## cr1732 ## Source details **Canonical URL:** [cr1732](https://www.imf.org/-/media/files/publications/cr/2017/cr1732.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr1732.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr1732.pdf.json) --- ### Assessing the Impact of Shocks to Tourism - Tourist arrivals fell sharply in 2016: tourists from Europe down by a quarter and from Russia by more than two-thirds in January-September 2016. - Immediate sectoral effects: - Negative impact on accommodation, transportation, and food services. - Output contracted in Q3 2016; some pickup expected by year-end conditional on government measures and gradual removal of Russian sanctions. - External sector subtracted from growth in 2016 due to the surge in real imports and fall in tourist arrivals. - Macroeconomic context amplifiers: - GDP growth: "3.9 percent (year-on-year) in the first half of 2016". - Current account deficit: "over 4.5 percent of GDP". - Unemployment increased since March 2016; seasonally-adjusted employment declined by "2.5 percent" in industry and "5 percent" in construction between May and July. - Financial and credit implications: - SME loan expansion fell from "21 percent in 2015:Q3" to "6 percent in 2016:Q3". - Retail credit growth rose from "around 4 to 7 percent" driven mainly by state-owned banks after macroprudential loosening. - Bank system-wide Tier 1 CAR increased to "13.7 percent". - Banks’ negative on-balance-sheet, net open FX position decreased from "minus 30 to minus 8 percent of regulatory capital". - Tourism shock quantitative estimates: - Given linkages, a "10 percent shock to foreign arrivals is estimated to have 0.3-0.5 percent impact on GDP in the first year after the shock". - Model prediction: absent policy measures GDP would decelerate to "around 2 percent in 2016". - Key vulnerabilities arising from the shock: - REER overvaluation implied of "5–15 percent on average in 2016". - External debt around "60 percent of GDP" vulnerable to valuation shocks. - Non-resident withdrawals of "US$2.5 billion by mid-November 2016". ### Authorities’ Growth Outlook and Near-Term Drivers - Authorities attribute the 2016 slowdown primarily to tourism shock which "shaved more than 1 percentage point off growth in 2016." - Recovery drivers expected in 2017: - relaxation in macroprudential measures; - reduction in domestic interest rates; - investment stimulus packages; - improved relations with Russia boosting tourism and exports; - political stability and structural reforms. - Medium-Term Program (authorities): growth projected at "4.4 percent in 2017" and "5.0 percent in 2018". - Staff projection: medium-term growth projected at "around 3.5 percent, unchanged from previous estimates". ### Monetary Policy: Staff Advice and Authorities’ Views - Staff recommendations: - Maintain a broadly neutral monetary stance consistent with orderly FX markets and a moderately looser fiscal stance. - Tighten monetary policy if excessive Lira volatility or inflation spillovers materialize. - Simplify monetary framework: provide liquidity at a policy rate; close gap between average cost of CBRT funding and the policy (one-week repo) rate; make corridor symmetric; keep real cost of liquidity provision positive. - Gradually withdraw extra Lira liquidity provided after the failed coup attempt. - Increase NIR: staff advised increasing net international reserves by about "US$10 billion" for GIR to reach "100 percent of the IMF’s ARA metric". - Authorities’ views: - Re-affirmed commitment to simplify the monetary framework; timing conditional on inflation and external conditions. - Have started gradual withdrawal of extraordinary Lira liquidity against FX collateral. - Consider conditions unsupportive of rapid reserve accumulation despite agreeing on need to build reserves. - Recent CBRT actions: - Lowered marginal funding rate by "250 basis points to 8¼ percent" from March to end-September 2016; later raised one-week repo and overnight lending rates after end-November depreciation. - FX reserve option and other reserve requirement changes provided FX liquidity; unlimited Lira liquidity against FX collateral was offered after the failed coup attempt. ### Fiscal Policy: Staff Advice, Risks, and Authorities’ Views - Staff recommendations: - Moderate fiscal loosening in 2017 appropriate with a credible medium-term consolidation plan. - Projected widening of the general government structural primary balance by "½ percent of GDP in 2017" to support demand. - Let automatic stabilizers work; consider extension of minimum wage subsidy at appropriately lower level. - Planned increase in public investment welcomed; caution on effectiveness of announced investment incentives. - Staff considers authorities’ 2017 revenue projections overly optimistic; tax-to-GDP ratio projected to increase by "0.4 percent of GDP in 2017". - Tax expenditures are "over 3 percent of GDP higher than previously estimated". - For 2018-19, planned reduction of current transfers by "1 percent of GDP in 2018–19" appropriate but needs measures to contain wage bill, pension and health care spending. - Fiscal space and risks: - Turkey has some fiscal space; central government overall deficit envisaged to remain "below 2 percent of GDP throughout the MTP horizon". - Contingent liabilities increasing due to reliance on PPPs; legal and oversight framework fragmented. - Staff urged stronger central oversight and disclosure procedures for public guarantees and a comprehensive PPP framework law. - Sovereign wealth fund carries potential fiscal and financial risks; staff recommended governance aligned with international best practices. - Authorities’ views: - Believe policies balance stimulus and fiscal responsibility; deem fiscal risks manageable and intend to align SWF with international best practices. ### Financial Sector Policies and Macroprudential Recommendations - Staff findings: - Banks face rising credit risks; non-performing loans increased in consumer and corporate loans. - Restructuring credits masks asset quality deterioration; broader definition of impaired loans shows deterioration, notably in household and SME sectors. - Urged revision of credit classification definitions to align with international norms and strengthen enforcement. - Questioned rationale for recent loosening of macroprudential rules for consumer loans; warned loosening could be counterproductive given high private indebtedness. - Recommended macroprudential measures to lower FX risk in corporate borrowing, including: (i) quicker phase-in of reserve requirement measures and net stable funding ratio; (ii) increase remuneration differential between Lira and FX reserves; (iii) increase capital charges and/or provisioning on FX loans; (iv) align prudential treatment of FX-indexed lending with FX lending; (v) introduce tax measures to discourage NFCs from borrowing in FX. - Encouraged implementation of FSAP recommendations on AML/CFT. - Authorities’ views: - See loosening macroprudential measures for consumer lending as stabilizing domestic demand and lowering financial sector risks. - Maintain relaxation will help recovery in credit growth while aware of corporate sector’s elevated negative FX position. - System metrics: - Bank system-wide Tier 1 CAR: "13.7 percent" (noted earlier) and elsewhere "overall capital adequacy ratio of 16 percent". - SME credit growth: fell from "21 percent in 2015:Q3" to "6 percent in 2016:Q3". - Retail credit growth rose from "around 4 to 7 percent". ### Contingency Planning and Stress Scenarios - If marked growth slowdown: - Political uncertainty could raise counterparty risk, dampening investment and consumption. - Possible vicious macro-financial cycle: deleveraging, corporate investment cuts, income contraction. - Some fiscal space could be used and monetary policy could weigh output gap more; but macroprudential relaxation should not be used countercyclically. - Authorities should require prompt recapitalization if stress tests show capital shortfalls. - In case of large capital outflows or sudden stop: - Tighter monetary stance unavoidable; policy rate would need to increase sharply. - Given low net international reserves, scope for credible FX intervention is limited. - In a recession fiscal policy should be loosened as public debt sustainability is not immediate concern, but corporate default and bank liquidity/solvency problems could occur. - Stress-test findings (external debt-focused): - Permanent Lira depreciation by "30 percent" would push external debt stock to "85 percent of GDP by 2021". - Interest rate shock of "1 standard deviation" would raise debt level by "3 percentage points to 66 percent of GDP". - Combined shocks can push external debt to higher ratios (e.g., combined shock to "70" percent in one table). ### External Sector and External Debt Sustainability - External position and vulnerabilities: - NIIP widened to "about -56 percent of GDP in the end of 3Q2016". - Foreign liabilities just below "90 percent of GDP", including about "53 percent of GDP in foreign currency". - External debt estimated to reach "59 percent of GDP in 2016" (summary) and later stabilization "around 60 percent of GDP" or "around 64 percent of GDP" in different statements. - Gross external financing needs estimated at "about 27 percent of GDP in 2016" and "about 30 percent of GDP" in projection tables; gross external financing need (percent of GDP) listed as "27.2" for 2016 and "30.7" for 2017. - GIR level about "90 percent of the ARA metric"; adjusted reserves reduced to "60 percent of the composite adequacy metric at the end of October 2016". - Current account and REER assessments: - CA gap estimated in range "-1 to -4 percent of GDP"; staff assesses CA gap remains in range "-1 to -4 percent of GDP". - EBA current account gap: "-3.6" (presented). - EBA REER index estimates a "4.2 percent" overvaluation in 2016; REER level regression suggests "15.4 percent" overvaluation; staff assesses REER overvalued by "about 5–15 percent on average in 2016". - Projections snapshot (selected DSA figures): - External debt (percent of GDP): 2015 "55.4"; 2016 "59.6"; 2017 "67.1"; 2018 "67.8"; 2019 "66.6"; 2020 "64.9"; 2021 "63.5". - Gross external financing need (in billions of US dollars): 2016 "193.4"; 2017 "204.4"; 2018 "217.3"; 2019 "225.2"; 2020 "230.0"; 2021 "240.6". - Real GDP growth (percent): 2016 "3.9"; 2017 "4.1"; 2018 "2.7"; 2019 "2.9"; 2020 "3.3"; 2021 "3.6". - Current account balance, excluding interest (percent of GDP): 2016 "-4.9"; 2017 "-3.7"; 2018 "-3.9"; 2019 "-3.6"; 2020 "-3.0"; 2021 "-2.5". - Policy responses recommended: - Reduce CA deficit; avoid further monetary easing; real policy interest rates should remain positive. - Strengthen macroprudential measures to lower FX risk. - CBRT should continue to increase net international reserves and limit FX sales to smoothing periods. - Structural reforms to enhance private savings and reduce import dependency. ### Public Debt Sustainability: Key Figures and Stress Tests - Public debt profile and projections: - Public gross debt: "about 35 percent of GDP" and "32.9 percent at end-2015" in different sections. - Staff project debt-to-GDP ratio to reach "34.8 percent in 2021—up by 2 pp since end-2015." - Average maturity of public debt: "6.2 years". - Share at fixed interest rates: "68 percent of total debt" (table shows "69 percent" elsewhere). - Share of debt in foreign exchange: "only 35 percent of the debt in foreign exchange". - Gross public financing needs: "5.3 percent of GDP in 2015" and projected "8.5 percent in 2021". - Key table values (selected): - Real GDP growth projections: 2016 "4.0"; 2017 "2.7"; 2018 "2.9"; 2019 "3.3"; 2020 "3.6"; 2021 "3.9". - Effective interest rate: 2015 "8.8"; 2016 "8.1"; 2021 "10.6". - Spread (bp): "387"; CDS (bp): "302". - Stress-test scenarios: - Growth shock (real growth lowered by "1 standard deviation, or 4.2 percentage points, for 2 years starting in 2017"): nominal primary balance deteriorates to "-5 percent of GDP by 2018"; debt-to-GDP rises to "about 46 percent" during shock; gross financing needs climb toward "16.3 percent of GDP". - Interest rate shock (permanent increase in spreads by "about 400bps"): government implicit average interest rate reaches "15 percent by 2021"; debt-to-GDP climbs to "around 39 percent"; gross financing needs around "13 percent of GDP by 2021". - Contingent liability shock (one-time bailout equal to "10 percent of banking sector assets" combined with growth shock): shock equivalent to "4.8 percent of GDP"; debt rises to "45 percent of GDP in 2018"; gross public financing needs increase to "about 14 percent of GDP". - Policy implications: - Maintain fiscal discipline and monitor contingent liabilities. - Manage rollover risks and external financing