Public Information Notice: IMF Concludes Article IV Consultation with Turkey

August 13, 1998

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On August 6, 1998, the Executive Board concluded the Article IV consultation with Turkey1.


The Turkish economy continues to enjoy robust growth, a manageable external current account deficit, a broadly stable public sector debt ratio, rising official reserves, and access to international capital markets. Nevertheless, chronic high inflation, large fiscal deficits, the sizable open foreign exchange position of banks, and considerable short-term external debt highlight the continued vulnerability of the economy.

The authorities embarked in 1998 on a three-year program designed to reduce 12-month wholesale price inflation from 91 percent at end-1997 to 50 percent by end-year, 20 percent by end-1999, and single digits by 2000. Underpinning this effort is a strong increase in the primary fiscal surplus, a surge in privatization proceeds that will be used in part to retire debt, and close coordination between monetary and fiscal policy. The authorities’ program includes measures to address inflation inertia by moving from backward to forward indexation in the setting of public sector wages and agricultural support prices, as well as measures to improve tax administration, reduce agricultural subsidies, initiate an improvement in the finances of the social security system, and strengthen the banking sector.

A sharp improvement in the primary fiscal surplus from near balance in 1997 to 4.1 percent of GNP in 1998 and 4¾ percent in 1999 is the linchpin of the disinflation effort. In addition, the authorities are seeking to reduce the interest burden by building credibility for their program; increasing the share of inflation indexed securities to as much as 30 percent of new debt issues; and retiring debt through accelerated privatization, with at least US$2 billion (1 percent of GNP) in privatization proceeds to be used for debt reduction in 1998 and US$3 billion in 1999.

Monetary policy in the past has been geared mainly to providing the liquidity needed by the economy while preserving export competitiveness by maintaining a broadly stable real exchange rate. In the first half of 1998, the central bank intervened massively to sterilize a surge in capital inflows attracted by high domestic interest rates and the prospect of falling inflation, and keep reserve money growth below its preannounced target range. To reduce the incentive for capital inflows, the central bank announced at end-June that it would shift its monetary policy target from reserve money to a ceiling on its net domestic assets, intervene less actively in the interbank market to allow interest rates to fall and become more variable, and align the rate of lira depreciation with the 50 percent end-year inflation target, following the small real depreciation registered in the first half of the year. To further discourage capital inflows, the authorities also announced a phased reduction of the ceiling on banks’ net open foreign exchange positions.

Initial results under the program have been positive. There has been a major strengthening of fiscal policy in the first half of 1998 and good progress on privatization. Wholesale prices rose by 26.4 percent in the first half of 1998, some 10 percentage points less than in the corresponding period of the previous year, slowing inflation to 77 percent (yoy) by end-June (90 percent in the case of the CPI). Interest rates remained high in early 1998, but have begun to decline since.

The authorities have detailed their program in a Memorandum of Economic Policies that was widely disseminated at end-June, and have requested that IMF staff monitor its implementation through a Staff-Monitored Program for a period of 18 months through end-1999, to which IMF management agreed. A staff-monitored program is an informal agreement between national authorities and IMF staff to monitor the implementation of an economic program belonging to the authorities and considered by the IMF’s management and staff to be capable of achieving its targets if consistently implemented; such a program does not require nor imply endorsement by the IMF Executive Board. The monitoring will cover, inter alia, the achievement of quarterly targets for major economic variables.The authorities have stated that they would release the results of the staff’s quarterly reviews, as part of their commitment to transparency.

There are data weaknesses arising from the complex system of public sector accounts and inconsistencies between the fiscal, monetary, and external accounts, and between the external accounts and the national accounts. The interpretation of the external accounts is complicated by uncertainties surrounding the measurement of shuttle trade and the incompleteness of the external debt data.

Executive Board Assessment

Executive Directors observed that for the third successive year the Turkish economy had maintained rapid growth, a manageable external current account deficit, broadly stable debt ratios, rising foreign reserves, and access to international capital markets, despite a very large fiscal deficit and chronic high inflation. They viewed this performance as commendable, but also as eventually unsustainable.

Directors therefore welcomed the Turkish authorities’ decision to embark on a three-year effort to reduce inflation to single digits by the year 2000, although several Directors noted that a bolder approach would have been preferable. Directors commended the authorities on the results already achieved in lowering inflation during the first half of 1998. They also welcomed the authorities’ initiative in the context of the staff-monitored program to prepare and widely disseminate a Memorandum on Economic Policies that describes their economic program; this should help in program implementation.

Directors in general stressed that realizing in full the aims of the authorities’ program would require a strong and sustained fiscal effort, closer coordination of fiscal, monetary, and wage policies, stepped-up privatization, and well-conceived structural reforms, with particular emphasis on social security and the banking sector. Directors therefore emphasized the need for the steadfast implementation of announced measures, but several Directors noted that stronger policies may be needed.

Directors noted that, at the authorities’ request, Fund staff would monitor the implementation of the policies set forth in the Memorandum on a quarterly basis through end-1999, and that these quarterly staff assessments would be made public by the Turkish authorities. They welcomed the added transparency that this monitoring procedure would bring.

Directors stressed that fiscal consolidation was the linchpin of the disinflation effort. The large increase in the primary fiscal surplus targeted in 1998, and the further widening of the surplus targeted in 1999, were needed to help overcome the bulge in interest payments expected in those years, and to reduce inflationary expectations. Achievement of the targeted primary surpluses would require continued improvements in tax administration and primary expenditure restraint. In this regard, Directors welcomed the recent passage by parliament of tax reform measures designed to strengthen tax administration and cut collection lags, but encouraged the authorities to delay rate reductions if collections fell short of target.

