Turkey Lira Inflation: A Deep Dive into the Economic Reality

The Turkish lira has been experiencing some wild inflation, with prices skyrocketing in recent years. In 2021, inflation reached a staggering 36.1%, making it one of the highest in the world.

The main culprit behind this inflation is the government's loose monetary policy, which has led to a surge in money supply and a subsequent rise in prices. This has had a ripple effect on the economy, making everyday items unaffordable for many Turks.

In 2020, the Turkish lira lost over 20% of its value against the US dollar, further exacerbating the inflation problem. This has made imports more expensive, leading to higher prices for goods and services.

The impact of inflation on ordinary Turks has been severe, with many struggling to make ends meet.

Inflation in Turkey is a pressing concern, with prices increasing by 20.3% in 2021 alone. This is a significant rise from the previous year, when inflation was at 11.9%.

The Turkish lira has been experiencing a decline in value, making imports more expensive and contributing to inflation. In 2021, the lira lost 44% of its value against the US dollar.

The Central Bank of Turkey has implemented various measures to combat inflation, including raising interest rates. However, these efforts have had limited success so far.

Turkey's economic challenges are multifaceted and complex. The country's real GDP growth averaged 5.4% from 2002 to 2022, but this growth also heightened macroeconomic risks, including high inflation, currency depreciation, and a higher current account deficit.

The current account deficit has narrowed significantly since the May 2023 elections, but it still poses a challenge for the economy. In 2024, the deficit fell by $14 billion between the first quarters of 2023 and 2024.

High inflation is another major challenge for Turkey. In May 2024, inflation peaked at 75%, and it took time for disinflation to start, with it beginning in June 2024. The government's policies aim to tackle high inflation and build resilience against climate and earthquake risks.

The Turkish Central Bank's key interest rate increased from 8.5% to 50% in June 2023, and interest rates on commercial loans rose to 70%. This turnaround is expected to help rebalance the economy in the medium term, with forecasts predicting real GDP growth of 3% in 2024 and a gradual fall in inflation to 43% by the end of the year.

Türkiye's economic growth has been impressive, with real GDP growth averaging 5.4% from 2002 to 2022, more than doubling income per capita. This growth has significantly reduced poverty, halving the rate from over 20% in 2007 to below 10% in 2021.

The country's economy grew by 1.9% in 2020 and achieved 11.4% growth in 2021, driven by government policies and strong domestic and external demand. However, these policies also heightened macroeconomic risks, including high inflation, currency depreciation, and a higher current account deficit.

Despite these challenges, the economic management has moved towards economic normalization since the May 2023 elections. This has led to important outcomes, such as the growth rate remaining strong in 2023 at 5.1%, and the current account deficit significantly narrowing.

The normalization of macroeconomic policies has provided opportunities and challenges. Tightening monetary policy, coupled with decisive forward guidance of the Central Bank, has boosted confidence in financial markets and lowered medium-term inflation expectations.

However, disinflation will take time, and fiscal policy's support is yet to come. The coordination of monetary and fiscal policy is critical, as is fiscal consolidation, with fiscal policy also supporting vulnerable groups throughout the stabilization period to reduce poverty and inequality.

The economic team, led by Vice President Cevdet Yılmaz and Minister Simsek, has launched policies to address macroeconomic imbalances, aiming for sustainable growth and stability. These policies include shifting growth from private consumption to investments and exports.

The Turkish lira (TRY) has been under pressure, with the US dollar-to-Turkish lira exchange rate skyrocketing in June. The TRY briefly hit its current all-time low of 18.4 in late December 2021, after the central bank slashed its key interest rate from 15% to 14%.

The currency weakened by 44% against the dollar last year and has steadily lost 23% of its value since the start of the year. Analysts expect consumer inflation to rise above 80% in the coming months, before slowing down to near 60%.

The Turkish economy's underlying fragilities were revealed when the Fed switched to quantitative tightening in the mid-2010s.

Turkey was classified among the "fragile five" by Morgan Stanley, along with Indonesia, Brazil, India, and South Africa, all with large current account deficits and high external debt levels.

A classic dilemma faced Turkey: raise interest rates to keep the exchange rate stable, but tolerate slower growth, or keep interest rates low and tolerate currency depreciation.

Rising political instability from 2015 to 2019 compounded the crisis, with Erdoğan's governments prioritizing economic growth over long-term economic strength.

The Turkish government used its Credit Guarantee Fund to support credit expansion in 2017, leading to large current account deficits.

The good old days of high economic growth, low inflation, low interest rates, and low exchange rates were over, dependent on massive foreign capital inflows that had generated fragilities over time.

In 2020, another round of interest rate cuts brought the country to the brink of a balance of payments crisis as capital outflows continued.

The central bank had used most of its foreign currency reserves to stabilize exchange rates while keeping interest rates low, setting the stage for another round of interest rate increases in fall 2020.

Negative real interest rates have had a significant impact on companies, especially in Turkey. Companies with highly capitalized production and pricing power have benefited from cheap credit, stimulating their activity despite high inflation.

This is evident in the fact that companies have been able to maintain their profitability despite a significant explosion in production and wage costs, with unit labor costs increasing by 270% between 2021 and 2023.

Interest rates in Turkey have been set at a record low of 14%, despite inflation running at 21%.

The Turkish Central Bank has used billions of dollars in foreign currency reserves to prop up the currency, with at least $7.3 billion spent on interventions in December.

President Erdogan's lira deposit protection scheme, introduced in December, promises to pay back depositors in Turkish lira if the value of the currency drops by more than the interest rate.

However, this scheme has had short-lived effects and is now completely insufficient to restore confidence among Turkish residents.

The Turkish lira has lost 44% of its value against the dollar last year, and has steadily lost 23% of its value since the start of the year.

Turkey's gross international reserves have fallen to $60 billion from $88 billion in November 2021, due to a widening balance of payments deficit.

The Turkish Central Bank will only be required to conduct emergency rate rises if the situation becomes untenable, until the next presidential elections in 2023.

The fragile lira deposit protection scheme is now completely insufficient to restore confidence among Turkish residents, due to record negative real rates and annual inflation of over 70 percent.