## _cr07363

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---

### Executive summary — macroeconomic performance and recent developments
- Economic activity has been resilient as the economy rebalances away from high reliance on domestic demand.
- Growth: slowed from 7½ percent in the first half of 2006 to 5 percent in the second half of 2006; high-frequency indicators point to continuation of these trends into 2007.
- Foreign direct investment (FDI) rose to almost 5 percent of GNP in 2006.
- Net international reserves (NIR) reached US$40.6 billion at end-April 2007, considerably above the program floor.
- Net public debt ratio continues to fall rapidly.
- Current account: appears to have peaked at 7.9 percent of GNP in 2006; in volume terms, exports grew faster than imports.
- Inflation: end-March inflation was 10.9 percent, breaching the inner consultation band by 0.7 percentage points; inflation declined slightly in April but remained well above the end-2007 target of 4 percent.
- Financial markets: NIR buildup, portfolio inflows interrupted only by brief turbulence; domestic bond yields and CDS spreads remained high; stock market largely recovered.

### Vulnerabilities, risks, and political developments
- Persistent vulnerabilities:
  - Current account deficit remains high despite peaking.
  - Inflation persistently above target.
  - Large stock of portfolio investment by nonresidents increases susceptibility to shifts in investor sentiment.
- Political risks: Constitutional Court ruling invalidated first-round parliamentary presidential voting and led to rescheduling general elections from November 4 to July 22, limiting scope for initiatives requiring new legislation.

### Program commitments, Stand‑By Arrangement, and conditionality
- Authorities’ commitments (Supplementary Letter of Intent):
  - Target a 6.7 percent of GNP primary surplus in 2007.
  - Maintain a tightening bias in monetary policy.
  - Advance structural reforms.
- Stand‑By Arrangement (summary facts):
  - A three-year SDR 6.7 billion (559 percent of quota) Stand‑By Arrangement was approved in May 2005.
  - Cumulative purchases amount to SDR 3.7 billion.
  - A further SDR 749.5 million will become available upon completion of the sixth review.
  - Outstanding Fund credit amounted to SDR 5.2 billion at end‑April.
- Program implementation requirements (staff summary):
  - Substantial spending discipline needed to offset the disappearance of about 1½ percent of GNP in exceptional factors that boosted the 2006 outturn.
  - Structural measures to: revive social security reform; strengthen tax administration; strengthen financial regulation; increase efficiency in the health and energy sectors.
  - Program implementation and new conditionality summarized in the LOI Annexes A‑B.

### Program monitoring — selected quantitative and structural performance items
- Quantitative conditionality (performance criteria), December 2006–April 2007 (observations and shortfalls):
  - Floor on primary balance of consolidated government sector (CGS): Observed; Expected to be missed by 3,700-4,229 mil. YTL 2/
  - Floor on primary balance of CGS excluding State Economic Enterprises (SEEs): Observed; Expected to be missed by 3,600-4,102 mil. YTL 2/
  - Ceiling on consolidated primary spending of central government and social security institutions (SSIs): Not observed; Expected to be missed by 1,100-2,500 mil. YTL 2/
  - Ceiling on new external public debt with maturities exceeding one year: Observed; N.A., expected to be observed
  - Ceiling on new external public debt with maturities up to one year: Observed; N.A., expected to be observed
  - Floor on net international reserves of CBT and Treasury combined: Observed; Observed
  - Floor on overall balance (before transfers) of SSIs: Observed; Expected to be missed by 3,800-4,300 mil. YTL 2/
- Inflation consultation clause: Upper band exceeded, open letter issued (Attachment II); only inner band exceeded, discussions with staff held.
- Prior actions:
  - Publication of historical fiscal outturns on new "central government" basis: Done
  - Increase in number of auditors assigned to Large Taxpayer Unit (LTU) to 35: To be done within 5 days of Board meeting
  - Completion of initial public offering (IPO) of at least 20 percent of Halkbank: To be done within 5 days of Board meeting
- Structural performance criteria and benchmarks (selected):
  - No new amnesties of arrears on public sector receivables (continuous)
  - Parliamentary approval of legislation authorizing copayments for medical treatments and pharmaceuticals (end-December 2006) — later obviated by Constitutional Court annulment of social security reform
  - Parliamentary approval of second-stage personal income tax reform (end-February 2007) — passed with one day delay
  - Establishment of a large-taxpayer unit within the Revenue Administration (end-December 2006) — operational
  - Completion of the tender process for Halkbank (end-May 2007) — IPO completed May 9, 2007
  - Publication of report quantifying existing tax expenditure (end-June 2007): Pending

### Key statistics (selected, preserved exactly)
- Primary surplus target: 6.7 percent of GNP in 2007.
- Exceptional factors disappeared: about 1½ percent of GNP.
- End‑March inflation: 10.9 percent.
- End‑2007 inflation target: 4 percent.
- Current account peak: 7.9 percent of GNP in 2006.
- FDI: almost 5 percent of GNP in 2006.
- NIR: US$40.6 billion at end‑April 2007.
- Stand‑By Arrangement: SDR 6.7 billion (559 percent of quota); cumulative purchases SDR 3.7 billion; further SDR 749.5 million contingent on sixth review; outstanding Fund credit SDR 5.2 billion at end‑April.
- Program monitoring shortfall ranges (YTL): 3,700-4,229 mil. YTL; 3,600-4,102 mil. YTL; 1,100-2,500 mil. YTL; 3,800-4,300 mil. YTL.

---

### Macroeconomic framework, outlook, and projections
- Framework: Both sides agreed to leave the existing framework for 2007 broadly unchanged.
- Growth outlook:
  - Growth expected to continue easing due to high interest rates, slowing credit growth, and election‑related uncertainty.
  - Growth expected to keep near its estimated long‑run potential of 5 percent.
  - Main downside risks: uncertain external environment and possibly weaker‑than‑expected domestic demand.
  - Upside risks: early resolution of election‑related uncertainty.
- Main macroeconomic indicators (selected rows, 2003−07 as presented):
  - Real GNP y‑o‑y growth rate, percent: 5.9 9.9 7.6 6.0 5.0
  - Domestic demand (contribution to GDP growth): 8.9 13.9 9.1 5.9 4.3
  - Net exports (contribution to GDP growth): -3.1 -4.9 -1.7 0.3 0.7
  - CPI, end of period (12‑month percent change): 18.4 9.4 7.7 9.7 6.0
  - Central government primary balance: 4.9 5.3 5.5 5.8 5.2
  - Net public sector debt: 70.3 64.0 55.3 44.8 40.9
  - Gross public sector debt: 83.2 77.3 71.6 63.1 57.6
  - Current account: -3.4 -5.2 -6.3 -7.9 -7.3
  - Nonfuel current account: 1.1 -0.9 -1.1 -1.7 -1.3
  - Exports, y‑o‑y change in value (percent): 31.0 33.7 16.3 16.1 14.3
  - Imports, y‑o‑y change in value (percent): 37.6 39.4 21.5 19.3 10.4
  - Terms of Trade, y‑o‑y percent change: 2.0 1.0 -1.3 -4.5 0.4
  - FDI: 0.5 0.7 2.4 4.8 3.5
  - Gross external debt: 56.4 50.1 46.7 50.5 52.8
- Inflation outlook:
  - Annual inflation expected to start declining by the second quarter due to base effects from mid‑2006 spike.
  - Staff projection for end‑2007 raised from 5.5 percent to 6 percent (the upper limit of the consultation bands).
  - Upside risks: services inflation inertia, second‑round effects from recent food price increases, and unexpected strength in domestic demand.
- Current account projection: projected current account deficit: 7¼ percent of GNP.
- External financing prospects: remained favorable with robust FDI expected; continued vulnerability from large stock of volatile portfolio investments by nonresidents and large financing needs.

### Monetary policy, reserves, and exchange rate stance
- Monetary policy stance:
  - Given upside risks to inflation, policy needed to remain tight until inflationary pressures subsided.
  - Staff supported the central bank’s tightening bias: monetary policy more responsive to adverse than favorable developments to the inflation outlook.
  - Once inflation is firmly declining, interest rates could be cautiously reduced.
- International reserves:
  - Central bank renewed commitment to building international reserves for prudential reasons.
  - With the ratio of reserves to short‑term debt (at remaining maturity) below unity, staff recommended continued gradual and predictable reserve build‑up.
  - Central bank agreed to raise the end‑2007 NIR floor by US$2.8 billion and signaled willingness to raise reserves purchased at daily auctions if circumstances permitted.

---

### Fiscal policy: outturn, measures, and risks
- 2006 fiscal outturn:
  - Public sector primary balance estimated at 6.6 percent of GNP, about 0.7 percent of GNP less than programmed in October 2006.
  - Central government accounted for majority of shortfall, largely due to overruns on capital spending (0.2 percent of GNP) and nontax revenue underperformance (0.2 percent of GNP).
  - Net public sector debt ratio declined to 45 percent of GNP at end‑2006, partly helped by high privatization receipts.
- Fiscal measures for 2007:
  - Authorities agreed to measures to bring fiscal policy back in line with program understandings.
  - Blockages of low priority central government spending and cuts in state enterprise investment saved 0.8 percent of GNP and offset an emerging fiscal gap.
  - Blockages were front‑loaded to ensure end‑August fiscal performance criteria will be met; end‑April performance criteria were expected to be missed.
- Changes in fiscal projections, 2007 (Percent of GNP — components as presented):
  - Fiscal gap: 0.83
  - Agreed measures: 0.83
  - Offsetting 2006 expenditure overruns (required by program adjustor): 0.29
  - Spending blockages: 0.55
  - Updating revenue projections (due to lower 2006 base): 0.09
  - Capital spending: 0.24
  - Key policy initiatives taken outside of budget cycle: 0.27
  - Capital transfers: 0.08
  - Expansion of regional incentive scheme: 0.10
  - Other: 0.23
  - Conversion of temporary staff to permanent staff: 0.06
  - Contingencies: 0.19
  - Higher pension increase: 0.10
  - Health contingency: 0.11
  - Delay of social security reform (short‑term savings): -0.10
  - Other contingencies: 0.08
  - Higher health spending (carryover of unpaid bills from 2006 to 2007): 0.16
  - Cuts in SEE investment spending: 0.09
  - Delay in hiking energy prices: 0.16
  - Other, net: -0.03
- Health spending and safeguards:
  - Health spending in 2006 exceeded original budget allocations by over 25 percent.
  - Program targets agreed last October were significantly exceeded on an accrual basis as some payments shifted to 2007.
  - Authorities established a stronger mechanism to enforce public hospital budgets and capped medical personnel bonuses at the 2006 level.
  - Further cuts from the general budget would be made should health costs again exceed targets.
- Energy sector risks:
  - End‑user electricity tariffs have not increased since 2002 despite a doubling of world energy prices, creating rising financial difficulties in state‑owned energy companies.
  - Authorities preferred offsetting spending cuts rather than immediate price adjustments, but agreed measures were needed to strengthen the sector to avoid electricity shortages as early as 2009.
  - Planned measures: (i) facilitate cost‑recovery pricing; (ii) privatize the distribution network to improve efficiency; (iii) strengthen bill collection.
- Fiscal targets and risks:
  - Public sector primary surplus programmed at 6.7 percent of GNP in 2007.
  - Exceptional items contribution expected to be about 1½ percent of GNP lower in 2007 than in 2006, so the 2007 target embodies substantial policy tightening.
  - Downside risks: projected growth slowdown, weak tax revenue in Q1 2007, poor track record enforcing spending blockages, and erosion of tax base from proposals for targeted tax relief.

