## 2. Implications of Misclassifying Securities Repos

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### Key findings
- Staff estimate that inflows through portfolio debt in H1 2011 are thought to be overstated by some US$6.5 billion in the official balance of payments and external debt statistics because short-term external borrowing by domestic banks collateralized with government securities (securities repurchase agreements) are recorded as nonresidents’ purchases of government debt.
- Banks' securities repos are included in bank borrowing, with a corresponding deduction from portfolio debt (chart annotation).
- CBT reserves grew by US$17¼ billion since end-2009.
- Reserve cover of short-term debt (projected at US$130 billion—around 15 percent of GDP—in 2012) declined to 70 percent as of end October 2011.
- Banks absorbed the largest share of external funding—much of it short term—and the sector’s net external liability position rose to 8½ percent of GDP.
- Banks' loan-to-deposit ratio jumped from 76 percent at end 2009 to near 95 percent in mid 2011.
- As of June 2011, Turkish banks had US$15.6 billion of external repos, of which US$11.2 billion had maturities of less than one year.

### Implications for external financing and statistical presentation
- Misclassification of securities repos into portfolio debt inflows can materially overstate portfolio debt inflows (estimated overstatement: US$6.5 billion in H1 2011), thereby understating banks’ short-term external borrowing in official presentations.
- The statistical treatment contributes to a distorted composition of capital flows, making funding sources appear more stable (portfolio purchases) than they actually are (short-term bank borrowing).
- Misclassification affects reserve adequacy metrics:
  - Short-term debt is projected at US$130 billion—around 15 percent of GDP—in 2012.
  - Reserve cover declined to 70 percent by end-October 2011.
  - The true short-term vulnerability may be higher when repos are properly classified as bank borrowing.

### Risks to financial stability and assessment metrics
- Greater apparent portfolio debt inflows (vs. actual short-term bank borrowing) can mask heightened reliance on potentially-volatile short-term debt and errors and omissions.
- The difference in classification alters cross-country comparisons of reserve cover and reserve adequacy metrics, including the proposed new metric noted in charts (proposed new metric = 30 percent of short term debt + 10 percent of other portfolio liabilities + 5 percent of broad money + 5 percent of export income for countries with flexible exchange rate regimes).
- Distorted flow composition may have influenced policy calibration by obscuring the extent to which banks were tapping short-term foreign funding to support rapid credit growth:
  - Loans to the private sector grew by around 40 percent y-on-y during Q4 2010 to Q2 2011, to reach 48 percent of GDP.
- If foreign lenders refuse to renew repos, domestic banks must secure sufficient fx to repay the loan in full, exerting downward pressure on the currency; margin calls to top up collateral in response to a rise in domestic interest rates effectively shrink the net size of the loan.

### Policy considerations implied by the misclassification
- Reclassifying securities repos to reflect banks’ short-term external borrowing would provide a more accurate picture of the composition and maturity structure of capital inflows, improving assessments of reserve adequacy and external vulnerability.
- Improved statistical treatment would better inform macroprudential and monetary policy responses to reliance on short-term external funding by banks, particularly given:
  - banks’ rising loan-to-deposit ratio (from 76 percent to near 95 percent),
  - the sector’s net external liability position of 8½ percent of GDP,
  - banks’ external repos of US$15.6 billion as of June 2011, with US$11.2 billion maturing in less than one year.
- Transparent presentation of repos as bank borrowing would reduce the risk of underestimating funding fragility and support more targeted policy measures to lengthen the maturity of bank funding and contain credit growth.

*Source: 2011 Article IV Report — Turkey (excerpts).*

### 2. Implications of Misclassifying Securities Repos .....................................................................

### 2. Implications of Misclassifying Securities Repos

### Key findings
- Staff estimate that inflows through portfolio debt in H1 2011 are thought to be overstated by some US$6.5 billion in the official balance of payments and external debt statistics because short-term external borrowing by domestic banks collateralized with government securities (securities repurchase agreements) are recorded as nonresidents’ purchases of government debt.
- Chart annotation: banks' securities repos are included in bank borrowing, with a corresponding deduction from portfolio debt.
- CBT reserves grew by US$17¼ billion since end-2009.
- Reserve cover of short-term debt (projected at US$130 billion—around 15 percent of GDP—in 2012) declined to 70 percent as of end October 2011.
- Banks absorbed the largest share of external funding—much of it short term—and the sector’s net external liability position rose to 8½ percent of GDP.
- Banks' loan-to-deposit ratio jumped from 76 percent at end 2009 to near 95 percent in mid 2011.

### Implications for external financing and statistical presentation
- Misclassification of securities repos into portfolio debt inflows can materially overstate portfolio debt inflows (estimated overstatement: US$6.5 billion in H1 2011), thereby understating banks’ short-term external borrowing in official presentations.
- The statistical treatment contributes to a distorted composition of capital flows, making funding sources appear more stable (portfolio purchases) than they actually are (short-term bank borrowing).
- Misclassification affects reserve adequacy metrics: with short-term debt projected at US$130 billion (around 15 percent of GDP) in 2012 and reserve cover declining to 70 percent by end-October 2011, the true short-term vulnerability may be higher when repos are properly classified as bank borrowing.

### Risks to financial stability and assessment metrics
- Greater apparent portfolio debt inflows (vs. actual short-term bank borrowing) can mask heightened reliance on potentially-volatile short-term debt and errors and omissions.
- The difference in classification alters cross-country comparisons of reserve cover and reserve adequacy metrics, including the proposed new metric noted in charts (proposed new metric = 30 percent of short term debt + 10 percent of other portfolio liabilities + 5 percent of broad money + 5 percent of export income for countries with flexible exchange rate regimes).
- Distorted flow composition may have influenced policy calibration by obscuring the extent to which banks were tapping short-term foreign funding to support rapid credit growth (loans to the private sector grew by around 40 percent y-on-y during Q4 2010 to Q2 2011, to reach 48 percent of GDP).

### Policy considerations implied by the misclassification
- Reclassifying securities repos to reflect banks’ short-term external borrowing would provide a more accurate picture of the composition and maturity structure of capital inflows, improving assessments of reserve adequacy and external vulnerability.
- Improved statistical treatment would better inform macroprudential and monetary policy responses to reliance on short-term external funding by banks, particularly given banks’ rising loan-to-deposit ratio (from 76 percent to near 95 percent) and the sector’s net external liability position of 8½ percent of GDP.
- Transparent presentation of repos as bank borrowing would reduce the risk of underestimating funding fragility and support more targeted policy measures to lengthen the maturity of bank funding and contain credit growth.

*Source: 2011 Article IV Report — Turkey (excerpts).*

### 16.      Financial conditions tightened on

### 16.      Financial conditions tightened on

### Financial conditions and interest rates
- Monetary and prudential policy actions and more restrictive external financing conditions tightened financial conditions.
- Interest rates on lira-denominated bank loans have risen substantially, especially for households.
- Real rates for households are now back to pre-crisis levels.
- Real rates for corporates are considerably lower—but still strongly positive—than for households.
- Real rates on lira-denominated deposits remain low.
- A meaningful yield curve for deposits has been slow to emerge.

### Strengths and challenges and balance sheet vulnerabilities
- Private short-term foreign debt climbed sharply since 2008.
- Banks absorbed most of these liabilities and face intensified rollover risk despite aggregate CARs remaining well-above the allowable 12 percent floor.
  - CARs have slipped more than 4 percentage points to 16½ percent.
  - Open fx positions are small.
- Nonfinancial corporates’ net fx liabilities have risen to US$120 billion.
  - Short-term fx obligations are US$15 billion.
- Households retain long fx positions and are net savers.
  - Households are not permitted to borrow in fx and, since June 2009, are no longer permitted to use fx-indexed loans.
- Deposit concentration: the largest 0.1 percent of accounts hold more than 46 percent of system-wide deposits.
- Number of retail borrowers increased sharply, presumably expanding beyond very wealthy households.
- Headline fiscal balance continues to improve and public debt to GDP ratio returned to a downward path, but contingent on favorable macroeconomic conditions at home and abroad.

### Turkey: 2011 Risk Matrix — key sectoral vulnerabilities and potential impacts
- Banking sector
  - Vulnerabilities/mitigating factors:
    - Funding risk from increased loan-to-deposit ratio (close to 100 percent) and large ST external debt (9% of GDP);
    - Interest rate risk due to maturity mismatch (net on- and off balance sheet of US$117b up to 1 year);
    - Corporate borrowers often exposed to fx risk;
    - Deposits sticky;
    - CARs declining, but still strong (16.6 percent);
    - NPLs at historic low (<3 percent).
  - Potential impact: funding squeeze and TL depreciation could lead to credit crunch; rise in NPLs; losses on repricing of securities and higher funding costs; CAR deterioration.
- Banks with EA parents
  - Vulnerabilities/mitigating factors:
    - About a third of banking sector has links to euro-area banks under stress, but direct funding is low;
    - Wholesale funding costs partly linked to parents, but Turkish subsidiaries profitable.
  - Potential impact: parent banks sell stakes in Turkish banks; similar banking-sector stresses as above.
- Public sector
  - Vulnerabilities/mitigating factors:
    - Reliance on transient revenue;
    - Large share of variable-rate debt (nearly half);
    - High rollover requirement (10 percent of GDP);
    - Government securities concentrated at local banks (70 percent).
  - Potential impact: deterioration in NFPS balance from fall in transient revenue, weaker GDP and import compression, and higher cost of borrowing.
- Corporates/firms
  - Vulnerabilities/mitigating factors:
    - Large net FX liability position (US$120b);
    - High import content of production;
    - Large share of loans is short-term;
    - Half exports to EU.
  - Potential impact: TL depreciation, credit crunch, and weak demand squeeze profits and ability to repay loans (including in fx); cut production, investment, employment.
- Households
  - Vulnerabilities/mitigating factors:
    - Debt service absorbs a quarter of disposable income;
    - Loans unsecured but only in TL;
    - Households long in fx and have a net financial asset position.
  - Potential impact: reduced employment, credit crunch, higher inflation from depreciation and higher indirect taxes reduces ability to service loans and leads to lower living standard.

