Press Release No. 24/311

Turkiye: 2024 Article IV Mission Press Release

August 28, 2024

Washington, DC: An International Monetary Fund (IMF) mission, led by Mr. James P. Walsh, visited Türkiye during May 29 – June 11, 2024, to conduct the 2024 Article IV consultations. After virtual follow-up discussions during August 19 – 20, 2024, Mr. Walsh issued the following statement:

“A turnaround in economic policies since mid-2023 tightened Türkiye’s overall policy mix, sharply reducing crisis risks and raising confidence. The current account deficit fell to 2.7 percent of GDP in 2024:Q1, market sentiment improved, international reserves (net of swaps and other liabilities) increased by US$91 billion since April, international credit agencies upgraded Türkiye’s sovereign risk rating, and CDS spreads have declined nearly 440 bp since mid-2023. Headline inflation has started easing in the summer, but it remains high. The financial and corporate sectors have so far weathered liberalization and policy tightening without visible stress.”

“Under the authorities’ announced policies, IMF staff expect both GDP growth and inflation to decline this and next year. Tight monetary and incomes policies will weigh on domestic demand, bringing 2024 growth to around 3.4 percent. Despite favorable base effects, still-strong inertia would keep inflation at around 43 percent (y/y) at end-December. On the external front, the current account deficit would continue to fall to around 2.2 percent of GDP. In 2025, with fiscal policy expected to turn contractionary and real policy rates remaining positive, growth would further moderate to 2.7 percent, and inflation fall to around 24 percent. In the medium term, a further drop in inflation would boost confidence, and growth would rise back toward potential of 3.5-4 percent. Export growth would keep the current account deficit around 2 percent, and international reserves would stay above 100 percent of the IMF’s reserve adequacy metric.”

“While the authorities’ gradual approach to fighting inflation aims to limit the impact on growth, it bears downside risks. It prolongs the period during which risks and shocks that could derail disinflation might occur, such as higher global energy prices, geopolitical tensions arising from the conflict in the middle east or the war in Ukraine, or a reversal of capital flows. A faster re-anchoring of inflation expectations would reduce these risks. In addition, slower growth may increase credit risks, while FX borrowing and carry trade flows create FX liquidity risks. On the upside, rapidly falling headline inflation in 2024:Q3 could feed into backward-looking inflation expectations, easing price pressures.”

 “A tighter policy mix, focused on fiscal policy, would reduce risks and bring inflation down more quickly and sustainably. Fiscal, monetary, and incomes policies will all need to work together. While there would be a short-term cost to growth from tighter policies, a rapid disinflation is more likely to be sustainable, and would strengthen medium-term growth and financial stability.”

“A larger and more front-loaded fiscal consolidation is needed to help reduce inflation. Rationalizing tax expenditures and broadening the tax base can be done relatively quickly. Limiting spending on non-essential capital projects (while protecting earthquake-related spending) and reforming energy subsidies, while protecting vulnerable households would also help. Unifying VAT, reducing informality and boosting compliance would support disinflation and improve fairness in taxation. Taken together, and front loaded to the extent possible, measures amounting to around 2.5 percent of GDP would better calibrate the fiscal impulse over 2024-2025 to support the disinflation effort. Türkiye’s public debt is sustainable. The authorities’ medium-term deficit target of 3 percent provides appropriate fiscal space to address contingent risks from public-private partnerships and state-owned enterprises.”

“Tight financial conditions will be needed until sequential inflation is firmly on a downward path and inflation expectations converge to the CBRT forecast range. The tight monetary policy stance will need to be kept until headline inflation and inflation expectations fall to the CBRT’s forecast range. Financial conditions will tighten as inflation expectations continue to fall, but should sequential inflation not continue to fall toward a path consistent with the end-2025 target range, additional tightening might be called for. To improve the policy transmission, capital inflows should continue to be fully sterilized to the extent possible. As the policy rate becomes the binding factor on credit growth, quantitative credit caps should be phased out, which would strengthen communication and increase monetary policy effectiveness. Until sequential inflation is on a sustainable downward trend, the CBRT should continue smoothing temporary exchange rate volatility while avoiding undue real appreciation, and replenish reserves buffers opportunistically. As inflation falls and reserve buffers improve, intervention can be scaled back, and allow the exchange rate to act as a shock absorber. Intervening against persistent shocks should be avoided.”

“Still-high inflation inertia needs to be tackled. Setting prices, wages, and other contracts (such as rents) annually and according to forward-looking inflation is key to resetting expectations and protecting competitiveness. Once relative prices have adjusted, any backward-looking indexation should be eliminated, and public sector administered prices aligned with production and maintenance costs.”

“Maintaining financial stability will require continued vigilance and further reform. Macroprudential policies should focus on containing systemic risks. In this regard, lira reserve requirements should be simplified, money market functioning improved, and CBRT term deposits expanded. Consistent with the 2023 FSAP, the supervisory framework should be brought in line with the Basel Framework, notably for, FX, sovereign, credit, and interest risk; and the CBRT’s emergency liquidity assistance policies strengthened. Türkiye’s removal from the Financial Action Task Force (FATF) “Gray list” in June is welcome. “

“Strengthening policy frameworks, addressing barriers to SMEs, improving labor market functioning, and speeding the green transition would boost medium-term growth and make it greener and more evenly distributed. Priorities include reforms to reduce informality, increase labor market flexibility, and boost female labor force participation. Continuing to simplify regulatory burdens on SMEs, such as establishing a one-stop shop for business approvals and permits, will support innovation and growth. Reducing SME compliance costs and their tax burden would improve efficiency. National climate targets have been set.  Establishing a domestic Emission Trading System aligned with the European Union (EU) will contribute to achieve climate targets and help preserve the competitiveness vis-à-vis the EU.

The IMF team is grateful to the authorities and private sector counterparts for their kind hospitality and constructive and fruitful discussions.