## _cr16104 ## Source details **Canonical URL:** [_cr16104](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16104.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16104.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16104.pdf.json) --- ### Potential output and labor market - Economy broadly growing at potential; projected GDP growth: 3.8 percent in 2015; output and unemployment gaps are practically closed. - Potential growth drivers and outlook: - Potential output growth started to decline in 2006 and has remained low, mainly due to lower potential TFP growth. - Potential output growth expected to average 3–3½ percent from 2015–20 under current policies. - Labor force growth contribution: ½–1 percent. - Capital stock growth contribution: about 2 percent. - Potential TFP growth required: ½–1 percent to achieve 3–3½ percent potential growth. - Labor market metrics: - Employment rate: about 46 percent. - Female labor force participation increased from 46 percent in 2007 to 50 percent in 2013. - Unemployment rate: estimated 10.2 percent. - Over 2.5 million refugees; recent work permits pose absorption challenges and potential competition with lower-skilled women. - Headwinds to investment and productivity: - Weak investment contribution and declining profitability. - Increasing corporate FX debt burden: gross NFC FX debt US$291 billion, net US$184 billion. - Increasing real unit labor costs (ULCs) and stagnant TFP. ### Inflation, exchange rate, and external position - Inflation: - Headline and core inflation: 9.6 percent in January 2016, above the 5 percent target. - End-year headline inflation expectations rose from 7 to more than 8 percent in 2015. - Exchange rate and competitiveness: - REER depreciated by only 6.9 percent in 2015 as high domestic inflation offset nominal Lira depreciation. - Lira depreciation in 2015: 21 percent against the US dollar and 6 percent against the EUR. - External balances and NIIP: - Current account deficit (CAD) improved to 4.4 percent of GDP in 2015 due to lower energy prices. - NIIP about -50 percent of GDP in 2015; projected to deteriorate to -60 percent of GDP by 2021 under the baseline. - External debt increased to 56 percent of GDP in 2015; about one third of external debt is short-term. - Annual external financing needs: around 27 percent of GDP given high share of short-term debt. - Gross international reserves (GIRs) declined and fell below 90 percent of the IMF ARA metric; reserve cover of short-term debt declined to 64 percent at end-2015. - Net international reserves (CBRT): Gross foreign reserves reported 127.3 (2014) and 110.5 (2015) in billions of U.S. dollars; Net international reserves reported 42.9 (2014) and 28.7 (2015) in billions of U.S. dollars. ### Savings, buffers, and balance-sheet concerns - Saving and investment: - Private investment rate in 2015: 16 percent; private saving-investment gap: -3.8 percent of GDP. - Public saving-investment gap: around -0.5 percent of GDP. - Low private saving rate identified as primary cause of external vulnerabilities. - Buffers and balance-sheet indicators: - NIIP in 2015: -51 percent of GDP (Annex IV). - Households hold net FX assets amounting to around 14 percent of GDP as of September 2015. - Banks: average capital adequacy ratio 15.6 percent (13.2 percent Tier-1) at end-2015; ROAE declined to 11.3 percent. - Banking sector key ratios (2015): Total Assets 118.1 (percent of GDP); Gross Loans 74.4 (percent of GDP); Deposits 62.4 (percent of GDP); NPLs / Gross Loans 3.1 (percent); CAR 15.6 (percent); Loan-to-Deposit ratio 119.2 (percent); ROAA 1.2 (percent); ROAE 11.3 (percent). ### Medium-term projections and scenarios - Growth projections: - 2016 growth projected at 3.8 percent. - 2017 projected decline to 3.4 percent; medium term stabilize around 3.5 percent. - Inflation and unemployment projections: - CPI inflation (12-month; period-average): 2016 proj.: 9.8; 2017 proj.: 8.8; 2018–21 proj.: 7.3, 6.9, 6.6, 6.5. - Unemployment rate: 2014: 9.9; 2015: 10.2; projected steady at 10.8–10.5 in 2016–21. - External sector projections: - CAD: 2014: -5.5; 2015: -4.4; projections around -3.5 to -4.4 through 2021. - Gross external debt (percent of GDP): 2014: 50.4; 2015: 56.0; 2016 proj.: 57.3; 2018–21 around 55.7. - External financing requirements expected to remain at around 26 percent of GDP. - Stress scenarios: - A permanent 30 percent real depreciation would push external debt to 83 percent of GDP by 2020. - Staff scenario: a 20 percent depreciation shock would increase NFCs’ leverage by about 44 percentage points, to about 205 percent; banks’ capital ratios would deteriorate by about 2 percentage points. ### Policy agenda — cyclical and structural mix - Staff recommended mix to reduce CAD and stabilize NIIP: - Structural reforms: increase funding of private pension and severance pay systems to raise private saving; labor market reforms to increase participation (particularly women and refugees) and productivity. - Tighter monetary policy: quickly increase the one-week repo rate into solidly positive real territory and normalize the monetary framework. - Tighter fiscal policy: consolidation of 1.5 percent of GDP over 2016–18 to increase aggregate savings. - Higher reserves: increase gross reserves by US$14 billion in 2016 and another US$6 billion in 2017 to reach the ARA metric; thereafter grow in line with GDP; increase in GIR should be accompanied by a commensurate increase in NIR. - Macroprudential measures: retain and strengthen measures limiting credit growth, target wholesale FX external financing, lengthen maturities, and close data gaps on FX exposures. - Expected trade-offs: - Demand-management and tightening would lower growth in the short term by 1-2pps relative to the baseline but would increase potential output and stabilize NIIP in the medium term and reduce sudden-stop probability. ### Minimum wage impact - Minimum wage increase: - Net minimum wage raised to about TL1300 per month in January 2016; directly impacts more than 8 million formal-sector workers. - Government support during the year: TL100 per month for workers earning up to gross TL2,550 per month. - Ratio of statutory minimum to median wage highest among OECD since 2004. - Expected increase in labor costs: about 1.1 percent of GDP; government support reduces private sector cost to about half that amount in the first year. - If labor market impact is small, consumption could increase by about 0.6 percent of GDP, reducing net government cost to about 0.3 percent of GDP; a less benign scenario could increase fiscal costs and hinder growth. - Minimum wage increase could reduce female labor participation (currently around 31½ percent). ### Monetary policy recommendations and operational guidance - Staff recommendations: - Tighten monetary stance: raise the one-week repo rate into decisively positive real territory and sustain it; macroprudential policies cannot substitute for rate tightening. - Normalize monetary framework: narrow interest rate band and provide all liquidity demanded at a single policy rate; strengthen communication and guidance on policy responses to shocks. - Reserve accumulation: targeted increase in GIR of US$14 billion in 2016 and US$6 billion in 2017; halt off-market FX sales and daily FX auctions (while retaining option to auction); refrain from interventions absent disorderly markets; opportunistic FX purchases when market conditions permit. - Authorities’ view: - CBRT argued current framework and high marginal funding rate are appropriate; plan gradual return to 5 percent inflation target over three years; assessed probability of sudden stop as low and did not see need for additional tightening recommended by staff. ### Fiscal policy assessment and recommendations - Recent stance and medium-term program: - 2015 fiscal stance broadly neutral; structure of the budget worsened with above-target expenditure offset by stronger tax revenues and one-offs. - 2016 fiscal stance will loosen (minimum wage and electoral spending); consolidation expected to resume in 2017 with less ambitious targets than the 2015–2017 MTP. - Staff view: modest consolidation of ½ percent of GDP in three years is insufficient for rebalancing. - Staff fiscal recommendations: - Consolidation of 1½ percent of GDP by 2018, focused on current expenditure, while protecting investment. - Mobilize revenues (including higher carbon taxes) and reduce informality. - Strengthen governance: central oversight, approval and disclosure of PPPs; publish a fiscal risk statement. - Fiscal metrics: - Nonfinancial public sector primary balance (percent of GDP): 2014: 0.9; 2015: 1.2; 2016 proj.: 0.6; 2017–21 proj.: 1.3–1.4 range. - General government gross debt (EU definition, percent of GDP): 2014: 33.5; 2015: 32.6; projected decline to 25.0 by 2021. ### Financial sector and macroprudential policy - Banking and credit dynamics: - Banks’ CAR: 15.6 percent (end-2015); Tier-1 13.2 percent. - Some banks may need capital increases to remain above 12 percent threshold for closer scrutiny. - FX-adjusted credit growth decreased to 14 percent (annual). - Wholesale external FX funding rose to US$135 billion in October 2015; short-maturity exposure about US$78 billion. - Sector loan-to-deposit ratio: 119 percent; LtD 89 percent for FX and 142 percent for local currency. - Basel III and prudential transition: - Basel III measures expected to lower average CAR by about 0.6 percentage points; BRSA schedule will increase required minimum CAR by 4.5–7 percentage points over 2016–19. - Staff macroprudential recommendations: - Phase in reserve requirement measures and net stable funding ratio more quickly. - Increase remuneration differential between FX and Lira reserves to slow FX wholesale borrowing. - Consider higher capital charges and provisioning on FX loans; align treatment of FX-indexed lending with FX lending. - Close data gaps on NFC FX exposures; delay relaxation of consumer loan risk weights until debt-to-income ratios in place. ### Contingency planning and key risks (Risk Assessment Matrix highlights) - Overall balance of risks on the medium-term baseline: on the downside; Turkey exposed to a sudden stop. - Major downside risks: - Large annual financing needs, low and declining NIR, short-term nature of inflows, and negative NIIP. - US Fed could accelerate interest hikes increasing external financing costs. - Political pressures on CBRT; escalation of terrorist activity and geopolitical tensions; Russia sanctions. - Larger than expected adverse impacts from minimum wage increase on formal employment and investment. - Selected RAM entries: - Tighter or more volatile global financial conditions: Likelihood: Medium; Impact: High; Policy response: tighten monetary policy; use FX reserves to smooth volatility if NIR allows; consider loosening fiscal stance if recession. - Structurally weak growth in Europe: Likelihood: High; Impact: Medium; Policy response: diversify export destinations and improve competitiveness. - Loose domestic policies: Likelihood: Medium; Impact: High; Policy response: tighten monetary policy and fiscal policy; prioritize expenditure compression. - Geopolitical uncertainties: Likelihood: Medium; Impact: Medium; Policy response: increase FX reserves; improve competitiveness; reduce energy dependence. ### Annex highlights — debt sustainability, contingent liabilities, and reserves - External Debt Sustainability: - Debt path stabilizes just above 56 percent of GDP by 2020 under baseline. - In 2016 Turkey expected to repay over US$170 billion of debt to external investors; gross financing needs over 26 percent of GDP. - Effective interest rate on external debt fell to 1.5 percent in 2014–15; projected to increase to 4.3 percent over the medium term. - DSA: increase in interest rates by 1 s.d. would increase debt level by additional 2 percentage points to 58 percent of GDP. - Public Debt Sustainability: - Public debt about 32 percent of GDP; average maturity 6.4 years; 67 percent fixed-rate; 35 percent FX. - Debt-to-GDP projected to decline to 26 percent in 2020 under baseline. - Contingent liability shock: one-time bail out equal to 4.8 percent of GDP; debt rises to 36 percent of GDP in 2018. - Combined shock: debt increases to around 41 percent of GDP. - Reserves and external metrics: - Turkey’s gross reserves fell to 86 percent of the IMF composite adequacy metric at end-2015; adjusting for ROM reduces adequacy to 82 percent. - Net reserves available for intervention: US$29 billion at end-2015. - Staff assesses REER overvaluation in 2015 of about 5-10 percent. *International Monetary Fund — staff assessment and policy recommendations from IMF Country Report excerpts (content unit: _cr16104).