### Outlook, competitiveness and risks
- Authorities’ expectations (from 2012–14 MTP and authorities’ views):
  - GDP growth forecast to temporarily slow to 4 percent next year, before recovering to 5 percent thereafter.
  - CAD gradually moderating to 7 percent of GDP in 2014.
  - Inflation expected to drop to close to the 5 percent target by end-2012 and remain there through the medium term.
  - Indirect tax hikes expected to help stabilize imports relative to GDP.
  - Sustained growth and labor market reforms expected to continue to boost employment.
- IMF mission’s baseline outlook and divergence from MTP:
  - External financing reduction from US$75 billion in 2011 to US$60 billion in 2012—around 8 percent of GDP—is expected to compress imports measured in dollar terms.
  - Because imports are mostly raw materials and manufactured intermediates, GDP growth likely to moderate sharply from 7½ percent this year to 2 percent in 2012.
  - Some limited expenditure switching and expanded domestic production of import substitutes is projected to raise GDP growth thereafter and further moderate the CAD.
  - Persistent positive inflation differentials—with inflation surging to 9½ percent this year and to 6½ percent in 2012—are forecast to gradually erode initial competitiveness gains; the RER would remain noticeably overvalued relative to equilibrium.
  - Still-large current account deficits in the medium term are forecast to raise external debt to 50 percent of GDP by 2016.
- Risks skewed to the downside:
  - Weaker global activity and more severe international funding strains could spill over to Turkey.
  - Heightened risk aversion or deleveraging by European banks could sharply limit external financing, causing further depreciation, fx funding strains for banks and corporates amid low reserve buffers, and compressing imports and credit.
  - The effect on growth in such scenarios could be harsh, similar to 2008–09.

### Comparison of MTP and IMF staff projections (selected figures for 2011–2012)
- Real GDP growth (percent): Staff 7.5; MTP 7.5; Staff (2012) 2.0; MTP (2012) 4.0
- Current account deficit (billions of U.S. dollars): Staff -78.8; MTP -71.7; Staff (2012) -62.9; MTP (2012) -65.4
- Current account deficit (percent of GDP): Staff -10.2; MTP -9.4; Staff (2012) -7.8; MTP (2012) -8.0
- Exports (fob, billions of U.S. dollars): 2011 Staff 134.2; 2011 MTP 134.8; 2012 Staff 143.6; 2012 MTP 148.5
- Imports (cif, billions of U.S. dollars): 2011 Staff 241.6; 2011 MTP 236.9; 2012 Staff 243.5; 2012 MTP 248.7
- CPI inflation (eop, percent)1/: 2011 Staff 9.5; 2011 MTP 7.8; 2012 Staff 6.4; 2012 MTP 5.2
  - 1/ According to the CBT's latest Inflation Report (October 26, 2011), inflation in 2011 is forecast at 8.2 percent, with the 2012 forecast remaining as in the MTP.

### Policy framework — recommended rebalancing and instruments
- General assessment
  - Authorities committed to gradually reducing the CAD while bolstering macroeconomic stability; intended to maintain unconventional monetary policy framework supplemented by more ambitious fiscal adjustment in the 2012–14 MTP and structural reforms.
  - Fiscal consolidation seen as having limited effect at moderating the CAD due to accelerating private sector credit.
  - Monetary policy is overburdened while fiscal, prudential, and structural policies remain underutilized.
- Mission advice: rebalancing the policy mix within a standard inflation-targeting framework
  - Tighten structural fiscal position to support disinflation.
  - Financial policies should reduce macroprudential risks.
  - Monetary policy could then maintain inflation and policy rates at levels prevailing in other countries within a conventional inflation-targeting framework, reducing attractiveness to short-term inflows.
  - Structural reforms to reduce reliance on imports and support price flexibility.
- Counterfactual observation
  - If staff’s recommended policy mix had been adopted 18 months earlier, a more moderate capital flow-driven boom would have ensued: tighter structural fiscal position, saved transient revenue, and preemptive macroprudential strengthening would have reduced absorption of “hot money” inflows and limited credit, domestic demand and imports, lowering current account and vulnerabilities.
- Fiscal policy detailed recommendations
  - Target a strong structural primary surplus—excluding transient revenue—to support disinflation and protect against large negative revenue shocks.
    - The structural primary surplus target should be set sufficiently high to ensure inflation and nominal policy rates are broadly comparable to those of EM peers.
    - A structural primary surplus of around 1 percent of GDP is an appropriate target.
    - With the net interest bill around 2–3 percent of GDP, this would be consistent with a small overall structural deficit.
    - The 1 percent structural primary surplus target would safeguard sustainability in the event of an abrupt capital reversal.
  - Pace of reaching the target depends on the pace of economic activity.
    - For 2012, targeting a NFPS headline primary surplus near 2 percent of GDP—against the MTP target of just over 1 percent—would be appropriate under the baseline macroeconomic scenario.
    - Achieving a 2 percent target would require ½ percentage point in new measures relative to those already planned for 2012, best achieved by slowing the growth of current spending.
    - With a structural improvement of 1½ percentage points in 2012, a further ½ percentage point would be needed over the next few years to reach the 1 percent of GDP structural primary surplus target.
    - Slower structural adjustment is appropriate if growth considerably underperforms the baseline forecast.
- Fiscal planning observations
  - Mission commended the 3-year planning horizon for fiscal policy in the MTP but observed fiscal targets tend to be outdated early in the first year.
  - The current MTP assumes a 2011 NFPS primary outturn of 1.2 percent of GDP, against the mission’s projection of 1.8 percent of GDP based on performance through September and announced spending plans.
  - Unpredictability of policy limits relevance of the budget and MTP as indicators of fiscal stance and complicates macroeconomic coordination.
- PPPs and fiscal risk management
  - Some US$16 billion (1¼ percent of GDP) of PPP-financed infrastructure projects have been approved or are in the pipeline.
  - To limit risks, the mission recommended:
    - An updated legal framework integrating various laws covering PPPs;
    - PPP projects subject to the same cost-benefit criteria as other government investments;
    - Centralized decision-making with approval of Treasury and relevant line ministry before projects proceed;
    - Credit Risk Management Department of the Treasury compile a comprehensive PPP database and regularly report on associated fiscal risks;
    - Fiscal impact of PPPs, including contingent liabilities, transparently discussed in budget documents and integrated into debt sustainability analysis.
- Monetary policy stance and assessment
  - CBT viewed little alternative to its unconventional framework and was generally satisfied with results.
  - Narrower interest differentials and greater downside volatility of money market rates seen as effective at alleviating appreciation pressure; lira depreciation was a welcome side benefit.
  - URR increases seen as only partially effective at slowing credit because they are a blunt instrument, unlike the BRSA’s more targeted tools.

*Italic: IMF Staff Report excerpt — 2011 Article IV Report: Turkey*

### 30.      The mission recognized the appeal

### _cr1216 - 30.      The mission recognized the appeal

### Monetary policy framework and unconventional measures
- The CBT’s strategy aimed to regain monetary policy independence amid abundant international liquidity by segmenting the domestic financial market to allow co-existence of widely-dispersed interest rates.
- This segmentation helped engineer a large nominal depreciation intended to begin narrowing the current account deficit.
- Raising RR contributed to dampening deposit rates and slowing deposit growth—banks’ main funding source—which increased reliance on foreign financing and discouraged domestic saving.
- Capital inflows remained predominantly short term, and credit growth did not slow markedly until:
  - strains appeared in international financial markets,
  - the annual credit growth cap began to bind, and
  - the BRSA measure on GPLs was introduced.
- The mission warned that relying on multiple goals and policy instruments can lead to inconsistencies and unintended outcomes, noting severe tension with the inflation target.

### Dual-rate system, reorientation, and operational details
- In late October the CBT realigned its unconventional framework to tighten monetary conditions by generating greater upside variability in interbank rates to strengthen the lira and defend the inflation target.
- The CBT effectively considered two policy rates:
  - the 7-day repo rate (the official policy rate) at 5.75 percent, and
  - the new higher O/N lending rate at 12.5 percent.
- Operational approach:
  - Push banks to the upper-rate window on days of sharp lira depreciation; otherwise inject funds at the lower rate.
  - URR on shorter-duration lira liabilities were cut.
  - fx sales were temporarily suspended and resumed in November on a smaller scale.
- Mission concerns about this approach:
  - Rapid depletion of reserves may have encouraged speculative demand because sales needed to be halted to preserve limited reserve cover.
  - The volatility inherent in the dual-rate system may discourage speculative activity but will burden banks facing difficult external funding conditions, requiring larger liquidity buffers and risking abrupt deleveraging.
  - The system creates the impression that the exchange rate is the overriding policy goal.
  - The dual-rate system discriminates against banks more dependent on CBT funding and raises concerns about arbitrariness and CBT objectivity.
  - Selective tightening in response to only a single source of inflation—the exchange rate—is unlikely to restore price stability.

### Recommendation on single policy rate and inflation outlook
- The mission urged raising the policy rate within a transparent and consistent framework rather than relying on the dual-rate approach.
- Rationale:
  - Raising a single policy rate within a narrow interest rate corridor would send a clear signal on the future direction of policy essential for shaping inflation expectations.
- Staff forecast: inflation at 6½ percent at end-2012, broadly in line with expectations, but well above the 5 percent target.
- The mission noted:
  - The real policy rate is currently very negative; conditions warrant a firmly positive real rate, and a decisive first step is urgently needed.
  - If domestic and external demand quickly turn down, and the lira is not under disproportionate selling pressure, some reduction in the policy rate may be appropriate amid lower inflation and global monetary policy easing.

### Inflation targets and tolerance band
- Authorities considered current inflation targets appropriate; the mission recommended lowering them over the medium term to preserve competitiveness.
- Points made:
  - High targets and wide bands push up “acceptable” inflation outcomes; the top of the band has often been overshot.
  - The CBT viewed existing targets as warranted to avoid unduly constraining growth, with a wider band needed to accommodate high food price volatility.
  - The mission observed a tendency to downplay adverse consequences of inflation for competitiveness and noted volatility was not noticeably higher than in other EMs.
- Recommendations:
  - Narrow the tolerance band and introduce a continuous target to reinvigorate commitment to price stability.
  - Supported by a tighter structural fiscal stance, a lower inflation outcome would be feasible with more moderate real and nominal policy rates.

