S&P expects interest rate hikes in Turkey after inflation accelerates

Turkey is expected to increase interest rates after inflation accelerated in June, ratings agency Standard & Poor’s said.

The country, with double-digit inflation, is a notable exception in emerging markets, where price increases are generally below target, S&P said in a report published on Monday entitled 'Emerging Markets: the long road to a new normal'.

Turkey, along with South Africa and Latin America, will probably experience higher policy interest rates by the end of next year, S&P said.

Turkey’s central bank has slashed its benchmark interest rate to 8.25 percent from 24 percent over the past year in support of the government’s pro-economic growth policies. Monetary policymakers persisted with rate cuts even as inflation accelerated to 12.6 percent in June from 8.6 percent in October, before leaving them on hold last month.

The Turkish economy, hit by a sharp decline in tourism revenues and an economic slump in the Eurozone, is estimated to be in recession, S&P said. Economic activity is expected to shrink by 3.3 percent this year, before growing by 4.5 percent in 2021, it said.

The government has responded to the negative impact of the COVID-19 outbreak by flooding the economy with cheap lending from state-run banks and by instructing the finance industry to restructure the debts of consumers and businesses and award them waivers on repayment. President Recep Tayyip Erdoğan is now predicting a strong revival in economic growth in the second half of the year.

Turkey’s policy response followed a “familiar script of pushing more credit into the economy at negative real interest rates,” according to S&P. “This could help accelerate the recovery, but risks reigniting macroeconomic imbalances.

“We're already observing an acceleration in inflation and a widening of the current account deficit. It will take a while for the tourism sector to recover, which will weigh on growth and foreign currency inflows,” the ratings agency said.

Turkey was recovering from a painful economic recession sparked by a currency crisis in the summer of 2018 when the coronavirus swept across the globe. The lira then hit an all-time low of 7.269 per dollar in early May as investors and savers worried about economic stability.

Still, Turkey’s private sector has proven resilient in the past and should help the country weather a period of weaker foreign trade conditions and higher uncertainty, S&P said.

“However, businesses are still dealing with the fallout from the 2018 balance-of-payments shock, and further hit to their balance sheets will constrain investment,” it said.