Turkey and the IMF
News Brief: IMF Managing Director Sees Impressive Commitment by Turkey to Economic Reforms; Executive Board Approves US$16 Billion Stand-By Credit
Country's Policy Intentions Documents
Mr. Horst Köhler
Dear Mr. Köhler:
After a very difficult year, the Turkish economy is beginning to show concrete and promising signs of recovery. The economic program that we have been implementing with your support is producing results. The structural reforms which we are continuing to enact are creating the legal and institutional infrastructure needed to realize Turkey's considerable growth potential. Strict fiscal discipline and a freely floating exchange rate have facilitated the re-establishment of macroeconomic equilibrium, and the ratio of debt to GDP and to exports is starting to decline.
The September 11 tragedy caused a serious threat to our progress. Interest rates rose, our currency lost value, foreign investors delayed their decisions, and our financing plan for 2002 was called into question. We responded quickly and decisively. The year 2002 budget proposed to Parliament in October and now passed further raised the primary fiscal surplus to 6.5 percent of GDP. We established an accelerated schedule for further structural reforms, including strong measures to support private sector development, improve the effectiveness of public administration, reform the tax system, and complete the ongoing strengthening of the financial sector. Your action in support of our program, including your intention to seek IMF Executive Board `s approval of our request for US$10 billion in new financing for the year 2002, is critical and has helped us reestablish market confidence. Our determined policies, together with the support of the Bretton Woods institutions, are now beginning to show results.
Attached is a new Letter of Intent prepared by Minister Derviş and Governor Serdengeçti. It summarizes the government's economic objectives, as well as the policy measures we are going to take in 2002 and beyond. It presents a medium-term strategy which has the full support of the coalition parties and which is designed to take Turkey forward on a path of rapid, sustainable and equitable growth. We value the International Monetary Fund's continuing support, and we trust that our joint efforts will allow Turkey to achieve the ambitious but necessary economic and social goals embodied in our economic program.
With best regards,
Mr. Horst Köhler
Dear Mr. Köhler:
1. From the outset, Turkey's economic reform program has had two main goals: conquering the chronic and persistent high inflation of the 1990s, and overcoming the associated macroeconomic instability which has constrained our economic growth. Although the original three-year program initiated in December 1999 has had to be adapted and strengthened in the light of events, including the February 2001 crisis, we have made considerable progress. We have implemented a major fiscal adjustment to help bring about debt sustainability. We have reformed the banking sector through an operational and financial restructuring of public banks, and a strengthening of the regulation and supervision of private banks. We have also pursued disinflation both under the original crawling peg regime and following the float in February 2001. Finally, we have deepened the role of the private sector in the economy, including through reforms to facilitate privatization.
2. Our revised program, adopted in May 2001, was beginning to achieve its aim of restoring investor confidence in the wake of the two crises, when the events of September 11 hit. From early August onward, as confidence began to return, interest rates started to fall, and the Turkish lira stabilized. The events of September 11, however, hit Turkey particularly hard, given our debt situation and our location. This severe external shock is affecting the Turkish economy through several channels: weaker demand in industrial countries, lower tourism receipts, reduced access to international financial markets, and poorer privatization and foreign direct investment prospects. This has resulted in a projected external financing gap of US$10 billion in 2002, and weaker short-term economic growth prospects.
3. We have responded to the fallout of September 11 and Turkey's ongoing economic problems by deepening and extending our economic program, building on our earlier reforms. The Turkish economy is entering 2002 with greater strength thanks to the reforms carried out so far, but is still facing very important challenges. Chief among them is the reduction of inflation to the targeted 35 percent, the resumption of growth which should continue to be export led, and the more rapid extension of the benefits of growth to the lower-income groups. We are determined to build on the positive results that have emerged at the end of 2001 thanks to the success of our fiscal policies, the competitive exchange rate, and the enactment of many important structural reforms. Despite the progress made, Turkey continues to face difficult macroeconomic and structural policy challenges, including a substantial public debt burden, high inflation, banking sector difficulties, and extensive state involvement in the economy. To tackle these problems, while addressing the repercussions of September 11, we have decided to adopt a strengthened medium-term economic program.
4. This letter lays out in detail our economic program for 2002-04, and requests a new stand-by arrangement in its support. Based on our balance of payments needs, and our strengthened policies described below, we request the approval of a new stand-by arrangement in an amount equivalent to SDR 12,821.2 million for the period January 2002 through December 2004. The current stand-by arrangement (2000-02) will be cancelled upon approval of the new arrangement. We will use the equivalent of SDR 4,916.4 million of what becomes available upon approval to repay outstanding resources under the Supplemental Reserve Facility. Annex A summarizes the main macroeconomic indicators under our program.
5. The program will be monitored through regular reviews, prior actions, quantitative performance criteria and indicative targets, and structural performance criteria and structural benchmarks. The reviews will be held bimonthly in March, May, and July 2002, and quarterly thereafter (starting in October 2002) for the duration of the arrangement. Annex B summarizes the quantitative performance criteria and indicative targets, while the structural conditions are listed in Annex C.
Objectives and strategy for 2002-04
6. Our program aims to insure the economy against future crises and lay the basis for sustained noninflationary growth. First, the program will improve the economy's resilience to shocks and reduce its vulnerability to future economic crises, by (i) maintaining the exchange rate float and using inflation targeting to deliver a significant reduction in inflation, (ii) pressing ahead with bank restructuring, and (iii) ensuring a viable government debt position. Second, the program will involve fundamental structural reforms aimed at raising Turkey's growth potential. Achieving these objectives will also help move Turkey closer to the goal of EU membership.
