Governor of the Central Bank of the Republic of Türkiye
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Adapting to changing global conditions and making the most of emerging opportunities, Türkiye, to reinforce its economic achievements of the recent past, started to implement the new “Turkish Economy Model”. Developed largely by using domestic capital and human capacity, the Turkish Economy Model prioritizes a sustainable economic growth by achieving permanent price stability through investment, employment, production and exports. The liraization strategy implemented by the Central Bank of the Republic of Türkiye (CBRT) is one of the key elements of this model.
Through the liraization strategy, the aim is to gradually increase the weight of TRY-denominated items in the assets and liabilities of households, companies and the banking sector, so that the financial system as a whole becomes centered on the Turkish lira. In this context, the monetary policy stance is determined in line with the primary objective of achieving sustainable price stability, taking into account the continuity of supply, the components of the current account balance, the growth, composition and purpose of loans, and healthy price formations in the foreign exchange market.
At a critical juncture that can preserve the unprecedented gains of the Turkish economy over the last two decades and move our country forward in terms of economic development and social welfare, the CBRT develops its monetary policy with a long-term perspective.
Gains and Structural Transformation of the Turkish Economy
In the years following the 2001 crisis, the Turkish economy demonstrated a historically significant economic restructuring and transformation. In this period, the average growth rate has been around 5.5% in Türkiye, while the global economy has grown by about 3%. The Gross Domestic Product (GDP) increased from USD 238 billion in 2002 to USD 807 billion by the end of 2021, and per capita income converged to USD 10,000 from USD 3,600. In that period, Türkiye ranked in the top echelons among OECD countries in terms of per capita income growth according to purchasing power parity. The number of people employed had reached almost twenty-nine million by the end of 2021, from around twenty million in 2005. In the same period, the labor force participation rate rose from 45% to over 50%.
Examining the more recent period, positive developments regarding growth and employment stand out. The Turkish economy grew by approximately 2% in 2020 despite the constraining effects of the coronavirus pandemic, and was one of the rare economies that recorded positive growth. Economic activity remained strong in 2021 as well, and Türkiye, with a growth rate at 11.4%, stood out among OECD and G20 countries. As of June, seasonally-adjusted employment posted a year-on-year increase of 2.1 million people. While the labor force participation rate continued to rise in this period, the unemployment rate decreased from 10.9% to 10.3%. Türkiye achieved the highest employment growth among OECD countries in the post-pandemic period.
Enhancing the capacity of exports and foreign exchange earning services is of decisive importance in terms of achieving and maintaining a sustainable current account balance and permanent price stability. Among other economies and peer countries, particularly its neighbors, the Turkish economy stands out in terms of the share of the manufacturing industry in exports, and the number of export products and markets, as well as the diversity of exports. The share of manufacturing industry products in Türkiye's exports is higher than that of most of its peers and neighboring countries, at around 78% when calculated based on 2018-2020 averages. Selling around 4,300 different products to more than 200 countries, Türkiye has managed to build a higher market and product diversification capacity than similar countries. The share of the three most exported products in total exports is relatively low, which indicates that Turkish exports are not concentrated in certain products. During the pandemic, Türkiye's position in global trade has grown in significance as tectonic shifts in global supply, demand and logistics chains were managed dynamically and skillfully by combining the right strategies. An important window of opportunity that would allow our economy to make use of its relative advantages was created and activated. In this period, our economy rapidly transformed into a global production center and gained critical infrastructure to become the primary player in the economic value chains of the future.
In addition to Türkiye's production-oriented transformation, its permanent positioning in global logistics chains and its positive performance in employment, it should be noted that Türkiye displayed one of the best performances in the world in terms of fiscal discipline during this period and did not compromise on budget discipline. This fiscal discipline performance acted as a very strong anchor, limiting the impact of the 2008 global financial crisis on our economy and playing a leading role in Türkiye's gains in combating inflation. However, despite the gains achieved during the disinflation process, unfortunately, inflation could not be brought down permanently to the 5% target. The tight monetary and fiscal policies implemented in this period failed to achieve permanent price stability amid a disinflationary environment across the world, and the fight against inflation was hampered by internal and external shocks that emerged in the meantime. The deterioration in the inflation outlook has become more evident recently with increases in all commodity prices, especially energy prices, driven by the armed conflict in our region, adding to the global supply problems due to the pandemic. Accordingly, the experience gained in recent years has demonstrated that policies addressing structural vulnerabilities that often push inflation away from the target are more important than short-term gains in the fight against inflation and a permanent structural stabilization program that prioritizes long-term sustainability is needed.
