November 19, 2007
MS. GAVIRIA: Good day, everyone. I'm Angela Gaviria with the External Relations Department of the IMF. I'm happy to welcome you to this conference call on the staff reports for Turkey's 2007 Article IV Consultation and Sixth Review Under the Stand-by Arrangement. These documents were published on Friday afternoon, and I hope you have had a chance to look at them.
Here with me is Lorenzo Giorgianni, Division Chief in the European Department and Mission Chief for Turkey. He will be reading brief remarks and then he'll be happy to take your questions. Let me remind you that this conference call is embargoed until 11:00 a.m. Washington time. Lorenzo, please.
MR. GIORGIANNI: Thank you.
As Angela just said, last Friday, we issued a set of documents including the staff report for the Sixth Review Under the Stand-by Arrangement and the staff report for the 2007 Article IV Consultation. In my opening remarks, I will focus mainly on the messages of the 2007 Article IV Consultation staff report, but of course I'll be happy to take questions on the other documents as well.
The 2007 Article IV Consultation staff report takes a fresh look at the Turkish economy and lays out a roadmap of reforms to raise potential growth in a durable way.
Since the 2001 crisis, Turkey has enjoyed a truly remarkable economic revival to the benefit of all its citizens. Growth has averaged over 7 percent, which is well above historic norms. Inflation has been brought down to the single digits for the first time in 35 years, and foreign direct investment has risen to unprecedented levels.
Private and public balance sheets have strengthened considerably. Public debt ratios have been cut in half, and banks are now enjoying high profitability and comfortable capital buffers. Not surprisingly, financial markets have responded favorably to these developments with stock prices reaching record highs.
There is no doubt that this success owes much to the sound fiscal and monetary policies and structural reforms embraced by Turkey over the last few years and supported by the Stand-By Arrangements with the IMF.
This strong economic performance, however, cannot and should not be taken for granted. In fact, economic growth has moderated to 5-5½ percent since mid-2006, while inflation remains well above the 4 percent official target. At the same time, fiscal performance has deteriorated considerably in 2007, making disinflation more reliant on high interest rates, and the fiscal-monetary policy mix less supportive of improvements in the external current account position, which is Turkey's Achilles' Heel.
Turkey also faces a number of structural challenges that hold back growth and employment. These include high informality, fiscal spending pressures, shallow financial markets, and potential bottlenecks in electricity supply. These policy challenges need to be tackled if Turkey wants to join the league of the most successful emerging market countries and accelerate convergence to EU income levels.
The agenda clearly is large. The question is: What are the policy priorities? Let me mention four areas.
First, fiscal policy discipline, which has been the cornerstone of Turkey's recent success, needs to be restored. This means ensuring that next year's primary surplus target of 5.5 percent of GNP is achieved, which, relative to this year's weak projected outturn of 4.25 percent of GNP, would represent a significant tightening of fiscal policy. Such a tightening is needed to create room for lowering real interest rates while assisting disinflation and current account adjustment.
Second and related, there is a need to create fiscal space to ease Turkey's high tax burden. Turkey has one of the highest tax rates on labor and heaviest regulatory burdens in the OECD. This holds back employment generation and suppresses productivity by shifting jobs to the informal sector.
Turkey also has high financial transactions taxes which distort incentives for allocating savings and drive financial intermediation offshore. But cutting these taxes is very costly. So how can fiscal space be created to allow room for cutting taxes? Well, the answer is by reducing tax evasion, avoiding ad hoc initiatives, such as the recent costly VAT cuts for textile and tourism, and by containing spending pressures.
On the spending side, the priorities are: one, to make the social security system viable by passing a strong social security reform; two, to increase the efficiency of health spending; and, three, to contain the growth in civil service costs.
Future tax cuts need, however, to be balanced carefully against the objective of bringing the public debt ratio to a safer zone. These competing objectives, tax cuts and debt sustainability, can only be achieved by restraining the growth of public spending going forward. To help anchor expectations in this regard, the government could publicly announce and commit to a target path for the next three to five years for expenditures and the primary surplus. Such commitments could eventually be formalized by an explicit fiscal rule that aims to restrain spending growth.
I should add that the benefits of such a rule for Turkey are discussed in the set of published documents which you should have access to.
The third policy priority is to remove potential bottlenecks in electricity supply. Keeping electricity tariffs constant in the face of sharply rising input costs has seriously damaged the finances of state energy companies. The electricity price freeze is not only a drag on the fiscal position, but is also the reason for chronic underinvestment in the sector and looming power shortages. To attract much needed private investment, what is needed is a new formula that eliminates discretion in price decisions and reliably passes changes in input costs to end-user tariffs.
Finally, Turkey needs to make its economy more resilient to external shocks to safeguard high growth and avoid the boom and bust cycles of the past. This means that Turkey should continue strengthening bank supervision to avoid excessive build-up of risks in the banking system. It should also create buffers in public balance sheets, for example, by raising international reserves further and by lengthening debt maturities.
