achieve targets, which could raise concerns among investors and rating agencies. However, they observe opposite and positive developments from investors and credit rating agencies. All three major agencies—Fitch, S&P, and Moody's—upgraded Türkiye's ratings, making it the only country to receive upgrades from all three in 2024. These developments indicate that the authorities are on the right track. Efforts to increase the efficiency and fairness of the tax system, broaden the tax base, and reduce tax evasion and informality will continue with greater determination and effectiveness. Tax expenditures will be analyzed, and ineffective exceptions, exemptions, and discount will be eliminated. The authorities will continue to take measures to control current expenditures and rationalize capital expenditures, and to phase out energy subsidies. In addition to earthquake-related expenditures, disaster risk management measures and better targeted social spending programs aimed at improving social welfare, reducing inequality, and supporting vulnerable groups will be important priority areas. In addition, revenue and expenditure policies will be put in place to ensure the allocation of the necessary resources to support the green and digital transformation.
Fiscal structural reforms will accompany the fiscal consolidation process. The authorities plan to update public procurement legislation in line with international norms and standards with a procurement approach that supports and prioritizes digitalization, innovation, and sustainability. To strengthen the long-term financial sustainability of the social security system, the authorities will take measures to increase the premium base and collection.
The authorities closely monitor and assess the risks related to quasi-fiscal activities and contingent liabilities. Regarding public-private partnerships (PPPs), Türkiye has a healthy portfolio spanning in various sectors, including health and transport. The authorities consider the risks to be manageable. Looking at the cumulative investment figures or adding up the debt assumption commitments and guarantees overstates the risks. The authorities aim to balance the benefits of PPP investments with the need to protect its fiscal position. However, the authorities concur with staff on the need to strengthen the oversight and management of PPPs and improve regular reporting and are working on a new PPP law to strengthen the overall PPP framework. Regarding state-owned enterprises (SOEs), the authorities plan to further strengthen the accountability and transparency of the SOEs to mitigate fiscal risks.
Financial Stability
The financial system remains sound, well capitalized and liquid. The ratio of non-performing loans (NPL) is at historically low levels. While lending rates are rising, limited credit growth and high provisioning further mitigate the risk of NPL deterioration. In addition, the CBRT is closely monitoring the liquidity in the financial system. Contrary to staff’s view, the authorities see the risks from the recent increase in the FX share of lending as well contained, as this increase is mostly due to large corporations or companies with FX income streams. Furthermore, households cannot borrow in FX. The monthly limits have been introduced to overcome excessive FX loan growth risk of firms.
Significant progress has been made in improving the efficiency of the financial system and achieving simplification, as outlined by staff. The authorities have taken several steps to strengthen the regulatory and supervisory framework, including the new supervisory review and evaluation process. The Bill on Amendments to the Capital Markets Law, which integrates crypto assets into the supervisory framework and fills data gaps, has been enacted. Work on sub-regulations is ongoing. The authorities have successfully implemented the action plan agreed upon with the FATF, addressed identified AML/CFT weaknesses, and exited the FATF Grey List in June 2024. The authorities are committed to making further progress in financial liberalization over the MTP period. The macroprudential policy framework, including credit growth caps, FX-protected deposit schemes, export surrender mechanism, and restrictions on offshore derivative transactions, is seen as complementary to the monetary policy and has worked well. However, as disinflation continues, the need for these measures will diminish, and they will eventually be phased out in line with the CBRT’s objective of simplifying and strengthening the transmission mechanism. In addition, the authorities will intensify their efforts to bring the supervisory and regulatory framework in line with the Basel III framework. In this context, the regulations on the Large Exposures (LEX) and (Net Stable Funding Ratio) NSFR Standards were entered into force at the end of 2023.
To improve competition, efficiency, and financial inclusion in the financial sector, several ongoing initiatives are being prioritized. Efforts to deepen capital markets are underway to help real sector companies diversify their funding sources. This includes facilitating access to sustainable financing instruments. The legal framework for participation insurance (Islamic insurance or takaful) will be developed to expand access to Sharia-compliant financial products. Additionally, participation banking (Islamic banking) and pension plans will be broadened. This will offer more inclusive financial services to segments of the population seeking products aligned with Islamic principles. To improve the digital finance and fintech ecosystem, regulatory frameworks will be revised. This will enhance the environment for fintech innovations, encouraging competition and driving the development of more efficient financial products and services, especially in digital payment solutions. The CBRT is progressing to the second phase of its Digital Currency Pilot Project. This phase focuses on integrating the digital lira into payment infrastructures and ensuring its interoperability with other financial systems. As financial technology grows, cybersecurity measures are being enhanced to protect payment systems and electronic money institutions.
Structural Reforms
The authorities are committed to strengthening the reform process to promote inclusive and sustainable growth. To strengthen competitiveness, they aim to increase R&D investment to raise total factor productivity and promote innovation across sectors. Ongoing governance reforms, such as measures to improve anti-corruption and transparency frameworks, simplify procedures to open businesses, and streamline judicial processes, will help improve the business environment and attract more foreign direct investment.
These efforts will be complemented by labor market reforms with measures to increase the flexibility of the labor market in the context of sectoral transformations, changing demands on the workforce, and working styles, and new generation work models. The economic and physical accessibility of institutional and childcare facilities will be improved, as the Workforce Adjustment Program will be implemented to provide young people who are neither in education nor in employment with the knowledge, skills, work habits and discipline to enable their transition to the labor market. The authorities will also continue to focus on improving access to quality education and addressing skills mismatches to increase the resilience of the labor market. By focusing on these areas, the MTP aims to strengthen the inclusion and economic participation of women and youth, reduce informality, and ensure that diverse perspectives and talents contribute to the country's growth. Together, these initiatives create a more dynamic and resilient economy that is better equipped to face global challenges.
Türkiye is implementing a comprehensive climate change mitigation and adaptation agenda to achieve net-zero emissions by 2053. The National Energy Plan, which provides a clear and holistic framework, aims to significantly expand renewable energy sources, achieve energy sustainability, and enhance energy security by building resilience to volatile energy prices, and reducing energy costs. In this context, at COP28, the authorities announced an ambitious plan to add 60 GW of expand solar and wind power capacity by 2035, doubling its current capacity. This will also support the broader green transformation needed for sustainable economic growth. In addition, the authorities plan to complete legislative work to establish a national green taxonomy in line with the European Union’s taxonomy. In this vein, a carbon pricing mechanism will be established to maintain competitiveness, to minimize the impact of the carbon border adjustment mechanism, and thereby to support the transition to a low-carbon economy. Moreover, the authorities launched the Water Efficiency Campaign in January 2023 to raise public awareness on water security and sustainable resource management.