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Turkey: Concluding Statement of the IMF Mission for the 2012 Article IV Consultation
October 8, 2012
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
After two years of rapid growth well above trend, the economy has slowed significantly, helping to unwind imbalances. Encouragingly, Turkey’s growth is expected to remain positive and become more balanced this year, despite weak activity in major trading partners. Macroeconomic policies have been supportive of the soft landing of the economy, but the authorities must stand ready to adjust policies if the trend in disinflation and the external deficit reduction starts to unwind. In the medium term, better macroeconomic coordination is needed to improve the policy mix and reduce volatility. Finally, the authorities have correctly identified increasing national savings as a top priority to reduce the reliance on external financing and reorient the economy towards a more sustainable growth model. The public sector needs to play an important role in this endeavor.
1. The economy is expected to grow at a more measured pace of 3 percent in 2012, despite weak growth in the EU. The marked slowdown in domestic demand in the first half of the year was partly compensated by the pick-up in net exports. Although weak imports have played a major role in this rebalancing, export growth has proved resilient thanks to the successful diversification of trade, particularly towards the Middle East and North Africa. The conditions for resumption in domestic demand growth are in place, with unemployment at a ten year low, relatively healthy private sector balance sheets, and more supportive macroeconomic policies. Beyond 2012, the economy is in a good position to return to its long-term trend growth rate of around 4 percent.
2. The moderate pace of growth is helping unwind imbalances. Macroeconomic policies have started to deliver disinflation and a reduction in the current account deficit. Inflation—headline and core—is decelerating but is expected to end the year above the top of the central bank’s inflation target band. The current account deficit is likely to decline to 7½ percent of GDP in 2012. Additional modest improvements in both inflation and the external deficit are in prospect for 2013.
3. The Turkish financial system continues to perform well. Banks’ profitability remains high by international standards; leverage and the level of non-performing loans are low relative to peers; and the introduction of Basel II and II.5 standards has resulted in only marginal reductions in the system’s still high capital adequacy ratio. Also, tighter macro-prudential measures have eased concerns over excessive credit growth. The growing dependence of the system on external financing observed over the last few years appears to be leveling off, although banks have been able to maintain high roll-over rates. Finally, foreign-owned banks’ reliance on parent funding remains low.
4. Turkey continues to face some considerable risks given the large current account deficit and the volatile nature of global capital flows in an uncertain external environment. Time is needed to achieve the orderly rebalancing of the economy. In the meantime, annual gross external financing needs are projected to remain notably high over the next few years. The unstable global financial environment presents a major risk as it could lead to a reversal in capital flows and force the economy into a sharp adjustment. There is also a risk that the easing of monetary policy in the advanced economies might be conducive to a resurgence of excessive credit growth in Turkey driven by ample short-term external financing, bringing to a halt—and even reversing—the unwinding of imbalances. That would postpone the much needed adjustment and weaken balance sheets.
Ensuring prudent policies
5. The authorities will need to follow a narrow policy path. Macroeconomic policies should remain supportive of economic growth as long as it is consistent with disinflation and a further reduction in the external deficit. Thus, in the near term, growth below potential would be warranted to continue reducing imbalances. Were growth to accelerate, undermining the inflation and current account objectives, the authorities should stand ready to tighten the macroeconomic stance.
6. The government’s 2012 budget target will be missed. In addition to weaker revenues that reflect a slowdown in growth, expenditure increases above the budget ceilings contributed to a worsening of the budget, resulting in a pro-cyclical fiscal policy, while a neutral stance would have been appropriate. Given the economic outlook, no further deterioration in the primary surplus should be targeted for 2013, consistent with a neutral stance.
7. It is important that the medium-term fiscal plan for 2013-15, currently under preparation, sets strengthening the budget structure as a key objective. The budget has structural weaknesses: there is an excessive dependence of revenues on buoyant domestic demand, while expenditures have become increasingly rigid. In particular, the public sector wage bill and pensions, which are difficult to reverse, have grown above the economy’s potential and the pace of improvements in tax administration. This rigidity could come at the expense of much needed infrastructure investment; it also reduces the scope for fiscal policy to help establish a more balanced macroeconomic policy mix and respond to shocks. In addition to ongoing efforts to broaden the tax base and improve tax administration, reforms on the spending side will need to focus on significantly restraining growth in real current expenditure, while examining whether additional efforts are needed to contain pension and health spending.
8. Inflation is declining, but the merits of the CBRT’s policy framework have not been fully established. Monetary policy tightening in the beginning of 2012 helped slow credit growth and stopped exchange rate depreciation, setting the stage for a reduction in inflation. In addition, the central bank still faces a difficult environment in which to set monetary policy, characterized by volatile capital flows and low interest rates in the advanced economies. In its attempts to deal with these challenges, the CBRT has resorted to a battery of new instruments to gain some degrees of freedom in segmenting domestic and international interest rates. Use of these instruments should be continuously re-assessed in light of experience gained to confirm that they do not come into conflict with the CBRT’s objectives of price and financial stability.