7. For 2002, our priority will be to restore financial and macroeconomic stability, and to further progress in structural reforms. To this end, we will ensure that our ambitious public sector primary surplus target of 6½ percent of GNP will be met. This, together with our active and flexible debt management strategy, should ease government debt rollover. We are also determined to deepen our structural reforms to build on the important results achieved so far. While in 2001 the sharp devaluation after the float of the Turkish lira in February and the September 11 shock raised CPI inflation to 68.5 percent, in 2002 monetary policy will be consistent with our 35 percent inflation target. Although real GNP is estimated to have declined by 8½ percent in 2001, a moderate economic recovery started in the third quarter, and is expected to continue in 2002. In light of the negative impact of the recent events on exports and tourism and our commitment to disinflation, we project real GNP growth in 2002 conservatively at 3 percent. We believe, however, that this projection has upside potential. As regards the external current account, we expect the September 11 shock, the economic recovery, and a modest rebound in the real exchange rate to result in a deficit of about US$2 billion in 2002, following an estimated surplus of a similar size in 2001.
8. For 2003-04 and beyond, our key objectives are sustainable growth, together with continued disinflation and a viable debt position. Continued implementation of prudent financial policies and structural reforms will lay the basis for higher growth of at least 5 percent annually in 2003 and beyond. The move to an inflation targeting framework will underpin our disinflation efforts. Recovery in world demand and the impact of structural reform on the competitiveness of our economy will support the current account. In this context, we expect government debt to show a marked declining trend relative to GNP, and the external current account position to be fully financed, with foreign exchange reserves at safe levels.
9. In support of these objectives, we will pursue a multi-pronged economic policy agenda in 2002-04:
10. Within this overall framework, economic policy will respond flexibly to unforeseen developments. Economic prospects and the balance of payments will depend on the duration and effects of the September 11 shock, and on the restoration of investor confidence. If the balance of payments outturn were better than predicted, we would in the first instance allow a build-up of foreign exchange reserves and adjust monetary policy to safeguard the inflation target. Should the overperformance be large and persist, with the overall debt position better than expected, we would also be prepared to make repayments of Fund resources ahead of schedule, or refrain from drawing scheduled disbursements. In the event developments are less favorable than anticipated, the program's prudent fiscal and monetary stance and strong reform agenda should help reassure markets and thus insulate Turkey. Nevertheless, we would further strengthen fiscal policy as needed to ensure that the debt situation remains manageable should the circumstances deteriorate markedly and market confidence be slow to return. 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 our program on track, in close consultation with the Fund. We will also consult with the Fund on its balance of payments policies after the expiration of the arrangement, in line with the Fund's policies on such consultations, while we have outstanding purchases in the upper credit tranches.
The program for 2002
11. We are putting in place a fiscal framework to increase the public sector primary surplus from the targeted 5.5 percent of GNP in 2001 to 6.5 percent of GNP in 2002. Even under the difficult economic conditions, we met all of our primary surplus targets through end-September with considerable margins, and expect to have met our full-year target as well. We will continue with this strong implementation in 2002, in view of our need to achieve a more sustainable debt situation. We have made some minor and neutral changes to our fiscal framework for 2002, due to changes in the macroframework. We expect much weaker-than-programmed oil prices and projections for a stronger-than-programmed currency to lift the primary surplus in our energy SEEs, which are large importers. The primary surplus, however, is now expected to be lower for the consolidated budget, since a higher price level will feed fully through to indexed wages and pensions, but in the case of revenues, be partially offset in impact by lower growth.
12. In support of our fiscal target for 2002, we have specified about 2 percent of GNP in new measures (detailed in Annex G of our letter of November 20), and have already implemented many of them. On the revenue side, we have passed a Finance Bill implementing changes in specific excises, raised the petroleum consumption tax (PCT) and extended it to natural gas, doubled property tax rates in metropolitan areas, amended the Construction Law (to allow our electricity metering program to proceed), and raised prices and eliminated discounts and exemptions in key SEEs. We have also passed a budget law reflecting most central government expenditure measures, and issued circulars to implement tighter cost controls in the health sector. Finally, we have instructed SEEs in the Annual Investment and Financing Decree and in three circulars to implement all cost savings measures in their budgets. Treasury auditors will monitor SEEs' compliance with these measures on a quarterly basis.
13. We will also implement as prior actions a number of additional measures to help achieve the 6.5 percent of GNP primary surplus target. On the revenue side, the Council of Ministers will approve a reduction in the share of central government tax revenues accruing to metropolitan municipalities to 4.1 percent. On the expenditure side, we will issue a circular to implement our attrition rules, and the Minister of Finance will approve a reallocation of spending to ensure adequate funding for Direct Income Support (DIS) for small-scale farmers. The reallocation is needed, because the budget approved by parliament did not reduce agricultural premia and increase DIS to the extent intended, and it involves reducing transfers to the sugar and electricity companies to fund an increase in it.
14. A few measures will be done later in the year, because they require more time. In early February, we will increase the PCT (on items excluding natural gas) by 1 percent in real terms. By end-March 2002 (as a structural benchmark), the Minister of Finance will identify savings from closing regional administrations and other regional line agency offices, and block relevant budget appropriations in the budget, and SEEs will approve budgets in line with the cost reductions mandated. Throughout the year, to safeguard government revenues we will refrain from introducing any new tax exemptions or incentives, except those specified in our tax reform plan (discussed below). Moreover, to safeguard SEE revenues, we will refrain from introducing any new discounts or exemptions for SEEs, except those pursued for commercial reasons by enterprises' managements.
15. We have expanded our monitoring to additional elements of the public sector for 2002. In addition to a performance criterion on the primary surplus of the consolidated government sector (Annex D), the program will include a semiannual indicative target on the primary balance of other elements of the public sector (Annex E). For 2002, this new target covers the social aid and solidarity fund, 10 SEEs, all revolving funds in education and health, special provincial administrations, and a municipal development bank. For 2003, it will also cover 10 more SEEs, and municipalities with a population of over 50,000. The program will also include an indicative target on the overall balance of the consolidated government sector (Annex F). A baseline for net lending has been specified (Annex G), below which amounts will not be counted toward our primary balance performance criterion. In 2003, all net lending will be counted toward our target.
