Turkey's Economy: A Future Full of Promise, Speech by Anne O. Krueger, First Deputy Managing Director, IMF
IMF News, May 5, 2005
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- Published: May 5, 2005
Overview and context
- Speech delivered at the Istanbul Forum, Istanbul, Turkey on Thursday, May 5, 2005.
- Main objective: review recent accomplishments in Turkey’s economy and outline opportunities and reform priorities to raise potential growth and living standards.
- Emphasis: macroeconomic stability achieved to date as foundation; necessity of continued structural reforms to raise potential growth and secure long-term gains.
Recent achievements
- Economic turnaround since the crisis years of 1999-2001 after a banking crisis and chronic inflation.
- Key performance indicators cited:
- Average real GNP growth over the past three years: close to 8%.
- Real GNP growth last year: just short of 10%.
- Inflation rate three years ago: 70%.
- Current inflation rate: close to 8%; lowest level in 35 years.
- Primary surplus last year: almost 7%, ahead of the government's 6.5% target.
- Ratio of public debt to GNP: has fallen by 30 percentage points of GNP since its 2001 peak.
- Observations:
- Macro- and structural reforms in monetary, fiscal, exchange rate policies, banking system, and public finances have transformed policymaking and strengthened credibility.
- Reforms have cumulative beneficial impact; each reform increases returns to other reforms.
Inflation
- Historical problem: chronic inflation averaged over 60% a year from the 1980s onwards.
- Recent progress:
- Spectacular decline in inflation alongside fiscal consolidation and healthy growth.
- Central Bank has outperformed its end-year target for three consecutive years.
- Policy objective:
- Further reduction of inflation desirable; suggested target range: 2% - 4%.
- Planned introduction of inflation targeting next year expected to facilitate further declines.
- Rationale:
- Low inflation improves resource allocation, decision-making by businesses, convergence with industrial economies, and reduces costs borne disproportionately by the poor.
- Notable textual item to preserve as stated: the global downturn of 2001-2202 is referenced in the speech.
Fiscal policy
- Root cause of past inflation: fiscal imbalances.
- Achievements and current status:
- Large fiscal adjustment undertaken over a relatively short period enabled significant reduction in public debt burden and risk premium.
- External debt is still more than 50% of GNP.
- Gross public debt is over 75% of GNP.
- Large part of public debt indexed to foreign currencies or linked to short-term interest rates.
- Policy priorities:
- Maintain the primary surplus target to enable further reductions in the debt burden.
- Further reduce debt-to-GDP ratio and smooth the debt profile to lower vulnerability to rising worldwide interest rates and exchange rate volatility.
- Observation:
- High primary surplus and declining inflation have not inhibited growth; rather, macroeconomic stability enabled rapid growth.
Structural reforms — priorities and specific areas
- General objective: raise potential growth without fueling inflation; make economy more flexible and market-oriented; enable rapid responses to incentives.
- Financial sector:
- Banking crisis prompted significant reforms: regulatory framework aligned closer to international standards; state banks restructured and recapitalized; banks shifting portfolios away from government paper to expand commercial and consumer lending.
- Government submitted a new Banking Law to Parliament to address weaknesses identified by the Imar Commission Report and to tackle bank intervention and resolution problems observed during the crisis.
- Continued evolution of the financial system is necessary to avoid its acting as a brake on growth.
- Tax and budgetary transparency:
- Reforms to improve budgetary transparency and tax system underway; more envisaged.
- High tax rates and complexity encourage participation in the informal sector.
- Policy tools recommended: streamline and simplify the income tax system, lower tax rates, broaden corporate tax base, improve compliance to reduce distortions and increase revenues.
- Expenditure and social security:
- Pension deficit widened from 2.5% of GNP in 2000 to 3.5% in 2004; on current trends could grow to 7% of GNP over the longer term without further reforms.
- Overall social security deficit (including health expenditures) could be more than double the current 4.5% of GNP in the long run.
- Legislation already submitted to Parliament expected to reduce the annual pension deficit by nearly 1% of GNP over a ten-year period and bring the deficit to below 1% of GNP over the longer term.
- Additional expenditure reforms needed in civil service pay and employment, health and education spending, the judiciary, and government subsidies for farmers to free resources for infrastructure, education, and growth-enhancing spending.
- Privatization and competition:
- Privatization of government assets to improve competition and reduce burden on state sector.
- 2003 Foreign Direct Investment Law noted for leveling the playing field for foreign and domestic investors.
- Investment Advisory Council established in 2004.
- Business climate and regulatory reform:
- Reforms aimed at cutting red tape, improving court system efficiency, aligning business standards with the EU.
- Administrative improvements achieved:
- Opening a business now takes 3 procedures instead of 13.
- Average time to register a business recently cut to less than a week.
- Plans to create a one-stop-shop for business permits.
- Labor market reform:
- Labor market rigidities and high minimum wages discourage hiring and encourage informal sector participation.
- Compliance costs: firms in Turkey must pay 112 weeks wages to lay someone off, compared with 40 for the OECD average.
- Turkey scores poorly on measures such as difficulty of hiring workers and rigidity of working hours.
- Evidence cited: when employers are freer to fire workers, they start hiring; increased flexibility in labor markets seen in countries like the United States, the United Kingdom, Australia and Chile associated with employment gains.
- Policy recommendation: labor market reform to increase wage and price flexibility, encourage hiring, reduce unemployment, raise real incomes, and reduce poverty.
Conclusion and policy implications
- Macroeconomic stability is necessary but not sufficient; ongoing structural reform is essential to maintain competitiveness amid globalization and technological change.
- Timing: favorable—prospects for sustained growth are better than in decades; economic upturns provide an opportune backdrop for reforms because benefits materialize more rapidly and adjustment costs are lower.
- Central message:
- Continue and deepen structural reforms across multiple fronts simultaneously to make past achievements irreversible.
- The payoff: higher growth potential and a more rapid rise in real incomes—benefits within Turkey’s grasp.
- Final exhortation: maintain reform momentum to secure cumulative benefits and broader convergence with industrial economies.
Anne O. Krueger, First Deputy Managing Director, International Monetary Fund — Speech delivered at the Istanbul Forum, Istanbul, Turkey, Thursday, May 5, 2005.