9. Ultimately the success of a monetary policy framework is tied to its ability to achieve the inflation target and anchor expectations. Inflation expectations have been stuck above the CBRT’s target of 5 percent. Given Turkey’s growth outlook, still-high inflation, and a history of deviations from the target, the CBRT should maintain a positive real policy interest rate. Were capital inflows to accelerate, it should rebuild net reserves for precautionary reasons through sterilized interventions. Furthermore, in the period ahead, the monetary policy stance needs to remain cautious and forward-looking, mindful of the impact that the resumption in domestic demand-led growth may have on inflation and wage formation. A return to a more conventional framework would be required should the inflation target remain elusive or inflation expectations stay high.
10. The CBRT’s communication policy needs to be strengthened. The monetary framework, with its multiple tools and objectives, has been widely explained to the public, including in the inflation reports. Still, its complexity requires an enhanced communication strategy. This would help avoid the impression that objectives and tools are at times in conflict, and thereby reduce uncertainty, which may otherwise prove costly if it were to continue. Moreover, with different economic actors interpreting monetary policy differently, a stronger communication strategy would help improve the monetary transmission mechanism.
11. There has been progress in supervision and regulation to strengthen financial stability. The banking supervisor (BRSA) has already started to close some of the gaps in the regulatory and supervisory framework, such as expanding the coverage of consolidated supervision and tightening the rules on asset classification and provisioning requirements. Banks seem well positioned for the introduction of Basel III by 2015, and accordingly the authorities may want to consider an accelerated time table. The Financial Stability Committee (FSC) will be instrumental in coordinating the work of the involved institutions, as financial stability challenges and concerns will continue emerging.
12. Despite this progress, the macro-prudential tool kit needs to be used in a more targeted and active manner to ensure financial stability. So far, the authorities’ prudent dividend payout rules have been very constructive in buttressing banks’ capital levels, but further efforts may be required to conserve existing capital buffers in times of rapid credit growth. Moreover, there is room to examine the expansion of the macro-prudential measures, within a well articulated framework, to manage key risks: namely, discouraging banks from funding their activities via short-term FX borrowing, limiting unhedged FX borrowing by the non-bank corporate sector, and preventing banks from excessively easing credit conditions that may lead to households’ overleveraging.
Rebalancing the policy framework and reducing dependence on external financing
13. Turkey’s low domestic savings make it heavily dependent on capital inflows and increase the amplitude of business cycles. Investment still needs to be maintained at the current level, or even increased further, to continue with ongoing enhancement of physical and human capital. Without policy changes, the current level of savings will leave the Turkish economy exposed to volatile capital inflows to deliver needed investment.
14. The authorities have correctly identified increasing savings as the key medium-term priority. They have recently undertaken several reforms in this area; in particular, the private pension reform, aimed at widening coverage and improving progressivity, is an important step to strengthen incentives for private savings. However, this and other measures, aimed only at the private sector, need to be complemented with a significant and sustained effort by the public sector.
15. The authorities should aim to deliver a sizeable increase in the primary surplus. The resulting increase in public savings would help boost national savings, even if not one to one. The forthcoming medium-term fiscal plan, based on prudent macroeconomic assumptions, should anchor the broad guidelines of the adjustment, complementing policies to improve the structure of the budget.
16. A stronger fiscal position in the medium-term is essential to improve the macroeconomic policy mix and rebalance growth. Tighter fiscal policy would relieve pressure on monetary policy to achieve its inflation target and deliver an environment less prone to real exchange rate appreciation. This would help deal with Turkey’s competitive challenges and support efforts to rebalance the economy away from import dependence and toward export growth. Moreover, it would allow for lower nominal interest rates, reducing Turkey’s exposure to volatile and destabilizing short-term capital inflows.
17. Boosting competitiveness requires a broad, multi-pronged approach. The new Commercial Code should improve corporate governance and encourage FDI. The package of investment incentives could stimulate investment into advanced technology sectors and lower the import content of production; however, such schemes tend to deliver mixed results and only in the long run. Thus, additional efforts should be considered to improve the functioning of the labor market, reduce informality, increase labor market participation, eliminate red-tape in product and service markets, improve the capacity and efficiency of the domestic energy sector, and deepen financial intermediation.
We are grateful to the authorities and our counterparts for their hospitality and open and constructive discussions.
1 An IMF team visited Turkey from September 13 to September 26, 2012 for the annual evaluation of the economy as part of the regular consultations under Article IV of the IMF’s Articles of Agreement. This statement describes the preliminary findings of the staff.
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