### Financial sector vulnerabilities and policy recommendations
- Banking sector risks:
  - Dependence on short-term funding heightens procyclicality and exposes banks to global funding shocks.
  - Current pressures in international financial markets reduce access to longer-term external funding.
- Recommended measures and observations:
  - Greater recourse to long-term funding would reduce rollover risk and permit lengthening of loan maturities.
  - Some progress made: differentiating URR by maturity since late 2010 and allowing banks to issue lira-denominated bonds since October 2010.
  - Banks’ large short-term external debt makes them vulnerable to ongoing funding strains.
  - Banks may prefer to de-lever loans while retaining government securities because of zero risk weight and collateral advantages.
  - BRSA’s new measure imposing capital charges on banks’ interest rate risk should be complemented by:
    - introduction of minimum lira and fx liquidity ratios at the 3-month and longer horizons (the current outer limit is one month), and
    - higher capital charges on shorter-term fx funding to reflect greater fx funding risk from the rising loan-to-deposit ratio.
  - Such measures should be phased in very gradually, with a lag, to avoid deleveraging.
  - Early enforcement of the recent increase in required capital for some banks with strategic foreign shareholders could force them to cut risk-weighted assets.
  - Deepening local capital markets and developing new private savings vehicles are needed to promote domestic savings and enhance resilience to global financial swings.
  - Limiting upside flexibility of the policy rate and providing undue assurances that the policy rate will remain low may preclude development of an upward-sloping deposit yield curve, thwarting attempts to lengthen deposits and increase savings.

### Macroprudential and supervisory coordination
- The Financial Stability Committee (FSC), established in June 2011 and comprising the Treasury, CBT, BRSA, Deposit Insurance Fund, and Capital Markets Board (chaired by the Deputy Prime Minister in charge of Economic and Financial Affairs), provides the basis for a systemic approach to financial supervision.
- The FSC meets frequently and discussions have included policy responses to recent international financial events.
- The mission noted the challenge of balancing institutional coordination with preserving independence and called for preemptive development of coordinated measures for future systemic risks.

### FSAP findings and AML/CFT status
- FSAP Update conclusions:
  - Banks’ sizable capital buffers could absorb a short-lived macroeconomic shock, but strains would be much greater if the shock were protracted.
  - A few banks would face significant funding pressure in a sudden stop.
  - The existing crisis management framework and CBT emergency liquidity facilities considered fully adequate.
  - Further strengthening supervision and regulation is needed: more stringent oversight of liquidity and operational risks, banks’ risk management frameworks and models, and more comprehensive supervision of financial groups.
  - BRSA needs to attract and retain specialist staff.
- AML/CFT:
  - Since June 2011, Turkey has been listed by the FATF among jurisdictions with strategic AML/CFT deficiencies that have not made sufficient progress in addressing them.
  - If not improved, heightened due diligence may affect financial markets.

### Structural policies to address the current account and labor market
- Structural reform priorities to reduce the current account deficit:
  - Moderate import demand via measures such as raising indirect taxes on imported consumer durables (large engine-capacity cars, cell phones) and considering measures to decrease dependence on imports of intermediate goods.
  - Attract investment to facilitate domestic sourcing of manufactured inputs by improving the business climate and combating informality to support a revenue-neutral cut in the tax burden on formal-sector employment and activity.
  - Timely adjustment of regulated energy prices to world prices and the exchange rate to encourage efficient usage and domestic production and avoid loss buildup in public energy companies; recent tariff increases welcomed as steps toward cost-recovery pricing.
  - Passage and full effectiveness of the updated Commercial Code and Code of Obligations (once fully effective in mid-2012) could significantly improve the business environment.
- Labor market reforms:
  - Greater flexibility of the formal labor market would raise employment, lower inflation persistence, and distribute growth gains more evenly.
  - Recommendations: lower restrictions on temporary and part-time work; replace ex post severance pay with a pre-funded, lower-cost insurance scheme.
  - Keep growth rate of the minimum wage and civil servant salaries strictly in line with the inflation point target—with no ex post adjustment for inflation overshoots—to improve external competitiveness and reduce inflation inertia.
  - Raise educational attainment at the lower end of the skill distribution (median for employed workers is 5 years of schooling) and better tailor education to employers’ needs, including through vocational training.

### Staff appraisal, vulnerabilities, and overarching policy mix
- Positive background:
  - Previous policy actions laid the foundation for robust growth; Turkey entered the 2008–09 global crisis with stronger private and public sector balance sheets and benefited from institutional reforms and revamped policy frameworks.
- Emerging problems:
  - A sizable competitiveness gap emerged due to delayed structural reforms, persistent inflation above other EMs, and indexation of wages to inflation, leading to import dependence and an elevated current account deficit.
  - Inadequate policy response to renewed capital flows caused growth to revert to an unbalanced path: fiscal policy failed to rein back crisis-era stimulus, structural balance weakened, and financial and monetary measures were too timid or delayed.
- Rising vulnerabilities:
  - Potentially-volatile short-term debt—much absorbed by banks—and unidentified inflows became primary external funding.
  - Household indebtedness increased, firms accumulated foreign currency debt, reserve cover of short-term debt and banks’ capital ratios declined.
  - Headline fiscal balances and public debt ratios improved but benefited from transient revenue and one-offs.
- Core recommendations to reduce propensity for capital flow-driven cycles:
  - Reconfigure the policy framework so monetary policy is supported by tighter structural fiscal position and financial policies aimed at moderating systemic risk.
  - This would allow monetary policy to maintain inflation and policy rates at levels similar to other emerging markets within a conventional inflation-targeting framework.
  - A much-strengthened structural fiscal position is key: restore a structural primary surplus for the nonfinancial public sector to a level similar to 2007 to moderate domestic demand, promote disinflation, and provide a buffer against reversals in capital flows.
  - Use a more comprehensive estimate of transient revenue to avoid unintended structural tightening during downturns and procyclical loosening during expansions.
  - Adjustment should be front loaded, unless growth is very weak.
  - Reinforce public financial management: set fiscal targets in structural terms, base budget forecasts on realistic base-year revenue and spending estimates, disallow spending appropriations without ex ante parliamentary authorization, and better regulate public-private partnership project financing.
  - A decisive increase in the single policy rate is essential to re-anchor inflation expectations and regain policy credibility.
  - Raising the single policy rate would also relieve selling pressure on the lira and allow conservation of scarce reserves by keeping fx sales on hold.
  - In tandem with a tightened structural fiscal stance, narrow the inflation tolerance band and gradually lower inflation targets.

*International Monetary Fund — 2011 Article IV Report: Turkey*

### 49.      With the financial cycle having

### _cr1216 - 49.      With the financial cycle having

### Financial cycle, external funding, and macroprudential policy
- With the financial cycle having begun to turn down, Turkey faces new challenges.
- Scope to mitigate an external funding shock is limited.
- More restricted external financing is therefore expected to slow loan supply, although demand is also likely to soften.
- Care is needed to avoid exacerbating the effect on the real economy by introducing measures intended to bolster banks’ resilience, but which would have been more appropriately implemented when systemic risks were building.
- More-timely detection and response to emerging macroprudential risk will hopefully be achieved with the new Financial Stability Committee in place.

### Structural reforms, labor and product markets, and competitiveness
- Further delaying labor and product market reforms is detrimental to competitiveness, social equity, and the ability to cope with volatile capital flows.
- Structural reforms are needed to prevent the emergence of a negative output gap as the current account is corrected; nominal depreciation provides only a temporary and partial fix.
- Specific policy recommendations:
  - Minimum wages in the formal sector should be brought into line with peer countries.
  - Restrictions on flexible work arrangements should be relaxed.
  - A benefit scheme cushioning unemployment spells—rather than discouraging job mobility—should be introduced.
  - Indexing public sector wages only to the point inflation target and halting asymmetric catch-up indexation for inflation overshoots to help break inflation inertia.
  - Timely adjustment of energy prices to movements in the domestic cost of imports to incentivize suppliers and users, and help lower Turkey’s energy trade deficit.

### Procedural recommendation
- It is recommended that the next Article IV Consultation with Turkey be held on the standard 12-month cycle.

### Box 1 — Turkey’s External Competitiveness: findings
- Relative to late 2010, Turkey’s external competitiveness has improved considerably on the back of a large nominal depreciation, but sustainability could be jeopardized by persistent differentials in the growth rates of prices and wages relative to trading partners.
- Real effective exchange rates based on consumer and producer prices fell by close to 20 percent from their October 2010 historical peaks, reflecting recent depreciation of the nominal effective exchange rate.
- Price-based REER indicators are now below levels prevailing during the crisis, but remain some 5 percent above levels of 2003.
- The ULC-based REER fell sharply in Q1 2011, but was partially reversed in Q2 2011 due to weakening labor productivity, keeping the ULC-based REER elevated.
- US dollar–euro exchange rate dynamics affect export profitability because many raw materials and intermediate inputs are priced in US dollars while about half of exports are sold in Europe, priced in euros.
- Growth of imports (around 70 percent of which are intermediate goods) tends to outpace that of exports when the US dollar weakens against the euro.
- Fairly rapid export growth has kept Turkey’s share of major advanced country import markets (Germany and the EU as a whole) fairly stable; penetration of emerging-market markets has declined considerably since the global financial crisis.
- CGER-type assessments in Fall 2011 continue to point to a considerable competitiveness gap despite substantial real depreciation since end-2010; still-large current account deficits and a deteriorating net foreign asset position projected for the medium term suggest a persistent competitiveness gap.
- The recent nominal depreciation since the CGER reference period of July-August would tend to reduce misalignment, but the magnitude in nominal effective terms is likely moderate and may not be persistent.
- In the context of large capital inflows, standard CGER assessments may overstate the extent of overvaluation: inflows can both finance and cause the current account deficit by relaxing consumers’ budget constraints.
- A rule of thumb (Ostry et al. (2010)) is noted: flows that push the REER toward equilibrium are more likely to be persistent than flows that lead to overshooting, suggesting current inflows into Turkey are most likely temporary.