In a nutshell, much has been achieved in recent years, but more needs to be done to ensure high and more stable growth. The newfound political stability offers a unique window of opportunity to reenergize reform and complete successfully the Stand-By Arrangement with the IMF, expiring in May 2008. With the right set of policies, there is no doubt that Turkey can raise its potential growth above 5 percent and secure sustained improvements in living standards for all its citizens.
Thank you. I'm happy now to take your questions.
QUESTIONER: How do you feel about monetary policy at this stage in Turkey? Do you think that they are addressing that correctly or do you consider that they keep raising rates?
MR. GIORGIANNI: Let me say that achieving a stable rate of inflation in the low single digits is good for growth and should be the overriding policy priority of the central bank. Now, in terms of the monetary policy stance and interest rate cuts that you mentioned, I think this process, as it started, can continue going forward, but any future interest rate cuts should be moderate and gradual. More importantly, any action on this front should be conditioned on continued progress in lowering inflation expectations toward the official 4 percent target.
The fight against inflation is not a fight that the central bank can fight alone. The point is that the central bank should do its part, but the government also can contribute on this fight by restraining spending and sticking to the fiscal targets it has announced.
QUESTIONER: Obviously, a lot of these reports that you put out were prior to the election, and now you have a new government in place or the same government but a shuffled one. What is the main reason that you think Turkey has gone a little off course here, economically?
MR. GIORGIANNI: The program so far has worked quite well. However, there is no doubt in my mind that conditions have become a little bit less favorable over the recent months. Growth has been moderating. External conditions have become less benign. So to continue to attract investments from abroad, which is needed to finance Turkey's current account deficit and to boost potential growth, Turkey will be best served by sticking to the reform path and by reestablishing fiscal discipline.
Now, in terms of your specific question, it's true that policy implementation has lagged somewhat in recent months but, in a way, the strength of Turkish financial markets and the country's much improved economic fundamentals might have reduced incentives for expediting reforms. The point, though, is that a country like Turkey that is trying to catch up with EU income levels and is trying to secure investor confidence cannot afford to slow down the pace of reform. This is clear.
Markets are fickle and external conditions have weakened in recent times. Also, countries that fail to reform risk losing their competitive edge in the current globalized marketplace. So all I'm trying to say is that if Turkey wants to successfully raise its growth potential and continue to attract foreign investment to finance its large current account deficit, it has one only option and that option is to stick to the reform path.
QUESTIONER: Do you think the latest turmoil has affected Turkey less than it would have, for example, shortly after 2001 or 2002, meaning, has Turkey's economy shown a lot more resilience than it would have when it wasn't following a lot of these policies?
MR. GIORGIANNI: Clearly, this is the case that the economy has strengthened considerably over the last few years and has become more resilient to external shocks. Balance sheets are stronger. Economic institutions are more robust. Just think about the independent central bank, the unified bank regulatory agency and many other reforms that have contributed to make Turkey more resilient.
But the country has shown in the past that it is prone, is susceptible to swings in investor mood. Now, we haven't seen much of an impact from the current global financial turmoil. There was a temporary impact during last August from increased risk aversion following the subprime-linked losses in the U.S. and Europe, but that impact was temporary.
I think Turkey, like other emerging market countries, is benefiting from a decoupling of growth and economic performance from the rest of the world, which is, of course, good news.
But there is still uncertainty as to the size and distribution of credit losses and the impact on global financial flows and world growth from the current unwinding of financial difficulties in mature markets. So there is certainly a risk that external financing and export performance might suffer, going forward. This, to my mind, underscores the need to have in place strong policies that reduce vulnerabilities and boost growth.
MS. GAVIRIA: Lorenzo, would you like to add anything to conclude?
MR. GIORGIANNI: Just to point out that our macroeconomic forecasts have been updated since the production of the documents that have been just released. Those were basically prepared around March-April of this year. I should take this opportunity very briefly to give a sense of how we have changed our outlook over the last few months.
Our sense is that the economy continues to do well, and we expect growth to evolve in line with potential between 5 and 5½ percent. Growth should be 5 percent this year accelerating next year to 5½ as real interest rates ease and consumer and business sentiment strengthen with the resolution of political uncertainty.
As to the current account, we expect the deficit to stay below 8 percent. It should be 7.5 or so this year, increasing slightly to 8 percent next year mainly because of the oil price developments, but FDI is expected to remain quite strong and financing around 40 percent of next year's current account deficit.
Also, on the inflation front, we expect inflation to gradually ease and stay within the central bank's forecast range. Now, there is some uncertainty as to the precise path of inflation. That mostly is on account of the uncertain timing of adjustments in administered prices and also pressures on food prices, and this is more of a global phenomenon than, strictly speaking, a Turkey-specific problem.
But all in all, inflation should stay below 7.5 percent this year, which is consistent with the central bank's projections, and we expect inflation to continue declining next year. The outlook remains uncertain, though, again because there are these risks from food prices and energy price developments. So it's difficult to say with precision when inflation will hit the 4 percent official target, but we're comfortable in saying that inflation should continue easing toward the target going into next year.
MS. GAVIRIA: Thank you, Lorenzo. We have no further questions. Thank you very much, everyone for participating.
MR. GIORGIANNI: Thank you.
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