Public debt management
16. In the last few months, the Treasury has been able to lengthen the maturity of domestic debt issuance and widen the range of investor participation, notwithstanding the turbulent conditions in world markets. We lengthened the average maturity of Treasury bill issuance to nearly 6 months in November, the longest since May, which illustrates growing market confidence. Retail investors augmented their securities holdings, spurred by the recent increase in the tax exemption threshold and improving domestic market conditions. With demand from insurance companies and foreign investors also on the rise, this diversified the investor base. Meanwhile, the Treasury issued US$1.5 billion in international bonds during the final quarter of the year, exceeding expectations under difficult international market conditions.
17. For 2002, we expect that additional external financing and the strong financial position of state banks will limit the domestic borrowing needs from the private sector to comfortable levels, facilitating a smooth rollover of the government's domestic debt. With stable growth in the state banks' deposit base expected to continue in 2002, these banks will be able to eliminate any remaining short-term liabilities, and at the same time contribute toward meeting the domestic financing needs of the budget through the swapping into longer maturities of the bonds held by the state banks. Available external financing will further reduce domestic borrowing from the private sector. Our borrowing program is based on a conservative assumption of US$2½ billion in international bond issues in 2002, augmented by the use of some US$7 billion in external support from the Fund (prudent external debt limits will be monitored through the performance criteria outlined in Annexes H and I). The residual financing needs, while large, are expected to be well within the ability of the domestic private sector to absorb. Taking all the above into account, we estimate the required private sector rollover ratio in 2002 to be a manageable 85 percent.
18. Beyond this, we will take several new debt management initiatives in 2002 to improve the robustness of the debt program to periods of market weakness, reduce remaining market concerns about the rollover, and diversify the investor base. In Treasury bill auctions and public offerings, we will continue to lengthen average maturity to the extent demand allows and to encourage a diverse range of investors. This should further reduce the gross borrowing requirement from the market, and hence the private banks' rollover ratio. We will also provide instruments and a market structure which seek to ensure that banks continue to play a major role in the funding of government debt. Accordingly, in issuing new domestic debt we will pay particular attention to the need to allow banks to match their foreign exchange and interest rate exposures.
19. Specifically, our new initiatives will include the following:
20. The main goal of monetary policy will be to reduce inflation to 35 percent by end-2002. The CBT will achieve this goal by initially using base money targets and later, as the preconditions are met, through the introduction of formal inflation targeting. To achieve this goal, we have developed a monetary program that sets performance criteria on the level of base money. Through 2002, we will target base money growth of 40 percent, in line with projected 3 percent real output growth and our target of 35 percent inflation. However, as the experience in 2001 has shown, the demand for base money is difficult to predict. Thus, during program reviews an assessment of base money demand will be a focus area, with targets for base money adjusted should money demand show signs of deviating markedly from program projections. In such assessments, indicators such as dollarization of deposits, velocity and currency movements, and yield curve indicators will be monitored closely.
21. In May 2001, we took the first crucial step toward inflation targeting, by granting the CBT full operational independence to pursue the goal of price stability. Throughout the turbulence in financial markets of the past year, we believe that CBT independence has helped stabilize monetary policy, keeping inflation from spiraling out of control. Looking ahead, we will ensure that any new laws or regulations do not undermine the independence enshrined in the CBT law. With confidence now showing signs of improving, the CBT's independence will play a crucial role in delivering a significant and sustained reduction in inflation.
22. We are taking important steps to fulfill the remaining conditions for the successful launch of inflation targeting. First, we have sustained our efforts to raise the public sector primary surplus and to improve debt management. This has put the public finances in significantly better shape which, in time, will give monetary policy greater freedom to reduce inflation. Second, we will continue to strengthen the banking system which, as a side benefit, will considerably ease the pressures facing monetary policy. Third, we believe that our strengthened economic program will sustain the recent improvement in financial market conditions, increased confidence in the Turkish lira, and exchange rate stability. Together with our adherence to the program's money supply targets, monthly inflation should soon fall quite sharply and, with it, expectations of inflation for the remainder of the year. Fourth, we will continue our technical preparations for the introduction of inflation targeting, including improved modeling and forecasting of inflation, highlighted in the CBT's inaugural Monetary Policy Report of November 2001--the forerunner to a quarterly Inflation Report. We believe that these four steps will play an important role in meeting all of the pre-conditions for successful inflation targeting by mid-year.
23. In support of the early introduction of inflation targeting, we are strengthening incomes policy and taking steps to reduce backward indexation in the economy. We recognize the need to move to a system of wage and salary determination that focuses increasingly on productivity and profitability rather than inflation. To this end, we will seek a significant reduction of the ex-post indexation element contained in current contracts during the next public worker collective bargaining round and civil service salary adjustment, and will use the Economic and Social Council as a forum for incomes policy discussions with the private sector. We will also consider the possibility of reducing backward indexation of administered prices, without compromising SEEs' financial conditions.
24. We will maintain the floating exchange rate regime, which is central to our monetary policy and the sustained reduction of inflation. Since the beginning of August, the CBT has almost completely refrained from discretionary foreign exchange intervention, limiting itself to pre-announced auctions, which in recent months have been daily. We will continue to strictly limit discretionary intervention outside the pre-announced auctions. In December, reflecting the lack of need for sales in that month, the CBT discontinued these auctions, a move well received by markets. However, significant external assistance to the budget will continue in 2002, and we will still need at times to make foreign exchange sales to convert this assistance into Turkish lira as needed for domestic payments. As in 2001, any such sales (or any purchases which may be needed to build up reserves) will be conducted in an orderly and predictable way, and not used to defend a particular level of the exchange rate. Specifically, any such sales will be effected through pre-announced auctions.
25. We are also introducing reforms to improve the working of the money and foreign exchange markets:
26. Implementation of the monetary program will be monitored through performance criteria on the monetary base and net international reserves (NIR), and indicative limits on net domestic assets (NDA). As outlined above, until the introduction of inflation targeting the main anchor of the monetary program will be the monetary base. Performance criteria on base money and indicative targets for NDA are presented in Annex J. In addition, performance criteria for NIR are designed to allow the use of US$7 billion out of the US$10 billion external financing under the program to ease pressures in financial markets (Annex K). Developments in this area, including the behavior of interest rates, NDA and NIR, will be monitored in close cooperation with the Fund, between and during the reviews, to ensure that program objectives are achieved.
