World Bank:  Turkish financial stability threatened by interest rate cuts

Turkey is faced with possible financial instability after the central bank cut interest rates to 18 percent from 19 percent last month despite surging inflation, the World Bank said in a quarterly report on Wednesday.


“The continuation of loose monetary policy could further weaken investor confidence, heighten market volatility, and threaten macro-financial stability in the upcoming period,” the World Bank said.


Central Bank governor Prof Kavcioglu meeting with analysts and investors on Thursday, hinted at further rate cuts. He is believed to be “inspired” by President Erdogan who needs higher growth rates to recover his fading popularity in election polls.



Turkey’s economy will probably expand by 8.5 percent this year, driven by a recovery in exports and consumer demand, the bank said. But it predicted that inflation would slow marginally to 17.7 percent in 2021, and then to 15 percent and 13 percent in 2022 and 2023, respectively, well above government and central bank targets.


The below is  reprint of the section of the World Bank report on Turkey:



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The government’s economic policy response to COVID-19 was swift but focused on loose monetary policy and rapid credit expansion. Turkey’s economy was one of the few in the G20 and OECD to experience positive growth in 2020. A favorable base effect, an easing of restrictions permitted by accelerated vaccinations, and supportive external demand led to double digit GDP growth in 2021H1, returning the economy and employment to pre-crisis levels. But inflation has risen to nearly 20 percent, while external financing needs have remained elevated and met largely through short term portfolio flows. Going forward, efforts to rebuild policy credibility and macro stability coupled with reforms focused on labor, product, and financial markets and on strengthening the way institutions work are needed to attract foreign investment and revive productivity growth. Moreover, the high energy and carbon intensity of the economy makes it vulnerable to global and regional decarbonization policies.


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Turkey’s economy grew by 21.7 percent in 2021Q2 – the second highest among G20 countries. Good progress in expanding vaccination coverage allowed pandemic-related restrictions to be relaxed in May, supporting a recovery in domestic demand. Private investment and consumption of durables, and increasingly services, have been major contributors to growth, despite the persistently high cost of borrowing and easing of fiscal support. Exports were buoyed by a strong recovery in external demand, currency depreciation, and an opportunity for Turkey to gain market share in the EU as Asian exporters grappled with rising logistic costs and global supply chain constraints.


Yet, inflation continued to rise with the weakening of the lira, rising international commodity prices and demand-side pressures. In August, consumer price inflation reached 19.3 percent and food prices soared by 29 percent whilst producer price inflation rose by 45.5 percent. Despite this, the central bank reduced the policy rate to 18 percent, resulting in negative real interest rates, and raising policy uncertainty among investors already conscious of frequent changes of central bank governor. Following a credit push in 2020 through public banks, credit growth declined from 30.9 percent at the end of 2020 to 9.3 percent in August in annualized FX-adjusted terms. As forbearance measures are still in place, NPLs are still low at 3.7 percent.


Despite a rising interest burden and elevated COVID-related expenditures, the central government fiscal deficit declined to 1.6 percent of GDP in H1 2021, thanks to strong tax revenue growth driven by buoyant domestic demand. On the other hand, general government debt stock rose from 32.7 percent in 2019 to 39.8 percent in 2020. The 12-month rolling current account deficit narrowed to 3.9 percent of GDP as exports recovered sharply and gold imports declined. This, combined with new swap deals and the global IMF SDR expansion, supported an increase in gross FX reserves to $122 billion in September. However, reserves, net of short-term drains, remain negative at -$21.1 billion.


While the growth momentum is expected to wane in 2021H2, the economy is still expected to grow by 8.5 percent in 2021 before returning to a path of 3 percent and 4 percent in 2022 and 2023. These baseline projections assume no further COVID-19 restrictions in Turkey or its major export markets or excessive flareups in macro-financial conditions.


Inflation is forecast to stay high but gradually decline from 17.7 percent in 2021 to 15 percent and 13 percent in 2022 and 2023. As tourism and exports recover, the current account deficit is expected to narrow to 3 percent of GDP in 2021. The general government deficit is projected to decline to 3.4 percent in 2023 as temporary tax reductions and COVID-19 related transfers are reined in.


External risks are balanced, with the upside of a quicker-than-expected recovery in global demand being netted out by potential global financial market disruptions caused by future tightening expectations and supply chain constraints. The continuation of loose monetary policy could further weaken investor confidence, heighten market volatility, and threaten macro-financial stability in the upcoming period. The banking sector remains highly capitalized and with adequate foreign exchange buffers. However, expected removal of forbearance measures are likely to put pressure on banks’ balance sheets.


Simulation analysis of the pandemic impacts suggests that Turkey had 1.6 million more poor people in 2020 than 2019, reaching the highest poverty rate since 2012. Swift early government action, including household support measures prevented worse outcomes. However, some job and income protection measures expired as of July 2021 and rising COVID-19 cases may require additional support to protect vulnerable households. The strong rebound in economic growth, the labor market and household incomes are expected to reduce the poverty rate from 12.2 percent in 2020 to 11.6 percent in 2021. Further poverty reduction hinges on ensuring an inclusive recovery with adequate support for vulnerable groups.


Turkish government and Central Bank resolutely stick to “inflation is transitory” rhetoric, which is possibly an excuse to open the way for more rate cuts. Global investment banks have peened in a wide range of rate cut forecasts for the rest of 2021.  These range from 50 basis points to 300.


Resident market participants predict another 100 basis point cut in 21 October MPC meeting, with strong upside for dollar/TL.  The government is betting on a weaker currency to stimulate exports, and claims dollarization has reached its natural end.


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Published By: Atilla Yeşilada

GlobalSource Partners’ Turkey Country Analyst Atilla Yesilada is the country’s leading political analyst and commentator. He is known throughout the finance and political science world for his thorough and outspoken coverage of Turkey’s political and financial developments. In addition to his extensive writing schedule, he is often called upon to provide his political expertise on major radio and television channels. Based in Istanbul, Atilla is co-founder of the information platform Istanbul Analytics and is one of GlobalSource’s local partners in Turkey. In addition to his consulting work and speaking engagements throughout the US, Europe and the Middle East, he writes regular columns for Turkey’s leading financial websites VATAN and and has contributed to the financial daily Referans and the liberal daily Radikal.