needs. ### Structural Reforms and Labor Market Policies - Staff priorities: - Restore business confidence by enhancing predictability, simplifying regulations, improving legal system efficiency. - Make labor markets more flexible: - Welcome legislative amendments liberalizing fixed-term contracts and temporary work agencies. - Reform and pre-fund severance pay to enhance mobility. - Advocate moderate minimum wage increases aligned with inflation and productivity; differentiate labor cost by region. - Support private pension auto-enrollment law but recommend design changes: - Centralize contribution collection in Social Security Institute; - Create capacity in Pension Monitoring Center; - Open competitive international auctions for asset management; - Argue contribution rate should be increased to "at least 6 percent" for meaningful impact. - Improve refugee integration: simplify work permit application, active communication, and full implementation of March 2016 EU-Turkey framework. - Box 6 on pension reform specifics: - Automatic enrollment starting in 2017 with minimum contribution "3 percent of gross wages". - Staying after two-month opt-out rewarded by one-off payment of "TL1,000". - Government top-up of employee contributions by "25 percent" and "5 percent bonus" on accumulated amount if annuitized. - Staff concerns: design weaknesses that may weaken consumer protection and limit impact on national savings. ### Refugees: Scale, Integration, and International Assistance - Refugee numbers: - Turkey hosts "around 3 million" refugees; officially registered Syrian refugees "about 2.75 million (45 percent of whom are children aged below 18)"; other nationalities almost "0.3 million". - Government validating registration records planned completion "by mid-2017". - Labor market integration: - Legislative changes in January 2016 allow work permits; by end-October around "13,000 applications" received, "10,000" approved. - Low uptake due to firm-level quotas, municipality restrictions, administrative hurdles, qualifications recognition, skill mismatch, language difficulties. - EU-Turkey Facility: - Initial budget of "€3 billion for 2016–17", additional funding "up to €3 billion by end-2018". - As of end-October, funding allocated for implementation "€2.2 billion"; "34 projects contracted worth €1.2 billion", "€677 million disbursed". - ESSN: "€348m" allocated; entire amount contracted and "€278.4 million" disbursed; aims to reach "one million refugees by the first quarter of 2017". - Direct grants of "€300 million" each to Ministry of National Education and Ministry of Health. - More than two-thirds of school-aged Syrian refugees remain out of the national education system; education grant should enable "around half a million Syrian students" to receive education in Turkish. ### Risk Assessment Matrix: Key Domestic and Global Risks - Global risks highlighted (likelihood, horizon, impact show in RAM): - Economic fallout from political fragmentation — Likelihood: "High"; Time Horizon: "Short to Medium Term"; Impact: "Low to Medium". - Tighter or more volatile global financial conditions — Likelihood: "Medium"; Time Horizon: "Short Term"; Impact: "High". - Weaker-than-expected global growth (China slowdown, EM slowdowns) — Likelihood: variable; Time Horizon: "Short to Medium Term"; Impact: "Medium". - Domestic risks: - Loose domestic policies leading to high inflation and deteriorating fiscal position — Likelihood: "Medium"; Time Horizon: "Short to Medium Term"; Impact: "High". - Private debt overhang triggering deleveraging and recession — Likelihood: "Medium"; Time Horizon: "Short to Medium Term"; Impact: "High". - RAM methodology note: - Likelihood definitions: "low" <10 percent, "medium" 10–30 percent, "high" 30–50 percent. - “Short term” within 1 year; “medium term” within 3 years. ### Data, Revisions, and Surveillance Assessment - Data adequacy: broadly adequate for surveillance though weaknesses exist in national accounts and government finance statistics. - TURKSTAT national accounts revision (period 2009–15): - Real GDP growth revised up; largest changes for 2011–2015: annual real GDP growth revised up by an average of "2.7 percentage points". - Newly published real GDP growth rates (percent): 2009 "-4.7"; 2010 "8.5"; 2011 "11.1"; 2012 "4.8"; 2013 "8.5"; 2014 "5.2"; 2015 "6.1". - Nominal GDP (billion Lira): 2015 "2,338". - Revisions lower 2015 CA deficit to "3.8 percent of GDP". - Recent developments update to January 4, 2017: - Q3 2016: seasonally and calendar adjusted GDP contracted by "2.7 percent" compared to previous quarter. - Lira depreciation: depreciation in last three months of 2016 about "20 percent" with respect to the US dollar. - GIR declined by "US$4 billion to US$114 billion" in November and continued to fall in December; net international reserves remained broadly stable. - December 8 policy package measures (authorities’ announcement): 1. Increase capital of Turkish Eximbank. 2. State guarantees up to "TRY25 billion (US$7.2 billion or 1.2 percent of GDP)" through Credit Guarantee Fund. 3. Cap interest rate on public sector deposits at public banks; reduce provisions and ease NPL restructuring. 4. Temporary tax cuts and deferring social security contributions from Q1 to Q4 2017. - Authorities estimate cost of state guarantees no greater than "TRY17.5 billion (0.6–0.7 percent of GDP)" and other measures "TRY15–16 billion (0.7 percent of GDP)" over three years. _International Monetary Fund staff report (excerpt). Source: cr1732 (IMF staff)._ ### 1. Assessing the Impact of Shocks to Tourism ___________________________________________________ 17 ### 1. Assessing the Impact of Shocks to Tourism ### Recent developments and immediate impacts - Tourist arrivals fell sharply in 2016: security concerns and Russian sanctions cut the number of tourists from Europe by a quarter and from Russia by more than two-thirds in January-September. - The decline in tourist arrivals had a negative effect on accommodation, transportation, and food services. - Output contracted in the third quarter of 2016, though some pickup was expected by the year’s end contingent on government measures and gradual removal of Russian sanctions. - The external sector subtracted from growth in 2016 due to the surge in real imports and fall in tourist arrivals. ### Macroeconomic context amplifying tourism shock effects - Growth slowed in 2016: GDP growth was 3.9 percent (year-on-year) in the first half of 2016, with quarter-on-quarter pace decelerating sharply. - Growth remained consumption-driven, supported by the January minimum wage hike and low energy prices; investment was weak amid heightened uncertainty and sharp deceleration of credit growth. - The unemployment rate increased steadily since March 2016 as the labor force grew faster than employment; between May and July, seasonally-adjusted employment declined by 2.5 percent in industry and 5 percent in construction. - The current account deficit remained sizeable at over 4.5 percent of GDP, with the weak tourism season contributing to the deterioration in the external balance. ### Financial sector and credit implications - Credit growth slowed markedly; SME loan expansion fell from 21 percent in 2015:Q3 to 6 percent in 2016:Q3. - Retail credit growth picked up from around 4 to 7 percent, led mainly by state-owned banks, after macroprudential loosening in Spring and September 2016 to support credit and output growth. - Bank system-wide Tier 1 CAR increased to 13.7 percent, aided by higher profits and credit slowdown; however, part of the improvement reflected relaxation of prudential norms (released provisions and lowered regulatory risk weights on consumer loans). - A broader definition of impaired loans, which includes restructured credits, shows deterioration in asset quality, especially in the household and SME sectors. - Banks’ negative on-balance-sheet, net open FX position decreased from minus 30 to minus 8 percent of regulatory capital as residents’ FX deposits declined and reliance on short-term FX funding decreased. ### Policy responses observed - The central bank (CBRT) lowered the overnight lending rate by 250 basis points to 8¼ percent from March to end-September 2016, and later raised the one-week repo and overnight lending rates after a steep Lira depreciation in end-November. - In response to the failed coup attempt, the CBRT lowered reserve requirements, allowed greater use of gold and foreign currency, and offered unlimited Lira liquidity against FX collateral; later FX liquidity caps and changes to the reserve option mechanism and reserve requirements in FX were applied. - Government measures included fiscal easing through new hires in education and health, inflation indexation, security spending, subsidy for the minimum wage increase, and temporary tax reductions/exemptions following the failed coup attempt; the MTP envisions a widening of the 2016 general government deficit by around 2 percent of GDP. - Macroprudential regime was loosened in Spring and September 2016 to support credit and output growth. ### Outlook for tourism-related recovery and broader growth - Some pickup in activity was expected in late 2016 if Russian sanctions were gradually removed and government measures to spur consumption and investment took effect; however, security concerns were expected to hold back full recovery in tourist arrivals. - Growth is projected to be below potential in 2016–18; over the medium-term, growth is projected to be at around 3.5 percent, unchanged from previous estimates. - Bank credit to the private sector is expected to remain subdued and not a significant factor in the growth recovery. - Net exports are expected to improve somewhat due to Lira depreciation, domestic demand retrenchment, and expected lifting of Russian sanctions, but tourism recovery is likely constrained by persistent security concerns. - Uncertainty and changing global financing conditions are expected to keep the cost of external borrowing elevated. ### Key vulnerabilities and risks related to tourism shock - The tourism shock contributed to a sizeable current account deficit (over 4.5 percent of GDP) and weaker external position relative to medium-term fundamentals; the current account deficit is 1–4 percent higher than the estimated norm, implying a REER overvaluation of 5–15 percent on average in 2016. - Turkey’s external debt of around 60 percent of GDP is vulnerable to valuation shocks; debt service costs are sensitive to tightening global liquidity and investor sentiment given large share of short-term liabilities and variable-rate loans. - Downside risks include: high FX exposure of non-financial corporations; large annual external financing needs against low net international reserves (NIR); sizeable short-term capital inflows; and possible widening of the negative NIIP. These could exacerbate negative effects of an increase in external financing costs and trigger deleveraging, a credit-income contraction cycle, and a recession. - Financial market performance deteriorated in 2016, with Turkey underperforming other large emerging markets and experiencing non-resident withdrawals of US$2.5 billion by mid-November 2016 amid sovereign rating downgrades and emerging market sell-off. *Source: IMF staff report excerpt — Chapter 1, “Assessing the Impact of Shocks to Tourism.”