CONTEXT
Prudent economic policies have achieved important successes. A reduction in the budget deficit from 4.7 percent of GDP in 2024 to a projected 3.6 percent of GDP this year, reflecting mostly continued expenditure restraint and improved tax compliance and administration has helped curb aggregate demand.[1] Inflation has gradually declined, from 49 percent in September 2024 to 33 in October 2025, and positive real policy rates, even after recent rate cuts, have maintained confidence in the lira. Growth reached 3.6 percent in 2025:H1, buoyed by earthquake reconstruction and a wealth effect from high gold prices. The current account deficit was 1.7 percent of GDP in the four quarters to 2024:Q2, after 1.3 percent in the year to 2025:Q2, and it remains well-funded; gross international reserves reached US$184 billion October 31. The financial system has stayed healthy.
But still-high inflation leaves the economy vulnerable and carries costs. The longer it takes to reanchor inflation expectations at a low level as envisaged by the CBRT, the higher the likelihood of a shock that refuels inflation, jeopardizing growth and financial stability. Furthermore, as the period of adjustment lengthens, reform fatigue may grow and inflation expectations may level or rise again, necessitating larger policy adjustments—with higher associated short-term growth costs to reach targets. At the same time, elevated inflation undermines financial sector deepening and general market efficiency, as shown by falling maturities for bank lending and the growing gap between corporate and SME profitability. It also adds to income and wealth disparities, including and asset price appreciation that disproportionately benefits high-income households.
OUTLOOK AND RISKS
The forecast envisages a smaller fiscal consolidation in 2026, which would loosen the overall policy mix. Based on announced policies and assuming continued revenue strength and expenditure restraint, the 2026 fiscal forecast projects the fiscal deficit at 3.7 percent of GDP, which is equivalent to a slightly negative cash fiscal impulse. In line with market expectations, monetary policy is expected to remain contractionary: interest rate cuts are expected to continue, but falling inflation expectations will support positive ex ante real rates around the current level while quantitative measures should remain in place, dampening monetary easing. Price and incomes policies are expected to be close to CPI inflation. Finally, as noted in the October 2025 WEO, energy prices are assumed to be stable and external demand to remain relatively subdued.
In the near term, GDP growth is expected to remain solid and inflation should continue to fall gradually. A sequential moderation in the second half would bring 2025 growth to around 3.5 percent. Falling policy rates and a less contractionary fiscal stance would support demand in 2026, with resulting stronger investment and consumption pushing growth to 3.7 percent. Inflation at end-2025 is forecast at 33 percent, above the CBRT target of 24 percent. Looking ahead, moderate wage growth and, as inflation falls, waning inertia will gradually bring down inflation. But an economy operating close to full capacity will slow this process and unfavorable recent inflation readings could indicate that current policies may not be tight enough to support further disinflation. Headline CPI inflation is thus estimated to reach 22 percent at end-2026. Boosted by midyear tourism receipts, the current account deficit would be around 1.4 percent of GDP in 2025, and remain at a similar level in 2026. Sustained depositor confidence and still-strong gold prices would allow continued modest reserves accumulation.
Inflation is projected to remain in double digits, and economic growth to fall short of its potential. Inflation would further decline, but stay double digits in the medium term. At such elevated levels, inflation weigh on investment and productivity, keeping GDP growth around 3.7 percent, below its pre-GFC trend. Benign commodity prices and external financial conditions are expected to keep the current account deficit moderate, but dollarization would remain high.
Risks have receded since last year, though they are still tilted to the downside. With demand strong and inflation expectations still not anchored completely, a shock—to energy prices, the exchange rate, or global risk aversion—could raise inflation expectations and spark higher inflation. A shift in domestic depositor behavior, particularly a shift toward gold or alternative assets, difficulties rolling over rising foreign exchange (FX) corporate debt, remain key vulnerabilities. Consumption could be affected by a gold price correction. The outlook also remains exposed to geopolitical shocks, a slowdown in tourist arrivals, or weak European growth. Trade risks, however, appear balanced, with limited direct exports to the U.S. and potential gains from trade diversion. On the upside, slowing growth could reduce price pressures more than expected, and rent increases may now have run their course, which would bring inflation down more quickly.
