Turkey and the IMF
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Perseverance in a Good Cause:|
The Benefits of Turkish Economic Reform
Keynote Speech by Anne O. Krueger
Acting Managing Director
International Monetary Fund
Istanbul, May 6 2004
I am delighted to be back here at the Istanbul Forum. As you know, I have been a regular visitor to Turkey for many years, and I always enjoy being here.
It is, though, a particular pleasure this year. I was at the Economic Congress in Izmir yesterday and I was struck there by the prevailing mood of optimism about Turkey's economic prospects. That mood is equally palpable here in Istanbul.
And it is justified. Turkey has made great strides in the past several years. And much has been achieved since I was here last year. The government is to be congratulated for sticking so closely to its economic objectives and its reform program. Achievements on many fronts have exceeded expectations.
I want to focus on those achievements, today, and to contrast them with the setbacks suffered in previous efforts at economic reform. But I want also to focus on the remaining challenges and provide some encouragement for pressing ahead. Above all, I want to remind us all of the great prize in store if the reform program continues to be implemented in full. I believe Turkey is at an historic turning point, and that is why perseverance now is so important. It would be a great pity—a tragedy even—if the opportunity for lasting change were, once again, to be lost.
The current outlook
But the IMF is blamed often enough for being the bearer of bad news. So let me first focus on the good news—of which, as you know, there is plenty.
The current global upturn is becoming more firmly grounded. The recovery is strengthening across the globe, and growth in the United States and emerging market Asia is particularly strong. Global growth this year is expected to be around 4%. This is an ideal international environment in which to continue to carry out economic reforms.
Turkey's recovery started earlier than the worldwide pickup, of course. And the Turkish economy's recent growth performance has been impressive: close to 8% in 2002, and about 6% last year. 5% is currently projected for the current year.
There has been progress on several other fronts, too. Inflation—which, remember, was around 70% in 2001—is now down to about 10%, its lowest level in a generation. Single digit inflation is clearly within reach. Interest rates have fallen as a result. And although it fell slightly short of the 6.5% target, last year's primary surplus was the highest ever recorded in Turkey—6.2%.
Maintaining a high primary surplus is, of course, crucial while Turkey's debt burden declines to a sustainable level over the medium term. Here, too, the numbers are starting to look encouraging, with the debt to GDP ratio already significantly down, from 100% in 2001 to around 70% now. Some advance the argument that rapid growth and fiscal prudence are mutually incompatible. Yet it is clear from Turkey's experience that a high primary surplus has not hampered growth performance. As real interest rates fall further, there will be an additional stimulus to growth.
Credible efforts to sustain macroeconomic stability help build the flexibility modern economies need. Those efforts need to be maintained, partly to guard against potential future problems, such as a rise in global interest rates which could have an adverse impact on emerging market economies. But flexibility is also important in helping economies exploit unexpectedly favorable developments, such a big rise in export demand, or technological changes that bring new opportunities. Flexibility in labor markets also creates the opportunity for employment expansion.
The impetus for this reform program was the crisis of 2000—perhaps the most serious economic setback Turkey has faced. It had finally become clear that half-hearted or unfinished reforms could not bring the stability and sustainable growth Turkey so badly needs.
That had been the pattern of Turkish economic management for too long. The intentions were there; but expenditures started to rise too soon. Reforms were undertaken, but once immediate crisis points were past, governments tended to relax their fiscal grip. The crisis of 2000 was the culmination of decades of not following through and staying the course.
The reform effort that started in 1980 is a good example of what I have in mind. The 1980s reforms offer a sharp contrast with present-day economic management; but they also offer an important lesson, which I want to develop further in a moment.
Let's look first at what happened.
The ambitious program that began in January 1980 marked the start of serious economic reform efforts after years of false starts. IMF standby arrangements in 1978 and 1979 had been failures. The results of decades of uneven economic performance were all too clear. In 1955 Turkey's per capita income had been estimated to be roughly double that of Korea; by 1980, Turkey had fallen significantly behind the Asian tiger. Inflation had reached 100% in 1980. Power shortages were common in Istanbul and elsewhere. There were shortages in many sectors because of quantitative restrictions on imports and a shortage of foreign exchange.
A big shake-up in both policymaking and policy signaled a completely fresh approach. The reforms of 1980 had three main aims: economic stabilization, including a reduction in the rate of inflation; a deliberate shift away from import substitution and towards an export- oriented economy; and a move towards a more market-oriented economy.
The lira was devalued, and a more flexible exchange rate regime was established. Price controls on State Economic Enterprises were virtually eliminated and budget constraints on them were toughened. Structural reforms were introduced in the financial sector. The trade regime was liberalized. And there were efforts to improve revenue collection and reduce the fiscal deficit.
