In September, the CBRT hiked its key policy interest rate by 625bp to 24%. We have concluded that the hike and its magnitude were necessary to calm financial markets and also sufficient to keep future inflation expectations in check. Turkish assets have stabilized since the rate hike. Moreover, the expected appreciation of the US dollar vs. the Turkish lira (as a proxy for expected inflation) was close to 24% in the four weeks prior to the rate hike. Hence, the new benchmark lending rate more or less matches the rate of interest that an investor in TRY-denominated short-term deposits or long-term bonds should demand.

Additional fiscal tightening is needed to stabilize the economy in the medium term. The Turkish government’s New Economy Program 2019-2021 heads in the right direction by focusing on a rebalancing of the economy. However, Turkey has a history of reform slippage and deviations from economic programs.

A technical recession (two to three quarters of negative growth in H2 2018 and H1 2019) is expected, resulting in full-year growth of just +0.4% in 2019.

Corporate sector debt is the key risk in Turkey. It was equivalent to 65% of GDP in Q1 2018, of which about 56% was denominated in foreign currencies. Hence, rolling over that FX-denominated debt will be challenging amidst the current global liquidity tightening, especially in a hard landing scenario.

The Turkish lira is forecast to depreciate by an average -40% against the US dollar in 2018 and by another -37% in 2019.