Turkey: How To Boost Growth Without Increasing Imbalances

Isabel Rial, Suchanan Tambunlertchai, Alexander Tieman

January 13, 2014

(Version in Türk)

Actual and Current Trend accountTurkey has received well-deserved praise for its growth performance over the last decade. Yet along with this success story has come a steady widening of the current account deficit, projected to come out at 7.4 percent of GDP in 2013. The counterpart of this deficit is a reliance on external financing, much of which is of a short-term nature, highlighting the Turkish economy’s main problem at the moment.

The external deficit presents a speed limit to economic growth
In our recent annual review of Turkey’s economy, regression analysis suggests that, barring a significant change in policies or the economic environment, the level of growth consistent with a stable current account is in the 2¾ - 3½ percent range. In other words, growth above this speed limit would lead to a wider current account deficit. This is why we argue that policies should aim at reducing the external deficit, as otherwise growth of 4 to 5 percent per year is unlikely to be sustainable.

This speed limit can change
Raising domestic savings – both public and private – would lower Turkey’s dependence on external financing and hence its current account deficit. Policies should aim to improve competitiveness further through structural change. At the same time, monetary policy should tackle persistently above-target inflation that chips away at Turkey’s competitiveness through real exchange rate appreciation.

These are reforms that will take considerable time to bear fruit. Meanwhile, it will be important for the government to maintain flexibility in the budget. This will help cushion the volatile economy by enabling officials to adjust spending and taxation to the economic cycle.

Policy recommendations to enable faster growth

Expenditure composition

Likewise, growing primary expenditure rigidities could undermine hard-won fiscal discipline. In fact, while Turkey has over-performed in terms of overall fiscal targets in the past, officials have systematically exceeded spending ceilings set in the medium-term fiscal plan, exposing weaknesses in public financial management practices.

Policies for a flexible budget

To preserve a flexible budget, Turkey should restrain spending growth and improve existing budgetary procedures. To do so, there are five main policy options the Turkish authorities have at their disposal: contain the public employment growth rate; introduce more flexible public wage indexation mechanisms; renew efforts to reform the pension system; save over-performance in revenues; and undertake a gradual move to a more binding spending ceiling framework, including a mechanism to adjust for past deviations.

A combination of these policies would help the government maintain budget flexibility and hence preserve the fiscal gains achieved over the past decade.

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