Ahead of the Monetary Policy Committee (MPC) meeting of the Turkish central bank this Thursday, let's stop and see how the Turkish economy has been performing since the beginning of 2022 and what to watch out in the next couple of months.
Btw the MPC meeting is the most crucial body for assessing economic and financial conditions in a country and deciding on monetary policy tools, in particular the policy rate at which banks can lend money at.
1. Big concern: Exchange rate
The Turkish lira has been weakening against the US dollar and the Euro in the past weeks. The lira is trading above 14 US dollar again (as of today at 14,6 USD/TRY) and the Euro exchange rate is also down now at 16 (as of today at 16,1 EUR/TRY). Multiple factors are causing this devaluation. Let’s focus on two drivers behind the fall of the Turkish lira, since those can be observed directly. First, the monetary policy decisions made at the end of last year. Despite high inflation the Turkish central bank lowered the interest rate up to 14% from 19%. This has caused a severe drop in the lira, as investors lost trust in the autonomy of the monetary policy authority. Around Christmas last year a new instrument was introduced to stabilize the lira (I wrote about the de-dollarization or so-called "Turkish Dollar" here and here), which showed initially positive effects as it managed to stop the fall of the lira. However, since the beginning of the Russian invasion the new method is losing steam, as we observe it by the drop of the lira for the past week. So, the second driver is the war in Ukraine (concern nr. 2 see below). Like many European countries, Türkiye is heavily dependent on Russian oil, gas and coal (in a nutshell: the relevant commodities). The war most likely will cause even higher commodity prices for the Turkish economy. This worries investors (and consumers) who fear the consequence of even higher prices in Türkiye (concern nr. 3).
2. Bigger concern: Russian invasion of Ukraine
The war in Ukraine could affect the Turkish economy twofold. First, as mentioned above (and below in more detail), commodity prices could increase and surge the already high inflation in the country. However, another crucial economic sector could be affected as well: tourism, which is one of the key economic drivers in Türkiye. It accounted for almost 8% of total employment and represented roughly 4% of GDP in 2018 (source). What is more, Russians account for the biggest tourist group (19%) and Ukraine builds the third largest group of tourists (with 8.3%) according to Reuters. The war would halt the recovery of the tourism sector that was already hit by the pandemic.
3. Biggest concern: Inflation
Last month the consumer price index (CPI), an index that measures how prices are changing, rose to 54% year-on-year (in other words to February 2021). Also, compared to the prior month prices increased around 4.8%, according to the Turkish Statistical Institute (TURKSTAT). Moreover, producer prices showed an increase in February as well and could be passed to consumers in the following months, leaving lesser room for the prices to cool down in the summer as prophesied by policy makers. Therefore, what is relevant now are the policies implemented by the central bank.
So, what to expect for tomorrows monetary policy meeting?
Amid the war in Ukraine and its consequences on energy prices, it is fairly unlikely that the central bank will cut interest rate. And as it does not raise them (due to political preferences) we can expect no change tomorrow. Still, we have to wait and see.
* Disclaimer: The views expressed herein are those of the author and do not necessarily reflect those of the Deutsche Bundesbank or of the Eurosystem.