The liraization strategy lays out a comprehensive policy framework that has been continuously improved to ensure that the Turkish economy, which has largely solved its infrastructural problems in health, education, transportation and defense, has generated a relative global advantage by making major breakthroughs in many sectors to reduce external dependence, and has accomplished all of this while maintaining its fiscal balance, achieves permanent price and financial stability.
The two main obstacles to permanent price stability are considered to be the high level of local currency substitution in household, corporate and bank balance sheets and the persistent deficit in the current account balance compared to advanced and peer emerging economies. High levels of these two interrelated vulnerabilities reduce the effectiveness of monetary policy by adversely affecting and often weakening the transmission mechanism, increase the sensitivity of the economy to external shocks, and cause the trade-off between growth and price stability to remain high.
In this context, the CBRT announced in its December 2021 Monetary Policy Committee decision that all aspects of the policy framework would be reviewed in order to create a foundation for a sustainable price stability. In the Inflation Reports of January and April 2022, the “Liraization Strategy” was shared with the public as the essential element of the policy review process.
High dollarization increases the sensitivity of the economy to internal and external shocks and leads to price formations in exchange rates that are detached from economic fundamentals. This necessitated a tightening response to shocks beyond the usual domain of the monetary policy to alleviate the pressures on exchange rates. In an economy running a high current account deficit, monetary tightening in response to the volatility in exchange rates reduces the current account deficit only in the short run by constraining domestic demand, while providing a partial and temporary decline in inflation. However, as the economy resumes its potential growth, inflation and the current account deficit reach unsustainable levels, while the increase in exchange rates exerts an additional pressure on the inflation outlook and creates a need for a premature and inefficient tightening in monetary policy. Thus, high dollarization weighs on both the magnitude of exchange rate shocks and exchange rate pass-through to inflation, while a growth structure sensitive to credit cycles driven by capital flows places additional pressure on the current account balance and exchange rates, in turn. This process transforms into a vicious circle in time. In addition to the exchange rate pass-through, pricing behavior and inflation expectations also exhibit a high exchange rate sensitivity due to balance sheets with high foreign currency weight. On the other hand, the wealth effect stemming from exchange rate increases due to the high weight of foreign currency in the savings of real and legal persons feeds domestic demand and exerts an additional pressure on inflation, while limiting the expected improvement in the current account balance in response to depreciation. Thus, high dollarization pushes inflation above the level that is implied by the costs driven by increased exchange rates, and obstructs the path leading to permanent price stability by causing rigidity in the current account deficit.
For these reasons, eliminating dollarization, in other words, the partial dependence of the country's economy and the main transmission of its financial system on foreign currency, not temporarily through relative price movements, but structurally and permanently, has been defined as the main objective of the liraization strategy of both the CBRT and all stakeholder institutions. It is worth noting here that dollarization has increased structurally also as a side effect of some policies implemented in the post-global financial crisis period. The freedom to make foreign currency contracts, the reserve options mechanism (ROM), and the gradual increase in foreign currency swap funding also caused dollarization to increase. As a matter of fact, the deposit and loan dollarization of the financial system has gradually increased from around 30% in 2010 to more than 50%. In the post-2010 period of abundant global liquidity, large FX loan utilization by companies, including those without FX income, was facilitated by allowing companies to borrow in FX, while the on and off-balance sheet assets, liabilities and asset dollarization tendencies in the banking system strengthened further with the convenience provided to banks in FX liquidity management.
In this period, Turkish lira reserve requirements were increased while FX reserve requirements were reduced, and banks were encouraged to collect FX funds by offering them access to Turkish lira liquidity in exchange for their excess foreign currency through the ROM facility. The period also saw the share of FX assets and liabilities on banks’ balance sheets increase rapidly, and banks freely converted their excess FX liquidity into Turkish lira via currency swaps abroad, which encouraged their preference to collect FX deposits. The delays in prioritizing lasting solutions continued to deteriorate sustainability of the external balance.
