Turkey's KKM Exit and the Road to Monetary Normalization: Implications for Currency Stability and Capital Flows

The phasing out of Turkey's FX-protected deposit scheme (KKM) marks a pivotal moment in the country's economic trajectory. Introduced in late 2021 as a desperate measure to shield lira deposits from the ravages of currency depreciation, the KKM became a costly crutch for a financial system struggling to adapt to a rapidly devaluing currency. By 2024, the scheme had drained nearly $60 billion from the state budget, a stark reminder of the limits of unorthodox policies in the face of structural imbalances. Yet, its decline—and the government's deliberate exit strategy—signals a shift toward more conventional monetary frameworks, with profound implications for inflation, investor confidence, and the lira's long-term viability.

The KKM Phase-Out: A Policy U-Turn

The KKM scheme, which allowed depositors to protect their lira holdings against exchange rate losses, peaked at $140 billion in 2023. By 2025, its value had plummeted to $11.8 billion, a reduction of 92%. This collapse reflects both the government's strategic exit and a growing trust in the lira. The Central Bank of the Republic of Turkey (CBRT) has played a central role in this transition, implementing measures such as limiting KKM returns to 40% of the policy rate and halting new corporate accounts. These steps, combined with a broader pivot to tighter monetary policy, have accelerated the scheme's obsolescence.

The KKM's demise is part of a broader policy reversal under President Recep Tayyip Erdoğan. After years of “Erdoğanomics”—a strategy of low interest rates to stimulate growth despite soaring inflation—the government has embraced higher rates to curb price pressures. The CBRT's repo rate, for instance, rose to 50% in March 2024, a level not seen since the early 2000s. This shift has been critical in anchoring inflation expectations, which have fallen from a peak of 75% in May 2023 to 33.5% by late 2024.

Investor Confidence and the Lira's Resilience

The KKM phase-out has been accompanied by a tentative but measurable improvement in investor confidence. Rating agencies have upgraded Turkey's sovereign debt, with Moody's raising its rating to Ba3 and S&P to BB- in 2024. These upgrades reflect a recognition of the government's fiscal discipline, a narrowing current account deficit, and the CBRT's commitment to disinflation. Foreign exchange reserves have also rebounded to $164 billion, a buffer that has helped stabilize the lira despite its ongoing depreciation.

Yet, the lira remains a volatile asset. In 2025, it has depreciated by 13%, a slower pace than in previous years but still a drag on confidence. The currency's long-term viability as a reserve asset is further constrained by its susceptibility to political shocks and high inflation. For now, the lira's role in global finance is confined to emerging market portfolios and regional trade, with no indication of widespread adoption as a reserve currency.

Capital Flows and Structural Reforms

The KKM's exit has also reshaped capital flows. As depositors shift from FX-protected accounts to regular lira deposits, the demand for foreign currency has declined, easing pressure on the central bank to defend the lira. This transition has been supported by higher interest rates, which have made TL deposits more attractive. By 2025, the share of KKM deposits in total bank deposits had fallen to 2%, down from 26.2% in 2023.

However, the lira's depreciation and inflation risks continue to deter foreign investors. While non-resident portfolio investment in Turkish assets reached $70 billion by mid-2025, this figure remains sensitive to geopolitical tensions and global liquidity conditions. The CBRT's forward guidance—projecting inflation to ease to 24% by 2025 and 12% by 2026—will be critical in maintaining market stability.

Investment Implications and Strategic Considerations

For investors, Turkey's transition presents both opportunities and risks. The shift to orthodox monetary policy has improved macroeconomic fundamentals, but the lira's volatility and inflation risks remain. Sectors such as technology, manufacturing, and infrastructure are well-positioned to benefit from lower inflation and a more stable currency. However, exposure to the lira requires careful hedging, particularly for long-term investments.

Investors should also monitor the CBRT's policy trajectory. A premature easing of monetary conditions could reignite inflationary pressures, while a sustained tight policy could support disinflation and attract capital. Currency-linked derivatives and ETFs offer tools to manage lira exposure, particularly for those seeking to capitalize on Turkey's structural reforms without bearing the full brunt of currency risk.

Conclusion: A Fragile but Credible Path

Turkey's exit from the KKM scheme is a necessary but incomplete step toward economic normalization. While the lira's depreciation and inflation remain challenges, the government's commitment to tighter monetary policy and fiscal discipline has laid the groundwork for renewed investor confidence. The lira's role as a reserve currency is unlikely to expand in the near term, but its gradual stabilization could enhance its appeal in emerging market portfolios. For now, the focus must remain on sustaining disinflation, reinforcing policy credibility, and navigating the delicate balance between growth and stability.

In the end, Turkey's economic future hinges on its ability to maintain this fragile equilibrium. The KKM's demise is a symbol of this transition—a painful but essential step toward a more orthodox and resilient economic framework.