* ### 18. The authorities believe growth will recover strongly in 2017. They attribute the ### 18. The authorities believe growth will recover strongly in 2017. ### Growth outlook and near-term drivers - Authorities attribute the 2016 economic slowing primarily to the drop in tourism, "which shaved more than 1 percentage point off growth in 2016." - Recovery expected in 2017 due to: - relaxation in macroprudential measures; - reduction in domestic interest rates; - investment stimulus packages; - improved relations with Russia and growth in traditional trading partners boosting tourism and exports; - political stability and structural reforms. - The Medium-Term Program projects growth at 4.4 percent in 2017 and 5.0 percent in 2018. ### Policy agenda: overarching goals - Two overarching goals: 1. avoiding an excessive slowdown of the economy; and 2. addressing external imbalances and reducing inflation. - Immediate priority: avoid an adverse loop between the slowing economy, large depreciation, and private balance sheets. - Medium-term priority: address external imbalances via macro policies and structural reforms to increase private saving and reduce dependence on external financing. ### Monetary policy (staff advice and authorities’ views) - Staff recommendations: - Maintain a broadly neutral monetary stance—to the extent consistent with orderly FX market conditions—and a moderately looser fiscal stance. - Monetary policy tightening could be required to prevent excessive Lira volatility and contain inflation spillovers. - Simplify the monetary framework so liquidity is provided at a policy rate; close the gap between average cost of CBRT funding and the policy (one-week repo) rate; make the interest rate corridor symmetric around that rate; keep the real cost of liquidity provision in positive territory. - Maintain the current positive, real CBRT funds rate as a balance between containing imbalances and providing a backstop to the slowing economy; tighten if recovery is stronger than expected and/or inflation fails to decline to its target. - Gradually withdraw the extra Lira liquidity provided after the failed coup attempt. - Increase international reserves: conditional on favorable global liquidity, staff advised a further increase of net international reserves (NIR) through (partially) sterilized interventions communicated in advance and by increasing the credit limit facility for the EXIM Bank. - NIR would need to be increased by about US$10 billion for GIR to reach 100 percent of the IMF’s ARA metric. - Authorities’ views: - Re-affirmed commitment to complete simplification of the monetary policy framework, with timing dependent on inflation dynamics and external conditions. - Have started gradual withdrawal of extraordinary Lira liquidity against FX collateral. - While agreeing on the need to build reserves, consider current conditions unsupportive of rapid accumulation. ### Fiscal policy (staff advice, risks, and authorities’ views) - Staff recommendations and assessments: - Moderate fiscal loosening in 2017 is appropriate, but a credible medium-term consolidation plan is needed. - The projected widening of the general government structural primary balance by ½ percent of GDP in 2017 would support domestic demand without exacerbating external imbalances. - Let automatic stabilizers work; extension of the minimum wage subsidy at an appropriately lower level could support growth and employment. - Planned increase in public investment is welcomed; caution that announced investment incentives may not be effective given high uncertainty and elevated private debt burden. - Tax incentives need to be well-targeted and supported by macroeconomic stability and rule of law. - Staff considers the authorities’ 2017 revenue projections overly optimistic: tax-to-GDP ratio projected to increase by 0.4 percent of GDP in 2017. - Tax expenditures remain an issue: revisions suggest they are in fact over 3 percent of GDP higher than previously estimated. - For 2018-19, the planned reduction of current transfers by 1 percent of GDP in 2018–19 is appropriate but needs specific measures to contain the wage bill, pension and health care spending and limit the increase in the debt-to-GDP ratio in the medium term. - Fiscal space and risks: - Turkey has some fiscal space to provide the recommended temporary stimulus; access to financing remains solid despite some increase in costs. - Fiscal position: debt-to-GDP ratio is moderate and projected to eventually resume a declining trend under the baseline and most stress scenarios; gross financing needs are low; projected primary balances exceed the debt-stabilizing level over the medium term. - Persistent external imbalances and dependence of banking and corporate sectors on external markets with substantial rollover needs call for prudence in using fiscal space. - Contingent liabilities are increasing due to continued reliance on PPPs; legal and oversight framework for PPPs is fragmented; growing share of fiscal risks falls outside the Treasury’s established approval and monitoring system and is not public. - Staff urged stronger central oversight, approval, and disclosure procedures for all public guarantees, backed by a comprehensive PPP framework law. - Newly announced investment incentives may add to fiscal risks, including extension of purchase and other guarantees. - The recently established sovereign wealth fund carries potential fiscal and financial risks; staff recommended governance aligned with international best practices, including published annual reports, audited financial statements, and a transparent investment policy. - Staff reiterated recommendation to publish an explicit fiscal risk statement. - Authorities’ views: - Believe policies appropriately balance stimulating the economy and remaining fiscally responsible; emphasize relatively low level of public debt and its composition. - Envision central government overall deficit to remain below 2 percent of GDP throughout the MTP horizon, ensuring a declining trend in public debt. - Believe new incentive schemes will boost investment. - Deem fiscal risks manageable; acknowledge desirability of expanding fiscal risk disclosure beyond the Treasury and strengthening PPP governance; intend to align the sovereign wealth fund with international best practices. ### Financial sector policies (staff advice and authorities’ views) - Staff recommendations and findings: - Further strengthen supervision and bank governance, building on the enhanced legal framework for financial regulation. - Banks face rising credit risks in the downward phase of the economic cycle; share of non-performing loans has increased in consumer and more recently corporate loans. - Restructuring of credits to hardest-hit sectors masks the extent of asset quality impairment. - Urged authorities to evaluate and revise the definition of credit classifications to bring them more in line with international norms and strengthen enforcement; strengthen supervisory processes and banks’ governance standards. - Questioned rationale behind recent loosening of macroprudential regulations for consumer loans; macroprudential policies should focus on financial system soundness, not active domestic demand management. - Argued that loosening risks being counterproductive given high private indebtedness and could add to financial vulnerabilities. - Recommended the macroprudential regime for corporate FX borrowing aim at lowering foreign exchange risk via specific measures: (i) quicker phase-in of reserve requirement measures aimed at lengthening the maturity of banks’ external financing as well as the net stable funding ratio; (ii) increasing the remuneration differential between Lira and FX reserves to further slow banks’ FX wholesale borrowing; (iii) increasing capital charges and/or provisioning on FX loans aimed at internalizing the increased indirect credit risk associated with FX lending; (iv) bringing the prudential treatment of FX-indexed lending in line with that of FX lending; (v) introducing tax measures to discourage NFCs from borrowing in FX, both domestically and externally. - Encouraged implementation of FSAP recommendations on anti-money laundering/combating the financing of terrorism. - Authorities’ views: - See loosening of macroprudential measures for consumer lending as stabilizing domestic demand and thereby lowering financial sector risks. - Maintain that relaxation will help recovery in credit growth, which has been subdued for three years, while aware of corporate sector’s elevated negative FX position. ### Contingency planning and stress scenarios - Staff cautioned use of additional policy space if there is a marked growth slowdown. In such a scenario: - Political uncertainty could elevate counterparty risk and worsen business climate, dampening private investment and consumption. - Potential vicious macro-financial cycle: deleveraging, cuts in investment by over-indebted corporates, and income contraction. - Some additional fiscal space could be used and monetary policy could assign a bigger weight to the output gap than to overshooting the inflation target; but relaxation of macroprudential policy should not be used for countercyclical purposes. - Authorities should require prompt recapitalization if stress tests show a capital shortfall. - In case of large capital outflows or a sudden stop: - A tighter monetary stance would be unavoidable; policy rate would need to be increased sharply to avoid damaging depreciation. - Given low net international reserves, scope for credible FX intervention is limited. - In a recession, fiscal policy should be loosened as public debt sustainability is not an immediate concern, but corporate default and bank liquidity or solvency problems could occur. - Staff reiterated the need to strengthen supervisory processes, banks’ governance standards, and a robust debt-restructuring framework. - Authorities’ views: - Stress resilience of the economy to negative shocks, citing low public debt level and composition, solid bank balance sheets, flexibility of the real sector, and renewed political stability. ### Structural reforms - Staff priorities and recommendations: - Restore business confidence and improve investment climate by enhancing predictability of the regulatory environment and ensuring adequate public institutional capacity. - Simplify regulations and administrative procedures for starting a business; increase efficiency of the legal system. - Make labor markets more flexible and raise competitiveness: - Welcome legislative amendments liberalizing fixed-term contracts and temporary work agency services. - Reform and pre-fund the severance pay system to enhance labor mobility. - Extend the minimum wage subsidy at an appropriately lower level to provide relief to strained firms. - Advocate moderate minimum wage increases aligned with expected inflation and productivity gains and differentiation of labor cost by region. - Support new pension auto-enrollment law but caution design weaknesses; recommend: (i) centralize collection of contributions in the Social Security Institute; (ii) create capacity in the Pension Monitoring Center for procurement and record keeping; (iii) open competitive international auctions for asset management now and for custodianship in the future; - Argue contribution rate should be increased to at least 6 percent for a meaningful impact on private saving. - Improve integration of refugees: - Simplify application process for work permits and implement active communication to improve uptake; - Full implementation of the March 2016 EU-Turkey framework would help improve refugees’ access to education, health care, and public utilities. - Authorities’ views on reforms: - Supportive of structural reform objectives and outlined policy intentions: - Private pension auto-enrollment law designed based on international best practices; government has authority to increase contribution rates if necessary. - Structural reforms to enhance business climate will focus on legislative amendments to simplify administrative and bureaucratic procedures and implement the regional investment incentive scheme. - Labor market improvements through labor code changes to support flexible employment, increased access to childcare facilities, relevant skill training, and internship programs. - More progress needed on severance pay reform with broad-based stakeholder consultation. - On refugees, authorities attribute slow uptake in work permits to skill mismatch; call for strong international financial assistance to support integration. ### Key fiscal-space and macro indicators (as presented) - 2016 Output Gap 1/: -0.3 - Gross public debt: 34.6 - Gross financing needs: 6.5 - EBA current account gap: -3.6 - 1/ Percent of potential GDP. _International Monetary Fund staff report (excerpt)._ ### 44. The challenges facing Turkey have increased considerably since the last Article IV ### 44. The challenges facing Turkey have increased considerably since the last Article IV ### Rising challenges and key vulnerabilities - Domestic political uncertainty has increased significantly, taking a toll on economic activity and testing several key domestic institutions. - International conditions have become more challenging, marked by a rise in interest rates and dollar strength. - Weak confidence and a rapidly depreciating lira are reinforcing one another, raising concerns about the resilience of the nonfinancial sector. - Pre-existing weaknesses remain unresolved: - large current account deficits; - high external financing needs; - large FX-denominated debt in nonfinancial corporates; - a weak business climate; - high inflation. - Structural constraints: - productivity is lagging; - growth potential has declined against the background of structural bottlenecks and low private investment rates. ### Institutional capacity and reforms - Institutional strength is a pre-requisite to tackle these challenges, especially after the failed coup attempt. - Key requirements: - ensure key economic and financial public institutions remain strong and credible, with their mandates preserved; - bring policy frameworks further towards international best practice. - Specific needs highlighted by