Turkey and the IMF
News Brief: IMF Approves US$1.5 Billion Tranche Under Stand-By Arrangement to Turkey
Free Email Notification
of Intent, Memorandum of Economic and Financial Policies, and Technical
Memorandum of Understanding
Ankara, July 31, 2001
Mr. Horst Köhler
Dear Mr. Köhler:
1. We have continued to implement forcefully our ambitious economic reform program. The applicable quantitative performance criteria for end-May and end-June were observed, and we have taken further important steps in banking and other structural areas (Annexes A and B). On this basis, we request completion of the ninth review under the stand-by arrangement. We also request modification of the ceilings for the performance criterion on the cumulative primary expenditure of the central government for the remainder of 2001, consistent with our revised annual inflation projections. Moreover, we request modifying the indicative ceilings on base money, and thereby the performance criteria on the net domestic assets of the Central Bank of Turkey, for the remainder of the year in line with our updated macroeconomic framework. All other performance criteria and indicative targets remain unchanged.
2. After a difficult first half, the economy is beginning to show a positive response to the strengthened program. GNP fell in the first quarter of 2001 by 4.2 percent year on year, and is expected to have fallen further in the second quarter. Moreover, the persistence of very high real interest rates and the contraction of domestic demand are burdening bank and corporate balance sheets and putting pressure on the enterprise sector, especially on the small and medium enterprises that account for the bulk of employment. On the other hand, signs of an incipient recovery are emerging: capacity utilization edged up by more than three percentage points from April to June, and the central bank's business surveys show increased confidence among respondents, partly because of surging exports and a boom in tourism. Moreover, the inflationary impact of the large February depreciation seems to have largely played itself out, and the inflation slowdown, which began in May, continued in June with 3 percent CPI inflation during the month. Finally, the slowdown and the depreciation of the Turkish lira have led to a marked turnaround in the external current account.
3. Looking ahead, we believe that further progress under the program, together with continued international financial support, will rebuild confidence, help lower interest rates, and facilitate the economic recovery. The May 3 letter, updated by the letter of June 26, remains the main document describing our policies for 2001-02, and is further updated in this letter in several areas. The major financial support from the IMF (some US$19 billion committed for 1999-2002) and the World Bank (US$6.2 billion committed for 2001-03) provides assurances of adequate official financing. Regarding private sector involvement, following the June 12-13 meetings with foreign commercial banks, we have sent letters to the participants, seeking their commitment to maintain their exposures to Turkey at mid-June levels, with a view to restoring December 11, 2000 exposures as the program is implemented. We have already received responses, and are following up with foreign banks that have had difficulties in maintaining their exposure. We believe that the policies and measures described in this letter are adequate to achieve the objectives of the program, but we stand ready to take additional measures if necessary to keep the program on track, consulting regularly with the Fund.
4. We are making strong efforts to explain our economic strategy and achievements under the program. In recent months, we have already taken a number of steps, including outreach efforts by the State Minister for Economic Affairs and other senior officials in Turkey, meetings with international investors abroad, the issuance of statements and the publication on official websites of material explaining the program, and the revamping of the Treasury's media relations unit to facilitate a more pro-active approach to explaining economic policies and developments under the program. We have also continued to publish the letters of intent, and agreed to the publication of the IMF staff reports. In the period ahead, we will hold regular domestic press conferences; seek to better explain economic policies; and hold additional road shows in major international financial centers and Turkey. Moreover, building on our already active contacts with international investors, we are exploring the scope for setting up a more formal investor council, as has been done in other major emerging markets countries. Such a council would help to further improve investor sentiment, reduce the volatility in capital flows, and strengthen our ability to monitor shifts in market perceptions.
