Turkey’s Disinflation Drive Faces Crucial Test as Structural Reforms Lag

Annual inflation has fallen to 35.10% in August 2025 from 71.60% in June 2024 — the longest sustained decline in four years. But questions remain over whether the Central Bank’s policy mix and the government’s fiscal strategy can deliver lasting price stability without derailing growth.

Central Bank Walks a Tightrope

The Central Bank of the Republic of Turkey (CBRT) has been at the core of disinflation efforts. After lifting the one-week repo rate to 50% in March 2025, it began cutting rates in July, lowering the benchmark by 300 basis points to 46%.

This policy shift reflects a balancing act: maintaining tight conditions to anchor inflation expectations while easing to stimulate growth. The CBRT projects inflation will drop to 24% by the end of 2025 and to 12% in 2026.

Yet, credibility remains fragile. Markets welcomed the CBRT’s more data-driven approach, but past episodes of political interference under President Recep Tayyip Erdoğan have left investors wary. The real test will come if inflationary pressures resurface via a weaker lira or geopolitical shocks.

Fiscal Policy: Progress but Patchy

An official budget deficit target of 3.1% for 2025 and USD 8.8 billion in Q2 external borrowing have supported macro stability. However, July’s weaker-than-expected tax revenues cast doubt on whether fiscal goals will be met.

The government has restructured consumer loan and credit card debt to ease household pressure, but deeper reforms — from labor market modernization to public sector efficiency — remain on hold. Without them, fiscal credibility risks slipping, undermining investor confidence.

Structural Reforms Still Missing

Much of the recent disinflation owes to external factors — cheaper global oil, moderating food and energy prices, and a weaker lira’s limited pass-through to producer costs.

But vulnerabilities persist. The agricultural sector, hit by a 6% drop in Q2 commodity prices, needs investment in climate resilience. Manufacturing, with a PMI in contraction and capacity utilization at 74.1% in July, requires regulatory clarity and targeted tax incentives to revive confidence.

Risks and Market Watchpoints

While the lira’s depreciation has been managed, it remains a trigger for potential inflation spikes. Domestic politics also carry risk: the March 2025 arrest of Istanbul’s mayor rattled investors and accelerated capital outflows.

For long-term investors, Turkey’s rebalancing offers potential upside. The CBRT’s projected policy rate of 36% by year-end could attract foreign inflows if inflation expectations converge toward the 5% target. Technology, renewable energy, and logistics — sectors where Turkey enjoys geographic and demographic advantages — may outperform.

The Road Ahead

Turkey’s disinflation journey is far from over. The CBRT’s upcoming Inflation Report on August 14 and official August CPI data on August 20 will be closely watched.

A credible mix of consistent monetary policy, disciplined fiscal management, and tangible structural reforms could transform Turkey into an emerging market bright spot. Without them, progress risks stalling — and the hard-won disinflation gains could prove temporary.

Source: AInvest

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