* ### 1. Potential output in Turkey _____________________________________________________________________ 6 ### 1. Potential output in Turkey ### A. Context - The economy is broadly growing at potential but external imbalances keep accumulating. - Projected GDP growth: 3.8 percent in 2015; output and unemployment gaps are practically closed. - Net international investment position (NIIP): about -50 percent of GDP in 2015 and deteriorating under the baseline. - Annual external financing needs: around 27 percent of GDP, given the high share of short-term debt. ### B. Current Trends - 2015 growth displayed resilience despite several shocks; monetary policy was insufficiently tight and fiscal policy neutral. - Sources of uncertainty and headwinds: - Political uncertainty from two parliamentary elections, the war in Syria, escalating tensions with Russia, resumption of the armed conflict in the South East, and terrorist attacks—undermining consumer confidence and investors’ risk appetite. - Weak investment and declining profitability: investment lagging (despite strong 2015Q2), tighter external and domestic financing conditions, increasing corporate FX debt burden, decreasing profitability, and increasing real unit labor costs (ULCs). - Capital outflows pressured the Lira: gross NFC FX debt standing at US$291 billion, or US$184 billion on a net basis; non-exporting entities particularly affected, contributing to low private investment. - Depressed external demand: weak growth in trading partners, sharp fall in fuel prices affecting oil-exporting partners; contribution of net exports to real growth remained negative. - Factors enhancing resilience: - Benefited from low international oil prices in 2015. - Lira depreciation increased competitiveness of exporting firms. - Households hold net FX assets amounting to around 14 percent of GDP as of September 2015, improving households’ net wealth in lira terms. - Corporate profit remains high despite a long-term downward trend. - Companies hold sizable FX deposits; more than half of NFCs’ external debt has maturity of more than 3 years. ### Potential growth and labor market - Growth is below both the historical average and authorities’ 5 percent long-term target due to declining investment contribution and negative net exports. - Potential growth is slowing; stagnant total factor productivity (TFP) growth is a main factor (see Box 1). - Employment and labor metrics: - Employment rate: about 46 percent, much lower than the OECD average. - Female labor force participation increased from 46 percent in 2007 to 50 percent in 2013 (a 7 percentage point increase in female labor force participation and the female employment rate noted). - Unemployment rate: estimated 10.2 percent. - Low employment driven by rigid labor market rules (including a high labor tax wedge and high firing costs) and educational mismatches. - Over 2.5 million refugees—recently granted work permits—pose challenges for absorption and may compete for employment with lower-skilled women. ### Inflation and external position - Inflation: - Headline and core inflation: 9.6 percent in January 2016, above the 5 percent target. - End-year headline inflation expectations increased from 7 to more than 8 percent in 2015. - External vulnerabilities: - Current account deficit (CAD) improved in 2015 to 4.4 percent of GDP due to lower energy prices, but the trade balance excluding gold and fuel deteriorated. - Real effective exchange rate (REER) depreciated by only 6.9 percent because high domestic inflation offset much of the nominal Lira depreciation. - External position assessed as moderately weaker than the level consistent with medium-term fundamentals and desirable policies. - Quality of external financing is a concern: - Financial account balance (excluding reserves) shrunk to about 2 percent of GDP in 2015 with net portfolio flows turning negative. - Net FDIs remain low; net errors and omissions are large and volatile. - CBRT used international reserves to finance part of the CAD. - NIIP dynamics and debt: - NIIP reached -50 percent of GDP in 2015, supported by favorable valuation effects; projected to deteriorate to -60 percent of GDP by 2021. - External debt increased to 56 percent of GDP in 2015. - About one third of external debt is short-term; financing needs remain above 25 percent of GDP over the projection horizon. - Debt service payments are large due to size of NIIP and projected to increase given the large share of debt with short maturities and variable interest rates, and increasing international rates. ### Box 1 — Potential Output in Turkey (summary points) - Potential output growth started to decline in 2006, dropped further during the global financial crisis, and has since remained low—mainly due to lower potential TFP growth. - The decline in TFP was partially offset by capital accumulation and an increase in labor force participation from 46 percent in 2007 to 50 percent in 2013. - Potential output growth is expected to average 3–3½ percent from 2015–20 under current policies. - Labor force growth contribution: ½–1 percent to potential output growth. - Capital stock growth contribution: about 2 percent to potential output. - With about 2½–3 percent contribution from capital and labor, potential TFP growth of ½–1 percent is necessary for Turkey to achieve potential output growth of 3–3½ percent going forward. ### Savings, buffers, and balance-sheet concerns - Private saving and investment: - Low private saving rate identified as the primary cause of external vulnerabilities. - For 2015: private investment rate at 16 percent generates a private sector saving-investment gap of -3.8 percent of GDP. - Public saving-investment gap: around -0.5 percent, supported by an overall prudent fiscal policy. - Declining buffers: - Private sector: profitability of non-bank corporates and capital adequacy and profitability of banks have decreased. - Public sector: fiscal buffers remain high; primary surplus and trend real GDP growth above the real interest rate imply the debt-to-GDP ratio continues to decline gradually. - Gross International Reserves (GIRs) have declined and fell below 90 percent of the IMF assessment of reserve adequacy (ARA) metric. - Drivers of low private saving include expansion of safety nets and rapid urbanization (lowering precautionary savings), possibly financial deepening, and low international real interest rates providing cheap FX financing. ### Box 2 — NIIP Valuation Effects (summary points) - Persistent current account deficits led to accumulation of one of the largest negative NIIP among emerging markets, in excess of about -50 percent of GDP. - During 2000–15: - Foreign liabilities increased from 57 to 83 percent of GDP and exceeded US$600 billion. - Foreign assets grew from 20 to 33 percent of GDP (about US$227 billion). - In 2010–14 the difference between the sum of current account deficits and the change in the level of NIIP was US$109 billion—implying that absent favorable valuation and other effects NIIP would be close to -70 percent of GDP in 2015. - Contributing factors to the gap: - Introduction of the Reserve Option Mechanism (ROM) in 2011; use of ROM in gold reached about US$16 billion by end-2014, becoming part of CBRT’s gross reserves. - Net errors and omissions (NEO): in 2010–14 the net value of BoP transactions captured by NEO exceeded US$9.9 billion; CBRT believes much of this represents savings abroad. - Changes in currency and instrument composition of liabilities (foreign equity investments and Turkish-lira-denominated debt increased their combined share to 57 percent of total stock of liabilities) limited growth of foreign liabilities during Lira depreciation. - Cumulative valuation changes over 2010–14 estimated at about 10 percent of 2014 GDP. - 2015 valuation effects: - Lira depreciated 21 percent against the US dollar and 6 percent against the EUR in 2015, improving the NIIP in US dollar terms. - Effect of FX and other changes on the NIIP value in US dollars was in the order of US$90 billion. ### C. Medium-Term Projections and Policy Implications - Minimum wage increase and policy loosening: - Minimum wage increased by 30 percent in January 2016; relaxation of macroprudential measures on consumer credit scheduled for April 2016 (see Box 3). - A loosening of the fiscal stance is envisaged for 2016: nonfinancial public sector primary surplus will decline by about 0.6 percent of GDP, partly due to minimum wage impact and electoral-related spending. - For 2017–18, the primary surplus is expected to recover to its 2015 level as minimum wage support is discontinued and current spending is contained. - Growth outlook: - 2016 growth projected at 3.8 percent, supported by domestic consumption (minimum wage increase), relaxation of macroprudential policies, and accommodative fiscal and monetary policies; exports contained by weak external demand and sanctions from Russia. - 2017 growth projected to decline slightly reflecting slower real wage growth, recovering oil prices, and envisaged fiscal consolidation. - Medium term: growth projected to stabilize at around 3.5 percent, driven by domestic demand; contribution from net exports not expected to increase substantially unless reforms improve competitiveness. - Minimum wage effects (Box 3 summary): - Net minimum wage raised to about TL1300 per month; directly impacts more than 8 million formal-sector workers. - Government support during the year: TL100 per month for workers earning up to gross TL2,550 per month. - Minimum wage is relatively binding; ratio of statutory minimum wage to median wage has been the highest among OECD countries since 2004. - Increase could reduce female labor participation (currently around 31½ percent). - Increase in labor costs will amount to about 1.1 percent of GDP; government support will reduce private sector cost to about half that amount for the first year. - If labor market impact is small, consumption could increase by about 0.6 percent of GDP, boosting the economy and government revenues—reducing net cost to government to about 0.3 percent of GDP. - A less benign scenario with lower formal employment would hinder growth while increasing net fiscal costs. - Current policies and external balances: - In 2016, CAD projected to improve to 3.5 percent of GDP mainly because of low oil prices. - For 2017–2018, staff assumes gradual recovery in the EU and the Middle East and limited wage growth, helping push the non-oil balance into a surplus and boosting the overall current account. - Over the medium term the deficit is expected to climb again to 4.4 percent of GDP, driven by a moderately overvalued CPI-REER, higher energy prices, and low competitiveness (real earnings continue to grow more than productivity). - Consequences for external debt and financing: - External debt and NIIP projected to stabilize at around 56 and 60 percent of GDP, respectively. - External financing requirements expected to remain at around 26 percent of GDP as progressive lengthening of external liabilities (from recently adopted macroprudential measures) compensates for negative impact of higher international interest rates. *Source: IMF staff report — "1. Potential output in Turkey" (excerpts).