5. We have revised our macroeconomic projections for 2001 in light of recent data. While the fall in output in the first quarter was somewhat greater than forecast, leading indicators of activity and export developments suggest an output recovery starting in the third quarter. Taking into account the decline in activity that has taken place so far, we now project a fall in real GNP for 2001 as a whole of 5½ percent, compared with the original program projection of a decline of 3 percent. Although the increase in inflation in the second quarter resulting from the initial depreciation of the lira was slightly above original projections, the recent decline in inflation indicates that our target of 2 percent monthly inflation by end-2001 is within reach. For the whole year, we now expect CPI inflation (December over December) to be 58 percent, compared with the originally projected 52.5 percent. For the next twelve months (June over June) we expect CPI inflation to fall to the 30-35 percent range. The external current account balance is expected to show a US$5 billion (3 percent of GNP) surplus for the year (compared with the originally projected broad balance), given continued strong tourism performance, the rebound in exports (especially in the automobile sector), and the fall in imports.
Fiscal policy and debt management
6. Fiscal policy has remained on track. Through end-May, the primary surplus of the consolidated government sector reached 3.4 percent of annual GNP, comfortably exceeding the program target by 1.7 percent of GNP. This was underpinned by overperformance of income taxes (especially the withholding tax on interest); delays in investment by extrabudgetary funds; and lower-than-projected expenditures in state enterprises, especially in the agricultural area. For the consolidated central government budget, we kept primary expenditures within the end-May ceiling, and for end-June, our cumulative primary balance remains above program projections by 0.2 percent of GNP. On the policy side, we expect the revenue impact of the recent overruling of the proposed VAT rate increase on telephones to be offset by departure levies for residents, and a fee on savings deposits.
7. We remain on track to meet our primary surplus target of 5.5 percent of GNP in 2001, as revenue overperformance is expected to continue and as state enterprise finances are better than expected. We expect higher inflation to more than offset the impact of lower growth on revenues, leading to an additional 0.2 percent of GNP in revenue during the second half of the year. Combined with the overperformance already realized during the first half (0.2 percent of GNP), and higher-than-expected rate increases realized at Türk Telekom in June (yielding 0.1 percent of GNP for the year), this provides room to offset the weakening in real public expenditures implied by the revision to the macro economic framework. In any case, should deviations emerge later in the year, we would reduce discretionary noninterest expenditures, and take revenue measures as needed to ensure attainment of the primary surplus target.
8. The increases in primary expenditures consistent with the new macroeconomic framework and the primary surplus target are intended either to maintain the original path for real public spending or to alleviate the impact of the crisis on the most affected. Some 0.4 percent of GNP of the increase will be reflected in the consolidated central government budget, and is due to inflation indexation of pension payments and civil servants' salaries and additional transfers to social security institutions to help them maintain health expenditures constant in real terms. The revised performance criteria on the ceilings on the primary expenditure of the consolidated central government reflecting this increase are shown in Annex C. While the more depreciated exchange rate could raise our utility and agricultural subsidy costs (which are defined in U.S. dollars), we expect to be able to contain the possible additional costs within the budget appropriations. Spending will also increase in the broader public sector by 0.1 percent of GNP, accommodating outlays financed by an expected World Bank loan to support the Social Risk Mitigation Project. This loan is aimed at increasing education, health, and other social spending on the poorest members of society. This reflects our continued emphasis on supporting and strengthening the social safety net, given recent economic difficulties. For all other spending items, we will adhere to existing budget ceilings.
9. We are taking further steps to strengthen the overall
fiscal position and to improve overall budgetary management. We are
preparing the 2002 fiscal strategy with a view to further increasing the
public sector's primary surplus to 6.5 percent of GNP. This will require
tight expenditure restraint, and in our budget call we have asked agencies
to limit their spending requests to a level consistent with no real increase.
We expect to finalize the central government budget proposal in October.
While spending will be restrained next fiscal year, we hope to see an
increase in the efficiency of spending through the implementation of a
new public procurement law. We expect to submit this law to parliament
by October 15, 2001 (a structural benchmark), after consulting with the
World Bank and EU. To further support our budgetary restraint and our
cash planning, we will begin regularly monitoring expenditure commitments.