---

### Health sector diagnosis, dynamics, and policy priorities
- Diagnosis:
  - Health outcomes in Turkey are worse than in comparator countries, despite somewhat higher government spending.
  - Main reasons identified: excessive administrative costs; high drug spending, representing 40 percent of healthcare costs; overreliance on curative (rather than preventive) care and expensive hospital‑based treatments.
- Recent developments:
  - Recent expansion of access led to rising healthcare spending; health spending increased by 32 percent in 2006.
- Health spending breakdown (selected, preserved exactly):
  - Total health spending (percent of GNP): 2004: 3.8; 2005: 3.7; 2006: 4.1; 2007 Proj.: 4.1
  - Nominal growth of cash spending (percent): 2005: 9.1; 2006: 31.6; 2007 Proj.: 14.0
  - Medicines (percent of GNP): 2004: 1.8; 2005: 1.8; 2006: 1.7; 2007 Proj.: 1.7
  - Medicines nominal growth (percent): 2005: 13.8; 2006: 13.0; 2007 Proj.: 12.7
  - Hospital treatments (percent of GNP): 2004: 1.8; 2005: 1.7; 2006: 2.2; 2007 Proj.: 2.2
  - Hospital treatments nominal growth (percent): 2005: 10.2; 2006: 49.4; 2007 Proj.: 10.9
  - Ministry of Health hospitals (percent of GNP, 2005–07): 2005: 1.0; 2006: 1.4; 2007 Proj.: 1.4; nominal growth 2006: 63.5; 2007 Proj.: 17.5
  - Other hospitals (percent of GNP, 2005–07): 2005: 0.8; 2006: 0.8; 2007 Proj.: 0.8; nominal growth 2006: 31.4; 2007 Proj.: 0.4
  - Other (percent of GNP): 2004: 0.2; 2005: 0.1; 2006: 0.1; 2007 Proj.: 0.2; nominal growth 2005: -45.9; 2006: 63.7; 2007 Proj.: 85.4
- Short‑term priorities:
  - Increase efficiency by reducing unnecessary treatments and drugs.
  - FAD technical assistance recommended tying doctors’ bonuses to adherence to hospital budgets.
  - As a second‑best, hard caps on hospital budgets could be placed to make administrators accountable for costs.
- Medium‑term priorities (with World Bank support):
  - Increased use of information technology;
  - Lower‑cost primary care (family medicine) facilities;
  - Differentiated copayments;
  - Payment‑per‑case systems (noting legal difficulties encountered).

---

### Financial markets, regulation, mortgage law, and labor reform
- Financial market developments:
  - Global risk appetite dropped sharply in late February 2007; Turkish financial markets were among the worst hit as many investors unwound carry trades.
  - Global investor sentiment subsequently stabilized, allowing Turkish markets to recover earlier losses, but recent political events caused an increase in financial market volatility.
- Mortgage law and regulatory actions:
  - Mortgage law (passed February 2007) allows adjustable‑rate mortgages and loan securitization; tax deductibility of interest payments was not allowed.
  - Staff urged issuance of implementing regulations by end‑June 2007 and adoption of insurance legislation by end‑June 2007.
- Labor market reform:
  - Broad agreement on easing labor regulations and taxes as fiscal resources permit.
  - Any reform must fit within the fiscal framework and balance worker protection and labor market flexibility.
  - Authorities committed to seeking agreement with the Fund before adopting such reforms (¶26).
- Financial sector reform and privatization:
  - Staff urged prompt privatization of state banks.
  - Government launched an IPO of at least 20 percent of Halkbank; staff stressed selling the residual government stake within one year after IPO and initiating privatization of Ziraat.
  - Halkbank IPO completed May 9, 2007: sale of almost 25 percent of the bank’s shares was 8 times oversubscribed, raising US$1.8 billion; about 70 percent of shares sold were placed with foreign investors.

---

### Institutional, investment climate, SDIF, and privatization program
- SDIF asset disposition:
  - SDIF will have disposed of all its assets taken over from intervened banks by end‑2007, allowing it to focus on deposit insurance role; Treasury will resolve its receivables from earlier bank restructurings.
- Investment climate and FDI:
  - Record FDI in 2006: US$20 billion.
  - Expected FDI in 2007: "almost as high" as 2006, driven by M&A activity and investment across communications, energy, manufacturing, and real estate.
- Privatization program:
  - Committed to full privatization of electricity distribution and generation companies, Tekel tobacco, and state shares in other companies in the Privatization Agency portfolio in the 2007 to 2009 timeframe.
  - Proceeding with plans to privatize Petkim in the coming months (relative to document date).
- Institutional reforms:
  - Commitment to deregulation, reduction of administrative barriers, improved judicial efficiency, enhanced corporate governance.
  - Turkish Investment and Support Promotion Agency expected to become fully operational by the end of 2007.
  - New Commercial Code to require firms to prepare financial statements in accordance with International Financial Accounting Standards.

---

### Staff appraisal, recommendations, and operational decision
- Staff appraisal — macroeconomic performance and vulnerabilities:
  - Turkey’s macroeconomic performance remains strong: resilient activity, surge in FDI, reserve build‑up, and falling net public debt ratio.
  - Vulnerabilities remain: high current account deficit, inflation above target, increased political risks, and large stock of portfolio investment by nonresidents.
- Policy recommendations and near‑term priorities:
  - Maintain market confidence by adhering to strong policies under the Fund‑supported program.
  - Maintain tight monetary policies with a continued tightening bias until inflation is firmly on a downward path; central bank encouraged to increase daily foreign exchange purchases as reserves do not yet fully cover short‑term external debt (at remaining maturity).
  - Achieve fiscal targets to promote disinflation, current account adjustment, and market confidence; substantial effort required to offset loss of one‑off factors that boosted 2006 outturn.
  - Reinvigorate structural reforms: strengthen tax and social security collections; bolster finances and efficiency of energy and health sectors; improve fiscal transparency; revitalise privatization especially in banking and energy sectors; consider easing onerous labor regulations and taxes as fiscal resources permit.
- Staff recommendation and rationale (completion of sixth review and waivers):
  - Staff recommends completing the sixth review and approving the authorities’ request for waivers.
  - Support for waivers of nonobservance of fiscal performance criteria for end‑April (expected to have been missed) given authorities’ commitment to rein in spending.
  - Support for waivers of applicability of end‑April performance criteria for external debt (expected to have been met).
  - Support for waivers of nonobservance of the structural performance criterion on approval of second‑stage personal income tax reform (delayed by one day; omitted provision expected to be adopted in future legislation).
- IMF Executive Board action (Press Release No. 07/103, May 18, 2007):
  - Executive Board completed the sixth review under the three‑year SDR 6.66 billion Stand‑By Arrangement, enabling an immediate draw of SDR 749.5 million.

---

*Italic: IMF staff summary of content unit _cr07363 — Executive Summary, selected chapters, tables, and staff appraisal (excerpts and tables).*

### Executive Summary

### _cr07363 - Executive Summary

### Macroeconomic performance and recent developments
- Economic activity has been resilient as the economy rebalances away from high reliance on domestic demand.
- Growth: slowed from 7½ percent in the first half of 2006 to 5 percent in the second half of 2006; high-frequency indicators point to continuation of these trends into 2007.
- Foreign direct investment (FDI) has surged, rising to almost 5 percent of GNP in 2006.
- Net international reserves (NIR) reached US$40.6 billion at end-April 2007, considerably above the program floor.
- Net public debt ratio continues to fall rapidly.
- Current account: appears to have peaked at 7.9 percent of GNP in 2006; in volume terms, exports grew faster than imports.
- Inflation: end-March inflation was 10.9 percent, breaching the inner consultation band by 0.7 percentage points; inflation declined slightly in April but remained well above the end-2007 target of 4 percent.
- Financial markets: NIR buildup, portfolio inflows interrupted only by brief turbulence; domestic bond yields and CDS spreads remained high; stock market largely recovered.

### Vulnerabilities and risks
- Persistent vulnerabilities:
  - Current account deficit remains high despite peaking.
  - Inflation persistently above target.
  - Large stock of portfolio investment by nonresidents increases susceptibility to shifts in investor sentiment.
- Political risks: Constitutional Court ruling invalidated first-round parliamentary presidential voting and led to rescheduling general elections from November 4 to July 22, limiting scope for initiatives requiring new legislation.

### Program commitments and conditionality
- Authorities' commitments (Supplementary Letter of Intent):
  - Target a 6.7 percent of GNP primary surplus in 2007.
  - Maintain a tightening bias in monetary policy.
  - Advance structural reforms.
- Stand-By Arrangement (summary facts):
  - A three-year SDR 6.7 billion (559 percent of quota) Stand-By Arrangement was approved in May 2005.
  - Cumulative purchases amount to SDR 3.7 billion.
  - A further SDR 749.5 million will become available upon completion of the sixth review.
  - Outstanding Fund credit amounted to SDR 5.2 billion at end-April.

### Program implementation requirements (staff summary)
- Substantial spending discipline to offset the disappearance of about 1½ percent of GNP in exceptional factors that boosted the 2006 outturn.
- Structural measures to:
  - revive social security reform,
  - strengthen tax administration,
  - strengthen financial regulation,
  - increase efficiency in the health and energy sectors.
- Program implementation and new conditionality summarized in the LOI Annexes A-B.