27. The program aims to continue the strengthening of the banking system and oversight framework that has been underway since 1999. The focus is on measures to strengthen private banks, resolve intervened banks (those under the control of the Saving Deposit Insurance Fund, or SDIF), further improve the efficiency of state banks (with privatization the final goal), put in place frameworks for dealing with nonperforming bank loans, and further improve prudential regulation and supervision.
28. In 2001 we completed the financial restructuring of state banks, and for 2002 our objective is to conclude their operational restructuring. We have recapitalized Ziraat and Halk banks and reorganized them under new professional management. We expect them both to resume normal lending to the real sector and to be profitable in 2002. We will also pass the necessary legal amendments and issue a Council of Ministers' decree for staff reductions to continue the operational restructuring that is already underway (prior actions). By end-June 2002, we will reduce the number of branches by 800 (structural performance criterion). In this context, we will also reduce staffing correspondingly. For Vakif Bank, a privatization advisor is doing due diligence analysis, and we have invited potential investors to indicate their interest in the bank and submit bids in May.
29. We are introducing a comprehensive plan to further strengthen the private banking system so that it can perform its crucial role of financial intermediation to the real sector. In the first stage, we took over the weakest banks in the system. However, continued financial market turbulence has caused market losses and weakening economic conditions are causing loan losses, worsening the financial position of many banks. The capital-strengthening program implemented in 2001 brought in substantial amounts of private capital, but will not be sufficient. We have therefore initiated a strategy to ensure the soundness of the Turkish banking system, which we see as a precondition for banks to resume normal lending to the economy. The strategy will start with a rigorous and targeted evaluation of banks' loan portfolios and other counterparty risks. This will be accompanied by a public support scheme, which allows the SDIF to make equity and subordinated debt investments in viable private banks, provided that their owners meet certain capitalization targets. The scheme seeks to maximize private capital contributions, minimize the cost to the government, and bring about further rationalization of the banking sector. Once banking sector soundness has been restored, the general guarantee can be lifted with due prior notice.
30. The rigorous evaluation of banks' loan portfolios is an essential element of the new support scheme, providing a clear basis for investors and the government to inject necessary new capital into the banking system. In January 2002, the BRSA will issue guidelines to be applied in the evaluation, including the use of uniform criteria (prior action). The targeted evaluation of loan portfolios, collaterals, and certain other exposures will be performed by banks' existing external auditors, and will be completed by end-March 2002. Third-party auditing firms will be appointed by the BRSA by end-March 2002 to verify that the guidelines have been followed, and to ensure the integrity of the process (structural benchmark). The BRSA will complete the final interpretation of the evaluations by end-April 2002, and by May 15, 2002 will send letters to banks stipulating required actions on the basis of this interpretation (the latter is a prior action for the second review). Any losses identified in the evaluation will be fully absorbed by writing down existing shares. The evaluation results will be incorporated into banks' end-June 2002 financial statements.
31. Public capital support will be provided to solvent private banks whose owners are prepared to raise equity to certain thresholds. The support will be provided on a one-time basis. Owners of solvent banks can have their Tier-1 equity contributions matched by equity provided by the SDIF. Capital contributions in cash in 2001 will be counted as owners' contributions, except for amounts needed to cover negative net worth. SDIF equity contributions will be against a pledge of shares from banks' majority shareholders. In addition, banks that participate in the scheme will give the SDIF board representation and selective veto rights, and will adhere to restrictions on the distribution of profits as long as the SDIF remains an owner. To qualify for SDIF support, a bank or group of banks to be merged must have a market share of at least 1 percent of total banking system assets. In case there are banks that are insolvent or severely undercapitalized and unable to raise sufficient capital to participate in the scheme, they will be taken over and resolved by the BRSA and the SDIF. In addition to equity support, banks with a Tier-1 capital adequacy ratio (CAR) of at least 5 percent may qualify for convertible subordinated debt (Tier-2 capital) contributions from the SDIF, up to a CAR of 9 percent. The scheme will be administered by BRSA jointly with SDIF, which must receive applications for participation in the scheme before end-May 2002. Banks will make preparations for their participation in the scheme while the valuation assessments are going on, and the scheme will be completed before end-June 2002.
32. We expect that the legal framework for the scheme described above and related regulations will become effective in January 2002 (prior actions). On January 10, 2002, parliament passed the relevant legal amendments. Once effective, the amendments will create fast track procedures for calling shareholders' general assemblies, writing down existing capital, and raising new capital; assign a special commercial court to deal with all issues related to the support scheme; and limit the scope for shareholders and other parties from interfering in the implementation of the scheme. The amendments will also make more precise the conditions for the BRSA to intervene in, and SDIF take control of, chronically and severely undercapitalized banks before they become insolvent, to facilitate least cost solutions for the government. Details of the scheme, including the SDIF's rights as shareholder as well as the terms for the SDIF's exit from the scheme, will be regulated by the BRSA and announced in January 2002. Given the complexity of the legal issues involved, the BRSA will undertake legal consultations, as necessary, to ensure implementation of the public capital support scheme as planned.
33. We remain committed to the speedy resolution of banks taken over by the SDIF. With the exception of two banks, whose resolution has been halted by courts, all SDIF banks taken over before November 2001 were resolved by end-2001 (meeting a prior action). Their deposits, together with matching government securities, were successfully auctioned off to other banks. Most interbank liabilities with matching government securities were transferred to Ziraat. The SDIF will, however, retain one small bank with a small staff and branch network as a bridge bank with its operations strictly limited to asset management purposes; this bank will not accept deposits. The bank will be funded through the SDIF. Remaining assets and liabilities have been transferred to the Collection Department of the SDIF. The medium-size bank taken over in November 2001 is for sale; its final resolution method will be determined and initiated by February 2002.
