Türkiye's economic challenges and the medium-term programme for 2025-2027
Dr. Gülsüm Akbulut
Founder and CEO, Ankara Global Advisory Group
7 September 2024
Introduction
The recently announced Medium-Term Programme (MTP) for 2025-2027 serves as a roadmap for the government to address Türkiye’s economic challenges.[1] The MTP outlines key targets such as lowering inflation, reducing the budget deficit and achieving steadily increasing growth. However, several targets present additional complexities. For instance, balancing inflation reduction with robust economic growth remains a significant challenge. Similarly, lowering unemployment in slowing economy or achieving a relatively low trade deficit in a high-growth environment also pose further difficulties. Each of these projections requires further assessment.
[1] See main economic indicators and estimations in Table1.
Key Economic Targets and Challenges
This article aims to provide an overview of current developments in the Turkish economy and the outlook for 2024 and 2025 in line with the MTP. It examines the policy measures that have been implemented since the May 2023 elections, including those aimed at curbing inflation, stabilising the exchange rate and promoting fiscal sustainability. The article assesses key economic indicators such as inflation, interest rates, current account balance and fiscal position and provides insight into how these factors influence the future of the Turkish economy. It also highlights both the opportunities and potential challenges ahead.
Post-Election Policy Shifts
A major turning point for Türkiye's economic development came after the May 2023 elections, when Mehmet Şimşek was appointed Minister of Treasury and Finance. His approach signalled a departure from the previous strategy of maintaining low interest rates — negative real interest rates— which had encouraged spending through easier access to credit. Türkiye recorded economic growth of 5.5% in 2022 and 5.1% in 2023, but this strong growth was accompanied by a sharp rise in inflation, which peaked at 86% towards the end of 2022. The policy of negative real interest rates contributed to the rise in inflation and accelerated the depreciation of the Turkish lira, leading to increasing dollarisation.
Monetary and Exchange Rate Policies
In response to these challenges, the newly appointed central bank governors— although the first one had only been in office for seven months— pursued a tighter monetary policy and raised interest rates. Central bank interest rates rose from 8.5% in May 2023 to 50% in March 2024 and have remained at the same level to date. The central bank's main goal is to bring inflation down to 41.5% by the end of 2024 and 17.5% by 2025, with the long-term goal being to achieve single-digit inflation by 2026 and beyond, as indicated in the MTP announced on 5 September 2024.
Stabilising the exchange rate was also a priority to achieve the inflation target, as a devaluation of the lira would increase the cost of imported goods, worsen expectations and fuel inflation. Growing confidence in Şimşek’s programme and high interest rates with a near-stable Turkish lira attracted foreign capital into Turkish lira assets. Thanks to this capital inflow since the election, the international reserve position improved and net reserves excluding swaps turned positive in mid-2024, allowing the central bank to effectively manage the value of the Turkish lira. However, the central bank's room for manoeuvre remains limited, as it is not possible to control both interest rates and exchange rates simultaneously in an economic system with free movement of capital..
Fiscal Policy
On the fiscal side, the biggest challenge for the government was to cope with the financial impact of the devastating earthquake in February 2023. The cost of earthquake-related expenditures contributed significantly to the rising budget deficit in 2023 and 2024. The budget deficit as a percentage of GDP rose to 5.2% in 2023 and is expected to reach 4.9% in 2024 before falling to 3.1% in 2025, according to the MTP. To address these fiscal challenges, the government introduced new taxes in July 2023, including an increase in VAT. In July 2024, a more comprehensive tax reform package was passed, focusing on reducing certain tax exemptions, expanding tax audits and increasing corporate tax rates for public-private partnership projects, among other things. However, this was met with criticism from the business community, which felt overburdened by the increased taxes
Income Policy and Inequality
Incomes policy was also adjusted to limit wage and salary increases below the rate of inflation in order to dampen demand and reduce inflation. However, this led to a decline in real incomes that disproportionately affected lower and middle income groups, whose purchasing power fell. Since 2021, income inequality has worsened, as shown by the increase in the Gini coefficient in 2022 and 2023, and a further deterioration would occur in 2024. It is important to find a balance between inflation control and policies that protect vulnerable groups..
Current Account and Trade Outlook
Türkiye’s current account deficit stood at 5% of GDP in 2022, slightly improving in 2023. Exports in 2024 will be affected by both the real appreciation of the lira and slow growth in Türkiye's key export markets in the EU. Imports are expected to decline due to reduced domestic demand. As a result, the trade deficit is expected to narrow, with the current account deficit estimated to fall to 1.7% of GDP in 2024 and to 2% in 2025, according to MTP estimates.
Growth Projections and Challenges
The government’s restrictive monetary and income policy has slowed economic growth. Economic growth was 3.8 in the first half of the year in 2024. The MTP forecasts a growth rate of 3.5% for 2024, rising to 4% in 2025 and to 4.5% and 5% in the following years. These growth projections need to be reassessed, especially when it comes to how the decline in inflation, which is expected to reach 17.5% by the end of 2025, can be reconciled with the higher growth targets.
The medium-term programme calls for continued tight fiscal and monetary policy over the next two years to bring down inflation. This includes maintaining high interest rates, limiting wage growth and increasing tax revenues. These measures to curb inflation must be carefully managed to avoid damage to businesses, start-ups and the labour market. The government clearly intends to maintain these measures until inflation is significantly reduced. However, it must strike a balance between these measures and maintaining production capacity.
As the 17th largest economy in the world with a population of 85.5 million and an estimated economic output of 1.3 trillion dollars, Türkiye is expected to reach a per capita income of 15,551 dollars by the end of 2024. As one of the largest economies in the world, Türkiye's economic policy must be conducted with precision and foresight to avoid major mistakes. Given the size and complexity of the country, even small policy missteps can have far-reaching consequences. It is crucial to take measures that keep businesses afloat, avoid major closures and prevent unemployment from pushing the economy below its potential. Increasing protectionist measures in the global market, the intensification of regional conflicts and a possible rise in oil and commodity prices should tensions in the regions intensify are potential threats that could affect the Turkish economy. Therefore, Türkiye needs to focus on long-term growth potential, improve regional trade connectivity and continue its investments in strategic sectors such as energy, science and technology. Maintaining structural reforms to improve productivity, transitioning to a green and digital economy and curbing inflation, budget and current account deficits will be crucial to ensure economic stability and long-term prosperity and development.
Conclusion
In summary, Türkiye has set ambitious targets in its medium-Term Programme (MTP) for 2025-2027 to stabilize inflation, strengthen fiscal discipline and achieve sustainable growth. However, success will depend on the ability to balance inflation control with the need to promote growth, manage external risks and address domestic challenges such as income inequality and fiscal constraints. Continued investment in strategic sectors and structural reforms aimed at increasing productivity will be key to long-term economic stability and prosperity.
[2] E: Estimation P: Program
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