### Program monitoring: quantitative and structural performance (selected items)
- Quantitative conditionality (performance criteria), December 2006–April 2007 (observations and shortfalls):
  - Floor on primary balance of consolidated government sector (CGS): Observed; Expected to be missed by 3,700-4,229 mil. YTL 2/
  - Floor on primary balance of CGS excluding State Economic Enterprises (SEEs): Observed; Expected to be missed by 3,600-4,102 mil. YTL 2/
  - Ceiling on consolidated primary spending of central government and social security institutions (SSIs): Not observed; Expected to be missed by 1,100-2,500 mil. YTL 2/
  - Ceiling on new external public debt with maturities exceeding one year: Observed; N.A., expected to be observed
  - Ceiling on new external public debt with maturities up to one year: Observed; N.A., expected to be observed
  - Floor on net international reserves of CBT and Treasury combined: Observed; Observed
  - Floor on overall balance (before transfers) of SSIs: Observed; Expected to be missed by 3,800-4,300 mil. YTL 2/
- Inflation consultation clause: Upper band exceeded, open letter issued (Attachment II); only inner band exceeded, discussions with staff held.
- Prior actions:
  - Publication of historical fiscal outturns on new "central government" basis: Done
  - Increase in number of auditors assigned to Large Taxpayer Unit (LTU) to 35: To be done within 5 days of Board meeting
  - Completion of initial public offering (IPO) of at least 20 percent of Halkbank: To be done within 5 days of Board meeting
- Structural performance criteria and benchmarks (selected):
  - No new amnesties of arrears on public sector receivables (continuous)
  - Parliamentary approval of legislation authorizing copayments for medical treatments and pharmaceuticals (end-December 2006)
  - Parliamentary approval of second-stage personal income tax reform (end-February 2007)
  - Establishment of a large-taxpayer unit within the Revenue Administration (end-December 2006)
  - Completion of the tender process for Halkbank (end-May 2007)
  - Publication of report quantifying existing tax expenditure (end-June 2007): Pending
  - Some items noted as Not observed due to delay in energy price adjustments; others observed or subsequently obviated (e.g., legislation obviated by Constitutional Court annulment of social security reform).

### Key statistics and indicators cited
- Primary surplus target: 6.7 percent of GNP in 2007.
- Exceptional factors disappeared: about 1½ percent of GNP.
- End-March inflation: 10.9 percent.
- End-2007 inflation target: 4 percent.
- Current account peak: 7.9 percent of GNP in 2006.
- FDI: almost 5 percent of GNP in 2006.
- NIR: US$40.6 billion at end-April 2007.
- Stand-By Arrangement: SDR 6.7 billion (559 percent of quota); cumulative purchases SDR 3.7 billion; further SDR 749.5 million contingent on sixth review; outstanding Fund credit SDR 5.2 billion at end-April.
- Program monitoring shortfall ranges (YTL): 3,700-4,229 mil. YTL; 3,600-4,102 mil. YTL; 1,100-2,500 mil. YTL; 3,800-4,300 mil. YTL.

*Source: Executive Summary (PDF) of IMF staff report _cr07363.*

### 3.      Financial markets have stabilized after

### _cr07363 - 3.      Financial markets have stabilized after

### Financial market developments
- Global risk appetite dropped sharply in late February 2007; Turkish financial markets were among the worst hit as many investors unwound carry trades.
- Global investor sentiment subsequently stabilized, allowing Turkish markets to recover earlier losses, but recent political events caused an increase in financial market volatility.

### Macroeconomic framework and projections
- Both sides agreed to leave the existing framework for 2007 broadly unchanged.
- Growth outlook:
  - Growth was expected to continue easing due to high interest rates, slowing credit growth, and election-related uncertainty.
  - Growth was expected to keep near its estimated long-run potential of 5 percent.
  - Main downside risks: uncertain external environment and possibly weaker-than-expected domestic demand.
  - Upside risks: early resolution of election-related uncertainty.
- Main Macroeconomic Indicators, 2003−07 (selected rows, as presented):
  - Real GNP y-o-y growth rate, percent: 5.9 9.9 7.6 6.0 5.0
  - Domestic demand (contribution to GDP growth): 8.9 13.9 9.1 5.9 4.3
  - Net exports (contribution to GDP growth): -3.1 -4.9 -1.7 0.3 0.7
  - CPI, end of period (12-month percent change): 18.4 9.4 7.7 9.7 6.0
  - Central government primary balance: 4.9 5.3 5.5 5.8 5.2
  - Net public sector debt: 70.3 64.0 55.3 44.8 40.9
  - Gross public sector debt: 83.2 77.3 71.6 63.1 57.6
  - Current account: -3.4 -5.2 -6.3 -7.9 -7.3
  - Nonfuel current account: 1.1 -0.9 -1.1 -1.7 -1.3
  - Exports, y-o-y change in value (percent): 31.0 33.7 16.3 16.1 14.3
  - Imports, y-o-y change in value (percent): 37.6 39.4 21.5 19.3 10.4
  - Terms of Trade, y-o-y percent change: 2.0 1.0 -1.3 -4.5 0.4
  - FDI: 0.5 0.7 2.4 4.8 3.5
  - Gross external debt: 56.4 50.1 46.7 50.5 52.8
- Inflation outlook:
  - Annual inflation was expected to start declining by the second quarter due to base effects from mid-2006 spike.
  - With elevated inflation expectations, pace of disinflation was judged insufficient to meet the 4 percent target in 2007.
  - Staff projection for end-2007 was raised from 5.5 percent to 6 percent (the upper limit of the consultation bands).
  - Upside risks to inflation projection included services inflation inertia, second-round effects from recent food price increases, and unexpected strength in domestic demand.
- Current account:
  - Current account deficit was projected to narrow somewhat in 2007.
  - Expected drivers: export volume growth outpacing import volume growth and an expected rebound in tourism.
  - Projected current account deficit: 7¼ percent of GNP.

### External financing and vulnerabilities
- External financing prospects remained favorable, with robust FDI expected due to continued strong merger and acquisition activity despite postponement of several privatizations in early 2007.
- Continued vulnerability from large stock of volatile portfolio investments by nonresidents and large financing needs.

### Monetary and exchange rate policies
- Monetary policy stance:
  - Given upside risks to inflation, policy needed to remain tight until inflationary pressures subsided.
  - Staff supported the central bank’s tightening bias: monetary policy more responsive to adverse than favorable developments to the inflation outlook.
  - Once inflation is firmly declining, interest rates could be cautiously reduced.
- International reserves:
  - Central bank renewed commitment to building international reserves for prudential reasons.
  - With the ratio of reserves to short-term debt (at remaining maturity) below unity, staff recommended continued gradual and predictable reserve build-up.
  - Central bank agreed to raise the end-2007 NIR floor by US$2.8 billion and signaled willingness to raise reserves purchased at daily auctions if circumstances permitted.

### Fiscal policy: outturn, measures, and risks
- 2006 fiscal outturn:
  - Public sector primary balance estimated at 6.6 percent of GNP, about 0.7 percent of GNP less than programmed in October 2006.
  - Central government accounted for majority of shortfall, largely due to overruns on capital spending (0.2 percent of GNP) and nontax revenue underperformance (0.2 percent of GNP).
  - Net public sector debt ratio declined to 45 percent of GNP at end-2006, partly helped by high privatization receipts.
- Fiscal measures for 2007:
  - Authorities agreed to measures to bring fiscal policy back in line with program understandings.
  - Blockages of low priority central government spending and cuts in state enterprise investment saved 0.8 percent of GNP and offset an emerging fiscal gap.
  - Blockages were front-loaded to ensure end-August fiscal performance criteria will be met; end-April performance criteria were expected to be missed.
- Changes in fiscal projections, 2007 (Percent of GNP):
  - Fiscal gap: 0.83
  - Agreed measures: 0.83
  - Offsetting 2006 expenditure overruns (required by program adjustor): 0.29
  - Spending blockages: 0.55
  - Updating revenue projections (due to lower 2006 base): 0.09
  - Capital spending: 0.24
  - Key policy initiatives taken outside of budget cycle: 0.27
  - Capital transfers: 0.08
  - Expansion of regional incentive scheme: 0.10
  - Other: 0.23
  - Conversion of temporary staff to permanent staff: 0.06
  - Contingencies: 0.19
  - Higher pension increase: 0.10
  - Health contingency: 0.11
  - Delay of social security reform (short-term savings): -0.10
  - Other contingencies: 0.08
  - Higher health spending (carryover of unpaid bills from 2006 to 2007): 0.16
  - Cuts in SEE investment spending: 0.09
  - Delay in hiking energy prices: 0.16
  - Other, net: -0.03
- Health spending and safeguards:
  - In 2006, health spending exceeded original budget allocations by over 25 percent.
  - Program targets agreed last October were significantly exceeded on an accrual basis as some payments shifted to 2007.
  - Authorities established a stronger mechanism to enforce public hospital budgets and capped medical personnel bonuses at the 2006 level.
  - Further cuts from the general budget would be made should health costs again exceed targets.
  - Measures to enhance efficiency of healthcare provision over the medium term are being implemented.
- Energy sector:
  - End-user electricity tariffs have not increased since 2002 despite a doubling of world energy prices, creating rising financial difficulties in state-owned energy companies.
  - Authorities preferred offsetting spending cuts rather than immediate price adjustments, but agreed measures were needed to strengthen the sector to avoid electricity shortages as early as 2009.
  - Planned measures: (i) facilitate cost-recovery pricing; (ii) privatize the distribution network to improve efficiency; (iii) strengthen bill collection.
- Fiscal targets and risks:
  - Public sector primary surplus programmed at 6.7 percent of GNP in 2007.
  - Exceptional items contribution expected to be about 1½ percent of GNP lower in 2007 than in 2006, so the 2007 target embodies substantial policy tightening.
  - Downside risks: projected growth slowdown, weak tax revenue in Q1 2007, poor track record enforcing spending blockages, and erosion of tax base from proposals for targeted tax relief.
- Effect of exceptional fiscal transactions on primary surplus, 2006–07 (Percent of GNP):
  - Total exceptional contribution: 2.2 (2006), 0.7 (2007), delta 1.6
  - Savings Deposit Insurance Fund (SDIF) revenue: 0.9 (2006), 0.1 (2007), delta 0.8
  - State enterprise dividends: 0.5 (2006), 0.3 (2007), delta 0.2
  - Revenue share transfer accounting: 0.2 (2006), 0.0 (2007), delta 0.2
  - Collection of arrears to Social Security Institution: 0.6 (2006), 0.2 (2007), delta 0.4

### Fiscal stance and transparency
- Fiscal Policy Stance: Public Sector, 2004–07 (Percent of GNP, selected lines):
  - Headline Consolidated Primary Surplus: 7.2 6.8 6.6 6.7
  - Adjusted Consolidated Primary Surplus 1/: 7.2 6.8 5.8 6.5
  - Interest Bill: 11.7 7.9 7.4 7.6
  - Overall balance (=B-C): -4.6 -1.2 -1.6 -1.1
  - Memorandum item: Output gap ("+"=actual below potential): 1.3 0.5 0.6 1.0
- Authorities continued improving fiscal transparency:
  - Publication of local government data and historical data under the new central government classification.
  - Plan to publish quantification of existing tax expenditures by end-June 2007.

