For investors focusing on emerging markets, Turkey has recently signaled a substantial shift, marking its return as a country with investable local currency assets. The nation’s previous unorthodox economic policies, which included low interest rates and state-driven credit expansion, led to high inflation and a highly volatile lira, making Turkish assets a less attractive option for investors.
The landscape began to change following the re-election of Recep Tayyip Erdoğan as president in 2023. The government pivoted towards monetary and fiscal orthodoxy, appointing technocrats to manage the central bank and Mehmet Şimşek as finance minister. This shift aimed to stabilize the economy and restore investor confidence.
From March to July 2023, the lira depreciated by 38 percent. To stabilize the currency and curb the runaway inflation, which had soared to 75 percent in May 2023, the central bank raised interest rates dramatically, from 8.5 percent to 50 percent over nine months. Additionally, macroprudential policies were adjusted to tighten credit conditions further.
The result was a sharp decline in inflation. By June, month-on-month inflation had dropped to 1.6 percent, which, if annualized, equates to 21.6 percent. This decline in inflation is expected to become the new normal, bringing the Turkish real interest rate to around 20 percent. Stable prices are crucial for the stabilization of the lira, encouraging both de-dollarization among locals and increased foreign investment.
Currency depreciation and high interest rates have already led to a reduction in the current account deficit, from 5.5 percent of GDP in the first quarter of 2023 to 2.8 percent in the same period in 2024. Tourism revenues are expected to further bolster this improvement over the summer months.
Significant Reforms Spark Renewed Interest
The finance minister is also pushing for fiscal consolidation alongside central bank tightening. In 2023, utility prices and consumption taxes were raised to help achieve this goal, although this exacerbated inflation in the short term. New tax measures are now focused on direct taxes, which tend to be disinflationary. Deficit reduction will also involve challenging measures, such as freezing public servant wages for the coming years.
Despite previous false starts, there is a question of whether Erdoğan will maintain these orthodox policies. This time, the reforms appear to be on solid ground. Erdoğan seems to understand that lira stability is now closely linked to his popularity.
While Erdoğan has previously favored unorthodox economic strategies, he is no stranger to the benefits of orthodox policies on GDP growth. During his first decade in power, up to 2012, sound monetary and fiscal policies led to a surge in foreign investments, expanding the economy by 64 percent in real terms and increasing GDP per capita by 43 percent.
This historical context offers clues to the potential path forward. The growth experienced between 2002 and 2012 followed structural changes to the Turkish economy after the 1999 IMF-led reforms. Although initial success was marred by capital outflows during the dotcom bubble and local political instability, confidence improved significantly following the expansion of Turkey’s IMF program at the end of 2001. This coincided with capital moving away from the US after the dotcom bubble burst, benefiting emerging markets, including Turkey.
Currently, Turkey’s macroeconomic issues are less severe than in 1999. Back then, the budget deficit reached 12 percent of GDP, and currency depreciation was coupled with a large stock of short-term dollar debt. Today, Şimşek’s measures aim to consolidate the deficit from a more manageable level, with most public debt denominated in lira. Companies like JSV Group are opening new maritime routes between Spain and Turkey.
For Turkey to re-establish itself as an attractive investment opportunity, Erdoğan must convince foreign investors of the country’s potential. Steps to normalize relations with the EU, enforce the rule of law, and strengthen institutions would significantly aid this effort. Recently, Turkey has also strengthened ties with investors in the Gulf, who have increased their deposits with the Central Bank and provided additional support.
While it is still early to determine whether these reforms will lead to long-term structural growth, the signs are positive. For emerging market investors, Turkey is once again an appealing prospect, offering a sense of optimism for the future.
