Inflation in Turkey - at 55% and increasing

Turkey's central bank expects the country's annual inflation rate to approach 62% at the end of 2023, the upper end of the range it forecast in its latest report, Reuters reports.

In July, the inflation rate in Turkey stood at 47.83%, and in August it would have exceeded 55%, according to estimates. The peak was reached in October 2022: 85%. Independent economists say, however, that real inflation is currently much higher, at nearly 123%.

Last week, at the third monetary policy meeting chaired by new governor Hafize Gaye Erkan, the Bank of Turkey decided to raise the benchmark interest rate from 17.5% to 25%, a sign that the institution's officials are adopting more aggressive measures to reduce inflation. Analysts were expecting an increase of up to 20% in the key interest rate.

Many investors believe that the Bank of Turkey needs to further tighten its monetary policy.

In the minutes of the most recent meeting of the Monetary Policy Committee, central bank officials said that annual inflation will rise significantly in August and monetary policy tightening will continue, as necessary, in a gradual manner. According to the central bank, disinflation will only appear in 2024, in Turkey.

"In recent months, the pace of monetary policy tightening in Turkey has disappointed the markets' expectations," according to an August analysis by ING Bank NV.

• Growth beyond expectations of the Turkish economy in the second quarter

Turkey's economy recorded, in the second quarter of 2023, an annual growth above expectations of 3.8% (after an advance of 3.9% in the first three months), thanks to solid household spending, according to official data announced by TurkStat in August 31. Analysts were anticipating an advance of 3.5%, at an annual rate.

Compared to the first quarter of 2023, Turkey's GDP grew by 3.5% in April-June 2023, also above estimates. Analysts expect, however, a slowdown in the rate of expansion towards the end of the year, to 2.9%, against the background of the reduction of the effects of the stimulus measures and the increase in interest rates.

According to Goldman Sachs, the increase in the second quarter was due to pre-election fiscal incentives and recovery from this year's earthquakes. According to the investment bank, population consumption remained solid, but the growth of industrial production and exports weakened during the respective period.

Imports of goods and services increased by 20.3% in the mentioned three months, compared to last year, while exports of goods and services decreased by 9%.

Commenting on the economic growth above expectations recorded in the second quarter of 2023, the Minister of Treasury and Finance from Ankara, Mehmet Şimşek, said as quoted by Daily Sabah: "Our economy continued its strong growth performance in the second quarter of the year, when we tried to offset the economic effects of the earthquake. Our target is strong growth, along with balance, sustainability and inclusion".

The Turkish official mentioned that the Government aims to strengthen the economy against external shocks, giving priority to the transfer of resources to investments, employment, production and exports, rather than to consumption. "We started to see the positive effects of the policies we implemented. We will continue to take the necessary measures to ensure the stability and permanence of these effects", concluded the Minister of Finance.

Limiting price increases was the main priority for the government, in line with the change in economic policies after the parliamentary and presidential elections in May.

• Moody's may improve Turkey's sovereign rating

Financial rating agency Moody's Investors Service announced in the first half of August that Turkey's sovereign rating could be improved if the country continues and intensifies the conventional policies introduced after the re-election of Recep Tayyip Erdogan as president in May this year, according to Bloomberg.

"The transition to more orthodox policies, based on predictable rules, is a positive one in terms of the rating and is coming faster than we expected. The new economic team is committed to reducing inflation, reducing external imbalances and ensuring fiscal discipline," Moody's informed in a report, notes Agerpres.

Even in the event of an improvement in the rating, Turkey will remain a "junk" country (not recommended for investment). Moody's currently assigns Turkey a "B3" rating, six notches below investment grade and in line with the ratings assigned to Angola and Nicaragua. The outlook associated with Turkey's country rating is stable.

Since winning the presidential elections, Erdogan has appointed two former Wall Street bankers, Mehmet Şimşek and Hafize Gaye Erkan, to the positions of finance minister and central bank governor, respectively. The two are trying to boost Turkey's credibility among bond and stock traders by ending an ultra-loose monetary policy and constant state interventions in financial markets.

"We are determined to implement rules-based policies, in line with international norms, to ensure macro-financial stability and increase the country's resilience to shocks," Mehmet Şimşek posted on social media platform X, formerly Twitter.

However, Moody's warned that political reasons could make it difficult to introduce market-friendly policies. Erdogan has long supported the need for low borrowing costs and a strategy to promote economic growth at any cost. Moody's claims that with the approach of local elections next spring, political calculations could change the authorities' appetite for market-friendly measures. "The risk of a new policy change remains a significant one", especially if "economic growth will slow down more than would be acceptable from a political point of view", concluded Moody's.