### Structural fiscal reforms and tax administration
- Social security reform:
  - A Constitutional Court ruling in December 2006 annulled key provisions of the 2006 social security reform, significantly reducing its savings and leading the government to suspend implementation.
  - Annulled provisions included: all aspects pertaining to civil servants and tightening of the valorization formula for all workers.
  - Authorities are considering revisions: e.g., valorization using an index of consumer prices plus 25 percent real GDP; revisions to civil servant pension parameters in separate law and mixed indexing proposals.
  - Authorities committed to implement a modified social security reform and plan to issue a white paper describing constitutionally valid proposals aiming to recapture most original reform savings; expect to adopt revised reform to allow implementation by mid-2008.
- Revenue Administration (RA) and Social Security Institution (SSI) reforms:
  - Thirty-five auditors to be assigned to the newly established Large Taxpayer Unit (LTU); number to increase further to match LTU workload.
  - RA taking steps to combat VAT fraud and enhance cooperation with SSI; SSI implementing measures to improve collections from large employers.
  - Note: Taxpayers under the LTU account for about 30 percent of tax revenue, scheduled to rise to 50 percent by end-2007.
- Personal income tax reform:
  - Second-stage personal income tax reform was adopted with one day delay and one administrative item omitted; the omitted item is expected to be included in future legislation.

### Financial sector reforms and privatization
- State bank privatization:
  - Staff urged prompt privatization of state banks.
  - Government adjusted strategy on Halkbank in pre-election environment: launched an IPO of at least 20 percent of shares and expected to complete process in the second week of May.
  - Staff stressed selling the residual government stake within one year after IPO and initiating privatization of Ziraat; authorities reluctant to commit to a specific timetable beyond the May IPO but renewed commitment to prepare a strategy for Ziraat drawing on Halkbank experience.

*Source: IMF staff report content provided in the supplied document.*

### 18.      Staff welcomed passage of the mortgage law in February 2007 and discussed

### 18.      Staff welcomed passage of the mortgage law in February 2007 and discussed

### Mortgage law and financial regulatory environment
- The mortgage law lays the foundation for a stronger mortgage lending system, including by allowing adjustable-rate mortgages and loan securitization.
- To avoid narrowing the tax base and creating distortions, tax deductibility of interest payments was not allowed.
- Staff urged the authorities to:
  - issue key implementing regulations for the law by end-June 2007; and
  - adopt the recommendations of the recent Financial System Stability Assessment, including by passing a law by end-June 2007 to strengthen the insurance industry’s legal and regulatory frameworks.
- Adoption of the mortgage law was characterized as a major step forward in improving the financial regulatory framework.
- The law’s impact should be reinforced through timely issuance of the law’s implementing regulations and adoption of pending insurance legislation.

### Labor market reform
- There was broad agreement on the need to ease labor regulations and taxes as fiscal resources permit.
- Staff stressed that any reform would need to fit within the fiscal framework and properly balance the twin goals of ensuring worker protection and increasing labor market flexibility.
- The authorities committed to seeking agreement with the Fund before adopting any such reform (¶26).

### Staff appraisal — macroeconomic performance and vulnerabilities
- Turkey’s macroeconomic performance continues to be strong.
- Economic activity has been resilient as the economy shifts away from high reliance on domestic demand.
- FDI has surged, allowing a further build-up of reserves, and the net public debt ratio continues to fall quickly.
- Nonetheless, vulnerabilities remain:
  - Although the current account deficit is likely to moderate in 2007, it is still high;
  - inflation remains persistently above target; and
  - political risks have increased.
- These vulnerabilities, together with a large stock of portfolio investment by nonresidents, keep Turkey highly exposed to shifts in investor sentiment.

### Policy recommendations and near-term priorities
- Maintain market confidence by firmly adhering to strong policies in the context of the Fund-supported program.
- 2007 will be a challenging year, as approaching elections are limiting the scope for undertaking new reforms; the government can promote market confidence by maintaining disciplined policies and vigorously renewing the reform momentum in the immediate post-election period.
- Maintaining tight monetary policies will be essential to bringing inflation on target.
  - Given the challenging inflation outlook, a continued tightening bias is appropriate until inflation is firmly on a downward path.
  - The central bank is encouraged to increase its daily foreign exchange purchases, as reserves do not yet fully cover short-term external debt (at remaining maturity).
- Achieving the fiscal targets will promote disinflation, current account adjustment, and market confidence.
  - Fiscal slippages in 2006 and early 2007 were regrettable.
  - Staff welcome the authorities’ commitments to block low priority spending and contain health overruns to bring fiscal performance back on track.
  - Achieving the 2007 fiscal targets will require substantial effort to offset the disappearance of one-off factors that boosted the 2006 outturn.
  - The decision not to raise energy prices in line with program assumptions was unfortunate, even if this will be offset by cuts in state enterprises’ investment—a move that worsens budget quality.
- Progress on structural reforms will support the fiscal objectives:
  - Planned measures to strengthen tax and social security collections, bolster the finances and efficiency of the energy and health sectors, and improve fiscal transparency are welcome.
  - Reinvigorating social security reform is essential to securing long-run fiscal sustainability.
  - Close adherence to the authorities’ revised strategy is critical.
- Further progress on financial sector reforms, privatization, and labor market reforms would help bolster growth, thereby sustaining investor confidence.
  - Reinvigorating privatization, especially in the banking and energy sectors, would improve the investment climate.
  - Easing onerous labor regulations and taxes, fiscal resources permitting, would also improve the investment climate.

*Source: _cr07363 - 18.      Staff welcomed passage of the mortgage law in February 2007 and discussed*

### 27.      Staff recommends completing the sixth review and approving the authorities’

### 27.      Staff recommends completing the sixth review and approving the authorities’ request for waivers

### Staff recommendation and rationale
- Staff recommends completing the sixth review and approving the authorities’ request for waivers.
- Despite increased risks due to recent fiscal slippages and elevated legal and political uncertainty, the authorities’ track record in implementing the Fund-supported program and their forward-looking plans warrant support.
- Staff supports requests for:
  - waivers of nonobservance of fiscal performance criteria for end-April (which are expected to have been missed, although data are not yet available) in light of the authorities’ commitment to rein in spending to bring fiscal performance back on track;
  - waivers of applicability of end-April performance criteria for external debt (as these are expected to have been met, although data are not yet available);
  - waivers of nonobservance of the structural performance criterion on the approval of second-stage personal income tax reform, as this was delayed by only one day and the omitted provision is expected to be adopted in future legislation.

*Health Spending*

### Diagnosis of health sector performance
- Health outcomes in Turkey are worse than in comparator countries, despite somewhat higher government spending.
- Main reasons identified:
  - excessive administrative costs;
  - high drug spending, representing 40 percent of healthcare costs;
  - overreliance on curative (rather than preventive) care and expensive hospital-based treatments.

### Recent developments and spending dynamics
- A recent expansion of access (many provisions of the pending universal health insurance law were de-facto implemented in 2005) led to rising healthcare spending.
- Efficiency-enhancing measures envisaged under the law have not yet been fully implemented.
- Consequently, health spending increased by 32 percent in 2006.

### Health spending breakdown (2004–07, measures and projections in source)
- Total health spending (percent of GNP): 2004: 3.8; 2005: 3.7; 2006: 4.1; 2007 Proj.: 4.1
- Nominal growth of cash spending (percent): 2005: 9.1; 2006: 31.6; 2007 Proj.: 14.0
- Medicines (percent of GNP): 2004: 1.8; 2005: 1.8; 2006: 1.7; 2007 Proj.: 1.7
- Medicines nominal growth (percent): 2005: 13.8; 2006: 13.0; 2007 Proj.: 12.7
- Hospital treatments (percent of GNP): 2004: 1.8; 2005: 1.7; 2006: 2.2; 2007 Proj.: 2.2
- Hospital treatments nominal growth (percent): 2005: 10.2; 2006: 49.4; 2007 Proj.: 10.9
- Ministry of Health hospitals (percent of GNP, 2005–07): 2005: 1.0; 2006: 1.4; 2007 Proj.: 1.4; nominal growth 2005: ...; 2006: 63.5; 2007 Proj.: 17.5
- Other hospitals (percent of GNP, 2005–07): 2005: 0.8; 2006: 0.8; 2007 Proj.: 0.8; nominal growth 2005: ...; 2006: 31.4; 2007 Proj.: 0.4
- Other (percent of GNP): 2004: 0.2; 2005: 0.1; 2006: 0.1; 2007 Proj.: 0.2; nominal growth 2005: -45.9; 2006: 63.7; 2007 Proj.: 85.4
- Note: Measure is Social Security Institutions' health spending plus budgetary spending for Green Card and civil servants' health programs; actual government health spending is higher as some items are excluded due to data availability.

### Short- and medium-term policy priorities
- Short run: increase efficiency by reducing unnecessary treatments and drugs.
  - In an open-ended fee-for-service system, doctors tend to provide excessive treatments; doctors’ bonuses amount to nearly 40 percent of hospital costs.
  - FAD technical assistance recommended tying doctors’ bonuses to adherence to hospital budgets to incentivize minimization of unnecessary treatments while leaving medical decisions to doctors.
  - As a second-best, hard caps could be placed on hospital budgets, making hospital administrators responsible for managing costs within the budget allocation.
  - Measures to control demand are useful but less effective because demand is ultimately supplier-driven by doctors.
- Medium term (with World Bank support): promote efficiency through:
  - increased use of information technology;
  - lower-cost primary care (family medicine) facilities;
  - differentiated copayments;
  - payment-per-case systems (note: these have encountered legal difficulties).

*Selected Macro and Fiscal Indicators*

### Key real and price indicators (2001–07)
- Real GNP growth rate (percent): 2001: -9.5; 2002: 7.9; 2003: 5.9; 2004: 9.9; 2005: 7.6; 2006 Est.: 6.0; 2007 Proj.: 5.0
- CPI inflation (12-month; end-of period): 2001: 68.5; 2002: 29.7; 2003: 18.4; 2004: 9.4; 2005: 7.7; 2006 Est.: 9.7; 2007 Proj.: 6.0
- GNP deflator growth rate: 2001: 55.3; 2002: 44.4; 2003: 22.5; 2004: 9.5; 2005: 5.3; 2006 Est.: 11.7; 2007 Proj.: 7.0
- Nominal GNP growth rate: 2001: 40.5; 2002: 55.8; 2003: 29.7; 2004: 20.3; 2005: 13.4; 2006 Est.: 18.4; 2007 Proj.: 12.4

### Labor and interest rates
- Unemployment rate (percent): 2001: 10.4; 2002: 11.0; 2003: 10.3; 2004: 10.3; 2005: 10.2; 2006 Est.: 9.9; 2007: ...
- Average nominal treasury bill interest rate: 2001: 93.6; 2002: 64.6; 2003: 45.1; 2004: 24.7; 2005: 16.2; 2006 Est.: 18.1; 2007: ...
- Average ex-ante real interest rate: 2001: 35.5; 2002: 30.5; 2003: 33.9; 2004: 15.3; 2005: 6.0; 2006 Est.: 9.3; 2007: ...