* ### 16. On balance, the risks to the medium term baseline are on the downside, leaving Turkey ### _cr16104 - 16. On balance, the risks to the medium term baseline are on the downside, leaving Turkey ### Risks to the medium-term baseline - On balance, risks are on the downside, leaving Turkey exposed to a sudden stop (Annex I). - Positive upside factors: - Recent agreements to reopen EU accession chapters could serve as an anchor for reforms. - Intensification of trade with Iran and a stronger than expected recovery in the EU and neighboring countries could help reduce external imbalances. - Prompt passage and implementation of reforms promised by the new government may yield results earlier than envisaged, with higher than expected productivity gains. - Negative downside factors: - Large annual financing needs, low and declining net international reserves (NIR), the short-term nature of capital inflows, and the ever larger negative NIIP. - The US Federal Reserve could accelerate interest hikes and further increase the cost of external financing. - Political pressure on the CBRT could re-emerge, especially in the process of appointment of several board members. - Recent increase in terrorist activity, unrest in the South East, and any deterioration of the political situation could sharply reduce investor confidence. - Escalation of sanctions from Russia may further disrupt external demand. - The 30 percent minimum wage increase could have a larger than estimated negative impact on formal employment, corporate profits and private investment. - Timing: - Downward risks can affect the outlook in the short run while the positive risks will affect the scenario only in the medium term; thus the balance of risks is negative in the short term. ### Box 4 — Impact of Sanctions from Russia: key points and figures - Late 2015: Russia introduced restrictions on economic relationships with Turkey covering a wide range of food and manufacturing imports, tourism and construction services, restrictions on hiring Turkish citizens, suspension of visa-free travel starting January 2016, and construction of a nuclear plant project put on hold. Restrictions were later eased for selected manufacturing companies with production on Russian territory and construction companies with long-term contracts. - Trade and exposure: - Before the collapse of the oil price, trade turnover between the two countries was approaching US$38.2 billion. - Exports to Russia, including its share in the shuttle trade, constitute about 1.3 percent of Turkey’s GDP. - For some manufacturing businesses, about 60–80 percent of total sales were targeted to the Russian market. - Turkey receives over one half of its gas supply and about one fifths of its steel imports from Russia. - Sectoral impacts and estimates: - While the overall effect on the Turkish current account is likely to be moderate, the tourism sector could face a serious hit. - In 2016, Turkish exports to Russia are estimated to fall short by some US$6–8 billion, including about US$3.5 billion losses in the tourism sector. - Dynamics: - The announcement of economic restrictions created disruptions in late 2015 and it will take time for producers to redirect exports to other markets. - Export revenues were already shrinking as Russia was in recession and some large construction projects were finalized. - Further reduction of commodity prices will limit the increase in the deficit of Turkish trade with Russia. ### Policy agenda: achieving external equilibrium and higher growth — key messages (A. Key Policy Dilemma) - Problem statement: - Turkey needs to reduce sizable external imbalances. - Structural reforms are necessary to boost the private saving rate, increase competitiveness and raise potential output, but these deliver only over the medium term. - Meanwhile, vulnerabilities should be reduced with demand policies (monetary and fiscal) and prudential measures in the financial sector. - Staff’s recommended mix of cyclical and structural policies to reduce the CAD and stabilize the NIIP includes: - Structural reforms: increasing funding of the private pension and the severance pay system to permanently increase the saving rate; labor market reforms to increase participation (particularly women and refugees) and productivity. - Tighter monetary policy: to re-anchor expectations, contain NFC balance sheet effects, and is justifiable amid rapidly decreasing global liquidity. - Higher reserves: combination of higher reserves—currently at 86 percent of the IMF ARA—and other policies would contribute to a real effective depreciation of the Lira, improving external competitiveness. - Tighter fiscal policy: a consolidation of 1.5 percent of GDP over 2016–18 would contribute to rebalancing by increasing aggregate savings. - Expected trade-offs and outcomes: - Staff’s policy recommendations would lower growth in the short term (demand management policies would reduce growth by 1-2pps relative to the baseline in the short term) but increase potential output and stabilize the NIIP in the medium term. - Policies would decrease the probability of a disruptive sudden stop, reverse the NIIP’s negative trend, and help bring down inflation to its target. Structural reforms would support higher growth in the medium term. ### Structural reforms (B. Structural Reforms) - Background findings: - Private savings are insufficient to finance long-term growth. - Domestic investment is around 20 percent of GDP and is low by international standards. - Employment rate is well below the OECD average, especially for women; unemployment is high due to rigid labor market rules (including high hiring and firing costs) and educational mismatches. - Over 2 million refugees, recently granted working permits, add pressure. - The authorities’ reform program lacks prioritization and implementation remains in progress; proposed reforms include private pension system modifications, education and labor market reforms, expanding some tax bases, and deepening capital markets. - Minimum wage has been increasing in real terms over the last decade, standing over 50 percent of average wages in 2015; more than 30 percent of employees are estimated to earn minimum wages or less. - Staff position and recommendations: - Priority on reforms aimed at decreasing the saving-investment gap and increasing competitiveness. - Implement reforms to increase funding in the private pension and severance pay systems while maintaining a tight fiscal stance; these reforms could raise the private saving rate. - Full and swift implementation of pension and severance pay reform plans is key given the urgency of reducing vulnerabilities and time lags to affect the saving rate. - Macroprudential policies limiting credit growth should remain part of the policy mix. - Contain minimum wage increases at or below programmed inflation in the future; for the current year, targeted government support could have reduced fiscal costs. - Integrate refugees into the labor market; integration requires considerable fiscal effort (it is estimated that over 700000 children require schooling) but refugees could boost growth if integrated. - Boxes referenced: - Box 5: Boosting Private Savings — describes policy measures such as subsidized third pillar pension scheme, savings subsidy for dowry and housing accounts, piloted auto-enrollment funded pension scheme, proposals to reform severance pay by making it funded and transferable, and the role of macroprudential tools. - Box 6: Refugees in Turkey — key figures and policy developments: - Since March 2011, Turkey has received over 2.5 million refugees. - Authorities estimate they have spent over US$10 billion (including foreign contributions of US$0.4 billion) on refugees since 2011. - By end 2014, 86 percent of refugees had left camps; locations: 45 percent near the Turkish-Syrian border, 14 percent in Istanbul. - Until January 2016, refugees were not allowed to work legally; new legislation in January 2016 allows refugees to work with some restrictions. ### Authorities’ position on structural reforms - Authorities’ agenda: - Their 10th development plan, argued to deliver results this year, including more FDI to produce products currently imported, better commercialization of R&D, and development of capital markets. - Critical structural reforms in rule of law, education, private pensions, the labor market, income tax, and the judiciary to increase competitiveness, labor market flexibility, savings, and potential output. - Enlargement of the customs union with the EU to services, public procurement, and possibly agriculture; talks likely to start in 2017H1. - In 2016, coverage of the private pension system will be increased by introducing automatic assignment of workers. - On the minimum wage: - Authorities shared the view that the raise in minimum wage would have an immediate boost to growth and inflation. - They viewed the temporary labor subsidy as appropriate, citing a strong fiscal position, to reduce pressure on firms from higher wage bills and ameliorate possible negative consequences on employment and labor market formality. ### Monetary policy (C. Monetary Policy) - Background findings: - In 2015, monetary tightening was insufficient to lower inflation. The CBRT tightened moderately and in an opaque way by limiting the share of liquidity at the one-week repo rate; inflation remains above target. - The CBRT has not normalized its monetary framework; unorthodox framework impaired monetary transmission and failed to deliver target inflation. Marginal steps taken after August 2015; full normalization postponed. - Reserves are below the IMF ARA metric. The CBRT has intervened through auctions and direct sales of net reserves to importing SOEs; GIRs have declined and remain well below the ARA metric. - Staff position and recommendations: - Monetary stance should be tightened: the one-week repo rate should be quickly increased into solidly positive real territory and be sustained to bring inflation back towards the target. Macroprudential policies cannot substitute for such tightening. - Monetary tightening should be supported by fiscal consolidation and structural reforms (decreasing indexation) to contain growth in ULCs, rebalance the economy, and re-anchor expectations. - The monetary policy framework should be normalized and communication strengthened: narrow the interest rate band and provide all liquidity demanded at a single policy rate; provide clear guidance on reactions to demand and supply shocks, including expected inflation increase in 2016 from the minimum wage hike. - Net reserves should be increased to help weather shocks: - An increase in gross reserves of the order of US$14 billion in 2016 and another US$6 billion in 2017 would be needed to achieve the ARA metric. Thereafter, they should grow at the same pace as GDP. - The increase in GIR should be accompanied by a commensurate increase in NIR. - This could be partly achieved by halting off-market sales and daily FX auctions (while maintaining the option to conduct auctions), and refraining from interventions in the absence of disorderly market conditions. - Tighter monetary policy would alleviate pressure on the currency and, market conditions permitting, allow opportunistic FX purchases by the CBRT to strengthen reserves. - Authorities’ position on monetary policy: - The central bank argued the current monetary framework has served the economy well and the stance is appropriate. - They view the high marginal funding rate as appropriately tight and plan for a gradual return to the 5 percent inflation target over the next three years. - They noted headline inflation may remain high until 2016Q2 due to the minimum wage increase and elevated food inflation, while some core measures have started to decline. - Emphasized the role of macroprudential policies in containing financial stability risks from consumer credit growth and saw such measures as important to reduce external imbalances. - In February, the government announced price caps on certain red meat products with high inflation. - They assess the probability of a sudden stop as low and do not see the need for additional monetary tightening as recommended by Staff. - Operational and reserve details: - The monetary framework simplification will resume when capital flow volatility is reduced; simplification roadmap announced in August 2015 began but was delayed given global volatility. - CBRT management expects GIRs to stabilize from end-March onward as off-market FX sales to Botaş and on-market FX demand from Tupraş decrease with delayed effects of lower oil and