Financial Stability Now Outweighs Inflation as Primary Concern, Says Prof. Burak Arzova

Turkey’s nearly two-year effort to bring inflation under control appears to have entered a new phase, with concerns over financial stability now overtaking inflation targeting as the country’s most pressing issue. According to Professor Burak Arzova, the economic program pursued so far has been reliant almost exclusively on monetary policy, with limited support from fiscal tools or structural reforms aimed at addressing the informal economy.

Post-March Market Volatility Raises Alarm

Following a wave of volatility that began after March 19, 2025, pressure on Turkey’s financial system has intensified. In Arzova’s assessment, maintaining financial stability has now become more urgent than fighting inflation.

On April 17, 2025, Turkey’s Central Bank (CBRT) raised its policy interest rate from 42.5% to 46%. It also lifted the overnight lending rate to 49% and the overnight borrowing rate to 44.5%. Since then, the weighted average funding cost has climbed to 48.82%, exceeding the policy rate.

On May 3, the CBRT introduced macroprudential measures aimed at stabilizing the Turkish lira and rebuilding depleted reserves. The measures included discouraging liquidity in the market to prevent further dollarization and raising the minimum repatriation requirement for export revenues by 10 percentage points.

Corporate Sector Struggles with Liquidity Access

Despite the rise in commercial loan costs—estimated at around 10 percentage points since March—Arzova noted that companies are more concerned about liquidity access than borrowing costs. He warned that the cash flow constraints are so severe that businesses are nearing operational paralysis. In multiple meetings with company representatives, he has consistently heard complaints about the inability to secure working capital.

Meanwhile, political instability has fueled capital flight back into foreign currencies. The growing shift from lira to dollars, coupled with the liquidity crunch, has brought the country’s financial stability to a tipping point.

Political Dimensions Undermine Economic Management

As Arzova emphasized, once the problem becomes political, it moves beyond the Central Bank’s control. Despite official reassurances that “the program is on track,” the economist believes the plan is faltering significantly.

He added that the CBRT’s continued funding near the upper end of the interest rate corridor suggests the April 17 rate hike was insufficient. A second rate increase appears increasingly likely if dollarization and reserve depletion continue. However, he also pointed out that market participants are paradoxically expecting rate cuts by June or July—expectations that will be difficult to reverse.

Inflation Data Draws Skepticism

The latest inflation figures released by TurkStat on May 5 confirmed a 3% rise in consumer prices for April—below even the most optimistic forecasts. Year-on-year inflation dropped slightly from 38.1% in March to 37.86% in April.

However, Arzova noted that core inflation indicators tell a different story, with both goods and services prices continuing to climb. Even with TurkStat’s reported figure held at 3%, the underlying data signals growing price pressures.

At the April monetary policy meeting, the Central Bank’s 46% policy rate stood 8.14 percentage points above the annual inflation rate. But considering the actual funding rate of 48.82%, the real interest margin versus inflation rises to nearly 11 points.

Arzova emphasized that rising core inflation reflects deteriorating inflation expectations more clearly than headline numbers.

Inflation Forecasts Face Reality Check

According to the CBRT’s projections, the median inflation expectation for 2025 is 24%. With inflation at 13.36% for the first four months of the year, the target would require an average monthly rate of just 1.33% for the remaining eight months. “That may seem improbable—but with TurkStat involved, never say never,” Arzova quipped.

Central Bank Issues Subtle Warning

In its Monthly Price Developments Report published on May 6, the Central Bank acknowledged that core inflation had strengthened in April. The report stated that “seasonally adjusted monthly changes in consumer prices remained flat compared to March, while price increases in the B and C indices gained strength.” Notably, the report highlighted rising prices in core goods and processed food.

The Central Bank concluded that monthly inflation trends are on the rise, even if three-month averages appear more stable. Arzova interpreted this as a subtle warning from the monetary authority.

Political Leadership Must Step In

According to Arzova, both inflation control and financial stability now require political leadership. Without steps toward normalization, the risk of a full-scale economic reset grows with each passing day.

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