34. The SDIF will make strong efforts to deal with nonperforming loans and collaterals. The SDIF is developing a strategy and procedures for dealing with these assets with the assistance of a consulting firm, and is recruiting additional staff to deal with the large volume of problem assets. Transparency of SDIF's operations is essential, given the complexity of its transactions and the large funding it receives from the Treasury. Accordingly, the SDIF will prepare a monthly balance sheet starting end-March 2002 and become subject to annual external audits. The external audit for 2001 will be completed by end-April 2002 (structural benchmark).
35. We will take a number of measures to further strengthen the legal and regulatory framework:
Corporate debt restructuring
36. We are strengthening the framework for corporate debt restructuring to complement the restructuring of the banking sector. The existing legal, judicial, and institutional frameworks are inadequate for the scale of restructuring that is needed. As a first step, in January 2002 we will introduce a voluntary market-based framework (the "Istanbul Approach") for dealing case-by-case with multicreditor exposures to large and medium-size borrowers. A Technical Secretariat has been established under the Bankers' Association to monitor progress and an Arbitration Panel to resolve disputes. For its part, Halk Bank is renegotiating with and extending credit to small and medium-size enterprises, both at market terms. Given the need to accelerate the debt restructuring process, we will in early 2002 create a multiagency Coordination Committee with private sector participation under the Treasury. This Committee will be responsible for facilitating and monitoring the corporate debt restructuring process, as well as identifying and proposing the removal of impediments that may exist.
37. To facilitate corporate debt restructuring, we are also undertaking a major review of the bankruptcy and foreclosure frameworks, which will be overhauled as needed. This will complement our ongoing work of modernizing our Civil and Commercial Codes to conform with EU rules and directives. A World Bank Report on Standards and Codes (ROSC) on Turkey's insolvency regime is expected to be completed in January 2002. The Ministry of Justice will prepare an action plan based on the findings of that report and existing reform proposals, and form a Commission to prepare necessary amendments to the Bankruptcy Law. We will also support the upgrading administrative procedures in the judiciary to improve the capacity of the courts.
38. Financial disclosure of companies and especially of large corporate groups will be improved, and corporate governance standards strengthened. The Capital Markets Board (CMB) will introduce international accounting standards, including inflation accounting provisions, by January 1, 2003. Starting end-March 2002, the CMB will require corporate groups to provide consolidated financial statements, and will set up a dedicated group to monitor their finances. As of the same date, the CMB will also require corporate groups with financial affiliates to provide consolidated group statements and share those statements with the BRSA.
Public sector reform
39. We will significantly strengthen the central government's underlying fiscal position by implementing our ambitious public sector reform program. In particular, we will aim to increase expenditure efficiency (allowing more to be done with less), and reform the tax system (to broaden the base and make it more sustainable), and the civil service (to increase efficiency and improve the quality of the public service). To alleviate the impacts of these actions on the most vulnerable members of society, we will enhance and better target our social spending (paragraph 43 below).
40. Our key reform initiatives for the central government include the following:
41. We expect the biggest improvements in public resource use and the underlying fiscal position to arise from reductions in overstaffing, especially in inefficient SEEs. This will reduce the necessity for aggressive public sector price increases, thereby supporting disinflation, improve the efficiency of enterprises, and in many cases help to prepare the ground for privatization. Supported by a Prime Minister's circular issued on December 3, 2001, we have already initiated a voluntary retirement scheme for public sector workers. 15,000 individuals will have been retired or notified of their retirement by mid-January 2002 (prior action). We have also recently identified (with World Bank assistance) redundant workers in Türk Telekom and in the Privatization Agency portfolio of companies, and we will extend voluntary retirement offers to the individuals occupying them. For those who accept, we will provide payments, and allow them to retire, no later than end-March 2002. Also by end-January 2002, we will (i) identify all redundant workers and positions in SEEs (updating and expanding our earlier analysis); and (ii) eliminate all open, unfilled redundant positions (prior actions for the first review). Through voluntary retirement offers, and layoffs only when necessary, we will reduce the number of redundant workers by one-third by end-June, and cumulatively two-thirds by end-October 2002 (the latter being a structural performance criterion). By end-June 2003, we will phase out the remaining redundancies. For this well-targeted attrition, we will allow no replacement hiring, and the resulting unfilled positions will be immediately eliminated. We will audit SEE compliance with this program on a quarterly basis. Progress toward meeting the above targets will also be a focus of earlier program reviews. Since we are making long-term financial savings from this action, the net cost of this initiative (severance payments less wage savings) will not be counted toward our primary surplus target, up to a limit of TL 1.25 quadrillion in 2002.
42. We will enhance aggregate fiscal control, by strengthening the legal framework for fiscal policy, consolidating fiscal institutions, and deepening fiscal transparency reforms:
43. We will enhance and better target our social spending. Already in 2002, we are increasing social spending substantially in real terms. In addition, we will address the impact of public sector retrenchment through the labor redeployment and reinsertion program (supported under the World Bank's Privatization Social Support Project), and through unemployment insurance, for which benefit payments are set to commence in 2002 (this would protect those workers who are not eligible for adequate severance). Other key priorities will be (i) to increase resources allocated to direct income support for farmers (in support of this, we will eliminate all agricultural premia in the 2003 budget), and (ii) to fully implement the World Bank supported Social Risk Mitigation Project, which seeks to enhance safety net resources available to the poorest households.
Enhancing the role of the private sector
44. Our program places a special emphasis on fostering private sector development. The key elements—which have been developed in close consultation with the World Bank—include privatizing companies, encouraging domestic and foreign investment, and improving governance and transparency. We will also improve our communications policy, to underline both to the public and to investors that a genuine economic transformation is underway.