gas prices and possible reconsideration of FX auctions. - Footnote on reserves: The main difference between gross and net international reserves is accounted for by banks’ FX deposits in the CBRT, which stood at about US$80 billion in the end of 2015, including about US$25 billion of ROM in FX. _International Monetary Fund — staff assessment and policy recommendations from the specified chapter_ ### 37. The fiscal stance was broadly neutral in 2015 but the structure of the budget has ### _cr16104 - 37. The fiscal stance was broadly neutral in 2015 but the structure of the budget has ### Fiscal stance and medium-term program (MTP) - 2015: fiscal stance was broadly neutral but the structure of the budget has worsened; above-target expenditure was offset by stronger than envisaged tax revenues (particularly domestic VAT and some excises) and one-off contributions to social security from an amnesty. The fiscal tightening envisaged in the 2015–2017 MTP did not materialize. - 2016: fiscal stance will loosen to accommodate new spending related to election promises and a temporary labor subsidy to ameliorate the impact of the increase in the minimum wage. Consolidation is resumed later, with less ambitious targets than in the 2015–2017 MTP. - MTP objectives: enhance long-term growth and strengthen domestic savings through structural reform; ambitious structural reform agenda remains the backbone of the MTP. - Box summary: MTP seeks to accelerate long-term growth through structural reforms and to raise domestic savings to rebalance the economy; envisages strong growth, reaching 5 percent in 2017, and a current account balance that declines to 3½ percent of GDP; assumes structural reforms will increase potential output growth to 5 percent in two years; seeks to reach the 5 percent inflation target in 2018; non-financial primary surplus target accommodates the minimum wage and other election related spending in 2016, postponing consolidation until 2017. ### Fiscal targets, risks, and key macro projections - Staff view: fiscal targets do not support rebalancing and face important risks; modest consolidation of ½ percent of GDP in three years falls short of what is needed to support rebalancing and fight inflation. - Key risks: growth targets for 2016–2017 are about 1 percentage point of GDP above consensus; absence of such growth could yield a shortfall in central government revenues of about ¼ percent of GDP. On the positive side, lower oil prices may strengthen outturns for energy-related State-owned Enterprises. - Medium Term Program Targets (Percent) table reproduced as in source: - Growth: 2014 2.9, 2015 4.0, 2016 4.5, 2017 5.0, 2018 5.0 - Inflation: 2014 8.2, 2015 8.8, 2016 7.5, 2017 6.0, 2018 5.0 - CA (percent of GDP): 2014 -5.8, 2015 -4.4, 2016 -3.9, 2017 -3.7, 2018 -3.5 - Employment rate: 2014 45.5, 2015 46.1, 2016 46.5, 2017 46.9, 2018 47.4 ### Risk management, reporting, and fiscal periphery - Improvements: decade-long decline in debt to GDP, extension of public debt maturities to reduce annual financing needs, adoption of IPSAS 32 accounting standards. - Remaining gaps and concerns: - Rapid increase in public-private partnerships (PPP) since 2009 requires stronger central oversight, approval, disclosure, and anti-corruption measures. - Government fiscal risk register, alternative macro-fiscal scenarios, and long-term fiscal projections—including on pensions—are not published. ### Staff recommendations on fiscal policy - Consolidation target: staff recommends a consolidation of 1½ percent of GDP by 2018. - Rationale: bolster domestic savings; facilitate the CBRT’s efforts to reach its inflation target; boost policy space given increasing fiscal risks related to PPPs and guarantees, and private sector leverage and indebtedness. - Recommended composition: - Focus consolidation on current expenditure. - Do not further cut investment given large infrastructure needs (to avoid incentivizing PPPs despite their risks). - Scope to mobilize revenues, including through higher carbon taxes (see Box 8), and by lowering informality. - Governance: authorities should strengthen risk management and reporting, including central oversight, approval and disclosure of PPPs; publish a fiscal risk statement to manage risks, improve economic efficiency and reduce borrowing costs. ### Authorities’ position on fiscal stance and minimum wage - Authorities view slack in the economy as calling for a stimulus in 2016 given the strong overall fiscal position; estimate output is about 1 percent below potential. - Authorities expect the fiscal impulse to move the economy closer to internal equilibrium, while generating some inflationary pressure (recognized in the new MTP). - They consider a looser fiscal stance necessary to accommodate electoral promises but recognize the need to strengthen the fiscal stance in the medium term to preserve fiscal buffers, support price stability, and increase domestic savings. - On minimum wage: authorities agree the increase might have some negative impact and plan to use fiscal space to ameliorate effects on firms and the labor market; they view the minimum wage shock as temporary with consolidation efforts resumed in 2017. They acknowledge the minimum wage will foster domestic consumption, working against rebalancing. ### Financial sector: buffers, risks, and credit dynamics - Bank capital and profitability: - Banks had an average capital adequacy ratio of 15.6 percent (13.2 percent Tier-1) at end-2015. - Return on average equity (ROAE) declined to 11.3 percent (partly due to compressed net interest margins and fee rebates). - Some banks may need capital increases to stay above the 12 percent level, at which more intense regulatory scrutiny starts to apply. - Credit and leverage: - Total debt of non-financial corporates has increased rapidly in recent years. - FX-adjusted credit growth decreased to 14 percent on an annual basis. - FX deposits increased in reaction to the Lira depreciation; growth in FX deposits stopped in 2015H2 but the switch from non-core to core FX liabilities continues as overall credit growth is lower. - Macroprudential measures discouraging short term wholesale FX funding are lengthening maturity of FX funding; full impact expected only in 2018 (reserve requirement changes and increased remuneration of TL reserves by 200 bps since October 2015). - Wholesale external FX funding and rollover risk: - Sector loan-to-deposit (LtD) ratio stands at 119 percent, with LtD at 89 percent for foreign (FX) currency and 142 percent for local currency. - Wholesale external funding in FX rose from US$61 billion in 2009 to US$135 billion in October 2015; exposure at short maturity decreased marginally over the last two years to US$78 billion. - Banks hedge FX risk mainly off-balance sheet; net open FX position of the sector is small at 1 percent of regulatory capital. - NFCs’ net open foreign exchange position increased from US$67 billion at end-2009 to US$174 billion at end-October 2015; part hedged or covered by FX collateral but data gaps prevent quantification. - Basel III transition effects: - Introduction of Basel III may increase need for banks to raise capital. - Expected effects: new risk weights and countercyclical/systemic capital buffers phased in starting this year; risk weights on banks’ FX-denominated required reserves and ROM deposits at the CBRT will increase in April 2016; risk weights on consumer and mortgage lending will be lowered in anticipation of debt-to-income ratios; certain subordinated loans will no longer be counted as Tier 2 capital. - These measures are expected to lower average CAR in the banking system by about 0.6 percentage points. - BRSA announced detailed schedule: required minimum CAR will increase by a total of 4.5–7 percentage points over 2016–19; without capital increases many banks’ CAR may be close to or below required minimum, necessitating capital increases. - Over the medium term, move toward IRB risk weighting may increase the capital ratio. ### Staff recommendations on macroprudential policy - Strengthen macroprudential policies targeting banks’ wholesale FX external financing: - Phase in reserve requirement measures and net stable funding ratio more quickly. - Increase remuneration differential between FX and Lira reserves to slow FX wholesale borrowing. - Consider higher capital charges and increased provisioning on FX loans to incorporate increased indirect credit risk from FX lending. - Bring prudential treatment of FX-indexed lending into line with FX lending. - Close data gaps to better assess risks from FX exposures by NFCs. - Relaxation of risk weights on consumer lending should have awaited introduction of debt-to-income ratios. - Authorities’ stance: BRSA viewed slowdown in consumer credit growth as allowing relaxation of macroprudential measures and announced a decrease of risk weights on consumer loans from April; they will maintain maximum maturity restrictions on consumer loans and do not see need for new measures targeting FX risk given negligible net open FX position and decreased wholesale external financing; BRSA plans a move to a regulatory regime for consumer lending based on debt-to-income ratios once income data are available. ### Contingency planning and shock scenarios - Main short-term risk: sudden capital flow reversal leading to accelerated capital outflows or a sudden stop, making it difficult to roll over external debt and renew FX hedges, with likely recessionary outcome. - Staff scenario: a 20 percent depreciation shock would lead NFCs’ leverage to worsen by about 45 percentage points (Box 9); banks would see large credit risk materialize and the economy would likely enter a recession. - Staff recommended response in disorderly market conditions: - Employ both monetary and fiscal policies. - Modest nominal depreciation warranted; avoid sharp depreciation which can amplify shocks. - Sharp increase in the policy rate may be needed to support the exchange rate and facilitate orderly deleveraging. - Direct FX intervention may be warranted but reserves are low, limiting credible intervention scope. - In a recession, consider loosening fiscal policy to support the real economy; preemptively publishing an explicit fiscal risk statement may facilitate such fiscal reaction. - Swift and appropriate action may be required to address corporate liquidity or solvency problems. - Authorities’ view on sudden reversal risk: - Do not assess the risk as high; Turkey is faring much better than emerging market peers. - Asynchronous monetary policy of major central banks does not raise concerns about major liquidity gluts. - Strong trade and financial linkages with a recovering EU suggest rollover ratios will not decrease drastically even in crisis. - Authorities’ available instruments and buffers: - Policy buffers are high: prudent fiscal stance, low and declining public debt to GDP ratio. - Private sector resilience: households cannot borrow in FX, are not highly indebted, and have plenty of cash buffers. - Banks: no open FX position, well managed, high loss-absorbing capital. - Industrial structure flexible; Turkey has diversified exports. - Non-bank corporates have sizeable net open FX position but no signs of distress observed after recent large depreciation; suggests corporates largely hedged. - CBRT tools: remuneration regime of required reserves, liquidity provision framework, inclusion of FX assets in basket of eligible collateral for CBRT Lira liquidity; ROM could be drawn down with sufficient Lira assets as collateral under emergency liquidity assistance framework. - Authorities note unrecorded Turkish assets abroad would come back if necessary; net errors and omissions in the BOP are countercyclical. ### Box 9 — Balance sheet effects and quantitative scenario - Banks’ total external debt increased from about 8 percent of GDP in 2008 to about 29 percent in September 2015; these external liabilities are mainly in FX and mostly matched by FX denominated loans to NFCs and FX deposits with the central bank; household FX deposits are an important FX funding source. - NFC FX exposures: overall net FX open position about 27 percent of GDP by September 2015, consisting of: - 17 percent of GDP in external borrowing, - 25 percent in domestic FX borrowing, - 2 percent of GDP in other FX liabilities, - 17 percent of GDP in FX assets. - Households: FX deposits amounted to about 14 percent of GDP in September 2015; FX borrowing by households is restricted and outstanding FX-indexed debt is small relative to FX deposits. - Impact of a 20 percent depreciation shock: - NFCs leverage (debt-to-equity ratio) would increase by about 44 percentage points, to about 205 percent. - Banks’ capital ratios (measured by equity-to-total assets) would deteriorate by about 2 percentage points. - Households’ net wealth would improve in lira terms from holding FX deposits. *International Monetary Fund staff report (excerpts).