Sovereign Analysis /

Turkey: Full steam ahead into troubled waters

  • Unless the authorities allow for rate hikes, inflation will remain elevated and the lira will remain vulnerable

  • This is despite the short-term boost from the government’s 'lira-isation' efforts. But a policy reversal seems unlikely

  • The risk of debt distress is low, but budget deficit forecasts show this remaining pillar of strength will likely erode

Turkey: Full steam ahead into troubled waters
Tellimer Research
12 May 2022
Published byTellimer Research

Based on our discussions over the course of the IMF/WB Spring Meetings, as well as the Fund's recent World Economic Outlook, we present our key takeaways on Turkey. For more details, read our in-depth "IMF/WB Spring Meetings, April 2022 – country notes and global themes" report.

Turkey’s problems center on its unorthodox monetary policy stance, with the authorities continuing to resist rate hikes, despite real rates dipping to -47%. This is reflected in a sharp upward revision to the IMF’s inflation forecasts, which are projected to remain firmly in double digits. While the 'lira-isation' strategy has succeeded in stemming dollarisation and stabilising the lira in the near term, the currency and inflation will remain under pressure, absent rate hikes.

Unfortunately, we did not sense much optimism in our discussions that the central bank or President Erdogan would reverse course. Further, upwardly revised budget deficit and debt forecasts suggest that Turkey’s remaining pillar of strength –relatively conservative budgets and low debt levels – can no longer be taken for granted. And, like many other countries post-Covid, a strengthening of sovereign-bank linkages could leave Turkey vulnerable to financial stability risks if FX deposits start to leave the system again.

Overall, the tone on Turkey was little changed from last October. While the lira-isation strategy has provided a short-term boost to the lira and stemmed the risk of flight of further dollarisation or capital flight from the banking system, Erdogan and the central bank have seemingly become even more entrenched in their flawed obsessions with low interest rates, and the sharp rise in inflation, inflation expectations and wages make the need for rate hikes even more urgent.

We retain our Sell recommendation on the lira and local currency debt, and Hold recommendation on hard currency debt.

Turkey WEO