Moreover, after the termination of workers' remittances that used to be a safe and continuous source of foreign currency that supported FX financing balance, the Turkish economy that had already been running a chronic current account deficit became more dependent on short-term foreign capital flows. In foreign markets, speculative TRY positions became more persistent.
In the light of these evaluations, liraization refers to a macro process that is managed in an integrated policy framework in order to ensure that:
i) the main store of value in the financial system will be TRY-denominated assets,
ii) the weight of TRY in all balance sheets will increase significantly,
iii) overwhelmingly, fixed-income TRY-denominated assets will be used in the CBRT’s TRY funding as collateral,
iv) TRY will be the only medium of exchange in domestic commercial transactions.
With liraization, it will be possible to increase the weight of TRY-denominated items in assets and liabilities of households, companies and the banking sector, and thus, the financial system in its entirety will become TRY-weighted. Liraization also covers the principle of using the Turkish lira in contracts, pricing and payment transactions.
General Framework of the Liraization Strategy
While making monetary policy decisions in pursuit of the primary objective of price stability, the CBRT targets the removal of all elements that are determined to be ineffective and makes sure that the transmission mechanism operates efficiently.
An array of arrangements have been introduced in FX markets to prevent unhealthy price formations that are not supported by economic fundamentals and to support the liraization strategy. The regulations introduced in the fields of reserve requirements and collateral management, trade in local currencies that was introduced and expanded by swap agreements signed with other central banks, use of Turkish lira in payments, and arrangements introduced to make sure that loans extended in TRY are used so as not to create FX demand will altogether contribute to increasing the demand for TRY in the financial system permanently and structurally. As a result of the stability to be achieved in exchange rates, the exchange rate-driven direct cost pressure on prices will be alleviated; inflation trends will normalize once FX-indexation preferences in pricing decreases gradually and the confidence environment achieved makes expectations positive.
The use of loans provided to the real sector by the financial system for their intended purposes and the strengthening of financial stability through the distribution of resources are considered essential to reinforcing the economic transmission foundations of the Turkish lira. With the increase in the share of the Turkish lira in loans, the decrease in foreign currency liabilities of firms will permanently reduce the exchange rate indexing behavior and the related exchange rate pass-through in the price-setting process, and price increases due to exchange rate volatility will be eliminated. On the other hand, improving the composition of loans in favor of commercial loans will also limit the risks to the inflation outlook and external balance through consumption demand.
When Turkish lira loans are provided at a sustainable financing cost and in a financially inclusive way to increase the potential growth of our economy, stable development of both monetary growth and current account balance will be ensured. For the credit channel to work effectively, loans and monetary aggregates must support production in a way consistent with price stability. Within the scope of the liraization strategy, further macroprudential measures will be taken regarding the composition and growth of loans. Thus, the banking sector will be encouraged to maintain the balanced loan growth that is necessary for productive economic activity in a manner that will contribute to the monetary policy stance.
Accordingly, rediscount credits and Advance Loans Against Investment Commitment, which now comply more closely with the liraization principles and foster wider financial inclusion, are supported as an example for targeted loan practices.
While designing its monetary policy decisions, the CBRT is confronted with the Turkish economy’s structural problems, particularly regarding a sustainable external balance. In this process, instead of easy but temporary solutions, it focuses on permanent long-term solutions despite the difficulties in the short and medium term. This process is also a challenge to a structural problem that has remained unresolved despite many years of efforts.
With our liraization strategy, we are building the monetary policy pillars of our economic model and focusing on permanent reforms that will ensure sustainable price stability within the framework of free market dynamics. In line with the strategic global value of our country and matching the value added that our citizens have created with their unequalled human capital, we are determined to use our liraization strategy to ensure that the interest in the Turkish lira in the economy increases consistently, our national currency becomes the main payment instrument and store of value in our economy, financial resources are efficiently and evenly distributed for investment, employment, production and exports purposes, thereby establishing a permanent current account balance, and our financial architecture is designed in a way that will increase the effectiveness of monetary policy.
Our key priority is to resolve the problem of high currency substitution, which has been a structural problem in the fight against inflation for many years, as well as to achieve the sustainability of a permanent external balance via the liraization strategy. Also supported by macro- and microprudential measures, the sustainability of external balance will now accompany the strong balance in public finance and thus, the objective of achieving and maintaining price stability will be fulfilled.