* ### 58. Strong growth is set to continue in 2016, but with higher inflation. The 30 percent ### _cr16104 - 58. Strong growth is set to continue in 2016, but with higher inflation. The 30 percent ### Growth and inflation outlook - Strong growth is set to continue in 2016, supported by: - the 30 percent increase in the minimum wage, - a planned relaxation in macro prudential regulation, - a moderate loosening of fiscal policy, - an insufficiently tight monetary stance. - Inflation is well above the authorities’ 5 percent target and is on the rise. - Inflation expectations have remained unanchored. ### External imbalances and current account - Underlying external imbalances persist. - Improvement in the current account is due to lower oil prices; the non-energy balance has barely changed. - The economy’s external position remains moderately weaker than the level consistent with medium-term fundamentals. - Low private saving rate, if unaddressed, will perpetuate accumulation of external imbalances. - Financing of the deficit remains a concern, with some financing coming from reserves. ### Resilience and buffers - The economy has shown resilience to external shocks but buffers have decreased. - Large foreign currency debt of the nonfinancial corporate sector and banks’ dependence on foreign financing increase vulnerability to accelerating capital outflows. - International reserves have declined and the international investment position remains highly negative. - The fiscal stance has been loosened. - Bank balance-sheet indicators noted in the source: - Leverage (D/E) = 161% - Leverage (D/E) = 205% ### Near-term policy prescriptions - To reduce external imbalances in the short run: - Implement tighter fiscal and monetary stances. - Use macroprudential policies as a complement (not a substitute) to macroeconomic tightening. - Slower domestic demand growth and increased savings would lower external imbalances and create an opportunity for structural reforms. - Fiscal policy: - A tighter fiscal stance would reduce external imbalances and lower inflation, creating additional space to react to shocks. - With public debt at 32 percent of GDP, debt sustainability is not a concern, but fiscal consolidation could be more ambitious than envisaged in the MTP. - Increasing use of guarantees and PPPs to finance investment entails contingent liabilities that could materialize during a downturn. - Monetary policy: - A tighter monetary policy stance is needed to bring inflation back to the 5-percent target in the medium term. - The real policy rate should be increased into decisively positive territory to alleviate depreciation pressure on the lira. - Improve the monetary policy framework by narrowing the interest rate band and providing all liquidity demanded by the market at a single policy rate to strengthen the monetary transmission mechanism. - Reserves: - Given the improvement in the current account balance, the CBRT should increase its net reserves. - Interventions should be restricted to periods of disorderly market conditions. - Tighter monetary policy would help support, market conditions permitting, FX purchases. ### Macroprudential and banking sector guidance - Maintain banks’ buffers as risks persist: banks remain reliant on external wholesale funding and have large FX exposures to the domestic corporate sector. - Current strengths: - Capital adequacy ratios remain above regulatory minima and are mostly based on high-quality capital. - Nonperforming loans are low and well provisioned. - Macroprudential policies have lengthened maturities of banks’ wholesale FX external financing, adding resilience. - Recommended adjustments: - Prudential policies should be adjusted to reflect increased risks associated with FX lending. - Review the recent adjustment of consumer loan risk weights that will take effect in April if consumer credit growth rebounds too sharply. - Other macroprudential measures focused on overall indebtedness would be useful. ### Structural reforms and long-term policies - The authorities’ ambitious structural reform agenda is central to successful rebalancing. - Priority reforms include: - Increasing funding of the private pension and the severance pay systems to significantly raise the private saving rate. - Addressing lack of flexibility in the labor market. - Further developing local capital markets to boost growth and improve competitiveness. - Reform plans should be implemented swiftly and fully. ### Minimum wage increase: risks and benefits - The increase in the minimum wage will pose challenges to the labor market, competitiveness, and fiscal balance. - Potential benefits: - Higher wages may improve income distribution and provide a short-term economic boost. - Policy advice: - In the context of rigid labor markets, efforts to improve labor market flexibility would help avoid a surge in informal sector employment and diminish negative consequences of higher wages for competitiveness. *Source: _cr16104 — TURKEY, INTERNATIONAL MONETARY FUND (PDF).* ### 69. It is recommended that the next Article IV consultation be held again on the usual ### 69. It is recommended that the next Article IV consultation be held again on the usual 12-month cycle. ### Recent developments - Growth has weakened and the composition has shifted from public demand and net exports to private demand. - Credit growth is slowing: Banking Sector Total Credit Growth (Y/y, percent) series shown through Dec-15. - External imbalances remain high: Current Account (12mms, billion of U.S. dollar) series shown through Nov-15. - Financing of the current account deficit remains tilted towards portfolio and debt-creating flows: FDIM, MT debt, Portfolio, ST debt series shown. - Headline and core inflation remain well-above target: Inflation (Y/y, percent) series through Dec-15. ### Monetary policy and financial markets - The CBRT loosened headline rates throughout the year but tightened its effective funding rate; interest rate series shown (CBRT weighted avg. funding cost; CBRT overnight borrowing rate; CBRT one-week repo rate; CBRT overnight lending rate) through Jan-16. - Exchange rate: US-Euro Basket Exchange Rate (Lira per equal-weight euro/dollar basket) series through Jan-16; exchange rate depreciated. - Reserves are declining and net reserves are low: Gross International Reserves (Billion of U.S. dollar) series and Reserves (% Fund's metric adjusted for ROM) shown; reserves fall short of the Fund's benchmark metric (when corrected for ROM deposits) and the Guidotti-Greenspan rule. - The CBRT has been selling FX reserves instead of rebuilding buffers; Daily FX Auctions (Million of USD, negative denotes FX sale) series shown (does not include the CBRT intervention of US$3.1 bn in January 2014). - Bond yields rose: Benchmark Bond Rate (Percent; compounded) series through Jan-16. ### Fiscal stance - Deficits remain contained with double-digit total revenue growth; Central Government Revenue (Y/y, percent, 12-month moving average) series shown through Nov-15. - Revenue growth sustained by large VAT; VAT Components (Y/y, percent, 12-month moving average) series shown through Nov-15 (includes VAT and VAT imports). - Expenditure growth remains elevated: Central Government Primary Expenditure (Y/y, percent, 12-month moving average) series shown through Nov-15. - Public debt ratios remain comfortable: EU-defined General Government Gross Debt (Percent of GDP) series through 2015 and NFPS Primary Surplus by Subsector (Percent of GDP) series shown. ### Financial sector trends - Profitability remains under pressure: Return on average assets (ROAA) and Return on average equity (ROAE) series shown through Dec-15. - NPL ratios remain near historic lows: NPLs (Percent of total loans) series through Jan-16. - Capital ratios are declining but remain well-above regulatory minima: CARTier-1 Capital Adequacy Ratio (Percent) series through Dec-15. - Credit growth has started to decrease: Exchange Rate-Adjusted Total Credit Growth (Percent change, y/y and 13-w ma, annualized) through Dec-15. - Loan-to-deposit ratio is increasing with lending financed from abroad; banks are leveraging in FX to maintain profitability, positions fully hedged: Bank Debt Abroad by Maturity (Billions of U.S. dollars) and Net FX Position (Billions of U.S. dollars) series shown; note structural break in 2014. ### Financial sector profitability trends and structure - Profitability has steadily decreased, driven by both lower interest margins and higher non-interest expense: Banking Sector Profitability and Banking Sector Profitability Structure charts through Nov-15. - Loan book continues to grow while deposits fund an ever smaller share: Banking Sector Assets and Banking Sector Liabilities series show loans and deposits (Tril. of TL; lhs) and percent of total assets/liabilities (rhs). - Both TL and FX loans have increased while FX deposits increased at the expense of TL deposits: TL/FX composition charts for loans and deposits through Nov-15. ### Households and corporate sectors - Household debt ratios continue to increase but remain comfortable by peer standards; Turkish households have no FX debt. - Household Debt Service (Percent of disposable income) series shown; Debt-to-disposable income and Debt service components (Tax and fees; Interest; Principal) series shown. - Corporate sector: leverage has increased; net FX position is negative, large and growing, mostly long-term and partially hedged via swaps or export receipts: Non-Financial Corporate FX Position (Billions of U.S. dollars) series through Jul.15–Oct.15. - On aggregate across sectors, the net financial asset position has begun to deteriorate: Net Financial Assets (Percent of GDP) series 2006–2014. ### Turkey versus peers - Exposure to FX risk is larger than in most peer countries: FX Loans (2015Q3, percent of total loans) and Capital Adequacy Ratio (2015Q3, percent) charts. - Turkey has large gross financing requirements and lower foreign exchange reserves than peers: External Financing Requirement (2014, percent of GDP) and Reserve Adequacy (2014, percent of ARA metric) charts. - The financial system has buffers; there is ample fiscal space: Public Debt (2014, percent of GDP) chart and Capital Adequacy Ratio chart. ### Key statistics and projections (selected figures from tables) - Population (2014): 78.1 million; Per capita GDP (2014): $10,222; Quota (2015): SDR 1,455.8 million. - Real GDP growth rate: 2014: 2.9; 2015: 3.8; 2016 proj.: 3.8; 2017 proj.: 3.4; 2018–21 proj.: between 3.5 and 3.5 (annual values shown in Table 1 and Table 2). - CPI inflation (12-month; period-average): 2014: 8.9; 2015: 7.7; 2016 proj.: 9.8; 2017 proj.: 8.8; 2018–21 proj.: 7.3, 6.9, 6.6, 6.5. - Unemployment rate: 2014: 9.9; 2015: 10.2; projected steady at 10.8–10.5 in 2016–21. - Nonfinancial public sector primary balance (percent of GDP): 2014: 0.9; 2015: 1.2; 2016 proj.: 0.6; 2017–21 proj.: 1.3–1.4 range. - General government gross debt (EU definition, percent of GDP): 2014: 33.5; 2015: 32.6; proj. declines to 25.0 by 2021. - Current account balance (percent of GDP): 2014: -5.5; 2015: -4.4; projections around -3.5 to -4.4 through 2021. - Gross external debt (percent of GDP): 2014: 50.4; 2015: 56.0; projected 57.3 in 2016 then around 55.7–55.7 through 2021. - Net international reserves (CBRT): Gross foreign reserves (CBRT) series reported as 127.3 (2014) and 110.5 (2015) in billions of U.S. dollars; Net international reserves