The gradual downward trend in global inflation continued in 2024. However, inflation remained above the 2% target of advanced economy central banks, as the lack of a sharp contraction in activity and the absence of a significant weakening in labor markets affected services inflation. Throughout the year, geopolitical developments, political uncertainties, elections and the policy expectations arising from the election results caused volatility in both financial markets and commodities from time to time and hindered the disinflation process.
In 2024, the global economy is estimated to have grown by 3.2%, similar to 2023. According to the OECD, growth in 2025 is expected to remain below historical averages at 3.3%. The outlook remains that the developing countries will grow faster than the developed countries and that the European countries, our main trading partner among the developed countries, will diverge negatively. This outlook is expected to persist in 2025. Growth forecasts for 2024 and 2025 are 2.8% and 2.4% for the US and 0.8% and 1.3% for the euro area, respectively. In particular, the relatively weaker economic outlook in Germany, our largest trading partner, poses a downside risk to our external trade. China, on the other hand, is struggling to revive its economy and has recently implemented a comprehensive package of expansionary measures.
As global inflation rates gradually declined, central banks in the developed world also began to lower interest rates. The European Central Bank (ECB), which had cut rates for the first time in June in response to relatively weaker growth, lowered its key interest rate by a total of 125 basis points to 2.75% as of January. The Fed, on the other hand, began its first rate cut in September, reducing rates by a total of 100 basis points to 4.25%-4.50% in 2024 and left them unchanged in January. Uncertainty remains about the pace of rate cuts in the period ahead. In particular, the reaction of bond yields to the election of Trump as US President, whose policies are expected to be pro-growth and anti-inflationary, has been predictably upward. At its December meeting, the Fed also raised its inflation forecasts for 2025 and predicted a slower pace of rate cuts than in its September projections. The number of rate cuts for 2025 was reduced to 2 from 4 in September. Due to the slowdown in the European economies, the ECB is expected to continue to cut rates without slowing down in the first half of the year. While the high interest rate and resilient growth environment in the US keeps the dollar valuable against other currencies, expected growth and interest rate differentials support the 'strong dollar' trend. One of the main downside risks to global trade and growth in 2025 is how the US trade policy measures will be received by the countries concerned.
After closing 2023 with a growth rate of 5.1%, the Turkish economy maintained its strength in the first quarter of 2024 and started to slow down in the second quarter as the lagged effects of the tightening measures became more apparent. While demand continued to cool in the second half of the year, demand conditions declined to levels that would support disinflation and the composition of demand started to rebalance. In our view, the growth was around 3.0% in 2024.
The external balance improved significantly in 2024, despite weak external demand and the real appreciation of the Turkish lira. The 12-month cumulative current account deficit, which stood at $39.9 billion at the end of 2023, narrowed to $10.0 billion (0.8% of GDP) in 2024. However, the recent effects of real appreciation and the absence of a sharp contraction in activity suggest that the external deficit will widen in 2025.
Annual inflation continued to rise until May 2024, peaking at 75.4% due to cost shocks, strong demand conditions and base effects, and then fell sharply due to base effects and stood at 44.4% at the end of 2024. The stickiness in services inflation and inflation expectations that are not yet in line with the targets delayed the pace of deceleration in the underlying trend of inflation. Although monthly inflation rose to 5% in January due to periodical pricing, annual inflation decreased to 42.1%.
While the CBRT raised the policy rate to 50% with the increases in January and March, it continued to take additional steps throughout the year to maintain macro-financial stability, support the monetary transmission mechanism and sterilize excess liquidity. The tight monetary stance and quantity constraints pushed up lending rates. After the elections, depreciation pressure on the TL eased and the CBRT became a net buyer in the FX market, leading to a strong improvement in net reserves. From December, the rate cut cycle started in line with the projected disinflation path. The rate cuts in December and January brought the policy rate down to 45.0%. The rate cuts are expected to continue at a similar pace in the short term.
In 2024, the budget recorded a deficit of 2.11 trillion TRY and a primary deficit of 835.7 billion TRY. Thus, the budget deficit was in line with the year-end forecast in the MTP (2148.5 billion TRY; -4.9% of GDP). In the banking sector, despite challenging conditions, the non-performing loan ratio remained low at 1.8% in 2024, while the capital adequacy ratio remained well above the legal limit at 19.7%. As a result of the steps taken towards currency protected deposits (FXPD), the FXPD stock declined by $100.6 billion to $27.0 billion as of 7 February 2025 from its peak in August 2023. As a result, the share of FXPD in total deposits declined from its peak of 26.2% to 5.0%. The CBRT's net FX position improved significantly. Net foreign assets excluding swaps reached $72.5 billion as of 17 February (1 April: -$63.7 billion, total increase of $136 billion).
To sum up, 2024 was a period in which conventional monetary policy implementation gained weight to reduce macroeconomic imbalances, complex financial regulations for the banking sector were partially simplified and free market conditions were largely established. While a significant improvement in the current account balance was achieved, consumer inflation started to decline after peaking in May. With increased policy predictability and a decline in the country risk premium, external financing possibilities improved, foreign capital inflows and residents' preference for the lira strengthened. Thus, for the first time in a long time, a steady upward trend in CBRT reserves was achieved. However, the efforts to stabilize the economy have created some challenges for the banking sector. In addition to high funding costs and credit growth constraints, the decline in market volatility also limited the sector's profitability.
The Turkish economy enters 2025 on the back of falling inflation and the expectations that interest rate cuts will begin. However, the stickiness in services inflation confirms that the CBRT should maintain its tight monetary policy for a long time. We expect economic growth to remain below potential on a quarterly basis until mid-2025 due to the tight monetary policy, weak external demand and a tightening fiscal stance. The disinflation strategy based on the real appreciation of the Turkish lira is also expected to be maintained. The CBRT's year-end inflation forecast is 24%, but upside risks weigh on this forecast. With the improvement in macroeconomic data and the maintenance of the positive outlook, the country risk premium is expected to continue to decline, the sovereign credit rating is expected to continue to rise, capital flows are expected to continue with a healthier composition and dollarization is expected to maintain its downward trend. As earthquake spending declines, fiscal policy is expected to become less supportive of growth and more coordinated with monetary policy.
2025 will be a year when the worst is behind the Turkish banking sector. The projected decline in the policy rate and the expected easing of macroprudential measures will have a positive impact on the profitability of the banking sector. In the period ahead, it will be crucial to maintain monetary and fiscal discipline, establish predictability and confidence in policy-making, and steer the economy towards a sustainable growth path. With the political uncertainties behind us, the coming years create a favorable environment for economic recovery and rebalancing. The establishment of an environment of macroeconomic stability, in which inflation can be brought back to single digit levels and predictability increased, the reduction of the country risk premium, the expansion of external financing opportunities and the improvement of the investment environment will support the long-term growth potential of the financial sector.