## IOverview

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### Transformation since the 2000–01 crisis
- Almost five years after the 2000–01 economic crisis, the fortunes of the Turkish economy have been transformed.
- The economy has grown rapidly for three successive years.
- Inflation has fallen from 70percent at the end of 2001 to single digits.
- Both nominal and real interest rates have dropped sharply.
- The government debt ratio has fallen significantly, improving prospects for debt sustainability.
- The analysis is based on data available as of July 2004.

### Growth performance and prospects
- Improving Turkey’s growth performance has been a key objective of the 2001–04 reform program, through both macroeconomic stabilization and structural economic reform.
- Recent performance has been slightly better than the world average, especially since 1980, mainly because of increased openness to trade, financial market liberalization, and broader economic reform efforts.
- A key factor holding back growth and increasing volatility has been the lack of discipline in fiscal, monetary, and financial policies.
- The analysis suggests Turkey has the potential to grow at a rate similar to those of the East Asian economies.
- The recent decline in inflation should help boost the growth rate in the future.
- Maintaining policy discipline and ongoing structural reforms will be essential to sustain high growth and reduce volatility.

### Inflation dynamics and expectations
- Reducing high and persistent inflation has been a focus of reform policies aimed at enhancing Turkey’s medium-term economic performance.
- Inflation first took off in the 1970s, peaking at more than 100 percent with the second oil price shock, and then rising again in the mid-1990s.
- Much of the persistent inflation was self-fulfilling: the inflation process was driven more by expectations of future high inflation than by formal backwards indexation.
- Fiscal policy is a key determinant of inflation expectations.
- The reform program’s focus on generating sustained, high primary surpluses has been central to the success of disinflation.

### Balance sheet developments and vulnerabilities
- Preexisting balance sheet weaknesses in the financial and corporate sectors contributed to Turkey’s propensity to fall into crisis.
- These weaknesses were magnified by the depreciation of the Turkish lira in 2001 and the increase in interest rates during the crisis.
- Private sector balance sheets have been restored in part because of the economic recovery and success in macroeconomic stabilization.
- Some vulnerabilities have been transferred to the government, which has taken on greater foreign currency and interest rate risk.
- Despite improvements, Turkey remains vulnerable while dollarization remains extensive.
- Continued low inflation is needed to encourage demand for lira-denominated assets and reduce vulnerabilities.

### Public debt, sustainability, and debt management
- The weakness of the government’s balance sheet has been a source of instability.
- The reform program has stressed ensuring debt sustainability and improving debt structure.
- Turkey’s external debt ratio is well above levels considered safe for emerging markets.
- High public debt raises concerns about fiscal dominance of monetary policy, which could undermine inflation reduction efforts.
- Improving the government balance sheet depends on reducing government debt; achieving this will take many years.
- Effective debt management is essential to ensure safe rollover and greater resilience to shocks.
- Chapter VI reviews authorities’ debt management strategy and gauges success in matching investor needs, widening the investor base, deepening liquidity of benchmark bonds, and improving Treasury risk management.

### Fiscal adjustment: achievements and risks
- Fiscal adjustment and sustained primary surpluses are essential to reduce government debt.
- Chapter VII finds Turkey’s fiscal adjustment since 2000 has been impressive and marks a significant break with past performance.
- There is a risk that primary surpluses will revert to lower levels predicted by cross-country analysis.
- Structural fiscal reforms will be needed to sustain the adjustment.
- Chapter VIII finds the adjustment since 2000 has relied mainly on tax increases.
- Spending on investment has been cut, offset by increased current expenditure.
- Based on other countries’ experience, such an adjustment could prove difficult to sustain.
- Redirection of adjustment toward cuts in current spending, and less reliance on temporary tax increases, would help make the fiscal adjustment easier to sustain.
- Emergence of a stronger and more disciplined government, and efforts to curtail quasi-fiscal operations in state enterprises and extra-budgetary funds, should help sustain adjustment.

### Financial sector reform and bank restructuring
- Reform of the financial sector has been central to the program to prevent recurrence of precrisis weaknesses and to foster increased lending and recovery in the real sector.
- Reforms included restructuring state banks and recapitalization of private banks.
- The strategy has largely succeeded in strengthening the banking system and maintaining depositor confidence.
- Asset recovery and resolution of intervened banks have been slow, increasing the costs of the crisis.
- Further reforms are needed to enhance the effectiveness of banking supervision and asset resolution.

### Labor market developments and challenges
- Recent developments include low employment rates, increased unemployment, and low labor force participation rates, especially for women.
- Increases in labor productivity have helped maintain competitiveness and reduced pressures on inflation, but at the cost of weak employment growth.
- Compliance costs of recent statutory employment protection legislation are more than twice the average of OECD nations.
- New regulations have entrenched a dual labor market structure, making it harder for new entrants to find work in the formal sector.
- Labor market reform may be needed to ensure improved growth translates into reduced unemployment.

*Prepared by a team led by Reza Moghadam; authors include Oya Celasun, Xavier Debrun, Mark Griffiths, Mats Josefsson, Christian Keller, Christoph Klingen, Chris Lane, Cheng Hoon Lim, David Marston, Donal McGettigan, Ashoka Mody, Ernesto Ramirez Rigo, Martin Schindler, and Mathew Verghis. Analysis based on data available as of July 2004.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-publications/external/pubs/nft/op/242/_op242.pdf_