### Box 2 — Implications of Misclassifying Securities Repos: findings and implications
- In recent years, many emerging markets saw capital inflows tilt toward portfolio debt securities; Turkey received considerable such flows during 2010 and Q1 2011, with some of the largest reversals in September 2011.
- Some portfolio debt flows are the first leg of sale-and-repurchase agreements (securities repos), functionally equivalent to collateralized borrowing by the spot seller; in most emerging-market cases the cash exchanged is typically in fx.
- As of June 2011, Turkish banks had US$15.6 billion of external repos, of which US$11.2 billion had maturities of less than one year.
- Statistical treatment:
  - The BRSA follows the economic-character convention consistent with International Accounting Standards and the revised System of National Accounts: since the domestic bank retains the risks and benefits of ownership, the security remains on the domestic bank’s balance sheet throughout the repo contract; the loan is recorded separately as an “other investment” inflow in the BoP when the repo is initiated and an outflow when unwound.
  - The CBT records repos using the legal-ownership convention, treating them as spot sales and future purchases, which leads to different BoP and balance-sheet impressions.
- Implications of misclassification:
  - Official BoP and external debt statistics may suggest foreigners bear interest rate risk, whereas that risk resides with the domestic bank.
  - The maturity of the underlying security conveys no information about the duration of the loan.
  - Domestic banks’ short-term external debt is understated under legal-ownership recording.
  - If foreign lenders refuse to renew repos, domestic banks must secure sufficient fx to repay the loan in full, exerting downward pressure on the currency.
  - Margin calls to top up collateral in response to a rise in domestic interest rates effectively shrink the net size of the loan.

### Box 3 — Banks’ competition for market share and policy transmission
- The market share of the five largest banks—accounting for around 70 percent of system assets—has remained remarkably stable; rank-ordering of individual market shares has barely changed in recent years.
- Reasons banks prioritize market share over near-term profit:
  - Larger market share supports fee income.
  - Larger banks may be perceived as less exposed to deposit runs, lowering risk premia.
  - Size may reduce takeover vulnerability and provide economies of scale.
  - Size can improve access to and lower the cost of international wholesale funding.
  - BRSA limits on dividend payouts encourage growth in market share over current profits.
- State banks’ advantages:
  - Access to cheaper and more stable deposit funding due to perceived implicit government guarantee.
  - Generally offer lower lending rates because retail borrowers (including civil servants) are seen as good credit risks.
  - Lower loan-to-deposit ratios (LTDs) than other banks, reducing reliance on wholesale funding.
  - These factors allowed state banks to lead in the recent credit boom, pressuring other banks to expand lending to catch up.
- Policy transmission implications:
  - A collective-action problem may weaken or delay effectiveness of policies intended to slow credit growth.
  - Following the increase in URR, banks tended to absorb higher intermediation costs into lower profits and accelerate lending to compensate, undermining URR effectiveness initially.
  - Raising risk weights and provisioning in June 2011 directly impacted large state banks and encouraged immediate system-wide repricing of loans.

### Box 4 — The CBT’s recent policy actions (chronology and instrument changes)
- Two periods identified:
  - August–mid October: response to concerns about sovereign debt problems in Europe and global uncertainty.
  - Since mid October: response mainly to a sharp increase in inflation.
- August–mid October actions:
  - To support the lira and shore up fx reserves:
    - The CBT raised its O/N borrowing rate from 1.5 percent to 5 percent, considerably narrowing the interest rate corridor.
    - URR on banks’ fx liabilities were reduced three times (in July, August, and October) and mostly on longer duration liabilities by an effective 1.5 percentage points, releasing about US$2.8 billion to banks.
    - Part of RR obligations on TL liabilities (up to 10 percent from September and 20 percent from October) was allowed to be held in fx, potentially boosting CBT’s reserves by up to US$7.6 billion.
    - The CBT scaled back its daily fx purchases (from US$50 billion to US$40 billion in May and to US$30 billion in June), halted fx activity at end July, and switched to fx sales in early August; total sales reached US$4.9 billion through mid October.
    - URR were imposed on banks’ gold deposit accounts.
  - To support real activity: the 7-day repo rate was lowered by 50 bp in August to 5.75 percent.
  - To reduce the cost of financial intermediation in lira and promote longer non-deposit bank funding: RRs on TL liabilities were reduced in early October by effective 0.6 percentage points, releasing TL3.2 billion to banks.
- Since mid October actions:
  - To contain deterioration in inflation expectations resulting from TL depreciation:
    - The CBT engaged in large-scale fx selling auctions and direct intervention; total sales through auctions reached US$3.3 billion.
    - The O/N lending rate was raised from 9 percent to 12.5 percent (and from 8 percent to 12 percent for primary dealers).
    - On RR obligations relating to TL liabilities, a maximum of 40 percent (raised from the previous 20 percent) may be held in fx, and up to 10 percent may be held in gold; if fully utilized, this would add a combined US$7.7 billion to CBT reserves. In addition, URR on lira-denominated short-term liabilities were lowered, resulting in a 2 percentage point effective reduction.
    - The CBT re-opened its “blind broker” fx borrowing and lending facility to facilitate greater mobility of fx between banks.

### Box 5 — Inflation targets in Turkey: observations
- Turkey’s 5 percent target for 2012 is several percentage points higher than for most other major EMs.
- In mid-2008 Turkey revised up its end-of-period inflation targets from a constant 4 percent to 7.5, 6.5 and 5.5 percent, respectively, for 2009–11 in response to upside risks from food and energy prices.
- Turkey also has the widest tolerance band, intended to accommodate higher food inflation volatility; the inflation tolerance band is ±2 percentage points.
- The high share of unprocessed food in the consumption basket (around 15 percent) contributes to higher volatility of food inflation.
- Factors noted for food price volatility include measurement issues and restrictions on unprocessed food imports, limiting international trade as a smoothing mechanism.

*2011 ARTICLE IV REPORT TURKEY — INTERNATIONAL MONETARY FUND*

### Box 5. Inflation Targets in Turkey (concluded)

### Box 5. Inflation Targets in Turkey (concluded)

### Inflation drivers and structural factors
- Turkey has maintained high import tariffs and tight quotas to support farmers, who account for around a quarter of the workforce.
- This has contributed to a considerable increase of food price volatility since 2007, and the level of food inflation is among the highest within the EM group.
- Other structural factors compounding the effect of import controls:
  - uncertain agriculture subsidies,
  - geographical concentration of production,
  - volatile export prices and external demand,
  - long supply chains with a prevalence of small farmers which immediately price in weather effects.
- Reference: Orman, C., Öğünç, F., Saygılı, Ş. and G. Yılmaz (2010), "Structural Factors Causing Volatility in Unprocessed Food Prices", CBT Economic Notes No. 10/16.

### Inflation volatility and comparisons (sample period 2004-2011)
- Looking at sample period of 2004-2011, the volatility of headline inflation and of food inflation weighted by its share in the basket is not among the highest within the group of EMs.
- However, Turkey’s inflation was on average the highest among the group during 2004–11.

### Inflation-targeting performance and tolerance band use
- Despite the combination of a high point target and a wide tolerance band, Turkey has frequently overshot the top of the band.
- Exceptions to overshooting:
  - the recession year of 2009,
  - 2010, when inflation came in just below the revised target due to a large downward shock to food prices.
- The flexibility afforded by the wide band has tended to be used asymmetrically.

*2011 ARTICLE IV REPORT TURKEY  INTERNATIONAL MONETARY FUND*

### Box 6. Other Key Takeaways on the Banking Sector (Concluded)

### Box 6. Other Key Takeaways on the Banking Sector (Concluded)

### External Funding
- Nearly one third of Turkey’s banking system (measured by assets) has links to parents in peripheral Europe.
- Despite limited direct funding from their foreign parents, availability and cost of funding is likely to reflect to some extent the parents’ financial condition.
- Turkish banks have continued to tap syndicated loans at low spreads, but external funding conditions have been affected by funding strains in international markets.
- Possible de-leveraging by European banks as they rebuild their capital ratios may further affect Turkish banks’ access to wholesale funding.
- Turkish branches abroad:
  - Play a smaller role in providing loans to resident firms than in the past.
  - Have become more active in securing external funding (accompanied by an increase in their holdings of government securities).
- Overall, banks’ external funding is 13 percent of total liabilities.

### Open Foreign Currency Positions
- Banks’ on-balance sheet short fx positions recently widened close to its historical peak.
- These on-balance sheet short fx positions tend to be closed off-balance sheet through the use of cross currency swaps (CCS).
- The widening reflects banks’ growing recourse to external funding.
- The recent sharp increase in average CBT and market interest rates has fed into higher costs for short-term CCS.
- Banks repeatedly roll over sizable short-duration swaps, exposing them to interest rate risk.

*2011 ARTICLE IV REPORT TURKEY — Box 6. Other Key Takeaways on the Banking Sector (Concluded).*

### APPENDIX I: EXTERNAL DEBT SUSTAINABILITY

### APPENDIX I: EXTERNAL DEBT SUSTAINABILITY

### Baseline assessment and vulnerabilities
- Under the baseline, gross external debt is expected to rise to 48 percent of GDP by 2016.
- Drivers of the increase: a still-wide current account deficit, slower GDP growth than prior to the crisis, and a large share of debt-creating inflows.
- Standard tests show external debt is robust to a combined 1/4 standard deviation shock in interest rate, growth, and current account.
- External debt remains below 60 percent of GDP under individual shocks or a combination of the three shocks.
- A one‑time additional real depreciation of 30 percent in 2011 would cause gross external debt to increase to 70 percent of GDP in 2012.
- The analysis notes that a real exchange rate shock of this size would likely precipitate further adjustment in the current account and other second‑round effects that would partially mitigate the impact on external debt; these second‑round effects are not captured in the static debt sustainability exercise.

### Fund exposure and capacity to repay
- Turkey’s decreasing exposure to the Fund and moderate external debt levels should ensure adequate capacity to repay the Fund.
- Under the baseline scenario, exposure to Turkey would decline very rapidly and fall to only SDR 1.9 billion at end‑2011.
- SDR 1.9 billion corresponds to:
  - 129 percent of new quota,
  - 0.4 percent of GDP,
  - 3.3 percent of reserves.
- Annual debt service to the Fund would remain very small at around 0.1–0.4 percent of GDP.