45. Our privatization strategy aims to complete in 2002 the preparatory work for the divestiture of all major companies slated for sale. Besides selling enterprises for which the technical preparations have already been completed—notably TÜPRATM (petroleum refinery) and POATM (petroleum distribution)—we are committed to completing in 2002 all preparatory work for the privatization of Türk Telekom, TEKEL (tobacco and spirits), TMEKER (sugar), THY (airlines), ERDEMIR (steel), EUATM (electricity generation), TEDATM (electricity distribution), BOTATM (natural gas), and state-owned land. Specifically:
46. We aim to make Turkey substantially more attractive for domestic and foreign investors. A list of follow-up actions to a Foreign Investment Advisory Service (FIAS) report finalized in mid-2001 has been sent to the Council of Ministers, and is expected to be adopted in January 2002 (prior action). As envisaged under that action plan, we will:
47. We attach the highest importance to improving governance and transparency. To this end, the Council of Ministers will adopt a strategy for increasing transparency and combating rent-seeking activities by end-January 2002 (structural benchmark). Concrete follow-up actions for the remainder of the 2002-04 program period based on this plan will be defined and included as program conditionality in subsequent program reviews.
48. Finally, we will further improve our strategy for explaining
the goals and policies of the program. To this end, we will establish
an Investor Relations Office by February. This Office will serve as the
focal point for two-way communication between the Turkish authorities
and the domestic and international investor communities, and will be set
up as a permanent structure within the Treasury. Furthermore, we will
establish an Investor Council consisting of prominent business representatives
from Turkey and abroad. This Council, which is expected to have its first
meeting by mid-2002, will advise on issues relevant for the attractiveness
of Turkey as an investment destination and will meet with regular intervals.
In addition, the recently intensified efforts of the of the Treasury,
the CBT, and the BRSA to explain policies under the economic program in
their respective areas will be further strengthened, including through
the arrangement of regular (bimonthly) press conferences by the Treasury.
Primary Balance of the Consolidated Government Sector
Table 1. Turkey: Performance Criteria and Indicative Targets
on the Cumulative
1. The primary balance of the consolidated government sector (CGS), Table 1, comprises the primary balances (primary revenue minus noninterest expenditures) of the consolidated central government (consolidated budget), the extrabudgetary funds (EBFs) identified below, the ten state economic enterprises (SEEs) identified below, the social security institutions (SSIs), the unemployment insurance fund, and any new government funds and institutions established after January 1, 2002. The floors on the primary balance of the CGS will be monitored:
2. For the purposes of the program, the primary revenues will exclude interest receipts of the consolidated central government and the unemployment insurance fund, profit transfers of the Central Bank of Turkey (CBT) and proceeds from the sale of assets of the CGS (privatization proceeds or transfers thereof). Interest receipts of EBFs, SEEs, and SSIs will not be excluded. As well, the floor on the primary balance will be adjusted upwards for any increase in revenues arising from changes in the revenue sharing agreement between any components of the CGS and other elements of the public sector, including local authorities. The floor on the primary surplus will be adjusted upwards (downwards) in line with the projected surplus (deficit) of the primary balance of any fund or entity that is incorporated in the CGS after March 31, 2001.
3. For the purposes of the program, revenues of the CGS will exclude payments-in-kind and other nonmonetary forms of payments. As well, net lending of any component of the CGS will be considered as a noninterest expenditure item. Payment of guaranteed debt by treasury on behalf of other components of the public sector will not be regarded as net lending up to the baseline reported in Annex G.
4. For the purposes of the program, primary expenditure of the CGS will exclude any payments related to bank recapitalization and to the restructuring of private and state banks. It will also exclude severance payments made to retire or retrench public workers, and pension payments to them (net of projected wage savings during 2001 from this retrenchment), up to a cap of TL 1,250 trillion (above which they would count towards the target).
Extra budgetary funds
5. The two EBFs included in the definition of the performance criterion for 2002 are: the defense fund and the privatization fund. The balances of the social aid and solidarity fund and the promotion fund—which do not have the legal authority to borrow, and will not be given such authority during the duration of the stand-by arrangement—are excluded from the definition of the performance criterion.
State economic enterprises
6. The ten SEEs whose primary balances will be included in the definition of the performance criterion are: TTK (coal company), TSFAS (sugar company), TMO (soil products office), TEKEL (tobacco and alcoholic beverages company), TCDD (state railways), BOTAS (natural gas), TEDAS (electricity distribution), EUAS (electricity generation), TETTAS (electricity trade), and TEIAS (electricity transmission). The primary balance of these SEEs will be monitored as the sum of net financing minus accrued interest made by the SEEs. Net financing will be monitored as: net financing from the banking system (excluding pre-export financing from the Eximbank) plus net external borrowing (excluding normal trade financing), plus the change in net arrears to and net advances from the private sector and to/from the non-CGS public sector (including subsidiaries and joint ventures), plus net interest payments undertaken by the Treasury. The net change in arrears on tax liabilities will be excluded.
7. Net financing from the banking system (excluding pre-export financing from the Eximbank) is defined as the change in all claims of these institutions on the SEEs listed above, including loans and capitalized interest arrears, less the change in deposits and repos of SEEs in these institutions, as reported by these SEEs. Changes in claims and deposits denominated in foreign currency will be valued at the average of the exchange rates between the Turkish lira and each corresponding currency prevailing during the quarter in question. As of September 30, 2001 the stock of net banking claims on SEEs as defined above stood at TL 254 trillion, valued at the exchange rates on that day.
8. Net external borrowing is defined as the receipt of external loans (including guaranteed debt and on-lending, and excluding normal trade financing) less amortization (excluding repayments of guaranteed debt and on-lending undertaken by the Treasury), valued at the exchange rate at the time of transaction. As of September 30, 2001 the stock of external loans stood at TL 6,186 trillion, valued at the exchange rates on that day.
Social security institutions
9. The deficits of the social security institutions (SSIs) will be covered by transfers from the central government budget, and they are thus expected to be in primary balance in 2002. The floor on the primary surplus of the CGS will be adjusted upwards 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. The stock of arrears of Bag Kur stood at TL 120 trillion on September 30, 2001, while ES and SSK had no expenditure arrears.
10. The floors for the primary surplus will be adjusted upward for any issue of noncash debt other than for bank recapitalization and securitization of duty losses and for the restructuring of the Agricultural Sale Cooperative Units. They will also be adjusted upward for any off-balance sheet expenditure of any component of the CGS.
