Al-Monitor Pro

The Turkish turnaround: How the central bank's bold actions could reshape investment landscape


Al-Monitor Pro members


Piero Cingari

Financial analyst


Sept. 6, 2023

Bottom Line:

The Central Bank of Turkey raised interest rates to 25% to combat inflation, delivering the fastest rate-hike cycle over two decades. While recent economic indicators show a mixed picture, Turkish assets have displayed strong performance, signaling renewed investor confidence. Achieving currency stability is essential to attracting foreign capital inflows and advancing domestic de-dollarization efforts. 

Background Facts:
  • The Central Bank of the Republic of Turkey (CBRT) raised its one-week repo rate from 17.5% to 25.0% during the August MPC meeting, surpassing consensus estimates of 20% and marking a significant policy shift. 
  • The rapid and aggressive 1,650 basis point hike in four months, under new Governor Hafize Gaye Erkan's leadership, is unprecedented in two decades
  • The CBRT's statement underscored a commitment to strengthening monetary tightening until a substantial improvement in the inflation outlook is achieved, hinting at further rate hikes in the future. 
  • Government officials are now also demonstrating a strong commitment and synchronization with monetary authorities in their efforts to combat inflation. Turkish President Recep Tayyip Erdogan, during a nationally televised address unveiling Turkey’s new medium-term economic program, stated that they aim to bring down inflation to single digits through the backing of a robust monetary policy.  
  • According to the Medium-Term Program, the government revised its year-end 2023 inflation forecast to 65% from 25%, aligning it with the central bank’s latest estimate. The central bank anticipates a gradual decline in inflation, targeting 33% by the end of the next year and 15% by 2025. Government sees inflation falling to single digits by 2026.  
  • Economic growth has been lowered to 4.5% in 2023 from the previous 5% estimate, with expectations of a return to 5% in 2026. 
  • Recent economic data has painted a mixed picture, characterized by higher-than-expected inflation, robust economic growth, an improving current account balance and deteriorating consumer confidence. 
  • Turkey's economy expanded by 3.8% year-on-year in the second quarter of 2023, slightly below the previous period's 3.9%, but exceeding expectations of 3.5%. 
  • Turkey's annual inflation rate continued to rise for the second consecutive month, reaching 58.9% in August 2023, topping expectations of 55.9% and hitting the highest level since December 2022. The upward pressure came from food inflation reaching 8-month high at 72.9% and transportation costs, up 70.2%. On a monthly basis, consumer prices rose sharply by 9.1%, following a 9.5% increase in July. 
  • The current account balance swung into a surplus of $670 million in June 2023, a significant turnaround from the $2.58 billion deficit the previous year. Tourism played a crucial role, with arrivals reaching a record high of 7.15 million tourists in July 2023. Tourist arrivals for the first seven months of 2023 were 16% higher than in 2022. 
  • However, the consumer confidence index dropped sharply to 68 in August 2023, its lowest reading since the previous August, due to concerns about the general economic situation and household finances. 
  • Foreigners’ net inflows into Turkish stocks were $1.1 billion in June, the highest since November 2020. They also deposited $2.6 billion in Turkish banks, of which $750 million was in Turkish lira accounts.  
  • Turkey's financial assets have demonstrated robust performance recently. Since the new monetary course, the BIST 100 index has surged by 73% in four months, reaching new all-time highs on Aug. 31, 2023. 
  • Dollar-denominated government bonds also thrived. Using a 5-year maturity as a benchmark, the 6.125% bond maturing in October 2028 has seen its price rise to 93 cents on the dollar, up from 75 cents a year ago. 
Alternative Scenarios:

Scenario 1: Turkish Lira finds stability as high interest rates drive de-dollarization and attract foreign capital 

Governor Erkan's bold interest rate hikes mark a significant departure in the Central Bank of Turkey's strategy, demonstrating a resolute stance against inflation. 

Interest rates now at 25% aim to stabilize the currency. Initially, the Turkish Lira strengthened by 5%, but later retraced some gains. 

Short-term government bonds and bank deposits now offer returns exceeding 20%, a rarity among G20 economies. This could potentially lure hot money flows back into the local-currency government bond market if currency stability prevails, reversing the trend of mass exodus during recent years. 

Notably, 40% of bank deposits in Turkey remain in foreign currency. With the central bank's recent call on commercial banks to raise lira deposit rates, there's a chance for Turks to shift to competitive Turkish Lira accounts, possibly reversing dollarization. 

Rising foreign capital inflows into Turkish assets and bank deposits are expected to gain momentum, improving the financial account balance and potentially alleviating balance of payment pressures, especially if the current account weakens post-tourism season. 

The yield to maturity on dollar-denominated Turkish sovereign bonds, over 8%, can attract high-yield investors. Orthodox policies can drive this yield to the 7% average for emerging market dollar bonds.  

Scenario 2: Brief lira stability gives way to renewed depreciation amidst economic slowdown, foreign outflows 

In this alternative scenario, the lira may briefly stabilize but then face renewed depreciation due to ongoing economic challenges and persistent inflation. 

Factors such as Germany's stagnant economy (Turkey's key trade partner), declining domestic consumer confidence and a global manufacturing slowdown could lead to a more severe decline in Turkey's economy than expected. 

Turkish policymakers have often relied on the devaluation of the lira to shoulder a greater share of the required economic rebalancing. 

The end of the tourist season and expected debt maturities between October and December could strain the balance of payments, potentially reversing the positive trend in foreign exchange reserves. 

Turkish residents may need to keep a significant portion of their bank deposits in foreign currency, possibly sustaining or increasing the structural dollarization rate. Exchange rate pressures might deter foreign investors from Turkish assets. 

Conclusion - Most Likely Scenario:

Near-term currency pressure eases, Turkish assets positive performance to continue 

There's a noticeable shift in the monetary policy stance, driven by the urgency of addressing inflation exceeding 50%. Turkey cannot afford to repeat the same mistakes done in the past by switching to unorthodox policies.  

Gradually, markets may trust Governor Erkan's leadership, potentially halting lira depreciation. 

In the event of a sustained period of currency stability, a shift of resident deposits from US dollar to Turkish Lira-denominated accounts is likely. 

For non-resident investors unable to access local-currency bonds or equities, Turkish dollar assets continue to be highly attractive. The presence of dollar bonds yielding over 8% in a country with government debt at only 30% of GDP is a rarity, and the improving balance of payments dynamics should help alleviate foreign exchange (FX) concerns 

The iShares MSCI Turkey ETF (TUR), the only Turkey-related ETF available to US-based investors, offers more attractive valuations compared to broader emerging-market equities and especially when compared to US stocks. Specifically, the TUR ETF boasts a price-to-earnings ratio (P/E) of 8.5x, while a broader emerging-market equity ETF has a P/E of 12x, and the S&P 500 is at 20x.  

Barring major global risk events, the CBRT's new regime is poised to promote currency stability, attract capital inflows and potentially drive positive performance in Turkish assets.

Contributor Background:

Piero Cingari is a financial analyst and writer who has worked as a fixed-income, FX and commodities analyst in the asset management and brokerage industry. Throughout his career, he has covered and analyzed economic and financial developments in Turkey, Egypt, and the Gulf countries. Piero is particularly interested in how major macroeconomic trends influence financial markets and how global geopolitical events may affect the economy of the MENA region.

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