Prof. Demiralp: What are the possible economic scenarios in Turkey after the rate hikes?

As economists, we often rely on analogies from everyday life to explain complex concepts. These comparisons frequently come from the world of health, and sometimes from natural disasters such as storms or earthquakes.

On the morning of April 23, I had planned to begin this article by writing, “The events following the arrest of Ekrem İmamoğlu on March 19 triggered an earthquake in the financial markets.” But at 12:50 PM that very day, Istanbul was struck by a real earthquake with a magnitude of 6.2, shaking us both physically and emotionally. With that stark reminder, I turn now to the main focus of this piece: the economic outlook and key developments in the aftermath of March 19.

The Central Bank responded to the political turmoil following İmamoğlu’s detention by holding an emergency meeting and raising the upper band of the interest rate corridor by 350 basis points. Then, on April 17, it increased the policy rate by 3 percentage points, effectively ending the easing cycle that had begun in December. This shift not only reflects a change in monetary policy direction but also signals that the political tensions surrounding İmamoğlu’s arrest—and the resulting economic consequences—may be more lasting than previously assumed.

Over the past month, the Central Bank is estimated to have released nearly 50 billion dollars from its net reserves, excluding swaps. These reserves had been built up gradually over two years and were nearing 65 billion dollars. Their rapid depletion dramatically illustrates the erosion of confidence and the rise in dollarization. This trend is further confirmed by the household inflation expectations survey we conducted under the umbrella of Koç University.

In that survey, which included around 1,600 participants, we asked respondents how they planned to allocate their savings over the next twelve months. Comparing the answers given in March and April, we observed a noticeable shift in preferences following the political crisis. Alongside gold—historically one of Turkey’s most trusted savings tools—we noted a significant increase in foreign currency preferences, rising by 13 percent in April. At the same time, Turkish lira deposit preferences rose by 8 percent, suggesting that the Central Bank’s interest rate hikes had a partial stabilizing effect by curbing the flight to foreign currencies. Overall, it seems households are once again driven by both interest income and the desire to protect themselves from growing risks.

The question now is whether a soft landing remains achievable. After three consecutive rate cuts starting in December, the policy rate had declined from 50 percent to 42.5 percent. By April, it had climbed back to 49 percent, bringing us close to where we started. But in truth, we are not in the same place. Since December, we’ve seen a significant loss of international reserves, worsening inflation expectations, capital outflows, and a steep decline in market confidence. The crucial issue is whether the Turkish economy is prepared to endure a second round of harsh economic medicine.

The decision to cut interest rates in December appeared less motivated by optimism about inflation and more by political and economic pressures. Inflation indicators did not support such a move. The Central Bank’s target of 24 percent inflation by the end of 2025, which was set before the events of March 19, already seemed overly hopeful and likely required revision. Similarly, the forecasted growth rate of 1.5 percent, implied by the output gap chart in the Central Bank’s inflation report, was ambitious and politically difficult to accept, given the implications of an economic slowdown.

What began as an effort to loosen fiscal policy in support of the real sector has since turned into a phase of austerity. The longevity of this shift, and whether the private sector can withstand it, will largely depend on the trajectory of political tensions.

Meanwhile, current indicators provide little reason for optimism. The rise in deposit rates has begun to compress profit margins within the banking sector. As explained in the context of our household survey, these rising rates have already influenced savings behavior. However, the impact on the lending side will likely unfold more gradually. It remains to be seen how the broader economy will react.

Some signs of stress are already apparent. In the first quarter of 2025, 583 companies applied for concordat, a form of debt restructuring. This figure represents nearly a third of the total 1,723 applications recorded throughout 2024. Although the ratio of non-performing loans in consumer credit remains low by global standards, it has been steadily climbing and now stands between 3.5 and 4 percent, according to the latest available data.

All of this is unfolding against a backdrop of global uncertainty. President Trump’s contradictory statements on trade tariffs have reignited fears of a global recession. If this scenario materializes, Turkey—like many other countries—will feel the negative effects. In the long run, the global trade landscape may be redrawn, and it remains unclear whether Turkey will be able to position itself advantageously in this reshaped order.

In the short term, however, falling energy prices and a weakening U.S. dollar offer some relief to Turkey’s external balances. These developments could provide temporary support, despite the slowdown in export markets caused by the global economic cooling.

So, how will the year 2025 unfold? At the start of the year, our baseline inflation forecast stood at 32 percent, with a worst-case scenario of 36 percent. As of today, the probability of the pessimistic scenario has increased considerably. On the growth side, we initially projected an expansion of around 3 percent. Now, growth of about 2 percent still seems attainable. While this may not qualify as a recession, it certainly does not reflect strong momentum either. The term “soft landing” may still apply—albeit with many risks still looming ahead.