Primary Balance of Other Public Entities
Table 1. Turkey: Indicative Target on the Cumulative
1. The primary balance of other public entities (OPE), Table 1, comprises the primary balances (primary revenue minus non-interest expenditures) of the social aid and solidarity fund, the ten state economic enterprises (SEEs) identified below, the local governments and local government institutions defined below (LGs), and the revolving funds defined below (RFs). The floors on the primary balance of the OPE will be monitored:
2. For the purposes of the program, the primary revenues will exclude interest receipts of LGs and RFs and proceeds from the sale of assets of the OPE (privatization proceeds or transfers thereof). Interest receipts of the social aid and solidarity fund and SEEs will not be excluded.
3. For the purposes of the program, revenues of the OPE will exclude payments-in-kind and other non-monetary forms of payments. As well, net lending of any component of the OPE will be considered as a non-interest expenditure item.
State economic enterprises
4. The 10 SEEs whose primary balances will be included in the definition of the indicative target are Telekom (telecommunications); THY (airline); PETKIM (petrochemicals); MKEK (machinery and chemicals); ETI holdings (mining); TKI (coal mining); TPAO (petroleum extraction); PTT (postal services); DHMI (airports); and Caykur (tea).
5. The primary balance of these SEEs will be monitored as the sum of net financing minus accrued interest made by the SEEs. Net financing will be monitored as: net financing from the banking system (excluding pre-export financing from the Eximbank) plus net external borrowing (excluding normal trade financing), plus the change in net arrears to and net advances from the private sector and to/from the non-CGS public sector (including subsidiaries and joint ventures), plus net interest payments undertaken by the Treasury. The net change in arrears on tax liabilities will be excluded.
6. Net financing from the banking system (excluding pre-export financing from the Eximbank) is defined as the change in all claims of these institutions on the SEEs listed above, including loans and capitalized interest arrears, less the change in deposits and repos of SEEs in these institutions, as reported by these SEEs. Changes in claims and deposits denominated in foreign currency will be valued at the average of the exchange rates between the Turkish lira and each corresponding currency prevailing during the quarter in question. As of September 30, 2001 the stock of net banking claims on SEEs as defined above stood at TL 333 trillion, valued at the exchange rates on that day.
7. Net external borrowing is defined as the receipt of external loans (including guaranteed debt and on-lending, and excluding normal trade financing) less amortization (excluding repayments of guaranteed debt and on-lending undertaken by the Treasury), valued at the exchange rate at the time of transaction. As of September 30, 2001 the stock of external loans stood at TL 9,451 trillion, valued at the exchange rates on that day.
8. The LG entities whose primary balances will be included in the definition of the indicative target are all 81 special provincial administrations, and Iler Bank (a development bank serving the municipal sector). Special administrations' primary surplus will be measured from above the line on a modified cash basis. For Iler Bank, the primary surplus will be measured by its expenditures less its revenues (excluding, in both cases) interest.
9. The RFs whose primary balances will be included in the definition of the indicative target are all of those which exist in the health and education sectors (1,627 at present, with consolidation expected to reduce this number to 664 by end-March). Net financing for RFs will be monitored as: the change in cash holdings, plus net domestic borrowing, plus net foreign borrowing.
10. Net domestic borrowing is defined as the change in deposits in banks, as reported by the RFs. Changes in claims and deposits denominated in foreign currency will be valued at the average of the exchange rates between the Turkish lira and each corresponding currency prevailing during the quarter in question.
11. Net external borrowing is defined as the receipt of external loans (including guaranteed debt and on-lending) less amortization (excluding repayments of guaranteed debt and on-lending undertaken by the Treasury), valued at the exchange rate at the time of transaction.
Overall Balance of the Consolidated Government Sector
Table 1. Turkey: Indicative Floors on the Cumulative Overall
1. The overall balance of the consolidated government sector (CGS), Table 1, comprises the primary balance of the CGS as defined in Annex D, the net interest payments of the consolidated central government and the unemployment insurance fund and gross interest payments of the EBFs, SEEs, and SSIs, and the overall balance of any new government funds and institutions established after January 1, 2002. The monitoring of the different components of the overall balance will be as indicated in paragraph 1 of Annex D. Revenues of the CGS will be as defined in paragraph 2 of Annex D; i.e., excluding privatization proceeds.
2. All definitions and adjusters specified in Annex D to apply to the primary balance of the CGS will also apply to the overall balance of the CGS.
Program Baseline for Treasury Net Lending
Table 1. Turkey: Program Baseline for Treasury Net Lending
1. Net lending is defined as the sum of guarantee payments made by treasury minus repayments obtained by treasury. Repayments include those obtained in cash directly from municipalities, or those obtained through clawback mechanisms, either directly, by withholding of transfers of tax shares from the MoF, or indirectly, via withholding of transfers to be made by Iler Bank. Proceeds from privatization, direct or indirect, are not included as repayments.
2. For the purposes of program monitoring, the flows in U.S. dollars will be converted at the average TL/US$ exchange rate between test dates.
Short-Term External Debt Ceilings
Table 1. Turkey: Performance Criteria and Indicative Ceilings
on the Stock
The limits specified in Table 1 apply to the stock of debt of original maturity of one year or less, owed or guaranteed by the consolidated government sector (as defined in Annex D). The term "debt" has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to External Debt or Borrowing in Fund Arrangements (Decision No. 6230-(79/140), August 3, 1979 as amended by Decision Nos. 11096-(95/100), October 25, 1995, and 12274-(00/85), August 24, 2000). Excluded from this performance criterion are external program financing, sales of treasury bills denominated in Turkish lira or foreign exchange to nonresidents in either the domestic primary market or the secondary market, normal import-related credits, reserve liabilities of the Central Bank of Turkey, and forward contracts, swaps, and other future market contracts. Debt falling within the limit shall be valued in U.S. dollars at the program cross exchange rates specified in Annex L.
