Turkey's Central Bank Navigates Delicate Balancing Act Amid Economic Slowdown

As Turkey's economy grapples with one of the world's highest inflation rates, the country's central bank is poised to maintain an interest-rate pause, a move aimed at engineering a gradual slowdown to tame price pressures. Economists unanimously forecast the one-week repo rate will remain at 50% on Thursday, a decision that could extend well into the year or even beyond.

Steering the Economy Towards Disinflation

Tightening Monetary Policy Amid Fiscal Measures

The central bank's decision to keep rates unchanged comes as the economy is showing signs of slowing down. The rate hikes initiated a year ago have now started to exert a drag on the economy, with more restrictive financial conditions finally catching up to the generous fiscal measures, such as wage hikes, enacted by the government. This mismatch between monetary and fiscal policies has contributed to the current economic momentum reversal, as fiscal policy tightens and inflation is expected to start decelerating from this month after peaking above 75%.

Monitoring Manufacturing Activity and Business Sentiment

Indicators of economic activity paint a picture of a slowdown. A measure of Turkish manufacturing activity has been below the 50-mark, which separates expansion from contraction, for two consecutive months. Factories are also using less of their potential than at any point since last August, signaling a decline in production. Additionally, business sentiment is on the rise, with a survey by the central bank revealing growing pessimism among companies.

Targeting Inflation and Maintaining a Hawkish Bias

The central bank's primary focus is on bringing down inflation, which has remained stubbornly high. Officials are targeting an inflation rate of 38% by the end of the year, maintaining a hawkish bias and warning that they could further tighten policy if the outlook for price growth deteriorates. The central bank's preferred gauge, monthly inflation, has been well above its long-run average, staying at over 3% throughout this year.

Anticipating Fiscal Adjustments and Credit Tightening

Analysts expect the central bank to complement the rate pause with additional measures to support the rebalancing of the economy away from consumer spending. This could include further tightening in policies governing credit growth rates, reserve requirements, and banking regulation. The government has also drafted new tax proposals, signaling a broader fiscal adjustment in the second half of the year.

Navigating the Challenges of Tighter Policies

A key risk to the central bank's outlook is how the government handles the potential backlash from tighter policies on companies and households. The main opposition party has been calling for a mid-year increase to the minimum wage, a move that could fuel domestic demand and inflationary pressures, as was the case after a 49% raise at the start of this year. However, the government has ruled out such a hike, aiming to avoid further fueling inflation.

Burden on Small and Medium-Sized Enterprises

The impact of tighter policies is being felt by businesses, particularly small and medium-sized enterprises (SMEs). Companies like Uysal Sekerleme, a major confectionery firm, are facing high borrowing costs, costlier raw materials, and stagnant demand both domestically and abroad. The manager of Uysal Sekerleme expressed concerns about the future, stating that the "whole burden is on small and medium-sized enterprises," with many struggling to repay their loans.In navigating this delicate economic landscape, Turkey's central bank is walking a fine line, aiming to engineer a gradual slowdown to tame inflation while minimizing the impact on businesses and households. The success of this strategy will be closely watched by investors and policymakers alike, as the country seeks to chart a path towards more sustainable economic growth.