Turkey has been fighting inflation for a while now. But the way it was doing that - letting the currency depreciate slower than inflation to appreciate in real terms - may have hurt exports and the country's trade balance.
If your currency loses value slower than inflation, it actually gets stronger compared to other currencies after adjusting for prices. That makes a country's exports more expensive for foreign buyers.
And that is exactly what happened. The volume of real exports remained largely flat from 2022 through 2024 before falling in the latter half of last year, leading to a worsening of the current account, according to Goldman Sachs economists Clemens Grafe and Basak Edizgil.
The economists wrote in a report on Monday that a current account widening resulting from diminished export competitiveness is a typical vulnerability in any disinflation effort, and they believe Turkish officials are well aware of this dynamic. They expect Ankara to allow a faster slide of the lira to focus on stabilizing external balances rather than solely on reducing inflation, "even if that implies disinflation will be slower".
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Consequently, the lira is forecast to fall versus the dollar at a yearly pace in the mid-20% range.
A faster currency decline does not happen in a vacuum. It needs support from interest rates to keep investors from fleeing and to prevent further dollarization - something Turkey has been working to reverse.
Turkey's central bank currently sets its key one-week repo rate at 37%. Grafe and Edizgil wrote that "given that financial stability depends on maintaining the current level of de-dollarization, a more rapid rate of depreciation implies that interest rates would need to stay higher than currently priced".
The economists further predict that Turkey's current account gap will reach 3.5% of GDP, approximately $60 billion, by 2026.
According to the economists, China has captured segments of Turkey's intermediate goods market, and rivals from Central and Eastern Europe have replaced Turkish products in European consumer-goods markets. They added that the gains in capital-goods and defense exports have not offset these declines.
This shift reflects a structural challenge for Turkey's export sector. Lower-cost producers and geopolitical shifts have eroded its traditional advantages, making it harder to rely on trade to narrow the current account gap. Policymakers now face a delicate balancing act: allowing the lira to weaken faster could restore competitiveness, but it risks reigniting inflation and undermining the de-dollarization progress achieved over the past year.
The decision will be a big clue about whether policymakers agree with Goldman's view or plan to keep fighting inflation as the top priority.
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