Türkiye: Opposition Victory Makes Continuation Of Policy Normalisation More Likely

Thomas Gillet
Published: Apr 5, 2024, 10:49 GMT+00:00

The setback for Türkiye’s ruling AKP in local elections could support a continued restrictive monetary policy as persistent high inflation, an important economic weakness, was a key driver of the electoral outcome.

Turkey flag and a city, FX Empire

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The success of opposition parties in Türkiye’s local elections on 31 March, in which they kept control of Istanbul and Ankara, is partly attributed to voters’ frustrations with the economy, not least persistently high inflation running at 68.5% year-on-year in March that reduced real income and purchasing power, including for pensioners who support the AKP.

The result supports our view that the Central Bank of the Republic of Türkiye (CBRT) will continue targeting inflation in line with its monetary-policy pivot last year, a positive for economic stability. The bank’s objective is to bring year-end inflation down to 9% year-over-year by 2026 driven through significant interest-rate hikes.

This sustained shift towards a more consistent and independent monetary policy supported our rating agency’s revision of Türkiye’s Outlook to Stable from Negative on 12 January.

The CBRT’s pre-election action further confirmed our view. In addition to regulatory measures, the bank has raised its rate to 50% from 8.5% for one-week repos since May 2023, including a 500bp hike on 22 March. These decisive steps further improve the central bank’s credibility, which was significantly impaired by the unorthodox policies pursued in past years. (Figure 1).

Figure 1. Türkiye sticks to inflation-driven vs election-driven monetary policy (%)

Source: Macrobond, CBRT, Scope Ratings

Smooth Electoral Process, Monetary Tightening Support Investment In Lira Denominated Assets

The fact that President Recep Tayyip Erdoğan accepted the electoral outcome supports the country’s institutional strength, as it demonstrates the official recognition of opposition parties by Türkiye’s political leadership and institutions. It also makes constitutional amendments to overturn a two-term limit on the presidency less likely. This demonstration of a functioning democratic process could reassure investors and lead to higher investment in lira-denominated assets, which are now more attractive for foreign investors given high rates.

Under the baseline of continued restrictive monetary policy, we project inflation will rise to 60% on average this year, compared with 53% in 2023. This balances heavy pressure on prices over the first half and a downward trajectory by the second half of this year due to the lag effects of monetary policy and more-favourable base effects for inflation. In 2025, average inflation is expected to recede to 25%, significantly higher than the CBRT target of 5%.

Exchange-rate Volatility, Wage Growth May Cloud The Inflation Outlook

However, continued downward pressure on the lira could delay the disinflation process, as could sudden changes to the leadership of the CBRT and a premature end of the tightening cycle.

Although the CBRT operated a controlled devaluation of the lira ahead of local elections – the currency has depreciated by 8% against the dollar and 6% against the euro year-to-date – further devaluation is likely over the coming months given shrinking net foreign assets of USD 6.9bn at end-March, down from USD 27.2bn at the end of 2023.

This would be a repeat of what happened in June 2023 when the currency fell 20% against the dollar (23% against the euro), and 36% in 2023 (39%), increasing the price of energy – which accounts for around 20% of imports.

Still, a weak currency is not the only source of inflationary pressure. The disinflation process could be delayed by a further rise in the minimum wage after the almost 50% increase in January this year. Fiscal policy is also tighter but generally still accommodative following the February 2023 earthquake. The headline fiscal deficit is running at TRY 425bn year-to-date, an 86% rise from the same period in 2023.

Restrictive Policy Stance Will Hurt Domestic Economic Activity

Rebalancing the economy remains a significant challenge as tighter fiscal and monetary policy worsens the economic growth outlook. Real GDP growth is projected at 3.3% in 2024, after 4.5% in 2023 and 3.5% in 2025. This performance would be robust albeit much weaker than the 5.2% recorded on average over the past 10-years.

For a look at all of today’s economic events, check out our economic calendar.

Thomas Gillet is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Tom Giudice, intern trainee at Scope Ratings, contributed to drafting this economic update.

About the Author

Thomas Gilletcontributor

Thomas Gillet is Associate Director in Scope’s Sovereign and Public Sector ratings group, responsible for ratings and research on a number of sovereign borrowers. Before joining Scope, Thomas worked for Global Sovereign Advisory, a financial advisory firm based in Paris dedicated to sovereign and quasi-sovereign entities.

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