staff: - strengthen the monetary transmission mechanism; - enhance the management of contingent liabilities. - The FSAP underscores avenues to strengthen financial sector oversight and supervision. ### Macro-financial policy priorities - Stronger macro-financial policies are necessary to bring down stubbornly high inflation and reduce external vulnerabilities. - Root causes of vulnerabilities: - structural: low private saving; - cyclical: externally funded, private sector up-leveraging favored by easy international financing conditions. - Exacerbating factors: - persistent overshooting of the inflation target; - risks from the large, negative FX position of the economy. - Balance sheet risks: - banks and corporates are leveraged and highly exposed due to the high share of borrowing in foreign currency. ### Short-run stabilization: avoiding an excessive slowdown - Some near-term slowdown can help reduce external imbalances, but a large fall in GDP growth risks a vicious credit-income contraction cycle. - Appropriate demand management calls for: - a broadly neutral monetary stance—to the extent consistent with orderly FX market conditions; - allowing automatic fiscal stabilizers to operate in full. - Tighter monetary stance may be required to prevent excessive Lira volatility. - Fiscal stance: - Turkey has some fiscal space to provide discretionary measures; - any fiscal stimulus should internalize fiscal policy’s role as a stability anchor, particularly given the scarce credibility of monetary policy. ### Medium-term priorities - Rebuilding buffers and tackling structural weaknesses is important. - Key steps: - simplify the monetary policy framework; - rebuild credibility by appropriate tightening of monetary policy to reduce inflation. - Macroprudential policy: - recent loosening risks being counterproductive given high private indebtedness; - focus should remain on maintaining the soundness of the financial system. - External buffers: - net international reserves should be increased. ### Structural reforms and boosting potential - Slow progress with structural reforms and heightened political and economic uncertainty are holding back potential. - Policy priorities: - improve the investment climate; - ensure adequate public institutional capacity in the wake of the failed coup attempt; - boost internal and external competitiveness of the formal economy, including keeping future minimum wage increases in check and addressing labor market rigidities. - Low private saving constrains balanced growth potential. - Voluntary pension system reform is a step forward, but its impact will be limited unless its design is further aligned with international best practices. ### Article IV timing - Recommendation: the next Article IV consultation with Turkey be held on the standard 12-month cycle. ### Box 1 — Assessing the Impact of Shocks to Tourism - Tourism sector importance and trends: - Turkey’s share in global inbound tourist flows increased from 1.5 percent in early 2000s to about 3 percent in 2015. - Number of foreign tourist arrivals tripled and reached 36.2 million people. - In 2015, travel services earned around US$27bn of exports revenues (3.7 percent of GDP and about 13 percent of total export proceeds). - Direct employment estimate: about 600 000 jobs (2.3 percent of total employment); additional approximately one million estimated to be created indirectly. - 2016 shock and impacts: - Tourist arrivals from Europe fell by over 30 percent amid a sharp rise in terrorist attacks. - Russian tourists fell by more than two-thirds in January-September due to Russian restrictions. - Exports of transportation services fell about 30 percent. - Given linkages, a 10 percent shock to foreign arrivals is estimated to have 0.3-0.5 percent impact on GDP in the first year after the shock. - The model predicted that absent policy measures GDP would decelerate to around 2 percent in 2016. - Model and data: - Assessment based on a Bayesian VAR model estimated on quarterly data between 1998 and 2015. - Model variables: real tourism exports, gross value added for food & accommodation, transportation and the rest of sectors; weighted GDP of source countries and REER as controls; trend variable for tourism capacity. ### Box 2 — Benchmarking Private Debt Burdens - Aggregate metrics: - Turkey’s private debt-to-GDP ratio is significantly below the threshold of 160 percent used for unconsolidated data in the EU Macroeconomic Imbalances Procedure. - Aggregate debt burden in Turkey is higher than in the Czech Republic and Poland. - Sectoral solvency concerns: - Significant increase in exposure of corporates and households to vulnerabilities post-global financial crisis. - Turkey ranks second in solvency risk exposure across European countries outside the euro area. - Readings of corporate and household risk metrics exceed the indicative thresholds given by the cut-off point of the top quartile of the EU-wide distribution in 1995–2007. - Data note: - Official data for calculating sectoral liquidity risk metrics is not available for Turkey. ### Box 3 — Residential House Prices - Price and debt dynamics: - House prices rose cumulatively by 110 percent in nominal and 35 percent in real terms between end-2010 and July 2016. - Valuation appears stretched by metrics such as price-to-income and price-to-rent ratios. - Household debt burden has increased. - Demand drivers: - Young and rapidly growing population, rising urbanization, increase in number of households (decline in average household size), shift toward newer and larger houses with stronger construction codes. - Policy measures and market response: - Government launched a campaign for subsidized sales of 60,000 houses with mortgages offered at below-market lending rates and higher LTV ratios than the regulatory ceiling. - Following measures, total house sales rose by 2 percent year-on-year in August (year not specified in the excerpt). - LTV ceiling was raised from 75 to 80 percent. ### Box 4 — Contingent Liabilities Related to PPP and other Treasury Guarantees - PPP portfolio growth: - Total investment size increased fivefold since 2010. - Total investment value stands at $53 billion for 211 projects. - 33 PPP projects with total investment value of US$38.8 billion are under construction. - Disclosure and monitoring gaps: - Legal and regulatory framework for PPPs is highly fragmented across sectors and types of PPP arrangements. - Annual budget laws set upper limits for contingent liabilities only for those provided by the Treasury. - Treasury discloses contingent liability commitments in monthly Public Debt Management Reports. - Treasury guarantees and DACs: - Outstanding stock of Treasury guaranteed external debt stood at US$12 billion. - Loans for which Treasury offered debt assumption for 3 PPP projects stood at US$8.7 billion. - Estimated contingent liabilities: - Focusing on DAC exposure on projects under construction and assuming (a) only the minimum 20 percent of total investment is equity financed, and (b) all remaining financing is external debt covered by DACs, the estimated size of contingent liabilities would be roughly 4 percent of GDP (including the Treasury DACs above). - Treasury guarantee distribution: - Share of financial institutions in Treasury guaranteed external debt rose to over 80 percent in 2015 from 43 percent in 2006. - Share of public banks increased from 2 percent of external debt guarantees in 2006 to 55 percent in 2015. ### Box 5 — Summary of FSAP Findings and Recommendations - Resilience and risks: - Turkish banks can reasonably withstand severe stress provided it is short-lived, but capital shortfalls can become significant should stress persist and systemic risks and spillovers become high. - Supervision of banks, insurance companies, and FMIs: - Need further development and deepening of the risk-assessment nature of banking inspections and follow up. - Apply greater rigor to supervisory evaluation and enforcement of credit risk and corporate governance rules. - Strengthen governance, independence and accountability in insurance supervision; integrate supervisory functions and focus on corporate governance and internal controls within insurers. - For the National Payments System (NPS), address concentration of intraday liquidity at the end of the day and institute a risk management framework for interdependencies among FMIs. - Oversight and management of systemic risks: - Provide additional clarity on roles and responsibilities of the Financial Stability Committee (FSC), the Council of Ministers, and FSC member authorities. - Consider an explicit financial stability objective for all FSC members. - Implement procedures for more integrated risk identification and ex ante review of alternative policy options by the FSC. - Strengthen coordination of policy actions and follow-up through agreement to consider and respond to FSC recommendations in advance of policy decisions. - Enhance overall transparency and disclosure to foster credibility and accountability. - Crisis management and resolution: - Legal changes to equip BRSA with effective recovery planning powers and empower SDIF to undertake resolvability assessments and resolution planning. - Empower agencies to require banks to make necessary changes to make plans implementable. - Establish new resolution tools for the SDIF, including powers for more comprehensive business transfer, establishing and capitalizing bridge banks, and implementing bail-in. - Facilitate international bank data sharing by SDIF. - Strengthen institutional arrangements to clarify responsibilities and limit BRSA involvement to triggering resolution, not defining its type. - Improve coordination with FSC and review resolution funding arrangements to reduce contingent claims on taxpayers. - Bolster cross-border recovery and resolution arrangements. - Systemic liquidity management: - Orient liquidity provision towards a single key policy rate. - Increase net reserves such that gross reserves are within the range of 100–150 percent of the ARA metric. - Redefine CBRT FX lending facility as ELA and increase conditionality. - Improve ELA capacity (testing procedures, expand range of collateral, processes for government indemnities for CBRT). - Development of capital markets: - Support consolidation of an interest rate derivatives market and stimulate liquidity in government and corporate bond markets to facilitate hedging and enhance demand for capital market products. - Improve issuance regulations, disclosure and governance standards to restore investor confidence. - AML/CFT priorities: - Complete the national ML/TF risk assessment. - Address low level of convictions for ML. - Introduce customer due diligence requirements for politically exposed persons in line with the FATF standard. - Implement UN Security Council Resolutions requirements relating to terrorist funds and strengthen measures to monitor cross-border transportation of cash. *Source: cr1732 (IMF staff).