Turkey – an emerging economy in crisis

Figure 1: Turkey's central bank (CBRT) one-week repo rate, percent, 2023–2024

Extract A: Can Turkey's central bank tame inflation with historic rate hikes?

At an annual rate of nearly 75%, Turkey's consumer price inflation has reached levels that threaten the stability of the entire financial sector. However, recent monthly indicators suggest that the monetary tightening cycle may finally be anchoring inflation expectations. This aggressive policy stance represents a major shift for the Central Bank of the Republic of Turkey (CBRT), which has long battled a volatile national currency (the Turkish lira) that depreciated dramatically against major currencies throughout 2022 and 2023. The central bank has had to deploy extreme monetary tightening to combat this depreciation, even as a sharp domestic demand slowdown begins to take hold. Turkey's private sector is heavily leveraged, with a high proportion of corporate and commercial debt denominated in US dollars and euros. Stabilizing the lira is seen as crucial to prevent widespread corporate defaults and restore international investor confidence in Turkey's financial markets.

Monthly price increases are starting to decelerate, showing a cooling effect after several back-to-back interest rate hikes. The lira has found support, stabilizing after the central bank accelerated its rate hikes. However, the Turkish government and domestic business federations have raised concerns over the soaring cost of credit. They warn that these punitive interest rates could freeze the commercial credit market, suppress consumer spending on durable goods, and plunge the economy into a deep recession. Analysts from credit rating agencies suggest that while the rates are necessary to restore the central bank's inflation-fighting credibility, they pose a severe threat to bank asset quality as non-performing loans (NPLs) are projected to rise.

In the long run, Turkey's economic potential remains constrained by structural issues despite its favorable geographic position and strong manufacturing base. Between 2024 and 2050, Turkey's average GDP growth is projected to be around 2.5%, lagging behind other emerging peers like India (5.2%) and Vietnam (4.5%). While Turkey's export-oriented manufacturing and tourism sectors are highly resilient, the high interest rate environment makes domestic industrial modernization extremely costly. This low productivity growth continues to limit potential output per capita.