### Quantitative decompositions and key projections (selected figures from Appendix Table I.1)
- External debt (percent of GDP): 2006: 39.3; 2007: 38.4; 2008: 38.4; 2009: 43.7; 2010: 39.5; 2011: 42.9; 2012: 44.7; 2013: 45.5; 2014: 46.5; 2015: 47.2; 2016: 47.9.
- Change in external debt (percent of GDP): 2006: 4.1; 2007: -0.8; 2008: 0.0; 2009: 5.3; 2010: -4.3; 2011: 3.4; 2012: 1.9; 2013: 0.7; 2014: 1.1; 2015: 0.6; 2016: 0.8.
- Identified external debt-creating flows (percent of GDP): 2006: -1.0; 2007: -5.2; 2008: -0.8; 2009: 8.0; 2010: -2.1; 2011: 5.3; 2012: 4.0; 2013: 1.7; 2014: 1.4; 2015: 1.1; 2016: 1.7.
- Current account deficit, excluding interest payments (percent of GDP): 2006: 4.9; 2007: 4.8; 2008: 4.2; 2009: 0.7; 2010: 5.4; 2011: 9.2; 2012: 7.0; 2013: 5.5; 2014: 5.3; 2015: 5.7; 2016: 6.2.
- Deficit in balance of goods and services (percent of GDP): 2006: 6.3; 2007: 6.6; 2008: 6.6; 2009: 3.2; 2010: 7.2; 2011: 10.8; 2012: 8.9; 2013: 7.4; 2014: 7.2; 2015: 7.6; 2016: 8.1.
- Exports (percent of GDP): 2006: 22.3; 2007: 22.0; 2008: 23.4; 2009: 22.4; 2010: 20.6; 2011: 23.1; 2012: 23.7; 2013: 23.3; 2014: 22.9; 2015: 22.1; 2016: 21.4.
- Imports (percent of GDP): 2006: 28.6; 2007: 28.6; 2008: 30.1; 2009: 25.7; 2010: 27.9; 2011: 33.8; 2012: 32.7; 2013: 30.7; 2014: 30.1; 2015: 29.8; 2016: 29.5.
- Net non‑debt creating capital inflows (negative, percent of GDP): 2006: -4.0; 2007: -3.9; 2008: -2.3; 2009: -1.6; 2010: -1.5; 2011: -2.0; 2012: -3.0; 2013: -3.1; 2014: -3.1; 2015: -3.5; 2016: -3.3.
- Automatic debt dynamics (percent of GDP): 2006: -1.9; 2007: -6.1; 2008: -2.7; 2009: 8.9; 2010: -6.1; 2011: -1.9; 2012: -0.1; 2013: -0.7; 2014: -0.8; 2015: -1.1; 2016: -1.2.
  - Contribution from nominal interest rate (percent of GDP): 2006: 1.2; 2007: 1.2; 2008: 1.6; 2009: 1.7; 2010: 1.1; 2011: 0.9; 2012: 0.8; 2013: 0.6; 2014: 0.6; 2015: 0.6; 2016: 0.6.
  - Contribution from real GDP growth (percent of GDP): 2006: -2.2; 2007: -1.5; 2008: -0.2; 2009: 2.2; 2010: -3.3; 2011: -2.8; 2012: -0.8; 2013: -1.2; 2014: -1.4; 2015: -1.7; 2016: -1.8.
  - Contribution from price and exchange rate changes (percent of GDP): 2006: -0.9; 2007: -5.8; 2008: -4.0; 2009: 5.0; 2010: -3.9; 2011: ... (table continues).
- Residual, incl. change in gross foreign assets (percent of GDP): 2006: 5.1; 2007: 4.4; 2008: 0.8; 2009: -2.7; 2010: -2.2; 2011: -1.9; 2012: -2.1; 2013: -1.0; 2014: -0.3; 2015: -0.4; 2016: -1.0.
- External debt‑to‑exports ratio (percent): 2006: 175.9; 2007: 174.7; 2008: 163.9; 2009: 195.1; 2010: 191.2; 2011: 186.0; 2012: 188.6; 2013: 195.3; 2014: 203.6; 2015: 213.2; 2016: 224.3.
- Gross external financing need (billions of U.S. dollars): 2006: 108.1; 2007: 121.8; 2008: 132.1; 2009: 113.3; 2010: 132.0; 2011: 194.9; 2012: 194.6; 2013: 193.9; 2014: 212.7; 2015: 237.9; 2016: 264.5.
- Gross external financing need (percent of GDP): 2006: 20.4; 2007: 18.8; 2008: 18.1; 2009: 18.4; 2010: 17.9; 2011: 25.1; 2012: 24.0; 2013: 22.1; 2014: 22.4; 2015: 23.0; 2016: 23.4.

### Scenario tests and graphical results (Appendix Figure I.1, summary)
- Historical and baseline series plotted for 2006–2016 show baseline gross external debt reaching 48 (percent of GDP) by 2016.
- Interest rate shock: individual permanent one‑half standard deviation shock; figures indicate baseline value 48 and i‑rate shock average 48.
- Growth shock: individual permanent one‑half standard deviation shock; figures indicate baseline 48 and growth shock average 52.
- Current account (CA) shock: non‑interest current account shock (percent of GDP); figures indicate baseline 48 and CA shock average 55.
- Combined shock: permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance; combined shock average 54.
- Real depreciation shock: one‑time real depreciation of 30 percent occurs in 2011; this shock raises gross external debt to 73 (percent of GDP) in the scenario figure (box shows 73 vs baseline 48).

*Source: IMF staff estimates.*

### 3.      The real appreciation boosted

### 3.      The real appreciation boosted

### Real appreciation, imports, and output contraction
- Real appreciation boosted residents’ purchasing power over imports and diverted demand from locally-sourced goods.
- During this period, imports grew faster than other expenditure components, raising the import content of domestic and external demand.
- Non-energy imports tended to be the most cyclical.
- Firms shifted significantly to imported intermediate goods because locally-sourced products could not compete, lowering the domestic value-added content of local production.
- When external financing dried up in 2008–09, the resulting fall in imports contributed to a sharp output contraction.

### Current account deficit and saving-investment balance
- The widening CAD mirrored a declining private saving-investment balance.
- A large improvement in public net saving early in the decade compensated the weakening private saving ratio.
- More recently, public net saving remained broadly stable, while the private saving-investment balance has fallen sharply on strengthening consumption and investment.
- A large informal sector, with limited savings options, may have depressed the private saving rate.

### Financial deepening and foreign funding
- Bank lending to the private sector grew at an annual average 42 percent during 2004–08, raising the credit-to-GDP ratio to a relatively modest 36 percent.
- Rapid deposit accumulation was the primary funding source initially, keeping banks’ loan-to-deposit ratios considerably below 100 percent and the nonfinancial sector’s balance sheet position strong.
- Lately, new borrowing outpaced deposit accumulation, and household indebtedness has risen rapidly from a low base.
- Households maintain large long fx positions through extensive fx savings, while they are not permitted to borrow in fx.
- Corporates have large net fx liability positions due to extensive borrowing in fx—including directly from abroad—because of lower nominal interest rates on fx than on lira-denominated loans.

### Labor market rigidities and employment dynamics
- For much of the past decade, Turkey’s unemployment rate was stuck around 10 percent, even as labor force participation declined.
- Effective labor supply increased strongly due to rapid growth in working-age population and labor-shedding in agriculture.
- The inability to generate sufficient jobs reflects: a generous severance pay scheme, the large tax wedge on employment, a high minimum wage, and low average educational attainment.
- These factors reinforced incentives to expand employment in the informal sector and substitute imported capital and intermediate goods for labor and domestically-sourced inputs.
- The post 2008–09 crisis recovery saw a strong decline in unemployment, but part of this reflects a shift toward unpaid agricultural work—likely disguised unemployment.

### Policy mix and macroeconomic effects
- Turkey maintained a positive headline primary fiscal balance for much of the past decade and debt as a share of GDP has fallen considerably.
- Fiscal policy tended to be expansionary, reflecting revenue from cyclically-buoyant income and imports, and proceeds from several tax amnesties.
- As a result, the countercyclical response was relegated to monetary policy.
- Within inflation targeting, nominal policy rates were kept high relative to other EMs to offset the fiscal stance and subdue inertial inflation.
- High interest rates attracted interest-sensitive capital inflows and encouraged firms to borrow in fx, both on- and off-shore.

### Measuring the structural fiscal position: overview
- Accurately estimating the underlying fiscal position is key to avoiding unintentional pro-cyclicality.
- Traditional output-gap adjustment may not capture the full impact of economic cycles on revenue; revenue should be partitioned according to its underlying drivers.
- In Turkey, not accounting for cyclically-sensitive imports has systematically overstated the structural fiscal position and masked the recent fiscal impulse.
- Once these factors are accounted for, the structural primary balance deteriorated from surpluses of around 5 percent of GDP during 2003–06, to deficits of around 1 percent of GDP in 2010–11.

### Alternative cyclical adjustment approaches (key concepts)
- Standard output gap approach: assumes all tax revenue is driven by real GDP (Y); structural revenue R* is revenue at potential output Y*.
- Absorption gap approach: distinguishes absorption (A) from output; some revenue driven by absorption and some by output, with structural revenue when A and Y equal their norms.
- Import-gap extension: imports are more relevant than excess absorption for transient revenue in Turkey because imports are a major tax base while exports are largely untaxed.
- Other extensions: adjustments for asset price deviations and terms of trade/commodity price effects can be important in some countries.

### Application to Turkey: empirical findings and procedures
- Since early 2009, total tax revenue has risen much faster than nominal GDP after adjusting for tax policy changes.
- GDP does a poor job explaining collections of VAT on imports and VAT on domestic goods and services.
- Import VAT is closely aligned with nominal imports; import VAT has not moved together with nominal consumption.
- Taxes on imports (including import VAT, various excises, and customs duties) comprised 16 percent of tax revenue in 2010 and have been a dynamic source of tax revenue growth.
- The pronounced cyclical buoyancy of imports reflects Turkey’s persistent external competitiveness gap and volatile external financing flows.
- In 2009–10, corporate income tax paid by the banking sector was unusually large due to the boost to profits from the steep decline in the policy interest rate.
- A number of tax amnesties also temporarily boosted revenue in several years.