reported as 42.9 (2014) and 28.7 (2015) in billions of U.S. dollars; Net international reserves (exl. govt. FX deposits) 39.9 (2014) and 27.4 (2015). - Balance of Payments: Current account balance (Billions of US$): 2014: -43.6; 2015: -32.2; 2016 proj.: -26.3; 2017 proj.: -32.6; 2018–21 proj.: -35.4, -38.3, -40.3, -42.8. - Financial account components (Billions of US$): Direct investment, net: 2014: 5.5; 2015: 11.5; Portfolio investment, net: 2014: 20.1; 2015: 15.4; Other investment, net: 2014: 16.0; 2015: 14.6. - Gross external financing requirements (Billions of US$): 2014: 211.8; 2015: 199.9; 2016 proj.: 199.9; 2017 proj.: 197.5; 2018–21 proj.: 210.9, 225.1, 237.7, 250.6. - Public sector fiscal ratios (Percent of GDP): Primary revenue 2015: 23.1; Primary expenditure 2015: 22.4; Nonfinancial public sector overall balance 2015: -1.0; Interest expenditure (net) 2015: 2.2. - Banking system key ratios (2015): Total Assets 118.1 (percent of GDP); Gross Loans 74.4 (percent of GDP); Deposits 62.4 (percent of GDP); NPLs / Gross Loans 3.1 (percent); CAR 15.6 (percent); Loan-to-Deposit ratio 119.2 (percent); ROAA 1.2 (percent); ROAE 11.3 (percent). ### Observations and implications (drawn from presented data) - Macroeconomic: Growth moderate but weakening composition toward private demand; inflation remains elevated above target; external deficits persist requiring significant financing. - External sector: Large gross external financing requirements and reliance on portfolio and debt flows increase vulnerability; reserves and net international reserves have weakened relative to Fund metrics. - Financial sector: Banks face profitability pressure, rising loan-to-deposit ratios, increased reliance on external funding, and declining capital ratios while remaining above regulatory minima. - Public finances: Fiscal deficits contained; revenue growth strong (notably VAT); public debt ratios remain comfortable but current account and external debt dynamics warrant monitoring. *Source: IMF staff calculations and Turkish authorities as presented in the content unit.* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Tighter or more volatile global financial conditions - Risks: - Sharp asset price decline and decompression of credit spreads sharply deteriorating Turkey’s external financing outlook, as investors reassess underlying risk and respond to unanticipated changes in growth and financial fundamentals in large economies, the Fed policy rate path, and increases in U.S. term premia, with poor market liquidity amplifying volatility. - Surge in the US dollar exchange rate: a further dollar surge creates balance sheet strain for Turkey, where many corporates are dollar debtors, but dollar exports are limited. - Likelihood: Medium - Impact: High - Policy response: - Tighten monetary policy to bring it in line with the inflation target. - To the extent the NIR level allows, use FX reserves to smooth volatility in disorderly market conditions. - In case a recession ensues, consider loosening the fiscal stance. Publish a fiscal risk statement to guide policies. ### Structurally weak growth in Europe - Risks: - Weak demand and persistently low inflation from a failure to fully address crisis legacies and undertake structural reforms, leading to low medium-term growth and persisting financial imbalances in the Euro area, hurting demand for Turkish exports. - Likelihood: High - Impact: Medium - Policy response (medium term): - Diversify export destinations, increase high value-added exports, and improve competitiveness, thus boosting exports. ### Loose domestic policies - Risks: - High inflation and a deteriorating fiscal position, eroding confidence and leading to re-dollarization. This could occur if the government tries to spur growth through demand management, rather than long-term structural reform. - Likelihood: Medium - Impact: High - Policy response: - Short-run: Tighten monetary policy and normalize the framework. Tightening above and beyond what was originally called for might be necessary. - Medium term: Tighten fiscal policy to bring it back into line with the medium-term program. Prioritize expenditure compression. ### Geopolitical uncertainties - Risks: - Russia: the conflict between Turkey and Russia escalates, leading to further trade sanctions, possibly including energy supplies. - Heightened risk of fragmentation/state failure/security dislocation in the Middle East, leading to migrant flows, with negative global spillovers. - Likelihood: Medium - Impact: Medium - Policy response: - Preemptively increase FX reserves through sterilized intervention. - Medium term: Improve competitiveness through structural reform. - Reduce energy dependence by developing additional domestic generation capacity. - Clarify the CFT framework. *The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.* ### Annex II. External Debt Sustainability ### Key findings and background - Turkey’s external debt continued to increase and is estimated to exceed 50 percent of GDP in 2015. - The debt path is sustainable and robust to most stress tests under the baseline, but susceptible to a large Lira depreciation. - Annual external financing needs in excess of 25 percent of GDP expose the economy to high liquidity and rollover risks. - Background: - Turkey has relied on debt-creating flows, mainly short term, to finance its large and persistent current account deficit. External debt exceeded 50 percent of GDP in 2014. - Private creditors, including bondholders, hold close to 90 percent of debt. - Most external debt resides with banks that intermediate capital inflows into domestic loans, mostly in Lira but also in FX. - About one third of the total external debt stock, or about 16 percent of GDP, was short term in 2015. - Staff forecast the current account deficit to increase to about 4.5 percent of GDP over the medium term. - Effective interest rate paid on external debt fell to 1.5 percent in 2014–15; projected to increase to 4.3 percent over the medium term. - Assuming continued lengthening of new debt maturities, the share of short-term external debt (by original maturity) would decline slightly and stay at about 30 percent of the total debt stock. ### Assessment and vulnerabilities - Debt dynamics: - Debt path stabilizes at just above 56 percent of GDP by 2020 under the baseline scenario. - A steeper recovery of fuel prices, leading to current account of about 5 percent, would push the debt ratio above 60 percent over the medium term. - More than 90 percent of Turkish external debt is denominated in foreign currency, making the debt path susceptible to exchange rate movements. - A permanent Lira depreciation by 30 percent would push the external debt stock to 83 percent of GDP by 2020. - Note: This analysis does not take into account the potential contraction of the current account deficit associated with such a sharp currency movement. - External financing requirements: - In 2016 Turkey is expected to repay over US$170 billion of debt to external investors. - Combined with the interest rate bill and trade deficits this adds up to total gross financing needs of over 26 percent of GDP. - About three quarters of total external debt, including debt with short maturities, is indexed to global interest rates. - A normalization of monetary policy by advanced economies or rising spreads for emerging markets could quickly translate into higher borrowing costs. - DSA simulation: an increase in interest rates by 1 s.d. compared to the baseline would increase the debt level by additional 2 percentage points to 58 percent of GDP. - A sudden stop in capital flows may trigger simultaneous rises in borrowing costs and exchange rate pressure. ### Quantitative highlights (from DSA tables and charts) - Baseline external debt: stabilizes at just above 56 percent of GDP by 2020. - Permanent 30 percent real depreciation scenario: external debt reaches 83 percent of GDP by 2020. - Gross external financing need (in billions of US dollars) under baseline: values include 139.8, 192.7, 172.2, 208.6, 211.8, 199.9, 199.9, 197.5, 210.9, 225.1, 237.7 (as shown in the table). - Gross external financing need (in percent of GDP): 19.1, 24.9, 21.8, 25.3, 26.5, 10-Year, 10-Year, 27.2, 26.7, 25.0, 25.3, 25.6, 25.6 (as shown in the table). - External-debt-to-exports ratio (in percent): 185.8, 165.9, 165.2, 185.7, 182.5, 207.0, 226.8, 224.9, 223.0, 222.5, 223.7 (by year as presented). - Key macroeconomic assumptions excerpt: - Real GDP growth (in percent) historical and projections: 9.2, 8.8, 2.1, 4.2, 2.9, 4.3, 4.4, 3.8, 3.8, 3.4, 3.5, 3.5, 3.5 (as table rows indicate). - Nominal external interest rate (in percent): 2.0, 1.8, 1.9, 1.7, 1.5, 2.5, 0.9, 1.3, 2.5, 3.3, 3.9, 4.2, 4.3. ### Annex III. Public Debt Sustainability ### Summary and baseline outlook - Turkey’s public debt: - At about 32 percent of GDP (measured as general government gross debt according to Maastricht criteria), Turkey’s public debt ratio is well below its historical ten-year average. - Gross public sector financing needs have declined significantly and will remain low over the medium term. - The DSA suggests that Turkey’s government debt is sustainable even under different shock scenarios. - Debt structure: - Average maturity of 6.4 years. - 67 percent of total debt at fixed interest rates. - 35 percent of the debt in foreign exchange. - These features imply relatively slow direct interest and exchange rate pass-through to the budget. - Primary risks: - The impact of lower GDP growth rates represents a significant threat to debt dynamics. - High external financing requirements point to risks arising from the external debt position. ### Baseline and realism of projections - Debt-levels: - Staff forecast debt-to-GDP ratio will continue declining, reaching 26 percent in 2020—down by 7.4 pp since end-2014. - Gross public financing needs: 5.1 percent of GDP in 2015, down from 15 percent average for 2005–13. - Growth and yields: - Growth projections similar to 2014–15 levels; output gap roughly closed in 2015 and projected to remain closed. - Spreads against US bonds in the last three months averaged 283 bps. - Effective interest rate forecast to decline from 9.1 percent in 2015 to 8.2 percent in 2016; medium-term effective rates expected to increase due to international rates. - Fiscal adjustment: - Structural primary balance improves slightly in the baseline. - Maximum projected 3-year adjustment of the cyclically-adjusted primary balance is slightly positive. - Maturity and rollover: - Given average maturity of 6.4 years, 67 percent fixed-rate debt, and 35 percent FX-denominated debt, direct interest and exchange rate pass-through to the budget are small. ### Shocks and stress tests - Primary balance shock: - Deterioration of 1.0 pp of GDP in the primary balance for 2 years slows the downward trend of debt-to-GDP ratio relative to the baseline. - Sovereign borrowing costs rise by 25 bps for each 1 percent of GDP worsening in the primary balance. - Impact on debt-to-GDP ratio and gross financing needs by 2021 is modest. - Growth shock: - Real output growth rates lowered by 1 standard deviation, or 4.2 percentage points, for 2 years starting in 2017. - Decline in growth leads to lower inflation (0.25 percentage points per 1 percentage point decrease in GDP growth). - Nominal primary balance deteriorates significantly, reaching -2.6 percent of GDP by 2016 in the scenario. - Debt-to-GDP ratio increases to about 37 percent during the growth shock and then gradually trends down. - By the end of the period, gross public financing needs climb toward 8.5 percent of GDP. - Interest rate shock: - Real effective rate reaches similar levels as in 2009, implying a permanent increase in spreads by about 400 bps. - Government’s implicit average interest rate climbs to 14.1 percent by 2021. - Debt-to-GDP ratio remains at low levels below 30 percent; gross public financing needs increase but remain below 8 percent of GDP by 2021. *International Monetary Fund. Annexes I–III as presented in the IMF staff report excerpts.