These reforms initially had very good results. Inflation came down from a peak of about 100% to around 30% by 1983. Exports rose at a spectacular rate. In the last 1970s, they had been around 5% of GDP. Between 1980 and 1989 they grew at about 20% a year—and remember, the first half of this period coincided with a severe worldwide slowdown. By 1987 exports represented something like 20% of GDP by 1987.
The reforms brought growth, too. In the late 1970s, the economy had actually been contracting. GDP growth accelerated only slowly at the beginning of the reform process, though remember this was against the backdrop of a global slowdown. From 1984 onwards, the economy picked up speed, growing at around 5% a year. In the early years of the reform program, the government also succeeded in reducing the fiscal deficit. And the reforms succeeded in shifting Turkey permanently towards a more export-oriented economy.
Nor did the reforms peter out quickly. They only lost momentum briefly ahead of elections in 1983. New structural measures were introduced in what is regarded as the second phase of reform from 1983 to the late 1980s.
No, the real disappointment came later when the government ultimately failed to follow-through on its attempt permanently to bring inflation under control. When inflation started to pick up significantly in 1987, the real exchange rate was allowed to appreciate. But this made exports less competitive and ducked the real cause of the resurgence in inflation—lax fiscal control.
The reduction in the fiscal deficit was short-lived, in part because of the government's desire to push ahead with much-needed infrastructure investments. In 1981, the budget deficit had been brought down to 1.7% of GDP; by 1984 it had risen to 5.3% and the deficit remained a problem thereafter. Inflation, meanwhile, had started to climb once more—up to 70% by 1989.
By 1989 it was also clear that fiscal imbalances, the appreciation of the real exchange rate, and accelerating inflation were storing up trouble. But the stop-go pattern of economic management during the 1990s meant that the main problems were not permanently addressed. Only when the crisis of 2000-2001 erupted was there a determined effort to restore stability and, with it, sustainable growth.
The challenges ahead
As I said at the outset, much progress has been made. But much remains to be done, and this is that critical juncture when maintaining the momentum is both vital and challenging. Maintaining the reform momentum will make possible higher, sustainable growth, with all the attendant benefits. But failing to press ahead now will mean missing the opportunity to capitalize fully on what is possible, given what has been achieved. If that were to happen, the recent reforms, and the benefits they have already brought, will go down in history as yet one more attempt to put Turkey on a higher sustainable growth path.
Pushing on now is vital to enable Turkey's current growth performance to be sustained at a high level over the longer term and permit Turkey to achieve the 2023 goals. That requires continuing efforts to lower inflation, continuing improvement in the fiscal position—essential for delivering debt sustainability—and continuing reform on a wide range of structural issues.
Further progress is also vital because there is clear evidence that the returns to economic reforms increase sharply as more of them are undertaken. This really is an area where the whole is far greater than the sum of the parts. All reform is welcome, of course: but the full benefits will not come through if reforms elsewhere in the economy are overlooked, or postponed.
The reform agenda is challenging, because it is tempting to rest on achievements when economic performance has started to pick up. People wonder why more changes are necessary. But reforms are easier when implemented in a period of growth than in the middle of an economic crisis. The current upturn, both in Turkey and in the global economy, is the ideal time to press on.
I want briefly to mention some of the issues on which we in the Fund believe further progress is needed. I doubt that any of these will come as a surprise to anyone here today.
Clearly the reduction of inflation has to be a continuing priority. Losing control of inflation has undermined more than one reform program in the past, and Turkey's future economic credibility will depend crucially on bringing inflation down to internationally comparable levels this time. Of course we now live in a world of low inflation. That should make it easier to bring Turkish inflation down still further; it also makes this objective even more important.
The continued pursuit of appropriate monetary policy, and an eventual move to full inflation targeting, would certainly help the process of consolidation. But it is important in this context that other government policies are not overlooked. Continuing fiscal discipline is needed, both to ensure debt sustainability and also to enable the central bank to pursue the appropriate monetary policy. Wage and pensions increases must be moderate, so as not to undermine progress made on the monetary front and so as to create more employment opportunities. By staying the course, there is now, as I said earlier, every prospect that inflation will be brought down to single digits by next year.
Fiscal discipline remains important, and potentially challenging. The primary surplus last year was impressive, but it was a little below the target. It will be important to hit the target this year.
Fiscal sustainability means watching to ensure that adjustments to meet short-term fiscal targets don't make it more difficult to meet such targets in future years. Cutting capital spending to make way for permanent increases in current spending guarantees that the short-term problem recurs next year, and the year after, sometimes forcing more and more unpalatable decisions on government. Better to confront the issue head-on, at the first moment.
Structural reforms in the fiscal area can do much to help ensure fiscal discipline is maintained. Measures that widen the tax base; make tax rates more uniform, and remove distortions; and improve the efficiency of the tax collection system can all have a big impact on the fiscal balance. What's more, these are all relatively painless, except for those who have hitherto avoided paying their taxes. Yet they will also permit a more efficient allocation of resources and thus more rapid growth.