Procedure (decomposition of tax revenue)
- Total tax revenue is divided according to different underlying drivers:
  - IMPORTS_NON + OTHER_FINANCICAL + IMPORTS_TRADEVAT + R = (formula as in source)
  - (Source formula text preserved where: IMPORTS_NON, OTHER_FINANCICAL, IMPORTS_TRADEVAT, etc.)
- Import-gap approach relies on an estimate of Turkey’s current account norm from CGER exchange rate assessments, typically around -2¾ percent of GDP.
- The import norm is obtained by adding actual exports to the derived G&NFS norm.
- Cyclical adjustment for import VAT uses the effective VAT rate on imports; structural import VAT revenue is calculated using the average effective tax rate since 1999 (10.8 percent):
  - MetrR_MVAT ***_M·= (structural formula preserved as presented)
- Structural revenue from other import-related taxes uses:
  - (M M RR TRADE TRADE * *) = (formula preserved)
- Corporate income tax of the financial sector is assumed to fluctuate with banking sector profit; the norm RoA* is assumed to equal the average RoA for banks in Central, Eastern, and South-Eastern Europe (1.4 percent).
- Structural banking-sector revenue is derived from the banking profit gap using the formula:
  - (BP BP RR BankAssetsRoA BP FINCIT FINCIT * _ * _ ** = · = ) (formula preserved as presented)
- Remaining “other” revenue is adjusted using the standard output-gap approach:
  - (Y Y RR Other Other * * = )

### Quantitative impacts and evaluation
- The import gap is considerably more volatile over the cycle than the output gap, particularly since late-2008.
- Structural revenue calculations show that during 2001–03 and in 2009—years when both the import and output gaps were negative—structural primary tax revenue exceeded headline primary tax revenue (transient revenue was negative).
- In 2011, 3 percentage points of tax revenue (one-tenth of the total) was transient.
- Evaluating the approach: if structural revenue is correctly estimated, differences over time should be explained by changes in tax policy and/or compliance; large unexplained differences would raise doubts about the methodology.

*International Monetary Fund — TURKEY 2011 ARTICLE IV REPORT—ANALYTICAL ANNEX (excerpt)*

### 22.      In Turkey, adjusting import-related

### 22. In Turkey, adjusting import-related revenue

### Cyclical Adjustment of Import-Related Revenue
- Adjusting import-related revenue using only the output gap leaves large swings over time: "2 percentage points of potential GDP" in derived structural import revenue.
- Such large differences "cannot be explained by discretionary policy measures."
- The transient revenue approach applied to imports "generates a broadly stable estimate of structural import-related revenue."
- A similar result holds for total revenue: the structural revenue series obtained by deducting transient import revenue is "much smoother" than the one constructed by subtracting standard output-gap cyclical revenue.

### Discretionary Tax Policy and Transient Revenue
- To assess the transient revenue approach more systematically, "the impact of discretionary tax policy changes should be removed from structural revenue."
- The preferred cyclical adjustment is the one that "generates the flatter structural revenue series."
- Data limitations preclude adjusting for policy changes prior to 2008.
- Discretionary changes since 2008 include:
  - "a tax amnesty,"
  - "temporary stimulus tax cuts," and
  - "increases in various excise rates."
- These measures "raised revenue by ¼ to ¾ percentage points of GDP during 2008–10."
- Excluding these effects, "the transient revenue approach yields a flatter series for structural revenue, and hence is better at removing cyclical and temporary revenue effects than the standard output-gap approach."
- Footnote: "both approaches attribute the headline improvement in 2010–11 solely to cyclical factors."

### Structural Fiscal Position
- From an exceptionally strong position during and immediately after Turkey’s 2000 financial crisis, "the structural fiscal position has steadily weakened."
- This deterioration is "apparent independent of which approach is used to calculate structural revenue."
- The transient revenue approach "indicates a faster deterioration than the standard approach."
- While the headline balance suggests crisis-related stimulus was withdrawn in 2010, and with further improvement in 2011, "the transient revenue approach reveals further stimulus was added each year (while the standard approach indicates a neutral stance in 2010 and 2011)."

### Exchange Rate Depreciation and the Trade Balance — Overview
- Turkey’s 12-month rolling current account deficit "widened sharply to around 9½ percent of GDP in the first half of 2011."
- The trade deficit reached "an even higher 12 percent of GDP."
- The Turkish lira depreciated "by a cumulative 25 percent against an equally-weighted dollar-euro basket since October 2010."
- The depreciation was first achieved by "a refocusing of monetary policy, and occurred gradually," and "more recently, it reflected intensified global risk aversion and deleveraging, resulting in capital reversals from emerging markets (EMs)."
- Conclusion stated: "more limited external financing—rather than relative price-induced expenditure switching—is expected to improve the trade balance in the near term."
- Over the medium term, "in the absence of a tighter and rebalanced macro policy mix, the competitiveness gain from the recent nominal depreciation is likely to be eroded."
- If external financing is limited, "a smaller trade deficit may be accompanied by a persistent negative output gap."

### Theoretical Channels (Relative Price Channel and ERPT)
- Trade balance expression: TB = eP*_x X - P_m M (exports in local currency less imports in local currency), with e defined as units of local currency per dollar.
- A depreciation improves the trade balance if condition (2) holds, which depends on:
  - ERPT to import prices in local currency, ,m Pe β,
  - ERPT to export prices in dollars, *,x Pe β,
  - elasticities of export and import demand: *,x xP η and ,m mP η (both negative).
- ERPT ranges: ",m Pe β" between 0 and 1; "*,x Pe β" between -1 and 0.
- Key cases:
  - With zero pass-through (",0 m Pe β = and *,0 x Pe β =") a nominal depreciation "always improves the trade balance."
  - Classic Marshall-Lerner case assumes initial trade balance and full ERPT (",1 m Pe β = and *,1 x Pe β = -1"), yielding improvement if price elasticities satisfy the reduced condition.
  - An initial trade deficit ( *>1 m x PM eP X) "makes it harder to improve the trade balance," requiring larger price elasticities and/or lower ERPT.
- General factors making improvement easier:
  - (i) "the initial trade deficit is small;"
  - (ii) "ERPT to consumer prices of exports and imports is low;"
  - (iii) "demand for imports and exports is responsive to prices;"
  - (iv) "export supply is elastic."

### Impact on Terms of Trade and Prices
- Under complete ERPT to consumer prices, "a depreciation worsens the ToT."
- Under zero ERPT, "a depreciation improves the terms of trade."
- ERPT depends on market competition:
  - Exporters of homogeneous goods tend to have "zero ERPT" (fix dollar prices).
  - Exporters of differentiated goods are more likely to fix prices in local currency ("full ERPT").
  - Import ERPT is higher when "the local market is closer to perfect competition and when local demand is strong."
- ERPT may be asymmetric and may be larger for exchange rate movements perceived as persistent.
- Exchange rate depreciation typically affects the general price level due to "downward rigidity of prices of nontradables and indexation of wages to the exchange rate and/or inflation," which can offset competitiveness gains.

### Impact on Trade Volumes and External Financing
- Volume responses depend on size of price change, substitutability of goods, and export domestic supply conditions; responses may be non-linear or occur only above thresholds or if price change is seen as permanent.
- On imports:
  - Increase in import prices causes substitution and an adverse income effect proportional to the initial trade deficit, encouraging expenditure switching.
  - Composition matters: "More than 65 percent of total imports are raw materials and intermediates—including energy—and domestic alternatives are not readily available in the short term."
  - If imported intermediates feed exports, depreciation may increase derived demand for imports.
- On exports:
  - Short-run supply expansion depends on spare capacity; if exporters operate at full capacity, export volumes may be inflexible.
  - Over the medium term, export supply elasticity can increase through investment and diversification, but incentives depend on expectations of real depreciation permanence.
- External financing channel:
  - A rapid drop in external financing compresses imports immediately unless reserves are run down.
  - Trade credit for pre-financing exports may be more resilient than other short-term capital inflows.
  - If capital reversals reduce bank funding, "bank credit-financed imports—such as consumer durables—would decline."

### Impact on Real GDP
- A sustained real depreciation may "reduce GDP growth in the short run" but over the medium term "is more likely to be expansionary."
- Near-term GDP declines if imports are essential inputs and export sector lacks spare capacity.
- During the 2008–09 global financial crisis, imports fell "by more than GDP in percentage terms," reducing current account deficits; over the longer horizon, import substitution and export expansion can raise GDP if resources can be redirected.

### Turkey’s Previous Depreciation Episodes
- Mid 2006: lira depreciated "27 percent" due to global turmoil; depreciation was short-lived and "effect on the trade deficit and output growth was minimal."
- Early 2008–early 2009: nominal depreciation "41 percent" associated with larger effects:
  - Turkish investment and consumption dropped sharply.
  - Import volumes contracted "by considerably more than export volumes."
  - Together with a slight improvement in terms of trade, the current account deficit reduced "by more than half to 2¼ percent of GDP in 2009."
  - Domestic demand revived in Q2 2009 and in 2010 the current account deficit rebounded to "6½ percent of GDP."
- Prior episodes were sudden and quickly reversed; the late-2010 depreciation has been "mostly gradual and persistent."
- Earlier adjustments were "primarily due to compression of imports brought by more restricted external financing."
- For much of the recent depreciation episode, "global risk appetite has been strong."

### What to Expect This Time (Near-Term and Medium-Term)
- Empirical observations:
  - "Lira-denominated export and import prices have risen broadly in line with the nominal depreciation, but import prices have risen by slightly more."
  - This indicates "high ERPT to import prices" and "partial export ERPT."
  - "Non-tradable prices were not sufficiently flexible on the downside to prevent a sharp increase in the general price level," reducing real depreciation.
- Composition effects:
  - "More than 65 percent of total imports are raw materials and intermediates—including energy" → bulk of imports "could be fairly insensitive to price changes."
- Export capacity constraints:
  - Capacity utilization in top export sectors (textiles, wearing apparel, machinery) "has returned close to the pre-crisis levels,"
  - Some room to increase output in "vehicle and metal sectors (about 10 and 8 percent below pre-crisis levels, respectively)."
  - Weak EU demand may be the binding constraint; exporters rely heavily on imported raw materials priced in USD while main destination priced in euros, so "the euro/USD exchange rate may be more important than the lira-foreign currency exchange rate" for activity in key export sectors.
- Net implication: despite nominal depreciation, near-term trade balance improvement is more likely to come from "more limited external financing" compressing imports than from price-induced expenditure switching; absent sustained tighter and rebalanced macro policy and persistent external constraints, "any improvement in the trade balance is unlikely to be sustained."