* ### 9. Contingent liability shock. A one-time bail out of the financial sector is assumed to increase ### _cr16104 - 9. Contingent liability shock. A one-time bail out of the financial sector is assumed to increase ### Contingent liability shock: description and direct fiscal impact - A one-time bail out of the financial sector is assumed to increase non-interest expenditures by 10 percent of banking sector assets. - The shock is equivalent to 4.8 percent of GDP. - The contingent liability shock could be seen to cover (a combination of) other contingencies, part of which could be a bailout of PPP projects or loan guarantees: - PPP projects with treasury investment guarantees amount to 0.9 percent of GDP. - Treasury guaranteed loans (outside the general government) amount to 1.4 percent of GDP. - Loan subject to debt assumption amount to 1.1 percent of GDP. ### Macroeconomic assumptions combined with the contingent liability shock - The contingent liability shock is combined with a real GDP growth shock (1 standard deviation for 2 years). - Sovereign borrowing costs are pushed up by 25 bps for each 1 percent of GDP worsening in the primary balance. - Inflation declines by 0.25 percentage points per 1 percentage point decrease in GDP growth. ### Fiscal and financing outcomes from the contingent liability shock - Debt rises to 36 percent of GDP in 2018 and then gradually declines. - Gross public financing needs increase to about 8 percent of GDP in the medium term. ### Combined shock: definition and impact - The combined shock incorporates the largest effect of individual shocks on all relevant variables (real GDP growth, inflation, primary balance, exchange rate and interest rate). - For Turkey, a combined shock would increase debt to around 41 percent of GDP, still below the average debt level between 2004 and 2012. ### Selected scenario comparisons (key variables under Baseline, Contingent Liability Shock, and Combined Shock) - Baseline (selected projected values) - Real GDP growth: 3.8, 3.4, 3.5, 3.5, 3.5, 3.5 (2016–2021) - Inflation (GDP deflator): 11.5, 8.6, 7.2, 6.6, 6.3, 6.1 (2016–2021) - Primary Balance: 0.3, 0.9, 1.0, 1.2, 1.3, 1.3 (2016–2021) - Effective interest rate: 8.2, 8.7, 8.7, 8.7, 9.5, 10.1 (2016–2021) - Contingent Liability Shock (selected values) - Real GDP growth: 3.8, -0.7, -0.6, 3.5, 3.5, 3.5 (2016–2021) - Inflation: 11.5, 7.6, 6.1, 6.6, 6.3, 6.1 (2016–2021) - Primary balance: 0.3, -3.3, 1.0, 1.2, 1.3, 1.3 (2016–2021) - Effective interest rate: 8.2, 10.3, 9.1, 8.9, 9.4, 9.9 (2016–2021) - Combined Shock (selected values) - Real GDP growth: 3.8, -0.7, -0.6, 3.5, 3.5, 3.5 (2016–2021) - Inflation: 11.5, 7.6, 6.1, 6.6, 6.3, 6.1 (2016–2021) - Primary balance: 0.3, -0.8, -2.6, 1.2, 1.3, 1.3 (2016–2021) - Effective interest rate: 8.2, 9.1, 9.9, 11.6, 13.2, 14.3 (2016–2021) ### Debt dynamics and stress-test outcomes (high-level) - Under the contingent liability shock debt peaks at 36 percent of GDP in 2018 and then gradually declines. - Under the combined shock debt increases to around 41 percent of GDP. - Gross nominal public debt and public gross financing needs rise under adverse shocks, with public gross financing needs increasing to about 8 percent of GDP in the medium term under the contingent liability shock. ### External sector vulnerabilities and recommended policies (from Annex IV) - Key external metrics and vulnerabilities: - NIIP in 2015: -51 percent of GDP. - Foreign liabilities are in excess of 80 percent of GDP. - Short-term debt and portfolio investments in debt securities account for about 30 percent of GDP. - Gross external financing needs are estimated at over 26 percent of GDP in 2016. - Turkey’s gross reserves fell to 86 percent of the IMF composite adequacy metric at end-2015 (from 95 percent at end-2014). - Adjusting for ROM-related reserve holdings reduces reserve adequacy to 82 percent of the composite adequacy metric at end-2015. - Reserve cover of short-term debt declined to 64 percent at end-2015. - Net reserves available for intervention: US$29 billion at end-2015. - Staff assessments and projections: - Unless the current account (CA) deficit improves substantially, Turkey’s NIIP would continue to deteriorate by some 10 percentage points of GDP in the medium term. - The CAD is estimated to have narrowed to 4.4 percent of GDP in 2015; forecast to widen to 4.5 percent of GDP in the medium term as oil prices recover. - Staff assesses the CA gap in 2015 was in the range of -1 to -3 percent of GDP. - Staff assesses that the REER was overvalued by about 5-10 percent in 2015. - Potential policy responses recommended: - Reducing the CA deficit further is necessary to diminish vulnerabilities. - Monetary policy should keep real interest rates solidly in positive territory. - The CBRT should increase net international reserves, limiting foreign exchange intervention to smoothing periods of excessive volatility. - Structural reforms aimed at increasing private sector savings, including pension reform, are needed to enhance private savings and allow high growth with a sustainable current account deficit. - These reforms should be supported by fiscal policy tightening over the medium term to increase public saving. *Source: IMF staff.* ### Annex VI. Authorities’ Response to Past Policy Recommendations ### Annex VI. Authorities’ Response to Past Policy Recommendations ### Traction of past Fund advice - Authorities and staff agree that the external imbalance should be reduced, and that this should be done while preserving investment. - Authorities and staff concur that lowering inflation is a key objective. - To preserve financial stability, the authorities introduced well-targeted macroprudential measures to slow the rise in household leverage and encourage banks to increase core funding. - Authorities plan to tackle structural issues through the 10th Development Plan. - Authorities believe risks are lower than what Staff believes and that the economy has enough buffers to withstand reasonable shocks. - Consequently, fiscal and monetary policies would remain more accommodative than recommended by staff. ### Fund relations — key institutional and financial facts (Data as of January 31, 2016) - A three-year SDR 6,662.04 million (691.1 percent of quota) Stand-By Arrangement was approved in May 2005 and expired on May 10, 2008. Cumulative purchases amounted to SDR 4,413,601,500. - There is no outstanding Fund credit as of January 31, 2016. - Membership Status: Turkey became a member of the Fund on March 11, 1947. Turkey has accepted the obligations of Article VIII, Sections 2, 3, and 4 as of March 22, 1990. - General Resources Account: - Quota: 1,455.80 SDR Million (100.00 percent Quota) - Fund holdings of currency: 1,343.03 SDR Million (92.25 percent Quota) - Reserve position in Fund: 112.78 SDR Million (7.75 percent Quota) - SDR Department: - Net cumulative allocation: 1,071.33 SDR Million (100.00 percent Allocation) - Holdings: 966.12 SDR Million (90.18 percent Allocation) - Latest Financial Arrangements (in millions of SDRs): - Stand By 05/11/05–05/10/08: Amount Approved 6,662.04; Amount Drawn 4,413.60 - Stand By 02/04/02–02/03/05: Amount Approved 12,821.20; Amount Drawn 11,914.00 - Stand By 12/22/99–02/04/02: Amount Approved 15,038.40; Amount Drawn 11,738.96 - Of Which: SRF 12/21/00–12/20/01: Amount Approved 5,784.00; Amount Drawn 5,784.00 - Projected Payments to the Fund (forthcoming; in millions of SDRs): - 2016–2020 Principal: --; Charges/Interest each year: 0.07; Total each year: 0.07 - Safeguard Assessments: An assessment of the central bank’s safeguards framework was completed on June 29, 2005; recommendations in internal audit and controls have been implemented. - Exchange Rate Arrangement: Turkish lira; de jure arrangement free floating; de facto arrangement floating. - Article IV Consultations: Last staff report IMF Country Report (14/329) issued December 5, 2014; Board discussion November 21, 2014. ### Recent technical assistance highlights (select) - STA January 2016: Compilation system for independent annual estimates of GDP. - FAD/MFD February 2005: Treasury cash management and state bank reform. - MFD 2005–06 (several missions): Inflation targeting and monetary policy implementation. - Multiple missions across 2005–2014 on income tax reform, revenue administration reforms, national accounts, stress testing, monetary and financial statistics, government finance statistics, and public sector debt statistics. ### World Bank relations — strategic engagement and financing (summary) - Turkey’s National Development Plans (Ninth 2007–13 and Tenth 2014–18) form the basis of the partnership with the World Bank Group. - Current CPS delivered financing of over US$9.3 billion during FY12–16: - US$4.3 billion through IBRD - US$4.0 billion through IFC - US$982 million through MIGA - IBRD: 10 projects with total net commitments of US$3.92 billion (as of February 2016). - IFC: Portfolio around US$3.43 billion; in FY15 IFC invested US$1.8 billion; FY15 commitments included US$1.3 billion in equity and long-term loans across 28 projects and US$530 million in short-term trade finance. - MIGA: Turkey represents about 7.0 percent of MIGA’s gross portfolio; in first half of FY16 MIGA’s portfolio in Turkey was 8 projects with gross exposure of US$918 million (US$425 million net of reinsurance); under CPS MIGA delivered approximately US$982 million to Turkey. - Trust funds: Turkey trust fund portfolio consists of 39 trust funds amounting to US$256 million, with US$190 million from the Clean Technology Fund (CTF). ### Statistical issues — data adequacy and quality (As of February 22, 2016) - General: Data provision broadly adequate for surveillance, with shortcomings in national accounts and government finance statistics. - National Accounts: - Quarterly national accounts published with a 2–3 month lag. - TURKSTAT compiles quarterly GDP by production and expenditure approaches, in current prices and in volume terms. - Main weaknesses: lack of annual benchmarks and reliance on fixed ratios from 2002 Supply and Use Tables (SUTs). - TURKSTAT is implementing a regular compilation system for independent annual estimates of GDP and for quarterly GDP benchmarked to annual data. - By June 2016, TURKSTAT will disseminate new series of national accounts—both annual and quarterly—covering 2009–14 based on 2008 SNA/ESA 2010. - Sectoral financial balance sheets compiled for financial corporations quarterly; for general government and nonfinancial corporations annually; financial accounts for households and rest of the world not yet disseminated. - Price Statistics: - CPI and PPI generally conform to international standards. - CPI does not cover owner-occupied dwellings, commodities produced by households for own consumption, and expenditures on commodities obtained through in-kind payments. - PPI compiled only by product (not by economic activity). - Government Finance Statistics: - Coverage of the budget largely complete; some extra budgetary funds data available only with long lags. - Quasi-fiscal operations by state banks, SOEs, and other public entities complicate fiscal analysis. - Latest data available for Government Finance Statistics Yearbook are for 2012 covering general government sector. - Monthly cash-basis budgetary data and quarterly accrual-basis general government data reported irregularly for publication in IFS starting September 2009. - Monetary and Financial Statistics: - CBRT reports monetary statistics using standardized report forms consistent with the IMF’s Monetary and Financial Statistics Manual. - BRSA reports all 12 core FSIs and nearly all the encouraged FSIs. - External Sector Statistics: - Compiled in broad conformity with BPM6. - Data Standards and Quality: - Turkey subscribes to the Special Data Dissemination Standard (SDDS) since 1996. - Latest Data ROSC published September 2009. ### Selected macroeconomic developments and authorities’ observations (Statements by Mr. İbrahim Çanakçı and Mr. Cem Gökçen, March 25, 2016) - Growth: - Economy expanded by 4 percent in the third quarter of 2015. - Leading indicators suggest the 2015 growth figure will be around 4 percent. - Employment: 0.8 million new jobs were added in the last 12 months; total increase in employment has reached 6.9 million since its trough in 2009. - Inflation: - Consumer prices edged up by 8.8 percent (year-on-year) at 2015 year-end. - Unprocessed food price inflation posted a 13.9 percent annual increase. - Headline inflation recently fell by 0.02 percent (month-on-month) in February 2016. - Measures to curb food prices: Food and Agricultural Products Markets Monitoring and Evaluation Committee founded December 2014; Ministry of Food, Agriculture, and Livestock set a ceiling on red meat prices and left open the option of meat imports. - External sector: - Current account deficit narrowed to US$ 32.1 billion in 2015, from US$43.6 billion in 2014. - Exports declined by 8.7 percent in 2015. - Contributing factors to narrower current account: slowdown in consumer loan growth and shift in loan composition from consumer to commercial loans following two rounds of macroprudential measures, contributing to import contraction. *Annex VI. Authorities’ Response to Past Policy Recommendations — IMF staff report content (selected excerpts).