Tackling social security reforms and other budget rigidities can also do much to help the fiscal position while improving the overall efficiency of the economy. I am struck by the fact that the size of the social security deficit last year was almost the same as the central government primary surplus.
Around the world, one area of reform that tended to be overlooked in the past was in the financial sector. The Asian financial crisis brought home to many of us quite how crucial a healthy financial sector is in crisis prevention. After all, the financial sector plays a key role in allocating resources in any economy. It is essential that this be done in the most efficient manner. The IMF now invests much effort in monitoring financial sector health and providing assistance to our members in order to help them implement effective oversight and regulation while creating a market-friendly environment.
I know reform of the Turkish financial sector is under way, and that many difficult issues—such as the reform and consolidation of state banks—are being tackled. I know, too, that the authorities are keen to ensure that Turkey's banking sector is brought into line with European Union standards. I can only urge the government to continue with these efforts and with all possible speed. Reform of the financial sector is a vital ingredient for a healthy, well-functioning economy. It is also a vital ingredient in making Turkey attractive to foreign investors.
Improving the business climate more generally is important. As Turkey's performance continues to improve, and Turkish economic credibility strengthens, investors will be increasingly eager to invest in business activity here. I know you have recently established an Investors' Council. Indeed, Horst Kohler, until recently the IMF's Managing Director, had been planning to address its inaugural meeting before his early departure from the Fund in order to return to German public life.
But businesspeople respond, above all, to economic incentives and to prospects over the longer term. I'm not talking about tax breaks to make investing here artificially attractive but about fundamental improvements in the economic structure so that investing in Turkish businesses and setting up new businesses becomes attractive in its own right. That means a level playing field for public and private sector actors, for example. It means less red tape. And, above all, a stable economic environment, a predictable legal framework, and low inflation.
A sense of urgency
Credibility matters in the global economy, perhaps today more than ever. The high-speed transmission of information that we all take for granted, and from which we all gain, also means that markets can act quickly. The markets can be harsh judges, as many emerging market economies have painfully discovered. It is important that economies, and economic policymakers, benefit from market discipline. The rewards can be substantial, in terms of lower interest spreads and more foreign investment, for instance.
So Turkey can gain a lot by maintaining and enhancing the credibility achieved so far. I don't have to remind you that such economic credibility is much harder to win than to lose. That is why it is desirable to maintain the momentum of the reform program. The timing matters. As I noted at the outset, the current outlook is unusually auspicious. This is the moment, while the global outlook remains favorable, for Turkey to build in more room for maneuver in the future. All countries could benefit from the greater flexibility that makes shocks easier to cope with and opportunities easier to exploit. Turkey has more to gain than most.
Economic reform is a continuous process. There's no getting away from that. It is going on in the United States, the European Union, and, indeed, all countries, as new problems arise as governments try to maintain high rates of growth. The global economy is constantly changing, and economies need also constantly to adapt, if they are to maintain competitiveness and continue to deliver rising living standards.
I want to repeat: Turkey can indeed be at the start of a new and successful economic era; and the goals for 2023 are within reach. The desire for reform, and the determination to deliver it, is evident. And the benefits to be had are enormous. Let me remind you of what could be within Turkey's grasp if the reforms are followed through successfully.
Macroeconomic stability is worth striving for because it is a necessary condition for an even more important end—the rapid sustainable growth in income and employment that raises living standards and reduces poverty. Low inflation makes economic decision-making easier for all citizens; it makes resource allocation more efficient; and it benefits the poor disproportionately.
Sound fiscal policies give governments and citizens more choice. A sustainable fiscal position makes it easier for society to decide on its priorities.
Increased economic resilience makes it easier to cope with unexpected shocks. These will always come, we just cannot predict when or in what form: the stronger the economy, the less harm those shocks do to a country's citizens, especially the poor.
I've said very little today about the role of the Fund. But I should remind you that the Fund stands ready to provide advice and technical assistance as well as the financial support already provided under the program. We want Turkey to succeed.
The title of my talk—"Perseverance in a good cause"—is taken from an eighteenth century English novel, Tristram Shandy. The full quotation is telling: perseverance in a good cause, but obstinacy in a bad one. In Turkey's case there is no doubt that the cause is a good one.
Continuing economic reform is in the interests of all Turkish citizens. Living standards will rise, and poverty will be reduced more rapidly. Life will become more predictable, or at least less vulnerable to ups and downs.
As I said earlier, reforms build on each other. The returns rise more rapidly the more widespread and the more co-coordinated they are.
For countries that are ill-prepared, the modern global economy can seem harsh. For those with sound policies, the rewards are great indeed.
Perseverance is worth it.
IMF EXTERNAL RELATIONS DEPARTMENT