### Fiscal balances (percent of GNP)
- Central government primary balance: 2001: 4.8; 2002: 3.5; 2003: 4.9; 2004: 5.3; 2005: 5.5; 2006 Est.: 5.8; 2007 Proj.: 5.2
- Central government net interest payments (percent of GNP): 2001: 22.2; 2002: 17.3; 2003: 16.1; 2004: 12.3; 2005: 7.7; 2006 Est.: 5.8; 2007 Proj.: 5.9
- Central government overall balance (percent of GNP): 2001: -17.4; 2002: -13.8; 2003: -11.2; 2004: -7.1; 2005: -2.2; 2006 Est.: 0.1; 2007 Proj.: -0.7
- Consolidated public sector primary balance (percent of GNP): 2001: 5.5; 2002: 5.1; 2003: 6.2; 2004: 7.2; 2005: 6.8; 2006 Est.: 6.6; 2007 Proj.: 6.7
- Consolidated public sector net interest payments (percent of GNP): 2001: 22.6; 2002: 17.6; 2003: 15.4; 2004: 11.7; 2005: 7.9; 2006 Est.: 7.4; 2007 Proj.: 7.6
- Consolidated public sector overall balance (percent of GNP): 2001: -17.1; 2002: -12.5; 2003: -9.1; 2004: -4.6; 2005: -1.2; 2006 Est.: -0.8; 2007 Proj.: -0.9
- Net debt of public sector (percent of GNP): 2001: 90.4; 2002: 78.4; 2003: 70.3; 2004: 64.0; 2005: 55.3; 2006 Est.: 44.8; 2007 Proj.: 40.9

### Key levels and memorandum items
- GNP (billions of U.S. dollars): 2006 Est.: 444.0; 2007 Proj.: 401.4 (source shows GNP 2006: 444.0; 2007: 401.4 in one table and GNP 2007: 631,410 in YTL million in another consolidated fiscal table—figures are presented in their original table contexts).
- Per capita GDP (2006): $5,534
- Poverty Rate (2003): 26 percent (WB poverty line estimate)

*External Sector and Balance of Payments*

### External balances (2001–07, billions of U.S. dollars unless stated)
- Current account balance: 2001: 3.4; 2002: -1.5; 2003: -8.0; 2004: -15.6; 2005 Est.: -22.7; 2006 Est.: -31.7; 2007 Proj.: -32.2
- Trade balance: 2001: -3.7; 2002: -7.3; 2003: -14.0; 2004: -23.9; 2005 Est.: -33.5; 2006 Est.: -40.1; 2007 Proj.: -41.4
- Exports (f.o.b.): 2001: 34.4; 2002: 40.1; 2003: 51.2; 2004: 67.0; 2005 Est.: 76.9; 2006 Est.: 91.7; 2007 Proj.: 104.2
- Imports (f.o.b.): 2001: -38.1; 2002: -47.4; 2003: -65.2; 2004: -90.9; 2005 Est.: -110.5; 2006 Est.: -131.8; 2007 Proj.: -145.6
- Energy imports (c.i.f.): 2001: -8.3; 2002: -9.2; 2003: -11.6; 2004: -14.4; 2005 Est.: -21.2; 2006 Est.: -28.6; 2007 Proj.: -30.1
- Services and Income (net): 2001: 4.1; 2002: 3.3; 2003: 4.9; 2004: 7.1; 2005 Est.: 9.4; 2006 Est.: 6.8; 2007 Proj.: 7.3
- Tourism receipts (billions): 2001: 8.1; 2002: 8.5; 2003: 13.2; 2004: 15.9; 2005 Est.: 18.2; 2006 Est.: 16.9; 2007 Proj.: 18.2

### External debt and reserve indicators
- Gross external debt (end-period, billions of U.S. dollars): 2001: 113.6; 2002: 129.7; 2003: 144.3; 2004: 160.8; 2005: 168.8; 2006 Est.: 206.5; 2007 Proj.: 222.0
- Gross external debt (percent of GNP): 2001: 93.1; 2002: 77.3; 2003: 56.4; 2004: 50.1; 2005: 46.7; 2006 Est.: 50.5; 2007 Proj.: 52.8
- Net external debt (end-period, billions of U.S. dollars): 2001: 78.5; 2002: 88.5; 2003: 96.3; 2004: 102.8; 2005: 98.7; 2006 Est.: 109.9; 2007 Proj.: 120.0
- Gross official reserves (Central Bank of Turkey, billions of U.S. dollars): 2001: 19.8; 2002: 28.1; 2003: 35.2; 2004: 37.6; 2005: 52.2; 2006 Est.: 63.3; 2007 Proj.: 68.6
- Months of imports of goods and NFS (reserves): 2001: 4.5; 2002: 5.5; 2003: 3.9; 2004: 3.4; 2005: 4.1; 2006 Est.: 4.5; 2007 Proj.: 4.5

### Balance of payments financing dynamics and projections
- Overall balance (2001–07, selected): 2001: -12.9; 2002: -0.2; 2003: 4.1; 2004: 4.3; 2005: 23.2; 2006 Est.: 10.6; 2007 Proj.: 7.0
- Change in net international reserves (NIR change, + denotes decline): 2001: 12.9; 2002: 0.2; 2003: -4.1; 2004: -4.3; 2005: -23.2; 2006 Est.: -10.6; 2007 Proj.: -7.0
- Gross financing requirements (2001–07, billions): 2001: 42.9; 2002: 37.6; 2003: 46.0; 2004: 65.5; 2005: 76.5; 2006 Est.: 108.2; 2007 Proj.: 107.1

*Monetary and Central Bank Indicators*

### Monetary aggregates (selected)
- Nominal growth of M2Y (percent): 2001: 87.5; 2002: 25.4; 2003: 13.0; 2004: 22.1; 2005: 24.5; 2006 Est.: 24.1; 2007 Proj.: 14.9
- Broad money (M2Y, billions of new Turkish liras): Mar. 2005: 237.4; Jun. 2005: 267.0; Sep. 2005: 270.2; Dec. 2005: 284.9; Mar. 2006: 327.5
- Lira broad money (M2, billions of new Turkish liras): Dec. 2005: 185.1; Mar. 2006: 211.3

### Central Bank balance sheet (selected)
- CBT gross international reserves (at current cross rates, billions of U.S. dollars): 2001: 19.8; 2002: 26.2; 2003: 29.5; 2004: 35.4; 2005: 53.4; 2006 Est.: 60.6; Mar. 2006: 57.7; Jun. 2006: 59.1; Sep. 2006: 60.3
- Net foreign assets (CBT, billions of U.S. dollars): 2001: -8.8; 2002: 2.7; 2003: 6.1; 2004: 7.3; 2005: 25.8; 2006 Est.: 34.0; 2006 (Mar/Jun/Sep/Dec) series provided in table.

*Public Sector Finances and Consolidated Fiscal Presentation*

### Consolidated fiscal figures (2004–07, millions of new Turkish lira and percent of GNP)
- Public sector primary balance (millions): 2004: 30,798; 2005: 33,013; 2006 Est.: 37,940; 2006 Adj.: 40,717; 2007 Prog.: 43,043
- Primary revenue (millions): 2004: 143,066; 2005: 169,392; 2006 Est.: 201,903; 2006 Adj.: 203,093; 2007 Prog.: 223,253
- Primary expenditure (millions): 2004: 120,590; 2005: 142,745; 2006 Est.: 167,545; 2006 Adj.: 167,798; 2007 Prog.: 189,735
- Health spending (millions): 2004: 15,695; 2005: 17,967; 2006 Est.: 23,453; 2006 Adj.: 23,326; 2007 Prog.: 25,583
- Public sector primary balance (percent of GNP): 2004: 7.2; 2005: 6.8; 2006 Est.: 6.6; 2006 Adj.: 7.2; 2007 Prog.: 6.7
- Primary revenue (percent of GNP): 2004: 33.4; 2005: 34.8; 2006 Est.: 35.1; 2006 Adj.: 36.1; 2007 Prog.: 34.5
- Primary expenditure (percent of GNP): 2004: 28.1; 2005: 29.3; 2006 Est.: 29.1; 2006 Adj.: 29.9; 2007 Prog.: 29.3
- Pension spending (percent of GNP): 2004: 7.6; 2005: 8.1; 2006 Est.: 8.0; 2006 Adj.: 8.2; 2007 Prog.: 8.3

### Public sector fiscal structure (2002–07, selected)
- Tax revenue (millions): 2002: 61,713; 2003: 84,832; 2004: 100,342; 2005: 119,627; 2006 Est.: 137,474; 2006 Adj.: 137,643; 2007 Prog.: 157,854
- Major tax components (millions, 2006 figures): Personal income taxes: 28,983; Corporate income taxes: 10,500; VAT: 41,349; SCT: 37,016
- Primary expenditure composition (2006 Est., millions): Personnel: 45,234; Goods and services (incl. defense/security): 13,302; Transfers: 58,721; Capital expenditure: 11,934

*Fund Credit Indicators*

### Indicators of Fund credit (2002–10, selected)
- Outstanding Fund credit (end of period, in billions of SDRs): 2002: 16.2; 2003: 16.2; 2004: 13.8; 2005: 10.2; 2006: 7.2; 2007 Proj.: 6.0; 2008 Proj.: 5.5; 2009 Proj.: 3.6; 2010 Proj.: 1.4
- Outstanding Fund credit (in percent of quota): 2002: 1685; 2003: 1682; 2004: 1437; 2005: 1063; 2006: 601; 2007 Proj.: 553; 2008 Proj.: 361; 2009 Proj.: 118; 2010 Proj.: ...
- Net Fund resource flows (in billions of SDRs): 2002: 4.4; 2003: -0.7; 2004: -3.0; 2005: -4.2; 2006: -3.6; 2007 Est.: -1.6; 2008 Proj.: -0.9; 2009 Proj.: -2.3; 2010 Proj.: -2.3

*Concluding operational note*
- Staff supports waivers and completion of the sixth review conditional on the assessment that authorities will rein in spending and that expected compliance for external debt end-April criteria and eventual adoption of delayed structural tax provision will occur.