*Source: Turkey 2011 Article IV Report — Analytical Annex (excerpts provided).*

### 17. In sum, Turkey’s large initial trade

### 17. In sum, Turkey’s large initial trade

### Drivers of near-term trade-balance dynamics
- Turkey has a large initial trade deficit, high ERPT (exchange-rate pass-through) to import prices, relatively smaller ERPT to export prices, and inelastic trade volumes — these factors are not supportive of a relative price-driven improvement in the lira-denominated trade balance in the near term.
- High ERPT to import prices implies that depreciation raises import prices substantially, while smaller ERPT to export prices limits gains in competitiveness via export-price adjustments.

### Or mainly import compression? (short-term scenario if external financing tightens)
- Reduced external financing may dominate the expenditure-switching channel:
  - Portfolio outflows during September and October were a sizable US$4b.
  - The August current account deficit was fully financed by reserve drawdown, providing a temporary buffer to current account adjustment.
- If external financing remains constrained, the trade deficit can be expected to shrink as spending on imports is compressed. Effects:
  - Improvement in the trade balance through lower import spending.
  - Slower GDP growth due to fewer imports of goods used in production, including value-added from distribution and retail services on imports of consumer goods.

### Medium-term adjustment requirements
- Durable improvement in the trade deficit requires a sustained real depreciation.
- Sustained real depreciation necessitates containment of price and wage inflation to narrow inflation differentials with trading partners and peer emerging markets that undermine competitiveness.
- Fund staff projections suggest that even if Turkey were to meet its inflation targets over the medium term, its CPI inflation would exceed most other peers.
- Energy imports account for nearly one quarter of imports, limiting scope to substitute domestic production for energy imports.
- To lower its trade deficit, Turkey will need to become more competitive in import-replacing and export sectors so as to cover the cost of energy imports and still achieve a moderate trade deficit.

*International Monetary Fund — 2011 Article IV Report (Analytical Annex excerpt)*

### 5.      Much analytic and advisory work is

### _cr1216 - 5.      Much analytic and advisory work is

### Engagement overview
- Much analytic and advisory work is carried out together with the Turkish authorities, the private sector, academia, or civil society stakeholders.
- The World Bank Group engages with civil society in the preparation and implementation of projects and collaborates closely with other development partners such as the IMF, EU, United Nations organizations, and key bilateral partners.

### Statistical Issues — Summary
- Data provision to the Fund is broadly adequate for surveillance purposes, despite certain shortcomings.
- Turkey subscribes to the Special Data Dissemination Standard (SDDS).

### Real Sector Statistics
- Consumer and producer prices:
  - Data on producer and consumer prices are published monthly, with a short lag.
  - The CPI and the PPI generally conform to international standards.
  - The methodology of the CPI was improved with the introduction of a 2003-based index, and this new CPI was effective as of 2005.
  - The methodology of the CPI was further improved in 2009 regarding the collection of telecommunication services prices.
  - The new CPI does not cover owner-occupied housing, commodities produced by households for own consumption, and expenditures on commodities obtained through in-kind payments.
  - The PPI is compiled only by product (and not by economic activity).
- Industrial production:
  - Monthly data on industrial production are published with a lag of five to six weeks.
- National accounts:
  - Quarterly national accounts are published with a 2-3 month lag.
  - Turkstat publishes national accounts in current and constant prices for the production and expenditure approaches to gross domestic product (GDP) and in current prices for the income approach.
  - The national accounts are compiled in accordance with the 1993 System of National Accounts (1993 SNA) methodology.
  - In March 2008, revised annual and quarterly estimates were released for 1998 onwards following the introduction of ESA 1995 in Turkish National Accounts.
  - The new national accounts data implement the main recommendations from the 2001 Data Module of the Report on the Observance of Standards and Codes (Data ROSC): (i) improved estimation and deflation of output and household consumption; (ii) disaggregated deflation of trade in services and inclusion of shuttle trade in exports of goods; and (iii) improvement in the estimation of selected aggregates.
  - GDP time series have not been constructed for years prior to 1998.
  - Work is underway aiming at incorporation of data from annual collections, the development of independent estimates of household consumption, and further enhancement of estimates for the non-observed economy.
  - A project recently initiated aims at extending the scope of the accounts to a full sequence of accounts for the total economy, annual supply and use tables, and institutional sector accounts.
- Labor market:
  - There is a wide range of data on labor market developments, with the biannual Household Labor Force Survey (HLFS) replaced with a monthly survey at the beginning of 2000.
  - These new data are published quarterly with a three month lag.
  - Coverage of wage developments in the private sector has improved through the use of quarterly surveys of the manufacturing sector.

### Government Finance Statistics
- Budgetary data:
  - Budgetary data are published monthly, with a lag of some 2−3 weeks.
  - Coverage of the budget is incomplete, with some fiscal operations conducted through extra budgetary funds, for which data are available only with long lags.
  - Fiscal analysis is further complicated by the omission of certain transactions from the fiscal accounts, some quasi-fiscal operations carried out by state banks, state economic enterprises (SEEs) and other public entities; and technical problems associated with consolidating the cash-based accounts of governmental entities with the accrual-based accounting of SEEs.
  - It is difficult to reconcile fiscal data with monetary and BOP data, especially in the accounting of external debt flows and central government deposits.
- Reporting:
  - Turkey reports fiscal data for publication in the Government Finance Statistics Yearbook. The latest data available are for 2009 and cover the central government budgetary sector (including annex budget units).
  - Monthly data are being reported for publication in International Financial Statistics, starting from September 2009.

### Monetary and Financial Statistics
- Central bank and monetary data publication lags:
  - Data on the central bank balance sheet, and provisional data on the main monetary aggregates and total domestic credit, are published weekly, with a one- and two-week lag, respectively.
  - Data on the monetary survey and deposit interest rates are published monthly, with a one month lag, except for year-end data, where the lag is two months.
  - The CBRT reports to STA the Standardized Report Form (SRF) 1SR for the Central Bank on a monthly basis with a two-week lag and SRF 2SR for the Other Depository Corporations with a one month lag, except for year-end data, where the lag is two months.
- Banks’ external funding:
  - Public data on banks’ external funding could be improved.
  - The CBRT reports data on banks foreign assets and liabilities; however, this includes data on transactions with banks’ branches abroad that are classified as non-residents from the BOP perspective.
  - The BRSA maintains data on the consolidated banking sector with more accurate information on the true foreign assets and liabilities; however, this data is not currently disseminated in a public report.

### AML/CFT (FATF) Observations
- In June 2011, the Financial Action Task Force (FATF) issued a public statement listing Turkey among the jurisdictions with strategic anti-money laundering and combating the financing of terrorism (AML/CFT) deficiencies that have not made sufficient progress in addressing them.
- The FATF noted that Turkey has taken steps towards improving its AML/CFT regime, including by working on CFT legislation.
- Despite Turkey’s high-level political commitment to work with the FATF to address its strategic AML/CFT deficiencies, the FATF pointed out that Turkey has not made sufficient progress in implementing its action plan and that certain strategic AML/CFT deficiencies remain.
- The FATF stressed that Turkey should work on addressing these deficiencies, including by:
  - (1) adequately criminalizing terrorist financing; and
  - (2) implementing an adequate legal framework for identifying and freezing terrorist assets.

### External Sector Statistics
- In line with SDDS prescriptions, Turkey disseminates:
  - monthly balance of payments (BOP) statistics with a 5–6 week lag;
  - weekly international reserves with a one-week lag;
  - monthly data on the template on international reserves and foreign currency liquidity (reserve template) within one month after the reference period;
  - monthly merchandise trade data with a one month lag;
  - quarterly external debt with one quarter lag; and
  - international investment position (IIP) data with a six month lag.

*2011 ARTICLE IV REPORT—INFORMATIONAL ANNEX TURKEY — INTERNATIONAL MONETARY FUND*

### 12.      The central bank reports quarterly

### 12.      The central bank reports quarterly

### Reporting and statistical compilation
- The central bank reports quarterly BOP data to STA with about two months lag.
- Balance of payments and IIP statistics are compiled in broad conformity with the conceptual framework of the fifth edition of the Balance of Payments Manual (BPM5).
- The CBRT periodically reviews the international transactions reporting system (ITRS) to address problems of coverage and misclassification using supplemental data sources and estimation techniques.

### Data availability and frequency (selected)
- Exchange Rates: Date of latest observation 10/31/2011; Date received 10/31/2011; Frequency of data D; Frequency of reporting D; Frequency of publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation 10/28/2011; Date received 10/28/2011; Frequency W; Frequency of reporting W; Frequency of publication W.
- Reserve/Base Money (narrow definition): Date of latest observation 10/31/2011; Date received 10/31/2011; Frequency W and M; Frequency of reporting W and M; Frequency of publication W and M; Data Quality – Methodological soundness O,O, LO, O; Data Quality Accuracy and reliability O, O, O, O, O.
- Consumer Price Index: Date of latest observation Sept. 2011; Date received 10/03/2011; Frequency M; Frequency of reporting M; Frequency of publication M; Data Quality – Methodological soundness O,LO,O,LO; Data Quality Accuracy and reliability O, O, O, O, O.
- External Current Account Balance: Date of latest observation Aug. 2011; Date received 10/11/2011; Frequency M; Frequency of reporting M; Frequency of publication M; Data Quality – Methodological soundness O, O, O, LO; Data Quality Accuracy and reliability O, O, O, O, O.
- GDP/GNP: Date of latest observation Q1 2011; Date received 09/12/2011; Frequency Q; Frequency of reporting Q; Frequency of publication Q; Data Quality – Methodological soundness O, LO,O, O; Data Quality Accuracy and reliability LO, O, LO, O, LO.

### Executive Board summary (Public Information Notice No. 11/150; December 7, 2011)
Findings and current conditions:
- Growth through first half of 2011 continued strongly, increasingly fueled by domestic demand and imports.
- Current account deficit widened sharply to near 10 percent of GDP.
- Inflation is rising quickly; forecast to reach 9½ percent at end 2011, above the point target of 5½ percent.
- Capital inflows dominated by potentially-volatile financing; short-term external debt climbed sharply.
- Nonfinancial corporates’ net FX liabilities increased substantially.
- Headline fiscal balance continues to improve and public debt-to-GDP ratio is declining, but fiscal performance has been supported by benign economic conditions.