PUTTING TÜRKIYE ON A LOWER-RISK AND HIGHER GROWTH PATH
Additional policy effort is needed to bring inflation in line with the CBRT’s targets and strengthen resilience to shocks. Announcing and implementing a decisive and coordinated shift to tighter policies would help rebuild confidence and set inflation expectations on a clear downward path. Building on this year’s fiscal consolidation will be key and should be supported by higher real policy rates, greater exchange rate flexibility, and prudent incomes policies. This, together with a stronger social safety net, would offset the costs of prolonged high inflation on the economy and firmly place Türkiye on a more resilient and robust trajectory.
A lower-risk and higher-growth trajectory, however, would require tolerating short-term growth costs. Given that sacrifice ratios (i.e., magnitudes of output contraction needed to achieve disinflation) tend to rise as inflation falls, further demand compression will be necessary to bring inflation to the CBRT’s targets. The higher growth cost from tighter policies and rapid disinflation would be offset by a reduction in vulnerabilities and a sustainable convergence to Türkiye’s higher pre-COVID 2005–20 growth trajectory. Structural policies could help lower growth costs while reigniting productivity growth and reducing external vulnerabilities.
FISCAL POLICY
Accelerating disinflation and reducing risks will require continuing this year’s welcome fiscal consolidation. Fiscal measures above the baseline of around 1 percent of GDP in 2026 and 0.6 percent in 2027, along with lower interest payments, would reduce the fiscal deficit to 2.6 and 1.8 percent of GDP, respectively. This would lower domestic demand pressures, reinforcing tighter monetary and incomes policies. Revenue measures will be essential, including rationalizing generous corporate tax expenditures and incentives, simplifying the VAT structure by harmonizing rates across a broader base, and further improving tax compliance through digitalization, increased audits, and better coordination among revenue agencies. Expenditure cuts, such as phasing out energy subsidies while protecting vulnerable households and slowing absorption of non-essential capital spending, should also play a role. To minimize second round effects on inflation, noninflationary measures should be implemented first, while subsidy and VAT reforms could wait, in the context of strong implementation of the recommended tighter package of fiscal and monetary policies, until durable disinflation is underway. Recent reforms to reduce government contributions to the pension scheme are a step in the right direction, and ongoing initiatives to improve management of SOEs and PPPs should be continued.
Resources could be reallocated toward social goals. As inflation stabilizes, the deficit should return to the authorities’ 3 percent of GDP medium-term target, which remains appropriate given Türkiye’s low and sustainable level of public debt. Lower inflation and interest payments, as well as higher revenue from measures taken in 2026–27, would open around 1 percent of GDP in fiscal space that could be directed toward social priorities offsetting the increase in the cost of living that has disproportionately affected the poor. These could include cash transfers to vulnerable households, taking advantage of Türkiye’s strong targeting system, and changes to taxes and subsidies that would remove obstacles to greater labor force participation, particularly for women.
MONETARY AND EXCHANGE RATE POLICIES
Türkiye’s monetary policy framework has achieved important successes. Along with the policy rate, the current framework relies on quantitative tools such as credit growth ceilings and dedollarization targets, as well as exchange rate intervention. This flexible framework has brought down inflation without jeopardizing financial stability, and has allowed rapid responses to shocks. Moreover, the CBRT recently introduced a welcome distinction between inflation forecasts and targets, effectively introducing a nominal anchor. Building on this, CBRT communications now acknowledge the deterioration in sequential inflation outcomes and have appropriately signaled hawkishness, thus improving policy predictability.
Nonetheless, the context is challenging, and the use of multiple tools complicates CBRT communications and inflation expectations formation. Low corporate and household leverage and easy substitution into FX and, for large companies, borrowing from abroad, weaken monetary policy traction. Moreover, the effect of currency appreciation on inflation is reduced by high and sticky services inflation. Quantitative tools have supported disinflation, but they are less transparent than policy rates, they can potentially send conflicting signals, and they generate uncertainty about the CBRT’s potential response to shocks. This blurs the monetary stance and hinders communication, complicating loan pricing and expectations formation.
Achieving the CBRT’s inflation targets requires higher real rates, complemented by a framework firmly centered on the policy rate.
- Sequential inflation above levels consistent with CBRT’s targets, still-strong credit growth, and resilient aggregate demand warrant a higher real policy rate trajectory. This could be achieved by returning the policy rate to mid-2025 levels and postponing rate cuts until sequential inflation is consistent with CBRT targets.
- Dedollarization targets weaken interest rate transmission and credit growth ceilings distort bank portfolios, including by exempting credit cards, which have boosted consumption growth and inflation. They should be phased out before reducing the policy rate.
- Going forward, communication should aim at clearly explaining triggers for rate action. This will help to reanchor expectations.