*Italic: IMF staff summary of content unit _cr07363 — Staff recommends completing the sixth review and approving the authorities’ request for waivers (excerpts and tables).*

### 1.      Economic performance continues to be good. Growth remains close to the levels

### _cr07363 - 1.      Economic performance continues to be good. Growth remains close to the levels

### Economic performance and external position
- Growth and recent trend:
  - Economy grew by 6 percent in 2006, down from the 7.5 percent pace of previous years.
  - Growth expected at 5 percent in 2007.
- External balance:
  - Current account deficit reached almost 8 percent of GNP in 2006.
  - Expected to fall to 7¼ percent of GNP in 2007.
  - Continued high foreign direct investment expected to cover half of the current account gap.
- Public finances and debt:
  - Primary surplus in 2006 exceeded the 6.5 percent of GNP target by a small margin.
  - Net public sector debt fell further to below 50 percent of GNP.
- Inflation:
  - Inflation remains above target; the 4 percent target is the policy objective.
  - End-December 2006 inflation exceeded the outer band; end-March 2007 inflation was within the outer bands but exceeded the inner bands.

### Program implementation, compliance, and requests
- Quantitative targets:
  - Applicable external debt and net international reserve targets were met.
  - Missed ceiling on primary expenditure at end-December 2006 largely due to higher-than-anticipated investment expenditures.
  - Adjusted end-April 2007 primary surplus, expenditure and social security balance targets are expected to have been missed.
- Structural benchmarks and performance criteria:
  - State enterprise hiring benchmark observed; civil service hiring expected to be observed.
  - Continuous benchmark on excise taxes and SEE prices not met.
  - Personal income tax reform legislation passed on March 1 (missed end-February 2007 deadline); law came into force on April 4 but omitted one anticipated element.
  - Large Taxpayers Unit operational by end-December 2006.
  - Legislation authorizing Social Security Institutions to alter copayments approved end-December 2006 but later invalidated by Constitutional Court.
  - Privatization of Halkbank launched, with an IPO of at least 20 percent of its shares expected to be completed by May 15, 2007.
- Requests to the Fund:
  - Request completion of the Sixth Review under the Stand-By arrangement.
  - Request waiver for small delay in passage of personal income tax reform and omission of expected provisions.
  - Request waivers of applicability for end-April performance criteria on external debt (data not yet available).
  - Request waivers for nonobservance of end-April performance criteria on primary surplus of consolidated government sector, primary surplus excluding SEEs, primary spending of central government and social security institutions, and balance of social security institutions.

### Monetary policy and reserves
- Inflation strategy:
  - Committed to reducing inflation to the 4 percent target.
  - Expect inflation to converge gradually toward target during 2007, with a noticeable fall in yearly inflation rates starting in the second quarter.
  - Monetary policy to be conducted with a tightening bias (more responsive to adverse than to favorable developments).
- Reserve accumulation and FX operations:
  - Continue daily reserve purchase auctions with daily minimum purchase amount fixed at US$15 million.
  - Option for banks to sell up to US$30 million in additional foreign exchange to the CBT.
  - Auctions may be temporarily suspended in extreme circumstances.
  - Announced a yearly program for 2007; may consider increasing daily auction amounts if market conditions are favorable.
  - Retain option of discretionary intervention to prevent excessive exchange rate volatility.

### Fiscal policy stance and corrective measures
- Overall stance:
  - Disciplined fiscal policy remains cornerstone: declining debt ratios, facilitating disinflation, reducing real interest rates.
  - Aim to achieve a 6.7 percent of GNP primary surplus in 2007.
- Spending overruns and offsets:
  - Spending overruns of 0.3 percent of GNP recorded at end-December 2006 will be offset in 2007.
  - Finance Ministry issued instructions to block some 0.6 percent of GNP in spending on lower priority current and capital spending and transfers (bulk planned for first half of 2007).
  - Cut state enterprise investment spending by 0.1 percent of GNP.
  - Implemented safeguards and stepped up monitoring of health spending; set hospital-by-hospital quarterly budgetary targets beginning Q2 2007; legal framework to audit and settle hospital invoices; capped aggregate bonus payments at 2006 level.
  - All accumulated obligations to public hospitals as of end-March 2007 have been resolved, leaving no residual claims.
- Additional fiscal measures and limits:
  - Maintain excise taxes and SEE prices, including energy prices, in line with program assumptions (continuous structural benchmark).
  - Replace no more than 50 percent of civil servants leaving through attrition (quarterly structural benchmark).
  - Replace no more than 10 percent of employees leaving state economic enterprises (continuous structural benchmark).
  - Avoid new initiatives or sectoral tax cuts that would undermine the tax base or VAT structure.

### Health, social security, and structural fiscal reforms
- Social security reform:
  - Constitutional Court ruled in December that many key provisions of the April 2006 social security reform were unconstitutional (including civil servants’ pension aspects, valorization formulas, and medical copayments for civil servants), reducing long-term savings.
  - Postponed implementation; plan to issue a white paper and submit revised legislation soon after opening of new parliamentary session, aiming to put it in place within six months of submission.
  - Interim: ensure civil service pension increases consistent with indexation parameters in the new legislation.
- Measures to improve contribution collection and administration:
  - Legal framework requiring large employers to pay salaries through bank accounts to be put in place by end-June 2007 (structural benchmark).
  - Strengthen and expand the Large Employer Office; modernize debt collection techniques.
  - Establish by end-May a committee to enhance cooperation between SSI and the Revenue Administration; plan a unified tax declaration form by end-2007 (structural benchmark).
- Health sector efficiency:
  - Improve IT control mechanisms for hospital services, eligibility, and pharmaceuticals.
  - Introduce new procurement procedures for inpatient pharmaceuticals and medical devices to realize savings via joint negotiation.
  - Include copayments for outpatient services in social security reform at differentiated rates by level.
  - Expand family medicine program to 22 regions by end-2007 (structural benchmark).
  - If health spending exceeds targets, ready to take offsetting spending cuts elsewhere.

### Tax administration and revenue measures
- Large Taxpayer Unit (LTU):
  - LTU became operational on January 1, 2007.
  - Prior action for this review: raise the number of auditors assigned to the LTU to 35.
  - Plan to raise the number of auditors further over time.
- VAT and audit reforms:
  - Introduce a risk-based audit system by end-2007 (structural benchmark) to address VAT refund fraud.
  - Raise audit staff levels from 5 to 10 percent of total resources over the medium term.
- Personal income tax reform:
  - Second-stage personal income tax reform passed on March 1, 2007.
  - Replaces VAT expenditure rebates with standard family credits and broadens the tax base by lengthening the holding period for long-term real estate capital gains.

### State economic enterprises, privatization, and public financial management
- SEEs and privatization:
  - Finances of some SEEs deteriorated due to input cost increases and unpaid bills.
  - Strategy: privatization of regional distribution companies and subsequently generation companies; intend to sell first three distribution companies in 2008.
  - Considering measures to ensure full and continuous cost recovery; issued strict instructions for prompt settlement of bills by public institutions.
  - Plan to initiate action by next review to improve collection of companies’ receivables from local administrations and extend prepayment requirements for other public utility users.
- Fiscal transparency and reporting:
  - Published previous years’ fiscal figures in new “central government budget” format on March 30, 2007 (prior action).
  - Published end-2006 local budget realization figures on April 11 and plan quarterly publication going forward.
  - Committed to publishing a report that quantifies existing tax expenditures by end-June 2007 (structural benchmark).
  - Working on a public-private partnership (PPP) law framework.

### Financial sector reform and regulation
- State-owned banks:
  - Committed to privatization of state-owned banks.
  - Halkbank strategy revised: IPO for at least 20 percent of its shares as first step; completion expected by no later than May 15, 2007 (prior action).
  - Obtained CMB approval for the IPO and began a road show in late April 2007.
  - Intend to prepare a strategy for Ziraat drawing on Halkbank experience.
- Mortgage and securitization framework:
  - Parliament passed mortgage legislation in February 2007 enabling mortgage finance institutions, securitization of housing loans, and variable rate mortgages.
  - Legislation includes tight norms for real estate appraisal and prudent loan-to-collateral limits.
  - BRSA to supervise primary lending by banks, leasing companies, and consumer finance companies; CMB to supervise securitization of housing loans and Mortgage Finance Companies (MFCs).
  - By end-June 2007, CMB to issue regulations on operational requirements for MFCs, mortgage-backed securities and mortgage-covered bonds; BRSA to determine mortgage license requirements for leasing and consumer finance companies.
- Regulatory and supervisory improvements:
  - Aim to pass the insurance law before end-June 2007 (structural benchmark).
  - Committee on consolidation of supervisory functions presented report in December 2006; government reviewing findings.

*Source: _cr07363.*

### 23.      SDIF will have disposed of all its assets taken over from intervened banks as planned

### 23.      SDIF will have disposed of all its assets taken over from intervened banks as planned

### SDIF asset disposition and Treasury actions
- SDIF will have disposed of all its assets taken over from intervened banks by end-2007, allowing it to focus exclusively on its role as a deposit insurance agency.
- At that point, Treasury will resolve its receivables arising from earlier bank restructurings.

### Investment climate and FDI
- Ongoing efforts to improve the investment climate produced a record level of FDI in 2006 of US$20 billion, which exceeded the cumulative total of the previous five years.
- Expected FDI in 2007: "almost as high" as 2006, driven by ongoing merger and acquisition activity in the banking and other sectors and by investment across communications, energy, manufacturing, and real estate.

### Privatization program and timelines
- Committed to full privatization of electricity distribution and generation companies, Tekel tobacco, and state shares in several other companies in the Privatization Agency portfolio in the 2007 to 2009 timeframe.
- Proceeding with plans to privatize Petkim petrochemicals company in the coming months (relative to the document date).
- Noted delays in sales of some entities, but continued commitment to privatization and groundwork.

### Institutional and regulatory reforms to boost investment
- Commitment to further deregulation, reduction of administrative barriers, increased efficiency of the judicial process, and enhanced corporate governance to raise investment and long-term growth.
- Plan to hold the annual Investment Advisory Council meeting in June to report progress and identify new reform priorities.
- Established the Turkish Investment and Support Promotion Agency, which "will become fully operational by the end of 2007."
- Aim to obtain approval of a new Commercial Code that will introduce, among other things, "a requirement for firms to prepare financial statements in accordance with International Financial Accounting Standards."