Medium- and Long-Term Debt Ceilings
Table 1. Turkey: Performance Criteria and Indicative Ceilings
on Contracting and
The limits specified in Table 1 apply to the contracting or guaranteeing by the consolidated government sector (as defined in Annex D) of new, nonconcessional external debt with an original maturity of more than one year. This performance criterion applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (adopted by the Executive Board of the International Monetary Fund on August 24, 2000) but also to commitments contracted or guaranteed for which value has not been received. The term "nonconcessional" means containing a grant element of less than 35 percent on the basis of the currency-specific discount rates based on the OECD commercial interest reference rates in place at the time at which the contract is entered into, or guarantee issued. Excluded from this performance criterion are credits extended by the IMF, adjustment lending from the World Bank, and other external program financing, long-term liabilities of the Central Bank of Turkey and sales of treasury bills and bonds denominated in TL or FX to nonresidents in either the domestic primary market or the secondary market. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time the contract is entered into, or guarantee is issued.
Table 1. Turkey: Performance Criteria and Indicative Targets
for Base Money
(In quadrillions of Turkish lira)
1 These ceilings are
based on the average of the stocks prevailing during the five working
days including and immediately preceding each of these dates. The February
28, 2002 performance criterion will be calculated using the four working
day average of February 11-12 and March 11-12, to take account of the
transitory impact of the Bayram religious holiday on currency demand.
1. This Annex sets out performance criteria for base money, and indicative targets for net domestic assets of the Central Bank of Turkey (CBT) and Treasury combined.
2. Base money is defined as currency issued by the CBT, plus the banking sector's deposits in Turkish lira with the CBT. The net domestic assets (NDA) of the CBT are defined as base money less net foreign assets of the CBT. The net domestic assets of the CBT and Treasury combined are defined as net domestic assets of the CBT plus (i) Treasury liabilities to the International Monetary Fund and (ii) Treasury foreign exchange denominated borrowing with an original maturity of less than one year.
3. Net foreign assets of the CBT are defined as the sum of the net international reserves of the CBT (as defined in Annex K), medium- 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 December 31, 2001, net foreign assets of the CBT amounted to TL -12.75 quadrillion.
4. Net domestic assets of the Treasury are equal to Treasury liabilities to the International Monetary Fund and Treasury foreign exchange denominated borrowing with an original maturity of less than one year.
5. All assets and liabilities denominated in foreign currencies will be converted into Turkish lira at program exchange rates (Annex L).
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:
NDA = R*B,
where: R denotes the 4 percent reserve requirement plus the 2 percent liquidity requirement coefficient and B denotes the change in base generated by a change in the definition of the reserve aggregate, or due to any change in the averaging period.
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 R is the change in the reserve requirement coefficient and the liquidity requirement coefficient.
8. 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 2. Turkey: Indicative Targets on the Net Domestic
(In quadrillions of Turkish lira) 1
1 These targets are
based on the average of the stocks prevailing during the five working
days including and immediately preceding each of these dates. The February
28, 2002 target will be calculated using the four working day average
of February 11-12 and March 11-12, to take account of the transitory impact
of the Bayram religious holiday on currency demand.
Targets for Net International Reserves
Table 1. Turkey: Performance Criteria and Indicative Floors
on the Level of
(In billions of U.S. dollars)
1. For program purposes, net international reserves is defined as net international reserves of the CBT minus (i) Treasury liabilities to the International Monetary Fund and (ii) Treasury foreign exchange denominated borrowing with an original maturity of less than one year.
2. Net international reserves of the Central Bank of Turkey (CBT) comprise its gross foreign assets excluding encumbered reserves less its gross international reserve liabilities plus the net forward position of the central bank, denominated in U.S. dollars. Encumbered reserves are reserves that are not readily available.
3. For the purpose of the program, gross foreign assets are all short-term foreign (convertible) currency denominated claims on nonresidents, monetary gold valued at the December 31, 2001 average London fixing market price of US$276.5 per troy ounce, foreign bank notes, balances in correspondent accounts, and any reserve position in the IMF. At present encumbered reserves consist of foreign asset holdings in accounts of the Turkish Defense Fund (amounting to US$0.426 billion on December 31, 2001). The special Dresdner portfolio (amounting to US$0.808 billion on December 31, 2001) is also encumbered, but is not subtracted from foreign reserves given the overlap with one-year foreign currency denominated liabilities (see below). Reserve assets as of December 31, 2001 amounted to US$19.363 billion.
4. Gross international reserve liabilities include all foreign currency-denominated liabilities (or TL-denominated liabilities indexed to any exchange rate) to residents and non-residents with an original maturity of up to and including one year (including reserves against foreign currency deposits of the banking sector), claims from central bank letters of credit, overdraft obligations of the central bank, and central bank liabilities arising from balance of payments support borrowing irrespective of their maturity. Government foreign exchange deposits with the CBT are not treated as an international reserve liability. On December 31, 2001 reserve liabilities thus defined amounted to US$22.342 billion.
5. The net forward position is defined as the difference between the face value of foreign currency-denominated or indexed central bank off-balance sheet (forwards, swaps, options on foreign currency, and any future contracts) claims on nonresidents and foreign currency obligations to both residents and nonresidents. As of December 31, 2001 these amounts were zero.
6. As of December 31, 2001 the sum of: (i) Treasury liabilities to the International Monetary Fund and (ii) Treasury foreign exchange denominated borrowing with an original maturity of less than one year amounted to US$1.264 billion.
7. All assets and liabilities denominated in foreign currencies other than the U.S. dollar will be converted into U.S. dollars at the program cross exchange rates specified (Annex L).
Program Exchange Rates
Table 1. Cross Exchange Rates for Program Purposes
1. This table sets out the program exchange rates referred to in earlier Annexes. They shall apply to the performance criteria/indicative ceilings or floors for the period December 31, 2001-December 31, 2002. Currencies not specified here will be converted at the representative exchange rates reported to the IMF as of December 31, 2001.
2. Constituent currencies of the euro shall be converted into euro at the official European Union conversion rates and then converted into the U.S. dollar value.