Until our new computerized accounting system is operational (at the end
of 2001), and extended to include reporting of commitments, we will use
quarterly surveys as monitoring devices, beginning at the end of the third
quarter of 2001. To minimize the burden of taxation necessitated by our
expenditure plans, we will also seek to broaden the tax base. In this
context, last year we received technical assistance from the IMF on tax
policy and administration. We are now working jointly with the World Bank
to adopt a medium-term strategy for improving the tax system in Turkey
by end-2001. Finally, we continue to make progress on the extension of
tax identification numbers to financial transactions, expected to commence
on September 1, and we will intensify our efforts at collecting arrears
by setting strict performance standards for tax offices.
10. We are taking a number of steps to reduce the government's borrowing needs and costs so as to ensure the orderly rollover of government debt:
11. Confidence that Turkey's public debt burden is sustainable is a critical element of the program's success. Taking into account the more conservative assumptions on growth and inflation in 2001, Turkey's debt burden remains sustainable even if ex-ante interest rates were to remain close to the high averages of the past decade. To achieve sustained rapid growth—a basic objective of our program—a significant decline in real interest rates is required. In this regard, we believe that continued progress in implementing the program will further strengthen market sentiment and facilitate the convergence of interest rates and other macroeconomic variables to program objectives.
Monetary and exchange rate policy
12. We are moving ahead swiftly with our plans to introduce inflation targeting. To this end, the CBT has made considerable progress in strengthening its information base and accelerating its modeling and research efforts. Monetary policy decisions are already being increasingly guided by the inflation outlook. Since under this monetary framework communication with the public and markets will be important, we will also accelerate our efforts to establish mechanisms, including regular issuance of inflation reports, to ensure transparency and the effectiveness of monetary policy. The next inflation report will be issued by early October. In view of the expected improvements in the fiscal situation, the rapid progress on banking reforms, and the completion of the pass-through from the initial depreciation to prices, we intend to formally make an inflation target the nominal anchor of monetary policy beginning in the last quarter in 2001. At that time, we will announce an inflation target for 2002, supported by an indicative quarterly inflation path. In the meantime, the CBT will regularly assess the inflation developments and outlook and, based on this assessment, will adjust interest rates consistent with the disinflation objective. As the program is implemented and inflation continues to decline, we expect short-term interest rates to be on a declining trend, although the CBT stands ready to raise rates as needed to support a continued fall in inflation.
13. During the transition to inflation targeting, base money will remain the nominal anchor for the disinflation effort. In line with the updated macroeconomic framework, and more closely reflecting the seasonal behavior of currency demand, we have prepared revised targets for the monetary base (Annex D). To help achieve the base money target, the CBT will sell foreign exchange (see next paragraph) and adjust money market rates as needed.
14. Discretionary foreign exchange intervention will be limited to smoothing operations. Consistent with the program strategy, the CBT will continue to conduct two types of foreign exchange operations. First, the CBT will sell foreign exchange in the market to offset the impact on domestic liquidity of the use of external borrowing for the budget for domestic payments. To this end, the CBT will place all such external support in a special account. The portion of these funds which is used for domestic payments will be sold in pre-announced auctions. Second, the CBT may also intervene from time to time to smooth temporary exchange rate fluctuations. However, to avoid taking bets against the market, such intervention will be infrequent and in both directions, consistent with the floating exchange rate regime.
