Turkey: the medicine is working

Earlier this week, Turkey released its medium-term economic programme covering the period to 2029. The government cut its growth forecast for this year to 3.3 percent from 3.8 percent – still positive – but said it expects inflation of more than 28 percent by the end of December. The previous target was 16 percent, so that is quite an overshoot.

Even the revised estimate looks ambitious. Inflation was still over 31 percent in August, down only slightly from a hefty near-32 percent in July. Vice President Cevdet Yılmaz attributed some of this to the US-Israel-Iran war.

The Gulf economies have significant exposure to Turkey. Qatar owns a subsidiary in QNB Bank Turkey and has a stake in the Istanbul stock exchange operator. Kuwait Finance House, an Islamic bank, owns and operates Kuveyt Türk, a financial services provider.

From the UAE, Emaar has a large development in Istanbul’s Ünalan district, DP World runs two container terminals on the Gulf of Izmit and Emirates NBD owns nearly all of DenizBank, a mid-sized lender. The Dubai-based bank has also been linked with HSBC’s operations in Turkey.

Turkey faces multiple constraints: it depends on imports of oil and gas; the Ukraine war has disrupted Black Sea trade and pushed up grain prices; and now the Strait of Hormuz is squeezed. Defence spending is high.

But the banks are, for the most part, well-capitalised (despite allegations of missteps by some) and an entrepreneurial spirit has endured even with interest rates at 37 percent.

Those rates have attracted short-term overseas inflows – the carry trade – estimated at $50 billion. They have also restrained exports and made Turkey a more expensive destination for tourists. Some textile manufacturers are moving to Egypt.

Moreover, Fitch said last year that GCC banks with Turkish subsidiaries reported more than $7 billion of net monetary losses since 2022. That is a very large sum. The banks were forced to adopt an international accounting standard for hyperinflationary conditions, which mandates substantial write-downs.

Further reading:

• Turkey downgrades economic forecasts for next 3 years
• Stubborn Turkey inflation leaves little room for interest rate cut
• Emirates NBD gains on reports of HSBC Turkey purchase

It is more than three years since Mehmet Şimşek was appointed minister of treasury and finance for a second time. Şimşek, a former emerging markets strategist with Merrill Lynch, is at the heart of efforts to bring down inflation and bolster confidence in the lira, which has effectively appreciated despite a marginal weakening against the dollar.

The exemplar is the tenure of Paul Volcker at the US Federal Reserve. In the early 1980s, Volcker imposed two years of high interest rates and painful unemployment to squeeze inflation out of the US economy. Şimşek and Fatih Karahan, his ally at the central bank, have been at it for longer – but they have been dealt some unlucky cards.

And the medicine is working. Two years ago, inflation in Turkey peaked at 75 percent; it is now less than half that. Unemployment is a little above 8 percent, while the lira has lost only 17 percent against the dollar over the past 12 months.

Moreover, Yilmaz said the economy should hit $1.8 trillion for the first time by the end of the year. This compares with Saudi Arabia’s $1.3 trillion.

Monetary policy works – but with long and variable lags. Let us hope that, after so much pain, Şimşek and his allies are not derailed by politics.