IMF Team Wraps Up Visit to Turkey

• The IMF staff team welcomes the authorities' policy shift since the election. The recent actions to raise the policy rate, increase taxes, and liberalize some financial sector measures have reduced risks and lifted investor confidence, compressing spreads and improving the reserve position of the Central Bank of the Republic of Türkiye (CBRT).
• As monetary policy tightens and the overall policy stance becomes less accommodative, growth is projected to slow from 4 percent in 2023 to 3¼ percent in 2024, and the current account deficit to narrow to about 3 percent of GDP in 2024. Sequential inflation should also fall in 2024 and is projected at 46 percent year-on-year by December. These projections reflect recent developments and policy actions, and discussions during the staff visit. Therefore, they supersede the (upcoming) October WEO projections for Türkiye which were finalized earlier.
• The authorities should build on the current momentum. This requires prioritizing disinflation by bringing the ex-ante real policy rate into contractionary territory, continuing to liberalize financial regulations to improve the functioning of money and credit markets, and containing the fiscal deficit.

Washington, DC:A staff team from the International Monetary Fund (IMF), led by Mr. James P. Walsh, visited Türkiye, during September 25-29, 2023, to discuss recent economic developments, the outlook, and policies. At the conclusion of the mission, Mr. Walsh issued the following statement:

"Despite the tragic earthquakes in February, growth has remained resilient and should reach 4.0 percent this year. With policies turning appropriately less accommodative, growth is projected at 3¼ percent in 2024 while inflation is forecast to fall to 46 percent at end-2024 from 69 percent at end-2023 as exchange rate pressures ease but backward-looking wage increases and expectations remain. As confidence builds, the demand for gold is expected to decline, thus reducing the external current account deficit (3.1 percent of GDP in 2024 versus 4.1 in 2023). This, together with better prospects for inflows including from official sources, should reduce pressure on reserves. Gross reserves reached $122.5 billion at end-September, but net of on- and off-balance sheet short-term liabilities remain negative.

"The balance of risks is to the downside. On the domestic front, the key risk is that the policy shift now underway loses its strong momentum, eroding confidence and leading to increased FX demand and reserve drain. Externally, the key downside risks are higher commodity prices, a slowdown in trading partners' demand, and global systemic financial instability. On the upside, unexpected sources of external financing could materialize, or, should investor confidence recover fully, a virtuous cycle of inflows and a stronger exchange rate could bring down inflation faster than expected, while boosting growth.

"The authorities should be commended for raising the policy rate from 8.5 to 30 percent, which together with other quantitative measures has significantly tightened financial conditions. This has in turn boosted confidence, reduced pressures on the lira, and begun to cool domestic demand and ease distortions created by negative real interest rates. Further policy rate increases are needed to durably reduce inflation, accompanied by lower reliance on quantitative measures to increase the role of price signals in money and credit markets, which would help anchor a market-priced yield curve. Allowing the markets to allocate capital based on a higher policy rate would ensure that funds go to the most productive use. This would also support the lira, facilitating disinflation via the exchange rate channel, traditionally the most potent in Türkiye. The effect of higher rates on banks so far appears manageable: banks, especially private ones, appear to have prepared for higher rates mainly by reducing the asset duration.

"The CBRT commitment to allow the lira to float is commendable and should be maintained, with FX intervention limited to situations of severe market dysfunction. While reserve accumulation is desirable, in the short run FX purchases will have to be opportunistic and undertaken consistent with disinflation goals.

"Liberalization of financial measures should continue to be carefully calibrated. Higher rates complement liberalization, reducing credit growth and encouraging better risk pricing. But given the complexity of financial regulations, the current measured pace of unwinding is broadly appropriate to reduce the likelihood of unintended consequences. Nevertheless, some measures, such as those that improve monetary transmission and allow more risk-based loan pricing-such as removing lending rate caps-would be immediately beneficial. The unwinding of other measures, like certain liraization and FX-protected deposit targets, would likely need to proceed more cautiously and wait until the real policy rate has moved past the neutral level.

"Fiscal policy has turned expansionary in 2023. Earthquake-related spending, large wage hikes, and various subsidies have raised spending, with the 2023 general government deficit projected at 5½ percent of GDP, despite the appropriate recent tax increases. To be consistent with disinflation goals, the 2024 budget deficit should be below the Medium-Term Plan forecast. This would entail eliminating above-inflation compensation increases, introducing forward-looking, rather than backward-looking, pension and wage settings, and replacing blanket energy subsidies with targeted assistance. Other options to tighten the underlying fiscal stance, while allowing for earthquake reconstruction and protecting the most vulnerable, should also be pursued."

"The IMF staff team would like to thank the Turkish authorities and other counterparts for the candid discussions and their warm hospitality."