Directors considered that the stated intention to adjust public sector wages and agricultural support prices on a forward-looking basis was critical to lowering inflationary expectations and interest rates. They therefore expressed serious disappointment and concern at the recent decision to increase public sector salaries by more than the programmed amount. This decision would not only have a direct inflationary effect, but was also certain to hurt the credibility of the program.

Directors encouraged the authorities to hold fast to the principle of forward-looking indexation in preparing the budget for 1999. Noting that agricultural subsidies continued to weigh heavily onthe budget, Directors also suggested that agricultural support prices and fertilizer and credit subsidies be reduced.

Directors considered that the disinflation strategy would have scant chance of success unless slippages in policy implementation were promptly offset, signaling respect for the overall budgetary constraints and maintaining the credibility of the program. Directors suggested that contingency measures should be identified, which could include delays in planned reductions in income tax rates and reductions in exemptions, as well as intensified structural reform efforts beyond those envisaged in the program, notably in the area of social security.

Directors welcomed recent progress in privatization and encouraged the authorities to meet their ambitious privatization targets and to devote the resources so raised primarily to retiring debt. To this end, Directors urged the authorities to speed the judicial review of asset sales, permit international arbitration, and establish soon an appropriate regulatory framework for the telecommunications and energy sectors. They welcomed the recent move to international pricing for petroleum products, as this would facilitate privatization of the oil refining and petrochemical sectors. Several Directors noted that progress in privatization would also help attract foreign direct investment to Turkey.

Directors thought that the strengthening of the fiscal position within the framework of the staff-monitored program permitted a realignment of monetary policy more firmly in support of disinflation. Most Directors endorsed the decision to manage the exchange rate more actively with a view to achieving the announced inflation targets even if this would mean accepting a small real appreciation, as Turkey’s external position and export performance appeared strong. However, in the context of a more bold program than presently envisaged, a few Directors would see advantages in using an exchange rate peg as a nominal anchor. Directors also considered it appropriate for the Central Bank to focus on limiting the expansion of its net domestic assets, and to counter capital inflows by allowing interest rates to fall. In this context, Directors considered the proposed reduction in the ceiling on banks’ net open foreign exchange positions to be a positive step that would help curb capital inflows and reduce banking sector risk.

Directors observed that macroeconomic instability had increased banking sector risk, while high inflation had masked inefficiency. They urged that prudential limits be vigorously enforced and progressively tightened, and that an independent supervisory board with clearly-defined powers to strengthen supervision, improve reporting requirements, and enforce prudential requirements free from political interference, be established promptly. Directors also underscored the need to place the operations of the state banks on a commercial footing and to work toward their privatization.

Directors urged the authorities to undertake a comprehensive reform of the social security system designed both to ease the immediate fiscal burden and to put the system on a sound medium-term footing. Noting that the Turkish economy simply could not afford the present social security system, they urged the authorities to move quickly to raise the minimum retirement age to about 60 years, extend the minimum contribution period substantially,lengthen the reference period for calculating benefits, and improve the administration of the system.

Directors noted that there were important data weaknesses arising from the complex system of public sector accounts and inconsistencies across macroeconomic accounts, and urged a major effort to improve the consistency and coverage of key economic data.

Turkey: Selected Economic Indicators

  1994 1995 1996 1997 1998

Real economy (Change in percent)
Real GNP -6.1 8.0 7.1 8.0 4.5
Domestic demand -8.4 6.1 10.0 9.3 5.0
CPI (end-of-period) 125.5 78.9 79.8 99.1 55.0
WPI (end-of-period) 149.6 64.9 84.9 91.0 50.0
Unemployment rate (in percent) 8.1 6.9 6.0 6.4 ...
Gross national savings (in percent of GNP) 18.8 19.9 22.0 20.4 20.2
Gross domestic investment (in percent of GDP) 21.4 25.2 23.4 25.0 25.0
Public finance (In percent of GNP)
Consolidated budget balance -4.0 -3.8 -8.5 -7.5 -7.6
Primary consolidated budget surplus 3.7 3.3 1.7 0.1 4.1
Public sector borrowing requirement 9.6 5.8 11.4 11.6 10.4
Central government debt 43.5 35.6 37.6 36.3 35.4
Money and credit (End-year, percent change)
Broad liquidity 1/ 135.2 105.2 115.4 116.1 109.1 2/
Reserve money 3/ 120.8 79.2 91.5 100.8 78.5 4/
Credit to private sector 69.8 137.4 136.1 126.5 ...
Interest rates (Year average)
T-bill rate 5/ 160.7 125.8 132.4 105.2 108.6 6/
Overnight money market rate 591.7 108.2 115.8 101.4 ...
Balance of payments (In percent of GNP)
Trade balance -3.2 -7.7 -10.8 -10.9 -10.7
Current account balance 7/ 2.0 -1.4 -3.0 -2.5 -2.7
External debt 49.6 43.1 43.2 45.5 ...
Of which: short term 8.5 9.2 11.1 11.9 ...
Reserves (US$ mllion, end-of-period) 8,561 13,812 17,695 19,575 27,533 8/
Fund position (as of June 30, 1998)  
Holdings of currency, 154.4 percent of quota; Holdings of SDRs, SDR 1.94 million; Quota, SDR 642 million
Exchange rate  
Exchange rate regime and rate Managed float; TL 265,050 per US$ on June 30, 1998
Real effective rate (1990=100) 80.3 85.7 87.7 93.4 ...

Sources: Information provided by the Turkish authorities; and IMF staff estimates.

1/ Includes foreign currency deposits and repos
2/ 12-month change through May
3/ Excluding banks' foreign currency deposits at the central bank
4/ 12-month change through June
5/ Simple average across maturities, net of tax
6/ January–June
7/ Central bank current account data differ from national accounts data
8/ At end-June 1998.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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