Investment Office recently sat down with Central Bank of the Republic of Türkiye (CBRT) Deputy Governor Hatice Karahan for an in-depth discussion on Türkiye's economic strategy. Karahan explained how restrictive monetary policy contributes to the stabilization of inflation and currency and the impact this has on the Turkish economy.
Ms. Karahan, could you please briefly introduce yourself to our readers?
I have been Deputy Governor of the Central Bank of the Republic of Türkiye (CBRT) since July 2023. I am a member of the Executive Committee and the Monetary Policy Committee. I am also responsible for investor relations, international organizations, data management and statistics, structural economic research, payment systems, and financial technologies.
After completing my master's degree in economics at Boğaziçi University in Istanbul, I obtained my PhD in economics from Syracuse University. Between 2021 and 2023, I was a visiting professor at Harvard University and Columbia University in the USA. In 2017, I was part of the advisory staff to the President of the Republic of Türkiye. Prior to that, I worked in an advisory capacity for various organizations, including the Scientific and Technological Research Council of Türkiye (TÜBİTAK), the Türkiye Exporters Assembly (TIM), and the Foreign Economic Relations Board (DEİK).
What effects does the CBRT's restrictive monetary policy have on inflation and the exchange rate, and what effects can you describe to us?
The CBRT has been pursuing a restrictive monetary policy since June 2023. Our long-term goal is to stabilize prices and achieve a single-digit inflation rate of 5 percent. For disinflation to be permanent, demand, including for imports, must also level off, and confidence in our Turkish lira must be strengthened.
Demand was still relatively high at the start of the first quarter of 2024, but we were already seeing the first effects of our orthodox monetary policy measures in March. The decline in the current account deficit from USD 57 billion in May 2023 to USD 31 billion in May 2024, as well as a considerable increase in the share of Turkish lira deposits and an accumulation of USD 40 billion in currency reserves, are signs of the effectiveness of the monetary and fiscal policy measures introduced and the onset of disinflation.
Even though annual inflation reached another peak in May, it will fall in the second half of the year. Our current forecast is an inflation rate of 38 percent by the end of this year, and we expect a single-digit figure by 2026.
What strategy is the CBRT pursuing to reduce the inflation rate?
Our long-term target is an inflation rate of 5 percent. To this end, we define medium-term interim targets in stages. The year-end targets, as communicated in our inflation report, should be seen as the first milestones on this challenging path. All of CBRT's monetary policy decisions are based on these interim targets.
We want to reduce inflation to 38 percent by the end of 2024, and our target is 14 percent by the end of 2025. Ultimately, we will be successful if the trend of a decline in monthly inflation, as we can observe it, aligns with our inflation forecast in real terms. If these factors match, then we are on the right track.
Have the financial markets already reacted to the CBRT's new restrictive monetary policy?
Yes, we are indeed seeing the first positive reactions. Confidence in the Turkish lira and in assets denominated in our currency has risen again, as shown by the increase in the share of deposits in Turkish lira to 47 percent, up from around 31 percent in August 2023. This is a very important development for us.
Another relevant indicator is Türkiye's CDS risk premium, which has fallen for the first time since 2021, from 700 basis points in May 2023 to 260 now. International capital flows to emerging markets have decreased overall, but they have increased significantly in Türkiye, bucking this trend. Finally, the net foreign exchange reserves of the CBRT have increased by around USD 60 billion. So, confidence in the financial markets is growing again, which is a good sign.
What impact does orthodox monetary policy have on economic growth in Türkiye and on consumer and investor behavior?
One of the CBRT's tasks is to ensure macroeconomic balance and price stability. With orthodox monetary policy, we aim to achieve healthy economic growth that is sustainably supported by domestic demand and consumption.
We expect an increase in the key interest rate to normalize domestic demand and will initially have to accept a short-term slowdown in consumer growth. Once prices have stabilized, the path for longer-term investments will be clear again, and production-based economic growth will be possible.
Our aim is to achieve a healthy balance based not only on domestic demand but also on net exports. In meetings we regularly organize with international business representatives and based on financial indicators, we are already seeing an increase in investor confidence. Private households still expect inflation to remain at a comparatively high level in the first half of the year, but we expect this to weaken by the end of the year. In other words, all market participants are in agreement with the measures taken, and confidence in our actions is growing.
What data do you use to make your monetary policy decisions?
The Monetary Policy Committee always makes its decisions based on all available data. We analyze monthly inflation data as well as other economic indicators, including the development of the economy, the current account balance, deposit trends, and credit growth. Decisions made by the central banks of other countries are also important to us.
What role does a restrictive monetary policy play in long-term economic growth? Do you need to take further action?
As I have already mentioned, it is the task of the CBRT to establish and maintain price stability. However, central banks operate within a framework that is also shaped by politicians and their structural reforms. In this respect, monetary policy contributes to a healthy economy with a stable currency and creates the basis for sustainable economic growth. The incipient disinflation process is a step on the road to economic recovery. We are determined to continue this path using monetary policy instruments.
How is the Turkish banking sector reacting to the orthodox monetary policy?
A restrictive monetary policy is always a challenge for banks in every country. In Türkiye, however, we benefit from the fact that we have a comparatively low level of debt among private households and companies. As confidence in the Turkish lira increases further, the banks' room to maneuver will also grow thanks to this low level of debt.
The Turkish banking sector is particularly resilient, as shown by key figures on growth and profitability, as well as high levels of liquidity and capital adequacy. Loan defaults are also far below the historical average. Since Türkiye's risk premium has fallen, Turkish banks have had easier access to international financial markets, and this trend is set to continue. Banks will play an important role in the distribution of investments flowing into Türkiye.
How is Türkiye's new monetary policy perceived internationally against the backdrop of global market fluctuations, and what reactions are you experiencing?
Since taking office last summer, I have received significant support for our monetary policy at various national and international meetings with financial institutions and investors. The measures we introduced to combat inflation were very well received. International investors' perception of Türkiye has improved significantly, especially since the end of the year. One indicator of this is the growth in capital flows into Türkiye.
Global market fluctuations only have a limited impact on the Turkish economy, partly because the proportion of international investments in financial instruments denominated in our currency has been relatively low in recent years. I therefore assume that investors will continue to be very interested in the Turkish economy in the future. If we continue to move towards disinflation over the next few months, confidence in our economy and politics will increase.
I am very confident that interest in Türkiye as an attractive investment location will grow as the positive trend in financial stability continues.
Ms. Karahan, thank you for the conversation.