* ### Box 6. Turkey: Reform of Voluntary Private Pension System ### Box 6. Turkey: Reform of Voluntary Private Pension System ### Reform description - Starting in 2017, workers will be enrolled automatically in a private pension plan, with a minimum contribution of 3 percent of their gross wages. - Staying in the system after the two-month opt-out period would be rewarded by a one-off payment of TL1,000. - The government will top-up employee contributions by 25 percent and offer a 5 percent bonus on the accumulated amount, if at the time of withdrawal, participants elect to receive an annuity. ### Positive aspects highlighted - Preserves the freedom of individuals to choose. - Exploits consumer inertia to maximize the impact on aggregate savings. - Caps asset management fees to much lower levels than observed in the existing voluntary system. - Attempts to reduce wasteful competition in the market. ### Design weaknesses and risks - The legislation passed suffers from serious design weaknesses that weaken consumer protection and risk popular resentment, thereby undermining the reform’s key objectives. - The reform does not establish a public procurement board for periodic auctions of pension services, with the exception of asset management. Employers are unlikely to be more skilled than individuals in choosing pension plans for their workers. - Fee rates are charged on heterogeneous bases (asset under management) thus promoting competition in the market and unnecessary marketing expenses. - Fee rates would become obsolete over time and it will be necessary to lower them periodically exposing the authorities to the risk of regulatory capture. - The Social Security Institute will not collect pension contributions so average costs are not minimized. - Pension firms’ sales forces are used to retain individuals in the system, generating incentives and opportunities for mis-selling. A political appointee is in charge of investment rules. - The governance of the investment advisory committee is yet to be defined. Only Turkey-incorporated asset managers are allowed to participate in the auctions. - Finally, the reform is not projected to increase sufficiently national savings. *TURKEY INTERNATIONAL MONETARY FUND 23* ### Box 7. Turkey: Refugees in Turkey – Recent Developments ### Box 7. Turkey: Refugees in Turkey – Recent Developments ### Overview - Turkey is one of the largest refugee-hosting countries with around 3 million of refugees. - Officially registered Syrian refugees are about 2.75 million (45 percent of whom are children aged below 18) (UNHCR, 2016). - Refugees of other nationalities are estimated to be almost 0.3 million. - Precise estimation of refugee numbers is difficult because some registered refugees might have left while there may be other non-registered refugees in Turkey. - The government has begun validating the registration records and plans to complete this exercise by mid-2017. This exercise would also provide information on refugee movements within Turkey, and thus improve targeting of financial assistance. ### Social and economic integration - Given the large number of refugees, social and economic integration is challenging but crucial. - Around 90 percent of Syrian refugees had left the temporary protection centers (AFAD, 2016). - Prior to 2016, Syrian refugees could only work in the informal sector, which appears to have negatively affected local informal workers with low labor force attachments, such as women and the low-skilled (Del Carpio and Wagner, 2015). - Legislative changes in January 2016 allow Syrian refugees to apply for work permits. - At end-October, only around 13,000 applications by Syrian refugees have been received, of which 10,000 were approved. - One-third of the permits granted were to the textile and wholesale and retail industries. - Factors cited for the low uptake of formal work permits: - firm-level quotas; - requirement that refugees apply for permits only in the municipality of initial registration; - administrative hurdles; - limited communication; - qualifications recognition; - skill mismatch; - language difficulties. ### International assistance: EU-Turkey Facility for Refugees in Turkey - Under the EU-Turkey agreement to reduce irregular migration, the Facility for Refugees in Turkey was set up to provide support to refugees in Turkey in the areas of humanitarian assistance, education, migration management, health, municipal infrastructure, and socio-economic development. - The Facility has an initial budget of €3 billion for 2016–17, and additional funding of up to €3 billion by end-2018. - As of end-October, of the overall initial budget, the total funding allocated for implementation on humanitarian and non-humanitarian actions stood at €2.2 billion. - Of these €2.2 billion, 34 projects have been contracted worth €1.2 billion, out of which €677 million have been disbursed to the implementation units. ### ESSN, sectoral grants, and education outcomes - EC's Facility for Refugees in Turkey (allocated only): Total of €2.2 billion - ESSN €348m - Other humanitarian €248m - Min of Educ €300m - Min of Health €300m - Other non-humanitarian €1bn - Source: The European Commission (2016). - The largest humanitarian support under the Facility is the Emergency Social Safety Net (ESSN), which provides direct monthly cash transfers through debit cards to cover basic needs of the most vulnerable refugee families. - The entire €348 million in allocated funding from the Facility has been contracted, of which €278.4 million have been disbursed to implementing partners. - The ESSN support aims to reach one million refugees by the first quarter of 2017. - Of the funding allocated to non-humanitarian support: - Two direct grants worth €300 million each will be provided to the Ministry of National Education and the Ministry of Health for costs incurred in their efforts to integrate Syrian children into the Turkish education system and to ensure Syrian refugees have access to health care. - More than two-thirds of school-aged Syrian refugees remain out of the national education system. - The direct grant for education should enable around half a million Syrian students to receive education in Turkish. ### Implications highlighted in the text - Validation of registration records (planned completion by mid-2017) would improve estimates of refugee numbers and provide information on refugee movements within Turkey, thereby improving targeting of financial assistance. - International assistance, notably the EU-Turkey Facility and the ESSN, could play an important role in supporting humanitarian needs and facilitating integration through funding for education, health, and socio-economic programs. *Source: Box 7. Turkey: Refugees in Turkey – Recent Developments.* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Global risks: sources, likelihood, time horizon, impact, and policy responses - Economic fallout from political fragmentation - Risks described: - Rise in populism and nationalism in large economies could slow down or even reverse policy coordination and collaboration; international trade liberalization; financial, and labor flows; and lead to unsustainable policies, weighing on global growth and exacerbating financial market volatility. - Protracted uncertainty associated with negotiating post-Brexit arrangements could weigh on confidence and investment more than expected—most prominently in the UK and the rest of Europe with possible knock-on effects elsewhere. Increased barriers could also dampen the longer-run economic performance of affected countries more than expected. - Heightened risk of fragmentation/security dislocation in part of the Middle East, Africa, and Europe, leading to a sharp rise in migrant flows, with negative global spillovers. - Likelihood: High; Time Horizon: Short to Medium Term; Impact: Low to Medium (as shown in matrix) - Policy responses: - Preemptively increase FX reserves through sterilized intervention. - Medium term: Improve competitiveness through structural reform. - Reduce energy dependence by developing additional domestic generation capacity. - Tighter or more volatile global financial conditions - Risks described: - Sharp rise in risk premia with flight to safety: investors withdraw from specific risk asset classes as they reassess underlying economic and financial risks in large economies, or respond to unanticipated Fed tightening, and increases in U.S. term premia, with poor market liquidity amplifying volatility. Safe haven currencies—especially the US dollar—surge creates balance sheet strains for FX debtors. - Likelihood: Medium; Time Horizon: Short Term; Impact: High - Policy responses: - Preemptively strengthen bank and NFC balance-sheets through restrictions on the structure of liabilities and higher risk weights or provisioning on lending to NFCs in FX. - Tighten monetary policy. - To the extent the NIR level allows, use FX reserves to smooth volatility in disorderly market conditions. - In case a recession ensues, consider loosening the fiscal stance. - Weaker-than-expected global growth - Risks described: - Significant China slowdown and its spillovers: loss of investor confidence, disorderly corporate defaults, sharp fall in asset prices, quicker fading of stimulus impact; weak domestic demand suppresses commodity prices, roils global financial markets, and reduces global growth (Likelihood: low in short-term, medium thereafter). - Significant slowdown in other large EMs/frontier economies: turning of the credit cycle and fallout from excess household and corporate (FX) leverage as investors withdraw from EM corporate debt, generating disorderly deleveraging, with potential spillbacks to advanced economies. - Structurally weak growth in key advanced and emerging economies: weak demand, low productivity growth, and persistently low inflation leading to lower medium-term potential growth (the Euro area, Japan, and the United States) and exacerbating legacy financial imbalances especially among banks (the Euro area) (high likelihood). Tighter financial conditions and insufficient reforms undermine medium-term growth in emerging markets (medium likelihood). - Likelihood: Low/Medium to High/Medium depending on sub-risk; Time Horizon: Short to Medium Term; Impact: Medium - Policy responses: - Preemptively strengthen bank and NFC balance-sheets through restrictions on the structure of liabilities and higher risk weights or provisioning on lending to NFCs in FX. - Medium term: Diversify export destinations, increase high value-added exports, and improve competitiveness, thus boosting exports. - Structural reforms should be promptly implemented to gain competitiveness. - Medium term: Tighten fiscal policy to bring it back into line with the reduced growth potential. ### Domestic risks: sources, likelihood, time horizon, impact, and policy responses - Loose domestic policies leading to high inflation and deteriorating fiscal position - Risk described: Government tries to spur growth through demand management rather than long-term structural reform, eroding confidence and leading to re-dollarization. - Likelihood: Medium; Time Horizon: Short to Medium Term; Impact: High - Policy responses: - Short-run: Tighten monetary policy and normalize the framework. - Medium term: Tighten fiscal policy to bring it back into line with the medium-term program. Prioritize expenditure compression. - Private debt overhang weighs on domestic demand - Risk described: Slowdown in private sector credit growth can trigger a disorderly deleveraging cycle resulting in a recession. - Likelihood: Medium; Time Horizon: Short to Medium Term; Impact: High - Policy responses: - Preemptively strengthen bank and NFC balance-sheets through restrictions on the structure of liabilities and higher risk weights or provisioning on lending to NFCs in FX. - Short-run: Use some additional fiscal space and allow monetary policy to assign a bigger weight on the output gap, to the extent consistent with orderly FX market conditions. - Medium term: Put in place a robust debt-restructuring framework. ### Key overall RAM methodology note - The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). - Likelihood definitions: “low” indicates a probability below 10 percent, “medium” between 10 and 30 percent, and “high” between 30 and 50 percent. - “Short term” and “medium term” indicate the risk could materialize within 1 year and 3 years, respectively. - Non-mutually exclusive risks may interact and materialize jointly. --- ### Annex II. External Sector Assessment — findings, assessments, and policy responses ### Foreign asset and liability position and trajectory - Background findings: - Turkey’s net international investment position (NIIP) widened to about -56 percent of GDP in the end of 3Q2016. - Foreign liabilities are just below 90 percent of GDP, including about 53 percent of GDP in foreign currency. - External debt is sustainable. - Debt maturity improved, but risks remain significant given short-term debt and portfolio investments in debt securities of about 30 percent of GDP and 42 percent of long-term debt have floating interest rates. - Assessment highlights: - The composition of liabilities exposes Turkey to liquidity shocks, investor sentiment shifts and increases in global interest rates. - Unless the current account deficit (CAD) improves substantially in the years ahead, Turkey’s NIIP would continue to deteriorate by some 10 percentage points of GDP in medium term. - Overall assessment: In 2016, Turkey’s external position remains weaker than the level consistent with medium-term fundamentals and desirable policy settings. The current account deficit remains sizable despite gains from lower oil prices. Net international reserves are still low, and the NIIP will continue to deteriorate until the CA deficit is reduced. Given large financing needs and a high share of short-term capital inflows, Turkey remains vulnerable to capital flow reversal. - Potential policy responses: - Reduce the CA deficit to diminish vulnerabilities; on-going economic slowdown and deceleration of credit growth help rebalancing. - Some temporary fiscal loosening is appropriate to avoid excessive slowdown, but a credible medium-term consolidation plan to support increased public saving over the medium term is necessary. - Further monetary easing should be avoided; real policy interest rates should remain positive. - Strengthen macroprudential measures to lower foreign currency risk in the economy. - The CBRT should continue to increase net international reserves, limiting foreign exchange sales