### Labor market and employment reforms
- Intend to introduce reforms to reduce labor market rigidities and financial burdens on employment to address low employment ratios and a large informal sector.
- Preparing a reform package that will reduce nonfinancial and financial burdens on formal employment.
- Guiding objectives: increase labor market flexibility while preserving essential worker rights, and reduce informality.
- Any reform will stay within the constraints of the fiscal program framework and be prepared in close consultation with stakeholders and the Fund.

### Key quantitative and timing highlights (as stated)
- FDI in 2006: US$20 billion.
- Privatization timeframe cited: 2007 to 2009.
- Turkish Investment and Support Promotion Agency operational target: by the end of 2007.
- Requirement in new Commercial Code: firms to prepare financial statements in accordance with International Financial Accounting Standards.
- SDIF asset disposition completion target: by end-2007.

*Source: IMF staff communication in supplementary Letter of Intent and associated annexes.*

### 4.      Net lending of any component of the CGS will be considered as a non-interest

### 4.      Net lending of any component of the CGS will be considered as a non-interest

### Treatment of net lending and guaranteed debt
- Net lending of any component of the CGS will be considered as a non-interest expenditure item.
- If this net lending is negative, it will be considered as a non-interest revenue item.
- Payment of guaranteed debt by Treasury on behalf of non-CGS components of the public sector will not be treated as net lending up to the baseline reported in Annex G.

### Extrabudgetary funds (EBFs)
- The three EBFs included in the definition of the performance criterion are:
  - the Defense Industry Support Fund,
  - the Privatization Fund,
  - the Social Aid and Solidarity Incentive Fund.

### State economic enterprises (SEEs): scope and monitoring
- The 22 SEEs whose primary balances will be included in the definition of the performance criterion are:
  - TTK (coal), T. ŞEKER FAB (sugar), TMO (soil products office), TEKEL (tobacco), TCDD (railways), BOTAŞ (natural gas), TEDAŞ (electricity distribution), EÜAŞ (electricity generation), TETAŞ (electricity trade), TEİAŞ (electricity transmission), TPAO (petroleum exploration and extraction), ETİ Maden İŞL., MKEK, TKİ, ÇAYKUR, DHMİ, PTT, PETKİM, TİGEM, KIYEM, TDİ, and DMO.
- The primary balance of these SEEs will be monitored as the sum of net financing minus accrued interest made by the SEEs.
- Net financing is monitored as:
  - net financing from the banking system (excluding pre-export financing from Eximbank) plus
  - net external borrowing (excluding normal trade financing) plus
  - the change in net arrears to and net advances from the private sector and to/from the non-CGS public sector (including subsidiaries and joint ventures) plus
  - net interest payments undertaken by the Treasury.
- The net change in arrears on tax liabilities will be excluded.

### Definitions and baseline stocks for SEE financing
- Net financing from the banking system (excluding pre-export financing from Eximbank) is defined as:
  - the change in all claims of these institutions on the SEEs listed above, including loans and capitalized interest arrears, less the change in deposits and repos of SEEs in these institutions, as reported by these SEEs.
  - Changes in claims and deposits denominated in foreign currency will be valued at the average of the exchange rates between the Turkish lira and each corresponding currency prevailing during the quarter in question.
  - As of December 31, 2005 the stock of net banking claims on SEEs as defined above stood at YTL 1,243 million, valued at the exchange rates on that day.
- Net external borrowing is defined as:
  - the receipt of external loans (including guaranteed debt and on-lending, and excluding normal trade financing) less amortization (excluding repayments of guaranteed debt and on-lending undertaken by the Treasury), valued at the exchange rate at the time of transaction.
  - As of December 31, 2005 the stock of external loans stood at YTL 6,932 million, valued at the exchange rates on that day.

### Social security institutions (SSIs)
- The three SSIs included in the definition of the performance criterion for end-December 2006 are SSK, Bağ-Kur, and Emekli Sandığı.
- For the 2007 targets, the object of monitoring is the unified social security institution (SSI), including the activities of SSK, Bağ-Kur, and Emekli Sandığı.
- The deficits of the SSI(s) will be covered by transfers from the central government budget, and they are thus expected to be in primary balance.

### Adjusters to the floor on the primary surplus of the CGS
- The floor on the primary surplus of the CGS will be adjusted upwards for any increase in the expenditure arrears of the SSIs.
- Arrears of the SSIs are defined as the sum of:
  - (i) overdue pension payments;
  - (ii) medicine payments overdue by more than 45 days for both imported and domestic medicine (from the date of invoice receipt);
  - (iii) other payments overdue by more than 30 days and payments to hospitals overdue by more than 60 days (from the date of invoice receipt).
- In the case of Bağ-Kur they exclude the arrears to the common retirement fund.
- The stock of arrears for Bağ-Kur stood at YTL 0 million; for SSK stood at YTL 0 million; and for Emekli Sandığı stood at YTL 0 million on December 31, 2005. These stocks of arrears will be used for the purpose of calculating the adjustor.
- The floors for the primary surplus of the CGS will be adjusted upward for:
  - any issue of noncash debt other than for bank recapitalization and securitization of duty losses and for the restructuring of the Agricultural Sale Cooperative Units and military foreign financed in-kind spending;
  - any off-balance sheet expenditure of any component of the CGS (excluding military foreign financed in-kind spending);
  - cumulative interest receipts of the Defense Industry Support Fund in excess of YTL 300 million.
- The floor will be adjusted upward (downward) in line with the projected surplus (deficit) of the primary balance of any fund or entity incorporated in the CGS after January 1, 2007.
- The floor will be adjusted by the primary balance projected at program approval for any SEE included in the performance criterion when there is a change of control due to privatizations; the adjustor equals the difference between the primary surplus generated while in public control and the annual projection. This adjustor does not apply to Türk Telekom or TÜPRAŞ in 2006.
- The 2007 (end-April, end-August, end-December) floors on the primary surplus of the CGS were adjusted upward by YTL 1,888 million, which was the excess of primary spending of the central government and the SSIs relative to the end-2006 target.

### B. Primary Spending of the Central Government and the Social Security Institution(s)
- Table (performance criteria on cumulative consolidated primary spending) ceilings (In millions of YTL):
  - Cumulative primary spending from January 1, 2006 to:
    - December 31, 2006 174,000
  - Cumulative primary spending from January 1, 2007 to:
    - April 30, 2007 56,362
    - August 31, 2007 119,000
    - December 31, 2007 190,600
- The December 2006 ceiling is established on the sum of:
  - (i) primary spending of the central government, excluding transfers to social security institutions; and
  - (ii) primary spending of the social security institutions.
- The 2007 ceilings relate to expenditures of the fully consolidated central government and social security institution; central government transfers and payments of social security contributions are consolidated out, as are payments between SSIs.
- Adjusters:
  - Ceilings on primary spending will be adjusted symmetrically to compensate for any over- or underperformance in collections of the revenue bases subject to sharing with local governments and extrabudgetary funds.
  - The 2007 (end-April, end-August, end-December) spending ceilings were adjusted downward by YTL 1,888 million, which was the excess of primary spending relative to the end-2006 target.

### C. Overall Balance of the Consolidated Government Sector (CGS)
- Indicative floors on cumulative overall balance of the CGS (In millions of YTL):
  - Cumulative overall balance from January 1, 2006 to:
    - December 31, 2006  -6,900
  - Cumulative overall balance from January 1, 2007 to:
    - April 30, 2007 -6,612
    - August 31, 2007  -3,612
    - December 31, 2007  -6,512
- The overall balance of the CGS comprises:
  - (i) the primary balance of the CGS as defined in this annex;
  - (ii) the net interest payments of the central government (excluding in 2006 those combined penalty/interest charges associated with tax payments and already included as primary revenues); the UIF and the SEEs;
  - (iii) the interest payments of SSI(s) and EBFs;
  - (iv) transfers of profits from the CBT and net special revenues of the Turkish Mint to the consolidated central government;
  - (v) Ziraat Bank dividend payments and recapitalization-bond-related dividend payments from Halkbank;
  - (vi) expenditures under the risk account (net lending).
- Monitoring of the overall balance components follows paragraph 1 of the Annex.
- All definitions and adjusters specified earlier for the primary balance of the CGS apply to the overall balance, including adjustments for the overall balance of any new government funds and institutions established after January 1, 2007.

### D. Overall Balance (before transfers) of the Social Security Institution (SSI)
- Performance criteria on cumulative overall balance (before transfers) of the SSI (In millions of YTL):
  - Cumulative overall balance (before transfers) from January 1, 2006 to:
    - December 31, 2006 -24,300
  - Cumulative overall balance (before transfers) from January 1, 2007 to:
    - April 30, 2007 -5,000
    - August 31, 2007 -16,300
    - December 31, 2007 -24,200
- The overall balance (before transfers) comprises the balances of SSK, Bağ-Kur, and Emekli Sandığı for end-December 2006 and the unified SSI for 2007 test dates.
- It excludes additional payments made to pensioners in lieu of phased-out tax rebates (up to YTL 1.772 billion) for 2006.
- For 2007, these additional payments as well as billed payments are counted as both revenue and expenditure of the SSI.

### E. Amnesties and Public Sector Receivables
- Amnesties are defined as a reduction in the net present value of a public receivable, without reference to individual ability to pay or attempt to enforce individual payment.
- A public receivable is an obligation to general government (GFS definition) or to a state economic enterprise or state bank.
- This performance criterion will not apply to companies in the Privatization Administration’s portfolio.

### F. Structural Benchmark on New Civil Servant Hires
- A quarterly benchmark will monitor the 50 percent ceiling on the replacement ratio for civil servants as provided for in the 2007 Budget Law.
- The replacement ratio is computed as:
  - cumulative number of entries in each quarter in 2007 divided by the total number of attritions in 2006.
- Attritions comprise retirements, deaths, resignations, and transfers to other agencies; entries comprise appointments and transfers from other agencies.
- Data will be provided for total civil servants, divided into sub-categories: general administration, education services, health services, technical services, and other positions.
- These data will be prepared by the Ministry of Finance (General Directorate of Budget and Fiscal Control) on a quarterly basis and submitted to the Fund within 6 weeks of the end of the corresponding quarter.