* ### 14.4 percent. Plunging global commodity prices were also supportive of the external ### _cr16104 - 14.4 percent. Plunging global commodity prices were also supportive of the external ### External financing and reserves - Turkey continued to attract sizable resources to fund external financing needs even during times of stress, as evidenced by favorable rollover ratios. - Net FDI covered around 36 percent of the current account deficit in 2015. - External financing tilted towards longer-term resources with the help of MPMs, while portfolio and short-term fund flows weakened. - The CBRT provided off-market foreign exchange to energy-importing state-owned enterprises (SOEs); FX sales to SOEs reached US$ 11 billion in 2015. - Total liquidity provided through FX auctions was around US$ 12 billion in 2015. - Export rediscount credits helped propel reserve accumulation by US$15 billion in 2015 and will continue to support reserve buffers. - The FX demand of energy-importing SOEs and private companies is expected to decline in the coming months, driven by favorable energy prices. ### Macroeconomic outlook - The revised Medium-Term Program 2016-2018 (MTP) aims to promote strong and inclusive growth, ensure macroeconomic stability, tame inflation, and reduce external imbalances. - Authorities expect GDP growth to accelerate to 4.5 percent in 2016 and to rise to 5 percent in 2017-18, surpassing staff’s estimates. - Staff projects more modest growth due to different assumptions on the effectiveness of structural reforms and holds a constant labor force participation rate for medium-term projections. - Staff’s model excludes an education variable; the authorities argue increased education and active labor market policies can raise labor force participation and potential growth beyond staff’s estimates. - Staff projects the elasticity of Turkey’s growth rate with respect to global growth will decline to 0.9 percent during 2016-2020, from 1.2 during 1980-2014—authorities find this difficult to justify in a low energy price environment. - Inflation: CBRT expects inflation to register a slight decline to 7.5 percent in 2016, gradually converging to the target in 2018. - Current account deficit: projected to shrink to 3.9 percent of GDP in 2016 and to 3.5 percent of GDP by 2018. - Total domestic savings rate expected to reach 17.8 percent by 2018, a 3-percentage point increase compared to the 2015 level. - Gross international reserves are expected to stabilize supported by export rediscount credits and reduced FX demand. ### Fiscal policy - Fiscal prudence remains central; central government budget deficit fell to 1.2 percent of GDP in 2015, while the general government budget remained balanced. - The 2016 central government budget is designed to bolster growth potential, raise domestic savings, and curtail inflation. - Around 19 percent of the budget (or 24 percent of tax revenues) will be allocated to improve education quality and competitiveness. - Central government budget deficit expected to widen slightly to 1.3 percent of GDP in 2016 to accommodate rising public spending associated with the minimum wage hike and electoral promises. - Central government budget deficit projected to fall to 1.0 percent of GDP in 2017 and to 0.8 percent in 2018. - EU-defined general government debt stock projected to drop to 29.5 percent of GDP in 2018. - Authorities determined to adopt a new income tax law broadening the income tax base for salary earners and the property tax base and simplifying tax code implementation. - Contingent liabilities remain limited; risks associated with realization of all contingent liabilities under a stress scenario would be manageable. ### Monetary policy - CBRT maintained a tight monetary and liquidity stance in 2015; liquidity policy and effective cost of funding are important complements to the policy rate. - Interest rate corridor was asymmetric with O/N lending rate at 10.75 percent, one week repo rate (policy rate) at 7.5 percent, and O/N borrowing rate at 7.25 percent. - Average funding rate was around 7.8 percent in March 2015 and peaked at 9.1 percent in early February 2016. - CBRT regards financial conditions as tight when taking all tools into account. - In August 2015 CBRT unveiled a roadmap to simplify the monetary policy framework and strengthen financial stability; some liquidity management changes were implemented (TL and FX liquidity side adjustments). - Remuneration rates on TL required reserves were hiked by 150 basis points (cumulative) between September-December 2015. - Simplification of the framework was postponed due to heightened global financial market volatility; simplification will resume once global volatility subsides. - CBRT intends to maintain a flexible approach and a tight policy stance to keep inflation in check. ### Financial sector policies and corporate sector resilience - Turkish banking system is well-capitalized with strong liquidity buffers and asset quality; capital adequacy ratio around 15.6 percent remained well above the regulatory minimum. - Total non-performing loan ratio was stable; slight uptick in consumer loan credit cards and SME loans. - Risk weights on consumer loans remained well over Basel III norms and, with other MPMs, significantly helped contain consumer loan growth. - 13-week annualized rate of consumer loan growth slowed to 3.6 percent in 2015; the lowest reading since 2010. - Commercial loans posted higher growth rates, supporting external rebalancing. - Required reserve ratios on banks’ non-core FX short-term liabilities were raised to promote maturity extension and use of core liabilities. - CBRT lowered its FX lending rate to commercial banks by cutting foreign exchange deposit interest rates by 475 basis points to 2.75 percent in US dollars, and 525 basis points to 1.25 percent in euro. - Banking sector’s average FX liquidity coverage ratio currently stands at around 145 percent. Banks can tap deposits with the CBRT under reserve option mechanism and FX reserve requirements if adverse scenarios unfold. - Authorities view the revision in risk weights as transition to a more effective macroprudential measure rather than relaxation of MPMs; changes effective as of the end of March 2016. - Authorities plan to adopt a “debt-to-income ratio” as a new MPM to replace more costly measures on consumer credits once data collection improves. - Corporate sector FX risk mitigants: - Most firms with FX liabilities are hedged or have a natural hedge via FX revenues or intra-group receipts. - FX loans concentrated in large companies capable of absorbing depreciation impacts. - Corporate sector has net FX long position in the short term. - Around 75 percent of FX borrowing is long-term. - Offshore FX assets held by firms act as a buffer. - Share of FX loans in corporate loan volume is falling as companies shift to TL financing. - Nearly two-thirds of non-financial corporate sector’s FX liabilities provided by domestic banking sector; strengthening bank FX risk management will help contain NFC vulnerabilities. - Amendments to the Turkish Corporation Tax Code allow companies to deduct 50 percent of the interest amount calculated over the cash capital increases of the paid-in capital from the corporate tax base. - Staff analyses of NFC balance-sheet scenarios should be clearly presented as hypothetical and interpreted with caution due to data gaps on NFC assets. ### Structural reforms - Strong political ownership and resolve to implement comprehensive structural reforms to improve competitiveness, resilience, and address impediments to job creation and investments. - Building blocks of the reform agenda: - Sectoral and micro-reforms unveiled in the 25 transformation programs in the context of 10th Five-Year Development Plan. - Structural reforms in labor market, business environment, public administration and finance, judicial and education systems. - The EU accession process. - Reform Coordination and Monitoring Council established in December 2015 and met 9 times; actions with 3-month, 6-month, and 1-year deadlines identified and announced. - Among actions with 3-month deadlines, 10 out of 20 reform actions completed in the first two months of 2016, including: - Financing of machinery and equipment investments in manufacturing industry exempt from the Banking and Insurance Transactions Tax. - Istanbul Arbitration Center established. - Parliament adopted the trade facilitation agreement. - Regulations broadening activities of private employment agencies and temporary employment finalized in line with EU norms and standards. - Secondary legislations for dowry and housing accounts adopted. - Impediments to part-time employment of university students eliminated. - Labor market and inclusive growth measures include: - Draft law on flexible modes of employment (temporary employment, remote working) accepted by the relevant Committee of the Parliament. - Maternity leave and other benefits for women further improved. - Parents with children under school age given option to work part-time earning half their salaries until children start elementary school. - Young entrepreneurs exempt from income tax for three years (up to TL 75,000 annual income). - Salaries of young workers entering the job market after completion of “on-the-job training programs” financed from the budget up to one year (previously capped at 6 months). - Authorities considering automatic enrollment in the second pillar and a severance pay reform to boost savings; a draft automatic enrollment scheme prepared. ### Syrian refugees - Turkey has adopted an open-door policy and hosts around 2.7 million Syrian refugees, the largest refugee-hosting country. - Turkey has spent over US$ 10 billion on refugees since 2011. - Significant efforts funded to establish high-standard refugee camps and essential public services, including education and health. - Authorities recently granted work permits to refugees under temporary protection to integrate them into the labor market. - Turkey and the EU have intensified cooperation to manage the refugee crisis. ### Conclusion and assessment - Turkish economy continues to grow at relatively robust rates, with the external deficit shrinking. - Fiscal prudence and sustainable debt prospects support resilience and contributed to confirmation of Turkey’s investment grade rating. - CBRT plans to simplify the monetary policy framework once there is a visible drop in global volatility. - Government committed to pursuing a comprehensive structural reform agenda within established timelines; macro-policy coordination and reform implementation mechanisms are in place. - Authorities have a wide range of instruments to manage risks; taking these factors into account, Turkey’s proven resilience to shocks in recent years is expected to continue. - Authorities contend the Staff Report could have put more emphasis on pockets of strength and mitigating factors; some staff scenario and box analyses should be clearly labeled as hypothetical and interpreted with caution. *Source: _cr16104 - 14.4 percent. Plunging global commodity prices were also supportive of the external* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16104.pdf_