to smoothing periods of excessive volatility. - Structural reforms are needed to enhance private savings and allow higher growth with a sustainable current account deficit. The new pension auto-enrollment law is a step in the right direction, though in its current form the reform will have only marginal effect on aggregate savings. ### Current account - Background findings: - The CAD is projected to remain close to its 2015 level of 4.5 percent of GDP. - Weak tourism season, Russian sanctions on trade and strong non-oil imports likely to outweigh the effect of lower energy costs. - The EBA model estimates that in 2016 the cyclically-adjusted CA was some 3.6 percent of GDP weaker than the level implied by medium-term fundamentals and desirable policies. - External sustainability (ES) approach suggested the CAD was 1–2 percentage points above the level consistent with stabilizing NIIP at the current level. - Assessment: - Staff assesses that the CA gap remains in the range of -1 to -4 percent of GDP. - This is consistent with a CA norm in the range of -1 to -3.5 percent of GDP, reflecting large investment needs of a fuel-importing emerging economy. ### Real exchange rate (REER) - Background findings: - Since hitting a 12-years minimum in September 2015, REER increased by about 10 percent, as Lira remained broadly stable and inflation showed persistence. As of October 2016 the REER was slightly above its average 2015 level. - The EBA REER index approach estimates a 4.2 percent overvaluation in 2016; the REER level regression suggests a 15.4 percent overvaluation. - Based on the ES approach, about 6 percent REER adjustment is required to stabilize NIIP. - In November Lira depreciated by about 10 percent amid capital outflow from emerging markets. - Assessment: - Staff assesses that the REER remained overvalued by about 5–15 percent on average in 2016. ### Capital and financial accounts: flows and policy measures - Background findings: - Significant external financing needs have been comfortably met due to ample global liquidity. - Government and private sector enjoy access to international capital markets; net portfolio inflows turned positive in 2016 and were enough to compensate for lower rollover ratio on syndicated loans in 3Q. - Turkey has not made use of capital controls on inflows or outflows. - Assessment: - Large share of short-term debt exposes Turkey to significant rollover risks. - Gross external financing needs are estimated at about 27 percent of GDP in 2016. ### FX intervention and reserves level - Background findings: - Exchange rate is floating. - In April 2016 the central bank stopped selling foreign exchange to commercial banks through regular auctions and significantly reduced direct sales of FX to energy importing SOEs. - By October, Turkey’s gross reserves (GIR) increased by about US$8 billion due to government borrowings and rediscount credit operations, and net reserves increased to US$35billion. - Most of the gains in GIR were lost in November as a result of falling banks required reserves and restriction imposed on the use of FX collateral. - GIR level is about 90 percent of the ARA metric, and reserves coverage of short-term debt is about 70 percent. - Adjusting the level of reserves for ROM-related reserve holdings and banks swap positions vis-à-vis the CBRT reduced it to 60 percent of the composite adequacy metric at the end of October 2016. - ROM-related FX in gross international reserves stood at about US$27bn (23 percent of total reserves) as of September 2016. - Net reserves available for intervention are significantly lower than GIR. - Assessment: - Given low net international reserves, further reserve accumulation is warranted. - Foreign exchange sales should be restricted to periods of disorderly market conditions. - Technical background notes: - The windfall of lower energy prices are estimated at about 1 percent of GDP in 2016. - Fuel trade balance was -5.9 percent of GDP on average in 2011–2015. - In the first nine months of 2016, foreign tourist arrivals fell by 32 percent due to Russian sanctions and rising security concerns, contributing to falls in exports proceeds from travel (-31 percent), transportation (-30 percent), and the shuttle trade (-14 percent). --- ### Annex III. External Debt Sustainability — background, assessment, projections, and vulnerabilities ### Summary assessment - Turkey’s external debt, while sustainable, is high and vulnerable to valuation shocks. - Under the baseline, debt is forecast to stabilize at around 60 percent of GDP in the medium term (statement in the Annex). - Later assessment: The debt trajectory stabilizes under the baseline at around 64 percent of GDP. - Annual external financing needs in excess of 30 percent of GDP expose the economy to high liquidity and rollover risks. ### Background and assumptions / key facts - External debt continued to increase and is estimated to reach 59 percent of GDP in 2016. - A large share of external debt, about 26 percent of GDP, resides with banks who intermediate capital inflows into domestic loans, mostly in Lira but also in foreign currency. - Non-financial corporates (NFC) external debt is estimated to exceed 19 percent of GDP in 2016, increasing by about US$12bn over the year. - Bank loans constitute over 60 percent of total external debt of the outstanding debt stock of the private sector. - Private creditors, including bondholders, hold close to 90 percent of Turkey’s total external debt. - Short-term debt with original maturity of less than 12 months fell markedly in 2015, though much short-term syndicated debt was extended just beyond the 365-day threshold. - Rating downgrades have contributed to the increase in the cost of external funding; the cost of financing is increasing. ### Vulnerabilities and stress-test findings - Because over 90 percent of Turkish external debt is denominated in foreign currency, the debt path is susceptible to exchange rate movements. - Standard stress tests: - A permanent Lira depreciation by 30 percent would push the external debt stock to 85 percent of GDP by 2021 (analysis notes this does not account for potential contraction of the current account deficit associated with sharp currency movements). - A steeper recovery of fuel prices, leading to non-interest current deficit of about 4.2 percent would push the debt ratio to around 69 percent of GDP over the medium term. - An increase in interest rates by 1 standard deviation compared to the baseline would increase the debt level by additional 3 percentage points to 66 percent of GDP. - Large external financing requirements and a significant share of debt with adjustable rates make the economy vulnerable to shifts in global liquidity. - Annual rollover needs remain close to a quarter of GDP. - Total external financing needs are about 30 percent of GDP over the next few years. - Over 60 percent of total external debt, including debt with short maturities, is indexed to global interest rates. - A sudden stop in capital flows may trigger simultaneous rise in borrowing costs and exchange rate pressure. ### Projections snapshot (selected figures from the DSA table) - Baseline: External debt in percent of GDP (selected years shown in table): - 2015: 55.4 - 2016: 59.6 - 2017: 67.1 - 2018: 67.8 - 2019: 66.6 - 2020: 64.9 - 2021: 63.5 - Identified external debt-creating flows (summary): - Current account deficit, excluding interest payments (percent of GDP): 2016: 3.7; 2017: 3.9; 2018: 3.6; 2019: 3.0; 2020: 2.5; 2021: 2.6. - Net non-debt creating capital inflows (negative): 2016: -1.2; projected around -1.5 to -1.8 in later years. - Gross external financing need (in percent of GDP): 2016: 27.2; 2017: 30.7; 2018: 31.5; 2019: 30.9; 2020: 29.6; 2021: 29.2. - Key macroeconomic assumptions underlying baseline (selected): - Real GDP growth (in percent): 2016: 3.9; 2017: 4.1; 2018: 2.7; 2019: 2.9; 2020: 3.3; 2021: 3.6. - Current account balance, excluding interest payments (percent of GDP): 2016: -4.9; 2017: -3.7; 2018: -3.9; 2019: -3.6; 2020: -3.0; 2021: -2.5. - Exchange rate appreciation (US dollar value of local currency, change in percent): 2016: -6.4; 2017: 9.0; 2018: -10.0; 2019: -15.5; 2020: -6.6; 2021: -5.0. - Gross external financing need (in billions of US dollars): 2016: 193.4; 2017: 204.4; 2018: 217.3; 2019: 225.2; 2020: 230.0; 2021: 240.6. ### Stress scenario outcomes (select results shown) - Interest rate shock: baseline 64 → scenario 66 (external debt in percent of GDP). - Non-interest current account shock: baseline 64 → scenario 69. - Growth shock: baseline 64 → scenario 69. - Combined shock: baseline 64 → scenario 70. - Real depreciation shock (one-time 30 percent in 2016): baseline 64 → scenario 85. *Source: IMF staff assessments and tables as presented in the Annexes I–III of the document.* ### Annex IV. Public Debt Sustainability ### Annex IV. Public Debt Sustainability ### Overview and public debt profile - Public debt measured as general government gross debt according to Maastricht criteria is "about 35 percent of GDP". - Turkey’s debt-to-GDP ratio was "32.9 percent at end-2015". - Average maturity of public debt is "6.2 years". - Debt characteristics: "68 percent of total debt at fixed interest rates" (69 percent is used elsewhere for fixed share in table), and "only 35 percent of the debt in foreign exchange". - Gross public financing needs were "5.3 percent of GDP in 2015", down from "15 percent on average for 2005–13". - Given the debt structure, the direct interest and exchange rate pass-through to the budget is relatively low. - High external financing requirements imply risks arising from the external debt position. ### Baseline projections and realism of assumptions - Debt trajectory: - Staff project the debt-to-GDP ratio to reach "34.8 percent in 2021—up by 2 pp since end-2015." - The interest rate/growth differential contributes to the decline in the debt-to-GDP ratio; the primary balance first contributes to an increase then a decrease. - Growth and output gap: - Current growth projections are similar to "the levels for 2014–15". - A negative output gap is opening but is projected to close over the medium term. - Turkey’s debt is highly sensitive to big swings in GDP growth. - Sovereign yields and interest rates: - Spreads against US bonds in the last three months averaged "331 bps", higher than the lowest value of "118 bps observed in May 2013". - Effective interest rate is forecast to decline from "8.8 percent in 2015 to 8.1 percent in 2016". - In the medium term effective rates are expected to increase due to international rates. - Fiscal adjustment: - In the baseline the structural primary balance improves in the medium term. - The maximum projected 3-year adjustment of the cyclically-adjusted primary balance is "2 percent of GDP". - The maximum projected 3-year average level of cyclically-adjusted primary balance is "0.8 percent of GDP". - Debt structure restated: - Table values show nominal gross public debt: "32.9" for 2015 and projected "34.8" for 2021. - Public gross financing needs: "5.3" in 2015 and projected "8.5" in 2021. - Real GDP growth projections: 2016 "4.0", 2017 "2.7", 2018 "2.9", 2019 "3.3", 2020 "3.6", 2021 "3.9". - Inflation (GDP deflator): 2015 "8.3" (table shows 2015 = 8.3), projected 2021 "7.0". - Effective interest rate (defined as interest payments divided by debt stock at end of previous year): 2015 "8.8", 2016 "8.1", 2021 "10.6". - Sovereign spreads and CDS shown in table: Spread (bp) "387"; CDS (bp) "302". - Ratings in table: Moody's "Ba1"/"Ba1", S&Ps "BB"/"BB+", Fitch "BBB-"/"BBB". ### Identified debt-creating flows and decomposition (selected figures) - Change in gross public sector debt (cumulative projection): "1.9" (table). - Identified debt-creating flows (cumulative projection): "2.1". - Primary deficit path (in percent of GDP): 2015 "-1.4"; 2016 "-1.0"; 2017 "0.8"; 2018 "1.5"; 2019 "0.9"; 2020 "-0.4"; 2021 "-0.8". - Primary (noninterest) revenue and grants: 2015 "35.7"; 2016 "35.7"; 2021 "37.4". - Primary (noninterest) expenditure: 2015 "34.3"; 2016 "34.8"; 2021 "36.6". - Automatic debt dynamics contribution (cumulative): "-3.5". - Interest rate/growth differential contribution (cumulative): "-3.5". - Exchange rate depreciation contribution: 2016 "2.8" (table shows a 2.8 entry for 2016). - Other identified debt-creating flows (cumulative): "1.0". - Public Sector: Privatization Proceeds (negative cumulative): "-2.0". - Deposit build-up (cumulative): "3.0". - Residual, including asset changes (cumulative projection): "3.1". ### Shocks and stress-test results - General finding: Primary balance and interest rate shocks do not affect debt dynamics substantially, while growth shock and contingent liability shocks lead to a temporary increase in debt. - Primary balance shock: - Scenario: deterioration of "1.0pp of GDP in the primary balance for 2 years". - Sovereign borrowing costs increase "25 bps for each 1 percent of GDP worsening in the primary balance". - Impact on debt-to-GDP ratio and gross financing needs by 2021 is modest. - Growth shock: - Scenario: real output growth rates lowered by "1 standard deviation, or 4.2 percentage points, for 2 years starting in 2017". - Inflation response: decline of "0.25 percentage points per 1 percentage point decrease in GDP growth". - Nominal primary balance deteriorates, reaching "-5 percent of GDP by 2018". - Debt-to-GDP ratio increases to "about 46 percent during the growth shock" then gradually trends down. - Gross public financing needs climb toward "16.3 percent of GDP" before trending down to "14.2 percent of GDP by the end of the period". - Interest rate shock: - Scenario: real effective rate reaches similar levels as in 2009, implying a permanent increase in spreads by "about 400bps". - Government implicit average interest rate reaches "15 percent by 2021". - Debt-to-GDP ratio climbs to "around 39 percent". - Gross public financing needs increase to "around 13 percent of GDP by 2021". - Contingent liability shock: - Scenario: one-time bailout increasing non-interest expenditures by "10 percent of banking sector assets", combined with real GDP growth shock ("1 standard deviation for 2 years"). - Note: This shock is equivalent to "4.8 percent of GDP". - PPP and guarantees context: PPP projects with treasury investment guarantees amount to "0.9 percent of GDP"; treasury guaranteed loans (outside the general government) amount to "1.6 percent of GDP"; loan subject to debt assumption amount to "1.1 percent of GDP". - Sovereign borrowing costs increase "25 bps for each 1 percent of GDP worsening in the primary balance". - Inflation declines "0.25 percentage points per 1 percentage point decrease in GDP growth". - Debt rises to "45 percent of GDP in 2018" and then gradually declines. - Gross public financing needs increase to "about 14 percent of GDP in the medium term". ### Risk assessment and policy implications - DSA conclusion: Turkey’s government debt is sustainable under different shock scenarios, but vulnerability remains from large external financing needs and sensitivity to growth shocks. - Key vulnerabilities: - High sensitivity of debt dynamics to large negative GDP growth shocks. - External financing requirements and external debt position risks despite favorable domestic debt structure. - Policy relevance: - Maintain fiscal discipline to avoid primary balance deteriorations that could amplify borrowing costs. - Monitor external financing needs and manage rollover risks given links to sovereign spreads and international rates. - Contain contingent liabilities (banking sector exposures, PPP guarantees, treasury guaranteed loans) to limit fiscal fiscalization under stress. *Source: IMF staff.* ### 8. Turkey is MIGA’s largest country by gross exposure, representing almost 12 percent of ### 8. Turkey is MIGA’s largest country by gross exposure, representing almost 12 percent of ### MIGA exposure and interventions - MIGA’s portfolio in Turkey in FY16: - Gross exposure: US$1.695 billion - Net exposure: US$537 million - MIGA intervention helped mobilize foreign private financing in support of healthcare, the financial, and the transport sector. - MIGA’s product mix includes: - Traditional political risk insurance - Non-honoring, credit guarantee product ### Assessment of data adequacy for surveillance (As of December 1, 2016) - General: - Data provision to the Fund is broadly adequate for surveillance purposes, despite shortcomings especially in national accounts and government finance statistics. - National Accounts: - Quarterly national accounts are published with a 2–3 month lag. - TURKSTAT compiles and disseminates quarterly GDP by production and expenditure approaches, in current prices and in volume terms. - Annual GDP is a sum of the four quarters. - GDP by income approach was estimated for 2002–2012, but results are not yet published. - Main weaknesses: lack of annual benchmarks and reliance on fixed ratios from the 2002 Supply and Use Tables (SUTs). - TURKSTAT is putting in place a regular compilation system for independent annual estimates of GDP and for quarterly GDP benchmarked to annual data. - TURKSTAT plans to disseminate revised series of national accounts estimates covering the period 2009–15 based on the System of National Accounts 2008 (2008 SNA)/The European System of Accounts 2010 (ESA 2010) in the coming months. - Sectoral financial balance sheets compiled quarterly. - Sectoral income accounts data for 2009–15 expected to be published in the coming months. - Price Statistics: - CPI and PPI generally conform to international standards. - CPI does not cover owner-occupied dwellings, commodities produced by households for own consumption, and expenditures on commodities obtained through in-kind payments. - PPI is compiled only by product (not by economic activity). - Government Finance Statistics: - Coverage of the budget is largely complete. - Some fiscal operations through extra budgetary funds are available only with long lags. - Fiscal analysis complicated by quasi-fiscal operations by state banks, SOEs, and other public entities; technical problems consolidating cash-based accounts with accrual-based accounting of SEEs. - Difficult to reconcile fiscal data with monetary and BOP data, especially external debt flows and central government deposits. - Latest data available for Government Finance Statistics Yearbook are for 2015 and cover the general government sector with stocks and flows, including a full general government balance sheet. - Monthly cash-basis budgetary data and quarterly accrual-basis general government data reported on irregular basis for IFS starting from September 2009. - Monetary and Financial Statistics: - Central Bank of Turkey (CBRT) reports monetary statistics using the standardized report forms (SRFs) consistent with the IMF’s Monetary and Financial Statistics Manual. - BRSA reports all 12 core FSIs and nearly all encouraged FSIs. - External Sector Statistics: - Compiled in broad conformity with BPM6. - Data Standards and Quality: - Turkey subscribes to the Special Data Dissemination Standard (SDDS) since 1996. - Latest Data ROSC published in September 2009. ### Recent developments (update to January 4, 2017) - Growth and activity: - Economy contracted in Q3 2016: seasonally and calendar adjusted GDP contracted by 2.7 percent in Q3 2016 compared to the previous quarter. - Q4 indicators (sales of durable goods, house sales, VAT on imports, consumer loan growth) suggest stabilization and mild recovery in some sectors for domestic private consumption. - Industrial production, consumer and business sentiment, and job creation remain weak. - Exchange rate and reserves: - Lira continued weakening in December, with depreciation in the last three months of about 20 percent with respect to the US dollars. - Gross international reserves (GIR) declined by US$4 billion to US$114 billion in November and continued to fall in December. - Net international reserves remained broadly stable as fall in GIR driven mainly by withdrawal of banks’ FX deposits, including due to lower reserve requirements. - Policy package announced December 8: - Measures include: 1. Increasing the capital of the Turkish Eximbank. 2. Providing state guarantees of up to TRY25 billion (US$7.2 billion or 1.2 percent of GDP) through the Credit Guarantee Fund for corporate loans, with preferential terms for exporters and SMEs. 3. Capping the interest rate on public sector deposits at public banks below current market rates for longer maturities; reduction until end-2017 of general provisions on loans to firms; easing conditions for banks to restructure non-performing loans. 4. Temporary cuts in taxes and deferring social security contributions of employers from the first to the fourth quarter of 2017 to support employment and promote industrial investment. - Financing and costs: - Authorities estimate cost of state guarantees no greater than TRY17.5 billion (0.6–0.7 percent of GDP). - Authorities estimate TRY15–16 billion (0.7 percent of GDP) for the other measures over three years. - Authorities plan to fund measures by shifting existing budgetary allocations and have ruled out tax increases or additional borrowing, but sources of financing not identified within the budget. - Lira depreciation and corporate balance sheets: - Depreciation amplified pressures on corporate balance sheets and bank asset quality due to high share of FX loans. - Government instructed public institutions to collect FX receivables in lira in the short term and make new public procurement contracts payable in lira. ### Revision of national accounts data (TurkStat announcement December 12, 2016) - Revisions primarily affect period 2009–15. - Revisions due to updated methodology, improved estimation methods, and implementation of 2008 SNA/ESA 2010. - Both nominal and real GDP were revised up. - Largest changes for 2011–2015: annual real GDP growth revised up by an average of 2.7 percentage points. - Upward revision mostly affected construction and financial service sectors, and investment. ### Staff assessment and implications - New measures may ease loan supply constraints but effect probably limited in current uncertain situation. - Measures do not address underlying causes of credit slowdown (heightened counterparty risk from domestic uncertainty; effect of weakening currency on corporate debt overhang). - Government contingent liabilities will rise; asset quality issues could deteriorate, requiring banks to conserve capital. - External sector indicators improved but staff assessment of external position unchanged: - Revisions lower 2015 CA deficit to 3.8 percent of GDP (0.7 percent of GDP lower than before the revision). - Ratios at end-2015: external debt 46 percent of GDP; NIIP 44 percent of GDP (9 percentage points lower than before the revision). - Staff assesses 2016 CA gap in the range of -1 to -3 percent of GDP. - Turkey’s external position remains weaker than level consistent with medium-term fundamentals and desirable policy settings. - External debt remains sustainable; NIIP projected to widen significantly over the medium term. - Fiscal assessment: - 2015 fiscal deficit is 0.2 percent of GDP lower after revisions. - Decline in end-2015 public debt ratio is 5 percent of GDP. - Data revisions imply lower fiscal revenues relative to size of economy. - Public debt is sustainable; some fiscal space for temporary stimulus exists. - Persistent external imbalances and dependence on external financing with substantial rollover needs call for prudence in using fiscal space. - Policy recommendation (staff): - Moderately looser fiscal and tighter monetary stance. - Caution: new measures ease macroprudential regime and add to public contingent liabilities, increasing risks. ### Table 1 — Selected revised national accounts and differences, 2009–15 (selected highlights) - Newly published data — Real growth rates (percent): - Real GDP: 2009 -4.7; 2010 8.5; 2011 11.1; 2012 4.8; 2013 8.5; 2014 5.2; 2015 6.1 - Private consumption: -3.7; 10.8; 12.3; 3.2; 7.9; 3.0; 5.5 - Gross fixed capital formation: -20.5; 22.5; 23.8; 2.7; 13.8; 5.1; 9.2 - Financial and insurance activities: 30.2; 7.5; 5.7; 0.1; 25.8; 10.2; 7.7 - Newly published data — Nominal GDP (billion of Lira): - 2009 999; 2010 1,160; 2011 1,394; 2012 1,570; 2013 1,810; 2014 2,044; 2015 2,338 - Newly published data — General government overall balance (percent of GDP): - 2009 -5.7; 2010 -3.2; 2011 -0.6; 2012 -1.5; 2013 -1.1; 2014 -1.4; 2015 -1.2 - Newly published data — External sector: - Current account balance (percent of GDP): 2009 -1.8; 2010 -5.8; 2011 -8.9; 2012 -5.5; 2013 -6.7; 2014 -4.7; 2015 -3.8 - Gross external debt (percent of GDP): 2009 41.7; 2010 37.8; 2011 36.5; 2012 38.9; 2013 41.0; 2014 43.1; 2015 46.3 - Difference between new and old data — Real GDP growth (percentage points): - 2009 0.1; 2010 -0.7; 2011 2.3; 2012 2.7; 2013 4.3; 2014 2.1; 2015 2.1 - Difference between new and old data — Nominal GDP (percent): - 2009 4.9; 2010 5.6; 2011 7.5; 2012 10.8; 2013 15.5; 2014 16.9; 2015 19.7 - Difference between new and old data — General government overall balance (percentage points of GDP): - 2009 0.3; 2010 0.2; 2011 0.0; 2012 0.2; 2013 0.2; 2014 0.2; 2015 0.2 - Difference between new and old data — Gross debt (EU definition, percent of GDP): - 2009 -2.2; 2010 -2.2; 2011 -2.7; 2012 -3.5; 2013 -4.8; 2014 -4.9; 2015 -5.4 - Difference between new and old data — Current account balance (percentage points of GDP): - 2009 0.1; 2010 0.3; 2011 0.7; 2012 0.6; 2013 1.0; 2014 0.8; 2015 0.7 - Difference between new and old data — Gross external debt (percentage points of GDP): - 2009 -2.0; 2010 -2.1; 2011 -2.7; 2012 -4.2; 2013 -6.3; 2014 -7.3; 2015 -9.1 *Prepared by the European Department; Supplementary information to the Staff Report for the 2017 Article IV Consultation with Turkey (as of December 1, 2016).