Policy assessment and recommendations:
- Policy responses were insufficient to prevent a large current account deficit and high inflation.
- Monetary policy used an unconventional mix of reserve requirements, interest rate corridor, and policy rate, which has not demonstrated it can deliver price- or financial–stability.
- Prudential measures to slow credit growth and build buffers were sometimes delayed from a macroprudential perspective.
- Directors urged rebalancing the policy mix to ensure a soft landing in view of volatile capital flows and an externally financed credit boom.
- Recommended tightening the structural fiscal position and gearing macroprudential policies to prevent systemic risk, allowing monetary policy to focus on price stability.
- Suggested accelerating structural reforms to reverse eroding competitiveness and improve the business climate to facilitate current account adjustment.
- Recommended front loading fiscal adjustment as feasible, establish fiscal targets in structural terms, restrain current spending, expand the tax base, and strengthen oversight of public-private partnerships.
- With tighter fiscal stance and appropriate macroprudential policies, Directors saw scope for cautiously raising the single policy interest rate while considering impacts on growth and capital flows.
- Recommended moving toward a more transparent and consistent monetary policy framework, narrowing the inflation tolerance band, and gradually lowering the inflation target.
- Urged further efforts to address financial sector vulnerabilities to an external funding shock and possible regional deleveraging; underscore role for Financial Stability Committee.
- Emphasized bringing AML/CFT legislation into line with international standards.
- Endorsed labor and product market reforms: enhance labor market flexibility, tailor training to employer skill needs, align employment costs including minimum wage with regional peers, and adjust regulated energy prices timely to domestic import cost movements.

### IMF staff projections and near-term outlook
- Growth is expected to slow sharply to 2 percent in 2012 due to weaker capital inflows.
- Current account deficit constrained to about 8 percent of GDP under more limited foreign financing.
- Inflation projected to decline to 6½ percent in 2012, remaining still-elevated and eroding external competitiveness.

### Turkey: Selected Economic Indicators, 2006–12 (key series)
Real sector (percent)
- Real GDP growth rate: 2006 6.9; 2007 4.7; 2008 0.7; 2009 -4.8; 2010 9.0; 2011 7.5; 2012 Proj. 2.0.
- Private consumption growth rate: 2006 4.6; 2007 5.5; 2008 -0.3; 2009 -2.3; 2010 6.7; 2011 6.8; 2012 Proj. 0.5.
- Private gross fixed investment growth rate: 2006 15.0; 2007 2.6; 2008 -9.0; 2009 -22.5; 2010 33.5; 2011 25.2; 2012 Proj. 0.6.
Contributions to GDP growth
- Private domestic demand: 2006 6.3; 2007 5.0; 2008 -1.8; 2009 -8.3; 2010 12.6; 2011 9.4; 2012 Proj. 0.6.
- Public spending: 2006 0.9; 2007 0.8; 2008 0.6; 2009 0.8; 2010 0.8; 2011 0.7; 2012 Proj. 0.4.
- Net exports: 2006 -0.3; 2007 -1.2; 2008 1.9; 2009 2.7; 2010 -4.4; 2011 -2.6; 2012 Proj. 1.0.
Prices and labor
- GDP deflator growth rate: 2006 9.3; 2007 6.2; 2008 12.0; 2009 5.3; 2010 6.3; 2011 8.6; 2012 Proj. 8.6.
- Nominal GDP growth rate: 2006 16.9; 2007 11.2; 2008 12.7; 2009 0.2; 2010 15.9; 2011 16.7; 2012 Proj. 10.8.
- CPI inflation (12-month; end-of-period): 2006 9.7; 2007 8.4; 2008 10.1; 2009 6.5; 2010 6.4; 2011 9.5; 2012 Proj. 6.4.
- PPI inflation (12-month; end-of-period): 2006 11.6; 2007 5.9; 2008 8.1; 2009 5.9; 2010 8.9; 2011 11.3; 2012 Proj. 6.6.
- Unemployment rate: 2006 10.2; 2007 10.3; 2008 11.0; 2009 14.0; 2010 11.9; 2011 ...; 2012 ...
Interest rates
- Average nominal treasury bill interest rate: 2006 18.4; 2007 18.1; 2008 19.2; 2009 11.4; 2010 8.1; 2011 ...; 2012 ...
Fiscal sector (percent of GDP)
- Nonfinancial public sector primary balance: 2006 4.5; 2007 3.2; 2008 1.6; 2009 -1.0; 2010 0.8; 2011 1.8; 2012 Proj. 1.5.
- Net interest payments: 2006 5.1; 2007 4.9; 2008 4.4; 2009 4.6; 2010 3.7; 2011 2.6; 2012 Proj. 2.6.
- Overall balance: 2006 -0.6; 2007 -1.8; 2008 -2.8; 2009 -5.6; 2010 -2.9; 2011 -0.8; 2012 Proj. -1.1.
- Structural balance: 2006 3.0; 2007 1.5; 2008 0.3; 2009 -0.1; 2010 -0.1; 2011 -1.1; 2012 Proj. -0.1.
Public debt
- General government gross debt (EU definition): 2006 46.5; 2007 39.9; 2008 40.0; 2009 46.1; 2010 42.2; 2011 39.1; 2012 Proj. 36.2.
- Nonfinancial public sector net debt: 2006 40.1; 2007 34.4; 2008 34.5; 2009 39.5; 2010 36.6; 2011 33.5; 2012 Proj. 30.8.
External sector (percent of GDP)
- Current account balance: 2006 -6.1; 2007 -5.9; 2008 -5.7; 2009 -2.3; 2010 -6.5; 2011 -10.2; 2012 Proj. -7.8.
- Nonfuel current account balance: 2006 -1.3; 2007 -1.5; 2008 -0.2; 2009 2.0; 2010 -1.9; 2011 -4.1; 2012 Proj. -1.8.
- Gross financing requirement: 2006 21.1; 2007 18.7; 2008 18.9; 2009 17.4; 2010 18.9; 2011 22.2; 2012 Proj. 23.1.
- Foreign direct investment (net): 2006 3.6; 2007 3.1; 2008 2.3; 2009 1.1; 2010 1.1; 2011 1.6; 2012 Proj. 2.0.
- Gross external debt 1/: 2006 39.3; 2007 38.4; 2008 38.4; 2009 43.7; 2010 39.5; 2011 42.9; 2012 Proj. 44.7.
- Net external debt: 2006 21.0; 2007 21.0; 2008 21.5; 2009 24.7; 2010 24.0; 2011 27.8; 2012 Proj. 30.9.
- Short-term external debt (by remaining maturity): 2006 15.0; 2007 11.7; 2008 16.0; 2009 15.2; 2010 16.1; 2011 17.9; 2012 Proj. 17.2.
Monetary
- Nominal growth of M2 broad money (percent): 2006 22.2; 2007 15.2; 2008 24.8; 2009 12.7; 2010 18.3; 2011 ...; 2012 ...
National accounts (levels)
- GDP (billions of U.S. dollars) 2/: 2006 529.2; 2007 649.1; 2008 730.3; 2009 614.4; 2010 734.6; 2011 ...; 2012 ...
- GDP (billions of Turkish lira): 2006 758.4; 2007 843.2; 2008 950.5; 2009 952.6; 2010 1,103.7; 2011 1,288.3; 2012 Proj. 1,427.4.
- Per capita GDP (2010): $10,297 (WEO).

Footnotes in source:
- 1/ External debt ratio calculation methodology noted.
- 2/ GDP in U.S. dollars derived using average exchange rate consolidated from CBT daily data.

### Authorities' statement (Willy Kiekens and Omer Yalvac; November 30, 2011)
- Authorities emphasized strong growth in 2010–2011, resilience from strong fiscal position, political stability, well-capitalized banking sector, and skilful monetary policy.
- Reported creation of around 3.4 million jobs since April 2009 and unemployment rate dropping below 10 percent.
- Authorities target 4 percent growth in 2012 and acknowledge downside risks.
Fiscal policy and measures:
- Budget deficit expected to improve from 3.6 percent in 2010 to 1.7 percent in 2011.
- Medium-Term Program targets fiscal deficit of 1.5, 1.4, and 1 percent of GDP over the next three years.
- Authorities consider fiscal balance prudent; public sector primary surplus expected to be 1.2 percent of GDP in 2011, of which 0.8 percentage points result from restructuring of public receivables.
- For 2012, public sector primary surplus target is 1.1 percent, with 0.3 percentage points from public receivables.
- EU-defined General Government debt-to-GDP ratio expected to drop from 42.2 percent in 2010 to an expected 39.8 percent in 2011.
Monetary policy and external financing:
- CBRT pursued a non-conventional policy shaped by domestic and external developments; appreciation of TL moderated by policy measures, later reversed with global market deterioration.
- CPI expected to significantly overshoot its target by year-end; monetary authorities tightened policy to contain second round effects of temporary price increases.
- Authorities share concern that heightened risk aversion and deleveraging by European Banks could limit external financing; are ready to take coordinated measures.
Financial sector and macroprudential measures:
- Banking sector CAR: last September aggregate Capital Adequacy Ratio was 16.42 percent.
- Non-performing loan ratio declined to historical lows.
- Private sector credit reaches 48 percent of GDP.
- External debt of banking sector is 13 percent of total liabilities.
- Short-term FX obligations of nonfinancial corporates around USD 15 billion.
- Financial Stability Committee established, chaired by Deputy Prime Minister for Economic and Financial Affairs; members include Undersecretariat of Treasury, Central Bank, BRSA, Deposit Insurance Fund, Capital Markets Board.
- Policy actions: increased risk weights for consumer loans; increased general provisioning requirements for banks with high levels of consumer loans or non-performing consumer loans; BRSA restricted dividend payouts by banks with low CAR; modified criteria for minimum required CARs for foreign-owned banks; new capital charges on large maturity mismatches to take effect July 1, 2012; reserve requirements varying with liability maturity increased; new regulation on credit risk management being prepared.
Structural reform priorities:
- Implement Medium-Term Program reforms to improve business climate and combat informality.
- Focus public investment on infrastructure and human capital.
- Strengthen export capacity, enhance energy efficiency, promote renewable and domestic energy resources, and enhance labor force flexibility and quality.

*Italic: IMF staff report and related Public Information Notice and authorities' statement as presented in the source document.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1216.pdf_