### Annex G: Program Baseline for Treasury Net Lending
- Baseline for cumulative net lending (In millions of US$ and YTL):
  - Cumulative net lending from January 1, 2006 to:
    - December 31, 2006 335 (US$) 490 (YTL)
  - Cumulative net lending from January 1, 2007 to:
    - April 30, 2007 125 (US$) 185 (YTL)
    - August 31, 2007 225 (US$) 335 (YTL)
    - December 31, 2007 335 (US$) 500 (YTL)
- Net lending (risk account) by Treasury to other (non-CGS) components of the public sector is defined as the sum of guarantee payments made by Treasury on behalf of these entities minus repayments obtained by Treasury from them.
- Other components of the public sector include: extrabudgetary funds not in the CGS, revolving funds, associations or foundations, SEEs not in the CGS, state banks (including Eximbank and Iller bank), special provincial administrations, municipalities, municipal enterprises, build-operate-transfer projects, and build-operate projects.
- Repayments include those obtained in cash directly from municipalities.
- Repayments obtained through claw-back mechanisms, either directly by withholding transfers of tax shares from the MoF, or indirectly via withholding of transfers to be made by Iller Bank, and proceeds from privatization, direct or indirect, are not included as repayments.
- For program monitoring, flows in U.S. dollars will be converted at the average YTL/US$ exchange rate between test dates.

### Annex H: Short-Term External Debt Ceilings
- Performance criteria on the stock of short-term external debt outstanding — ceilings (In millions of US$):
  - December 31, 2005 1,000
  - March 31, 2006 1,000
  - June 30, 2006 1,000
  - September 30, 2006 1,000
  - December 31, 2006 1,000
  - April 30, 2007 1,000
  - August 31, 2007 1,000
  - December 31, 2007  1,000
- Limits apply to stock of debt with original maturity of one year or less, owed or guaranteed by the CGS (Annex F definition).
- Excluded from this performance criterion are external program financing, sales of treasury bills denominated in Turkish lira or foreign exchange to nonresidents, normal import-related credits, reserve liabilities of the Central Bank of Turkey, and forward contracts, swaps, and other future market contracts.
- Debt within the limit shall be valued in U.S. dollars at the program cross exchange rates specified in Annex J.

### Annex I: Medium- and Long-Term External Debt Ceilings
- Performance criteria on contracting and guaranteeing of new external debt — limits (In millions of US$):
  - Cumulative flows from end-December 2004:
    - December 31, 2005  16,000
  - Cumulative flows from end-December 2005:
    - March 31, 2006  8,500
    - June 30, 2006 14,000
    - September 30, 2006  18,000
    - December 31, 2006  21,500
  - Cumulative flows from end-December 2006:
    - April 30, 2007 9,000
    - August 31, 2007 15,000
    - December 31, 2007 22,000
- Limits apply to contracting or guaranteeing by the CGS of new, nonconcessional external debt with original maturity > one year.
- “Nonconcessional” means grant element < 35 percent based on OECD commercial interest reference rates at contract time.
- Exclusions: IMF credits, World Bank adjustment lending, other external program financing, long-term liabilities of the Central Bank of Turkey, sales of treasury bills and bonds to nonresidents, and debt used to retire other debt as part of liability management operations that improve the debt profile (subject to conditions).
- Debt within the limit shall be valued in U.S. dollars at the exchange rate prevailing at contract entry or guarantee issuance.

### Annex J: Program Exchange Rates
- Cross exchange rates for program purposes (TL value, YTL value, U.S. dollars per currency unit):
  - U.S. dollar 1,497,696 1.497696 1.0000
  - Euro 1,845,162 1.845162 1.2320
  - Japanese yen 13,469 0.013469 0.0090
  - Swiss franc 1,186,643 1.186643 0.7936
  - U.K. pound 2,707,645 2.707645 1.8086
- These program exchange rates shall apply to performance criteria/indicative ceilings or floors for the period May 31, 2005–May 31, 2008.
- Currencies not specified will be converted at representative exchange rates reported to the IMF as of September 29, 2004.
- Constituent currencies of the euro shall be converted into euro at official EU conversion rates and then into U.S. dollar value.

*International Monetary Fund. TURKEY — Sixth Review and Inflation Consultation Under the Stand-By Arrangement and Request for Waiver of Nonobservance and Applicability of Performance Criteria — Supplementary Information. May 16, 2007.*

### 1.      Recent developments have not affected the broad outlook for the economy:

### 1.      Recent developments have not affected the broad outlook for the economy:

### Recent activity and external position
- Industrial output growth eased slightly in March but still points to robust activity, bolstered by external demand.
- On the external side, March was the fourth consecutive month with a flat 12-month rolling current account deficit, supporting the view that the current account position may have stabilized.
- Market participants now expect end-2007 inflation at 7.8 percent (up 0.3 percentage points from the previous poll), underscoring the upside risks to staff’s 6 percent inflation projection. Medium-run inflation expectations are, however, basically unchanged.
- Reflecting recent political developments, Fitch downgraded its outlook for Turkey from positive to stable, while leaving the underlying sovereign ratings unchanged.

### Monetary policy
- In its latest meeting, the Monetary Policy Committee left interest rates unchanged but maintained a hawkish tone in its statement.

### Fiscal developments and program implications
- Fiscal developments continued to be weaker than expected, suggesting that greater spending discipline will be required to keep the revised fiscal program on track.
- For January–April, primary spending of the central government (a narrower aggregate than the consolidated government monitored under the program) was higher than expected by YTL 2.4 billion (0.4 percent of annual GNP), with capital expenditure and purchases of goods and services each accounting for about YTL 1 billion.
- Higher spending was partly offset by higher revenue (with strong nontax revenue more than compensating for some weaknesses in tax revenue).
- As a result, the cumulative primary surplus of the central government at end-April was some 0.2 percent of annual GNP lower than envisaged.
- The authorities provided revised estimates for the end-April fiscal program outturns and explained that the recent acceleration in spending reflects an advancing of spending plans and should thus be seen as temporary. The authorities reiterated their commitment to meet the August and December fiscal program targets.

### Structural and institutional developments
- The quarterly structural benchmark on keeping the replacement ratio of civil servants leaving through attrition below 50 percent was met at end-March. The replacement ratio was 19 percent.
- Two pending prior actions have been implemented:
  - On April 24, the authorities increased the number of auditors assigned to the Large Taxpayer Unit to 37.
  - The Halkbank IPO was successfully completed on May 9. The sale of almost 25 percent of the bank’s shares was 8 times oversubscribed, raising US$1.8 billion. About 70 percent of the shares sold were placed with foreign investors.
- The authorities are making progress on preparing a modified social security reform. A complete draft of a white paper describing reform options in line with previously agreed principles has been shared with Fund and Bank staff. The authorities are incorporating staff comments and intend to publish the paper shortly.

### Program monitoring: quantitative conditionality and performance at end-April 2007
- Floor on primary balance of consolidated government sector (CGS): Observed; Expected to be missed by 4,650-5,600 mil. YTL 2/
- Floor on primary balance of CGS excluding State Economic Enterprises (SEEs): Observed; Expected to be missed by 5,320-6,000 mil. YTL 2/
- Ceiling on consolidated primary spending of central government and social security institutions (SSIs): Not observed; Expected to be missed by 3,275-3,750 mil. YTL 2/
- Ceiling on new external public debt with maturities exceeding one year: Observed; N.A., expected to be observed
- Ceiling on new external public debt with maturities up to one year: Observed; N.A., expected to be observed
- Floor on net international reserves of CBT and Treasury combined: Observed; Observed
- Floor on overall balance (before transfers) of SSIs: Observed; Expected to be missed by 3,800-4,300 mil. YTL 2/

Notes and procedural items reflected in the monitoring table:
- Inflation consultation clause applies.
- Prior actions listed as Done:
  - Publication of historical fiscal outturns on new "central government" basis
  - Increase in number of auditors assigned to Large Taxpayer Unit (LTU) to 35
  - Completion of initial public offering (IPO) of at least 20 percent of Halkbank
- Structural performance criteria and existing structural benchmarks include measures on amnesties, copayments for medical treatments and pharmaceuticals, personal income tax reform, replacement ratios in state enterprises and civil service attrition, excise taxes and SEE prices, establishment of a large-taxpayer unit, completion of the Halkbank tender process, and publication of report quantifying existing tax expenditure.
- New proposed structural benchmarks include legal framework for large employers to pay salaries through bank accounts (end-June 2007, ¶15); adoption of unified tax declaration form (end-2007, ¶15); implementation of a risk-based audit system to address VAT refund fraud (end-2007, ¶16); passage of insurance law (end-June 2007, ¶22); and others noted in the Letter of Intent references.

### IMF Executive Board completion of the Sixth Review and press release highlights (Press Release No. 07/103, May 18, 2007)
- The Executive Board completed the sixth review under the three-year SDR 6.66 billion (about US$10 billion) Stand-By Arrangement for Turkey, approved on May 11, 2005.
- Completion of the sixth review enables Turkey to draw immediately an amount equivalent to SDR 749.5 million (about US$1.1 billion).
- The Board approved Turkey's request for waivers of nonobservance of the end-April 2007 quantitative performance criteria in the fiscal area (primary balances of the consolidated government sector including and excluding state economic enterprises, overall balance of the social security institutions, and consolidated primary spending of the central government and social security institutions) and of the end-February 2007 structural performance criterion on parliamentary approval of personal income tax reform.

John Lipsky, First Deputy Managing Director and Acting Chairman, summarized key assessments and recommendations:
- Macroeconomic performance has remained strong. Economic activity has been resilient to increased financial market volatility and elevated interest rates. Growth has become more broad based, with reduced reliance on domestic demand. Foreign direct investment has surged, allowing a further build-up of reserves, and the net public debt ratio has continued to fall rapidly.
- Challenges: inflation remains well above target, the current account deficit is high, and elections are approaching.
- Policy recommendations and conditionalities stressed:
  - Persevere with disciplined macroeconomic policies to preserve market confidence.
  - Authorities’ commitment to a 6.7 percent of GNP primary surplus target for 2007 is welcome; substantial discipline will be required to keep spending in line with the programmed path.
  - Maintain a tight monetary policy; given the challenging inflation outlook, a continued tightening bias is appropriate until inflation is firmly on a downward path.
  - Press ahead with structural reform: implement revised social security reform, bolster efficiency in the health and energy sectors, strengthen tax collections to safeguard the medium-term fiscal position and make room for tax cuts on labor and financial transactions.
  - In the financial sector: close supervisory oversight and further building of cushions in balance sheets to safeguard against risks inherent in rapid credit growth.
  - Advance privatization, especially in the banking and energy sectors; the successful public offering of Halkbank shares is a welcome initial step.
- Concluding appeal: Disciplined economic policies combined with comprehensive structural reforms are required to entrench recent macroeconomic gains, contain vulnerabilities, and lay the basis for high and stable growth. The authorities’ commitment to maintaining prudent monetary and fiscal policies and renewing impetus to structural reform in the coming months deserves the support of the international community.

*IMF Press Release No. 07/103; text of staff report and monitoring table as provided.*

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