- Reforms to protect central bank independence would also improve policy predictability and credibility.
Exchange rate policy should focus on smoothing excessive volatility that could dislodge inflation expectations. Foreign exchange intervention (FXI) has helped smooth lira volatility and respond to shocks that could destabilize inflation, but a sustained period of lira strength will eventually raise the risk of overvaluation and sudden adjustments. Macro adjustment aimed at bringing down inflation will reduce the need for FXI by helping reanchor inflation expectations. As this occurs and as reserve buffers recover, greater lira flexibility should be allowed. If high rates attract speculative inflows, reserve accumulation ceilings can add volatility, reduce carry trade attractiveness, and strengthen buffers.
INCOMIE POLICIES
Fully aligning wage and price setting with the disinflation strategy will reduce inflation inertia. Backward-looking indexation in wage setting at all levels , including of public sector wages, contributes to inertia and is thus an obstacle to disinflation; this should be phased out in favor of adjustments in line with forecast inflation. Regulated and administered prices (including public service tariffs) should be aligned in a forward-looking manner with underlying costs, avoiding one-off catch-up adjustments.
FINANCIAL POLICIES
The financial sector remains healthy, and the authorities have shown the ability to act swiftly and forcefully in the event of market stress. Banking sector profitability has declined from peak levels but remains in line with historical performance. Capital ratios and liquidity buffers remain adequate, and nonperforming loans, though rising, are appropriately provisioned. The share of FX deposits appears to have stabilized, and the authorities have skillfully phased out FX-protected deposits (so-called KKMs). Following financial market stress in March, the CBRT relaxed liquidity buffers, swiftly restoring financial stability and reassuring markets of the effectiveness of its policy toolkit.
While risks are broadly lower, FX liquidity risks need to be monitored. These risks stem from high dollarization and rising corporate FX indebtedness. At the same time, the level of gross reserves remains below the Fund’s reserve adequacy metric. Policy rates high enough to bring inflation down would also help contain FX demand, and the CBRT should continue to ensure that FX reserve requirements are set commensurate with potential risks. While appropriate for the time being, FX surrender requirements can be eased cautiously as FX liquidity conditions and inflation expectations improve, but lira short-selling restrictions should remain in place until broader financial liberalization is achieved.
The authorities should build on recent progress to strengthen supervisory frameworks. Recent changes to risk weights bring the supervisory framework closer to Basel standards and improvements to onsite supervision are welcome, and the authorities should continue to recognize and address credit and systemic FX liquidity risks. Banks calculate capital adequacy under market rates, but forbearance measures using older exchange rates could be dropped. Further enhancing the financial safety net, including bank resolution frameworks, and a timely review of emergency liquidity assistance would reinforce resilience. Finally, continued efforts to close crypto data gaps; monitor emergent risks, particularly from stablecoins; and integrate them into macroprudential frameworks are important to safeguard stability.
STRUCTURAL POLICIES
The growth cost of disinflation can be partly offset by productivity-enhancing reforms to labor and product markets, as well as legal frameworks. Tertiary education incentives could be better aligned with labor market needs, digital and vocational training expanded, and links between universities and the private sector strengthened. To support productivity across the economy, improvement in areas such as stronger protection of property rights, contract enforcement, and judicial integrity would be helpful, alongside reforms to product market regulations and anti-corruption efforts. Targeted measures for small- and medium-size enterprises (SMEs)—such as regulatory reforms, an SME-specific insolvency regime, and improved monitoring and support from the SME Development Organization—would address their productivity challenges and constrained access to finance, promoting inclusive economic growth.
Finally, reducing Türkiye’s vulnerability to global energy price fluctuations would enhance resilience. Notable progress has been achieved in expanding the share of renewables in the electricity sector. Wind and solar energy now comprise 22.4 percent of total generation, lowering the current account’s sensitivity to energy price shocks. The authorities’ ambitious goal of raising renewable capacity from 32 to 120 gigawatts by 2035 would raise renewables to around half of electricity generation, further diminishing reliance on hydrocarbons and strengthening the current account. The recently enacted climate law sets the foundation for Türkiye’s Emissions Trading System which is expected to align incentives effectively and mitigate potential adverse impacts of the EU Carbon Border Adjustment Mechanism.
The IMF team is grateful to the authorities and private sector counterparts for their kind hospitality and constructive and fruitful discussions.
[1] Authorities’ definition. Under the IMF definition, the deficit has fallen from 5.0 to 3.6 percent of GDP.