Banking sector reforms
15. We have continued to make rapid progress on banking sector reform. Commitment letters with plans to raise banks' capital to adequate levels by end-2001 have been signed with private banks identified as financially weak. Five banks that were unable to commit to credible recapitalization plans were intervened on July 10. Three of the four SDIF banks (Etibank, Interbank, and Esbank) for which no interest had been shown by potential investors were merged into a second transition bank (under Etibank) on July 2. Moreover, Bank Ekspres has been sold to a local group, and an international bank (HSBC) won the bid to further negotiate the sales and purchase agreement of Demirbank until September 20. Negotiations on the sale of Sümerbank are still ongoing. If no agreement can be reached about the sale, liquidation procedures will be initiated before end-September. We revoked the license of Emlak bank on July 9, and its banking assets and liabilities have been transferred to Ziraat, which has been adequately capitalized to absorb those assets. A monitoring system has been introduced to monitor profits/losses, liquidity, and interest rate margins of the state banks. The independent audit of the state banks has been completed, and outside advisors have been appointed to guide the operational restructuring of state banks. An omnibus law to facilitate the restructuring of the state banks as well as mergers of banks and their subsidiaries has also been passed.
16. Several further steps are being taken to strengthen the financial position of private banks:
17. We remain committed to resolving the banks taken over by the SDIF by end-2001, and will in the meantime continue the operational restructuring of these banks:
18. The work to prepare the state banks for privatization is moving ahead:
19. We will ensure that our strategy strengthens and consolidates viable banks. To this end, we have established basic principles for the resolution of the SDIF and undercapitalized private banks: (i) any bank to be sold or merged must be properly recapitalized upfront; (ii) the new owner must fully comply with the required "fit and proper" criteria; (iii) the new owner must also be able to provide a convincing business plan to ensure the bank's future profitability; and (iv) the recapitalized bank must be viable/profitable and be in compliance upfront with all prudential regulations. We will ensure that these principles are properly adhered to for all future bank sales or resolutions involving the BRSA or SDIF.
20. We will ensure that the BRSA has the legal right and financial resources to maintain and recruit qualified staff, with employment conditions in line with the institutions under its supervision. We realize that the soundness of the banking system to a large extent depends on the way in which the BRSA carries out its responsibilities, which in turn depends on the quality of its staff. Similarly, to maximize its loan recoveries and to minimize the cost imposed on taxpayers, the Collection Department within the SDIF will have the financial resources to recruit experienced private sector banking experts.
Privatization, business climate, and governance
21. The preparations for divestiture of large state-owned assets are advancing as planned. While market conditions will continue to guide the timing of asset sales, we are pushing ahead with the necessary preparations:
In sum, we remain confident that the expected proceeds from privatization of US$1 billion for the remainder of 2001 will be received as envisaged under the program.
22. We are also implementing planned steps to improve the business climate. The study on administrative barriers to investment by the World Bank (FIAS) was completed in June as envisaged. The executive summary of the report has been circulated to the relevant agencies for comments in preparation for a September workshop. An action plan will be presented to the Council of Ministers by end-September 2001.
23. We are also implementing our strategy to improve governance in the public sector:
24. We are taking steps to alleviate the impact of the temporary contraction of activity on viable private sector companies. We are channeling some of the long-term credits secured from the European Investment Bank and other sources to the small and medium enterprise sector. We are also protecting the funding of the Turkish Eximbank within the limits of our fiscal constraints.
Social dialogue and incomes policy
25. Our economic program respects the need for social consensus and social dialogue. To that end, we expect that the first meeting of the Economic and Social Council since its legal status was established will be held in August 2001. Moreover, to guide wage and price expectations, we have raised the minimum wage by 19.8 percent from July, consistent with projected inflation for the remainder of the year.
26. Finally, we are carrying out a number of enhanced social policies with the support of the World Bank. These include: (i) strengthened monitoring of the social impact of the crisis; (ii) preparations for the introduction of the unemployment insurance scheme from the middle of next year; (iii) strengthening the social safety net for the most vulnerable groups, especially children; (iv) providing cash benefits and re-insertion programs for workers displaced as a result of privatization; (v) protecting public expenditure on health, education and social protection at levels above the average of the last three years (as a share of GNP); and (vi) introducing direct income support to farmers during the remainder of 2001.