* ### 1. A prudent public sector financial management framework. The strong fiscal position ### 1. A prudent public sector financial management framework. The strong fiscal position ### Key strengths and structural features - Public debt is on a downward trend to sustainable levels, supported by strong fiscal position and decelerating real interest rates. - Monetary framework: independent central bank, inflation targeting, and flexible exchange-rate regimes have secured financial stability and brought the inflation rate closer to the target. - Financial sector governance: Turkish Treasury, the Central Bank of the Republic of Turkey (CBRT), the Banking Regulation and Supervision Agency (BRSA), the Capital Markets Board (CMB), and the Savings Deposit Insurance Fund (SDIF) have established solid risk management and monitoring capabilities. - Financial system soundness: no solvency problems; robust macro-prudential and resolution frameworks; significantly upgraded regulatory framework; effective Financial Stability Committee coordination. - Market development: local currency bond and equity markets have developed further; financial instruments are diversified and maturities extended. - Structural advantages: open economy, dynamic and flexible private sector, households with no FX liabilities, increasing per capita income, diversified and large economy, favorable demographic structure with a young population and increasing female labor participation, diverse trade linkages, and improved physical infrastructure. ### Recent macroeconomic developments (2016) - Economic growth: expanded by 3.9 percent in the first half of 2016, driven mostly by domestic demand and supported by services and industrial sectors. - Sectoral challenges: tourism contracted; agricultural output lackluster due to adverse weather; failed coup attempt reduced confidence and weighed on consumption and investment, contributing to a decline in Q3 2016. - Calendar effects and consumer credit: calendar effects limited Q3 growth prospects; activity rebounded in Q4 due to increased domestic demand following recovery in consumer loans. - Inflation drivers: high inflation mostly due to food prices, domestic currency depreciation, and increases in energy prices from tax adjustments and administered price changes; wage developments added to cost pressures. - Tourism and current account: plunging tourism revenues estimated to have wiped out around 1 percent of GDP in 2016; improvements in energy balance and gains in EU market share mitigated impact on current account deficit. - National accounts revision: TURKSTAT revised GDP series to align methodology with EU and UN; staff report uses the old GDP series unless otherwise stated. ### Economic outlook (2017–2019) - Authorities’ MTP projections: - Growth: growth expected to gain pace and reach 4.4 percent in 2017; authorities expect 5 percent in 2018 and 5 percent in 2019. - Inflation: authorities expect inflation to gradually decline in 2017 and reach 5 percent in 2018. - Staff view and factors: recovery in tourism and domestic demand (private investment and consumption) driven by recent government measures; structural reforms expected to raise total factor productivity (TFP). - External rebalancing: normalization with Russia and improving confidence expected to help tourism rebound; recent cyclical exchange rate depreciation will also aid rebalancing; structural reforms to reduce import dependency expected to lower the current account deficit in the medium term. ### Monetary and exchange rate policy - CBRT objectives: complete monetary policy simplification to improve transmission, align short-term market rates with the funding rate, and ensure funding via a single policy rate. - Policy actions: - Marginal funding rate: slashed cumulatively by 250 basis points to 8.25 percent since March 2016 while one-week repo and overnight borrowing rates kept constant until November. - November rate adjustments: one-week repo rate hiked by 50 basis points to 8.00 percent; upper end of the corridor raised by 25 basis points to 8.5 percent. - FX reserve requirement: cut by 50 basis points, releasing US$1.5 billion to the market. - FX rediscounts: maximum maturity extended to March 2017 allowing exporters to keep FX proceeds until March 2017. - FX liquidity and reserves: - CBRT stopped providing direct FX liquidity through FX auctions at end-April to preserve net FX reserves. - FX reserve option coefficient cuts in October and November provided additional FX liquidity of US$1.3 billion. - Increase of 1 point in the upper limit of FX reserve requirements maintained on average enabled banks to use US$2.9 billion for FX liquidity needs. - CBRT provided US$3.4 billion through daily USD auctions through April 2016 and directly sold US$4.2 billion to state-owned energy importers in 2016. - New facilities: improved export rediscount credits and admission of wrought or scrap gold as required reserves. - Intervention stance: CBRT did not directly intervene in the most recent episode but expressed readiness to intervene or provide FX liquidity through flexible auctions if necessary. ### Fiscal policy - Public debt levels and composition: - Public debt burden projected to fall to 32.9 percent of GDP in 2016 and envisioned to be below 30 percent at end-2019. - Composition improvements: 70 percent of central government debt is fixed rate; around 65 percent local currency denominated. - Duration: domestic debt duration around 3 years; external debt duration around 6.5 years. - Instruments: diversification with fixed and CPI-linked lease certificates (sukuks) and CPI-linked annuities targeted at insurance companies. - Budget balance and deficits: - Central government deficit expected at 1.6 percent of GDP in 2016. - Public sector overall deficit expected at 1.7 percent of GDP in 2016. - Projected to remain below 2 percent of GDP throughout the MTP period. - Interest payments around 2.5 percent of GDP, implying positive primary surpluses. - Fiscal stance and objectives: - Since 2001, fiscal policy aimed at reducing public debt, containing inflation and current account deficit via high primary surpluses. - MTP envisages fiscal policy to boost growth, maintain economic stability, keep current account deficit sustainable, and stimulate domestic savings and investments. - Main expenditures: public infrastructure investments, regional development, education, R&D support and incentives. - Fiscal risk management: - Treasury monitors contingent liabilities and risks, reporting to the Treasury Debt and Risk Management Committee. - July 2015 secondary legislation enhanced coverage of public institutions beyond the Treasury. - Authorities plan to expand fiscal risk disclosure beyond the Turkish Treasury and strengthen PPP governance; PPP Framework legislation under development. - Intention to align sovereign wealth fund with international best practices. ### Financial sector policies and FSAP findings - Regulatory and supervisory framework: significantly enhanced General Framework covering systemic risk oversight, liquidity management, financial safety nets, bank resolution, crisis management arrangements, and AML/CFT. - Macro-prudential policy: good progress in developing tools to contain cyclical risk build-up and strengthen structural resilience. - Financial Stability Committee: strategic oversight bringing heads of regulatory agencies together to exchange views on systemic risks and policy responses. - Banking sector resilience: - Overall capital adequacy ratio of 16 percent. - Conservative risk weighing and low leverage; liquidity and FX risk management more challenging. - FSAP stress tests: banks well-placed to handle short-term liquidity stress. - Banking sector accounts for around 90 percent of all financial services. - FX rollover and corporate sector: - FX debt rollover risk of banking sector limited due to extended maturity of external debt, reserve requirement ratios inversely related to maturity, and diversification of external funding. - NFCs’ FX debt concentrated in transportation, energy, construction and health sectors which either generate FX revenues or operate under state-guaranteed PPP projects. - Majority of FX loans have maturities over five years; firms’ short-term FX positions are balanced. - Macro-prudential measures to facilitate hedging FX risks for NFCs are being developed. - Consumer lending and credit growth: - Some macro-prudential measures on consumer lending calibrated to revitalize domestic demand and lower financial stability risks. - A revision in macro-prudential measures expected to help recovery in credit growth, subdued in the last three years. - BRSA lowered general provisions for corporate loans; new general provisions effective since January 1, 2017. - Policy orientation: authorities prioritize structural reforms—developing money and capital markets, diversifying instruments, extending maturities, enhancing capacity and transparency—and will consider FSAP recommendations. ### Structural reforms (actions in 2016 and planned) - Actions implemented in 2016: - Boosting domestic savings: budgetary subsidy to savings account holders with at least 3 years for first house and/or marriage; new private pension automatic enrollment system to stimulate total savings. - Incentivizing R&D: reduced minimum headcount for R&D company setup; extended government subsidies to researcher salaries to 2 years; tax exemption for these companies; new Patent Law ratified. - Improving judicial processes: Istanbul Arbitration Centers and Appeals Courts established; Expert Witness Act and Intellectual Property Act enacted. - Enhancing business climate: legislative amendments to simplify administrative procedures; project-based incentives to lower tax burden on investment; regional investment incentive schemes to establish investment hubs in eastern and southeastern provinces; leveraging public procurement to increase localization. - Enhancing SME access to bank loans: new regulation for collateral registries for movable assets enabling SMEs to provide all movable assets as collateral. - Improving labor market conditions: flexible employment mechanism added to Labor Code; Private Employment Agencies set up; enhanced maternity rights, childcare access, part-time work allowance for women until children reach formal schooling age; skill training and internship programs implemented. Authorities note more progress needed on severance pay reform requiring broad consultations. - Improving SOE governance: work to align SOE governance with international best practices. - Reforming Turkish Development Bank: restructuring with key international stakeholders to enhance corporate capacity and competitiveness. - Further planned reforms: - Establish an Academy for Teachers; develop vocational and technical training; implement school-based budgeting; provide better foreign language training and compulsory pre-school. - Conduct tax and expenditure reviews as backbone of fiscal management reforms. - Treasury’s commitment to Credit Guarantee Funds to be raised to TRY 25 billion, which could be leveraged up by the Banks to TRY250 billion, from current commitment of TRY 2 billion. - Enhance entrepreneurship and access to finance: introduce business angel scheme and launch crowd-funding system. - Social and labor considerations: - Authorities broadly share staff’s views on rising labor costs, competitiveness, and refugee integration. - Temporary minimum wage government subsidy judged appropriate and fiscally manageable. - Refugee workforce integration remains critical and requires strong international commitment. ### Conclusion and assessment - Turkey’s resilience to external and internal shocks rests on solid macroeconomic fundamentals and sound macro-framework: prudent fiscal position with sustainable low debt, sound monetary policies, strong financial sector with solid regulation and supervision. - Structural strengths: open, large economy; dynamic private sector; diversified economy; young demography; committed institutions supportive under high uncertainties. - Authorities committed to addressing longstanding structural problems via ambitious reforms. - IMF staff note that reports could have been more explicit about these supportive factors to present a more balanced picture of the Turkish economy. *Source: IMF staff report excerpt — "1. A prudent public sector financial management framework. The strong fiscal position".* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1732.pdf_