The European Bank for Reconstruction and Development (EBRD) on Wednesday raised its outlook for growth in Türkiye, marking the latest upward revision prompted by the fiscal stimulus in the run-up to the May elections and the post-vote shift in the economic policymaking.

Growth for Türkiye, the single biggest recipient of EBRD funds, has been revised up to 3.5% from 2.5% for 2023, the lender’s latest bi-annual growth forecast showed. This will help to partially offset weaker growth prospects in emerging Europe and the Mediterranean region, according to the bank.

The EBRD still highlighted the challenging external balances and maintained its view for the next year when it expects the Turkish economy to grow by 3%.

Overall, the EBRD region, which covers some 40 economies, is expected to expand by an average of 2.4% this year before picking up speed to register output growth of 3.2% in 2024 as inflation eases further.

Multiple global institutions, including the Organisation for Economic Co-operation and Development (OECD) as well as rating agencies Fitch and Moody’s, upgraded their 2023 forecast for Türkiye’s gross domestic product (GDP) growth earlier this month.

The revisals followed data showing the economy expanded by a more-than-expected 3.8% in the second quarter, following the revised growth of 3.9% in the first three months.

Yet, activity is expected to slow through year-end as election-related stimulus fades and big rate hikes weigh.

After winning reelection in May, President Recep Tayyip Erdoğan reshuffled his Cabinet and named an economy team of respected technocrats to lead a turn from a years-long easing cycle to aggressive monetary tightening to tackle the stubborn inflation.

Mehmet Şimşek was appointed as treasury and finance minister, and Hafize Gaye Erkan took the helm of the country’s central bank.

Since June, the central bank has tripled its benchmark one-week repo rate to 30%, including two sizable hikes in August and September. It says it is ready to raise rates further than needed to rein in inflation, which shot back to nearly 60% in August.

The EBRD highlighted foreign financing imbalances, stressing the short-term external debt exceeding $200 billion and the current account deficit at nearly $60 billion.

The lender also pointed out that foreign exchange reserves are increasing but continue to remain at a modest level. The central bank’s net international reserves have recovered strongly since June, increasing $30 billion in around four months.

EBRD economists say Türkiye has shown a relatively strong growth performance in recent years, but there has been a slowdown.

The report stated that GDP growth decreased from 5.6% to 3.9% in the first half of 2023 compared to the same period of 2022. It also highlighted the upward course in inflation, which is expected to rise to 60% by the end of 2023.

Foreign capital inflow

The new measures have encouraged an inflow of foreign capital, according to Rafik Selim, a regional chief economist at the EBRD, in what he says signals a return of foreign investors and helping rebuild the country’s reserves.

Selim said the shift toward orthodox economic policies needs to be sustained, noting that the steps since the May elections have been received with cautious optimism by markets.

"We are witnessing a decline in Türkiye’s credit risk premium (CDS) from its historic peak in May 2023. We are also seeing an improvement in investor confidence. Foreigners’ holdings of Turkish equities and bonds have picked up strongly," he told Anadolu Agency (AA).

A measure of protection against potential credit events, such as default, the CDS score, which stood at as high as 700 points before the May election, fell below 400 basis points following the policy pivot and unveiling of the country’s new three-year medium-term economic program.

"The new measures, such as consecutive hikes in policy interest rates, increases in the value-added and other taxes, and cutting back on interventions to defend the lira are expected to also lead to lowering the current account deficit, which has widened significantly, and rebuilding foreign exchange reserves," Selim said.

"The Medium-Term Program that was released in September has also been received positively by investors, signaling the authorities’ commitment to price stability, efficient distribution of resources and the sustainability of growth."

Selim said tighter fiscal and monetary policies will lead to a slowdown in growth in the second half of 2023.

"Leading indicators suggest that consumers and businesses are becoming more pessimistic and spending less. The fiscal deficit is also expected to remain larger than in recent years," he added.

Allowing the Turkish lira to depreciate led to a monthly current account surplus in July, the first since October 2021, and also because of solid tourism income, he said.

"The depreciated lira will also help increase the competitiveness of Turkish exports," Selim said.

"Foreign capital is flowing, signaling a return of foreign investors, and helping in the rebuilding of reserves," he said, adding that Türkiye was also able to secure investments from Gulf countries to the tune of $50 billion in different sectors, such as space and defense, energy and natural resources.

Şimşek last week said the country had secured $10.4 billion in external financing since June. Out of this, the banking sector secured over $6.7 billion, the real sector attracted $3.26 billion and the non-banking financial sector accounted for $367 million.

Selim stressed the importance of sustaining the shift toward orthodox economic policies, terming it crucial to attract investors and sustain their confidence, as well as ensuring more sustainable growth.

"There is also a need to strengthen the monetary transmission mechanism to continue with the revisions in macro prudential policies and to gradually phase out schemes introduced to support the lira," he said.

"At the same time, the structural reform agenda must be reinvigorated to improve the business environment and the investment climate. This includes addressing systemic issues affecting Türkiye’s long-term growth potential."