Very truly yours,
Table 3. Turkey: Performance Criteria on the Cumulative
1. The primary expenditure of the consolidated central government (Table 3) comprises the cumulative non-interest expenditure of the consolidated central government (consolidated budget). The quarterly ceilings will be monitored from above the line on a modified cash basis (the so-called consolidated budget adjusted non-interest expenditure).
2. For purposes of the program, primary expenditure (Table 3) will exclude tax rebates, transfers to Eximbank, treasury payments of guaranteed debt up to the quarterly baseline reported in Annex J of the May 3 MEP, and any payment related to bank recapitalization and to the restructuring of state banks.
3. The deficits of the social security institutions (SSIs) are covered by transfers from the central government budget. The ceiling on the primary expenditure of the central government (Table 3) will be adjusted downward for any increase in the expenditure arrears of the SSIs. Arrears of the SSIs are defined as those payments overdue by more than one month, and in the case of Bag Kur, exclude arrears to the common retirement fund. As of December 31, 2000, the stock of arrears of Bag Kur stood at TL 120 trillion, while the two other institutions had no expenditure arrears.
4. The ceiling on the primary expenditure of the central government (Table 3) will be adjusted downward for any off-budget expenditure of the central government.
Table 4. Turkey: Performance Criteria on the Net Domestic
Assets of the Central Bank of Turkey
1/ The compliance with the performance criterion (indicative target) shall be based on the average of the stocks prevailing during the five working days including and immediately preceding each of these dates.
1. The performance criteria and indicative ceilings on net domestic assets and base money have been revised. New targets are given in Tables 4 and 4a, which replace Tables 4 and 4a of Annex D of the June 26, 2001 MEFP.
2. The net domestic assets (NDA) of the Central Bank of Turkey (CBT) are defined as base money less the net foreign assets of the CBT valued in Turkish lira at end-month actual exchange rates.
3. Base money is defined as currency issued by the CBT, plus the banking sector's deposits in Turkish lira with the CBT. Indicative ceilings for base money are shown in Table 4.a below.
4. Net foreign assets of the CBT are defined as the sum of the net international reserves of the CBT (as defined in Annex F of the May 3 MEP), medium-term and long-term foreign exchange credits (net), and other net foreign assets (including deposits under the Dresdner scheme of original maturity of two years or longer and the holdings in accounts of the Turkish Defense Fund, but excluding CBT's net lending to domestic banks in foreign exchange. As of March 31, 2001, net foreign assets of the CBT amounted to TL 9,012 trillion.
5. The cumulative net change in the devaluation account from its balance at end-1999 (excluding any distribution of unrealized foreign exchange profits, in cash or through the write-off of government paper held by the CBT, since end-March 2001) will be subtracted from end-period NDA stock as defined above. The balance of the devaluation account at end-March 2001 was TL-1,380 trillion.
6. NDA ceilings will be adjusted for any change in the definition of the aggregate to which the reserve requirement applies according to the following formula:
where: R denotes the 4 percent reserve requirement plus the 2 percent liquidity requirement coefficient and denotes the change in base generated by a change in the definition of the reserve aggregate. The averaging period will not be changed during 2001.
7. NDA ceilings will be adjusted for any change in the reserve requirement coefficient according to the following formula:
where: B is the level of the base to which the reserve requirement applies on the test date and is the change in the reserve requirement coefficient and the liquidity requirement coefficient.
7. The NDA ceilings will be adjusted downward for any waiver of reserve requirements for any additional bank intervened by the BRSA. The adjustment will be equal to the existing reserve requirement coefficient times the amount of liabilities at these banks subject to reserve requirements.
Table 4a. Turkey: Indicative Targets for the Monetary
Base of the Central Bank of Turkey
1/ These ceilings shall be based on the average of the stocks prevailing during the five working days including and immediately preceding each of these dates.