Turkey: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, September 23, 2019
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- Published: September 23, 2019
Background — Growth and Imbalances
- Turkey achieved strong growth in recent decades while imbalances increased.
- Initially, broad-based macroeconomic and structural reforms supported growth, poverty reduction, and income convergence with advanced economies.
- As reforms waned, growth became increasingly dependent on externally-funded credit and demand stimulus.
- By early 2018 the economy was running above potential with a large current account deficit, largely financed by debt-creating flows.
- These imbalances contributed to the August 2018 lira depreciation and an associated recession in the second half of 2018, accompanied by a sharp increase in unemployment.
Recent Developments — Stimulus and Recovery
- Growth has resumed, aided by policy stimulus:
- Expansionary fiscal policy, rapid state bank credit provision, a strong contribution of net exports, and more favorable market sentiment supported positive growth in the first half of 2019.
- Staff expects growth to be positive this year—about ¼ percent—despite large negative carryover effects from last year’s recession.
- Exchange rate and current account:
- The lira has recovered as market pressures have abated.
- Import compression and a strong tourism season produced a remarkable current account adjustment; only a small deficit is expected this year.
- Inflation and monetary policy:
- High real policy rates, lira stability, favorable base effects, and lower inflation allowed the CBRT to cut policy rates.
- While inflation could fall to single digits over the coming months, staff expects end-year inflation of below 14 percent.
Outlook — Challenges Remain
- The current calm appears fragile:
- Reserves remain low, and private sector FX debt and external financing needs are high.
- Non-financial corporate balance sheets have been stressed by lira depreciation, higher interest rates, and lower growth.
- Banks report adequate capitalization and moderate NPLs, but loan restructuring has increased and staff expects lagged effects of the recession and the weaker lira to continue to strain asset quality.
- High dollarization reflects weaker domestic sentiment and state bank funding needs.
- Public debt is low, but the fiscal deficit has increased and uncertainty over contingent liabilities and potential debt rollover pressures limit fiscal space.
- Prospects and risks:
- Prospects for strong sustainable growth have weakened.
- Without consistent implementation of a comprehensive package of reforms, medium-term growth is likely to remain subdued given balance sheet strains.
- Risks include deterioration in sentiment towards emerging markets, policy implementation risks, and adverse domestic or geopolitical developments.
Policies — Securing Stronger and More Resilient Growth
- Overarching five-pronged policy response recommended:
- Tight monetary policy to boost central bank credibility, underpin the lira, durably lower inflation, and strengthen reserves.
- Steps to bolster medium-term fiscal strength.
- A comprehensive third party assessment of bank assets and new stress tests, with follow-up measures as needed, to further strengthen confidence in banks.
- Additional steps, building on existing reforms, to strengthen the insolvency and corporate restructuring framework.
- Focused structural reforms to support productivity growth and increase economic resilience.
- Note: Although reforms may have short-term output tradeoffs, the growth payoffs over the medium- and longer-term are likely to be large, and downside risks would be significantly contained.
Monetary Policy: Strengthening Credibility
- Primary objective: durably lower inflation to permanently lower interest rates.
- Staff view and recommendations:
- The central bank continues to work to enhance its credibility, including by seeking to strengthen its communications.
- In staff’s view, the CBRT easing cycle has been too aggressive given still-high inflation expectations and the need to mitigate macro-financial risks.
- Monetary policy should keep rates on hold until there is a durable downturn in inflation and inflation expectations. This would also underpin the lira, allow reserves to be rebuilt, and support de-dollarization.
- Reduce the many instruments and rates through which liquidity is provided to further clarify the policy stance.
- Implement a transparent framework for pre-announced FX purchases—with these being the sole preserve of the CBRT—at the appropriate time.
- As volatility subsides, phase out remaining measures that aimed at containing excessive volatility in capital flows.
Fiscal Policy: Preserving the Anchor
- Fiscal policy should remain a key anchor and preserve fiscal space.
- Recent fiscal stimulus helped recovery; unwinding of some measures is welcomed.
- Staff view and recommendations:
- A neutral fiscal stance next year would still support growth, allowing automatic stabilizers to work, but further discretionary stimulus should be avoided to contain financing needs and preserve fiscal space.
- Measures of about 1½ percent of GDP over the medium term would help stabilize the debt burden around current, commendably low, levels.
- Revenue mobilization measures could include broadening the tax base and enhancing revenue efficiency by raising and unifying reduced VAT rates; personal income tax could also benefit from reforms.
- On spending, remove backward-looking public wage indexation, rationalize subsidies and transfers, and better target social assistance.
- Strengthen oversight and management of PPPs, integrate PPPs fully into the budgetary process, publish a monitoring report, and introduce a new PPP law ensuring authorization and appraisal are budget-integrated.
- Consistent budget execution and publication of a fiscal risk statement would further strengthen fiscal credibility.
- Further monitoring of extra-budgetary institutions is needed; the Turkey Wealth Fund (TWF) risks fragmenting management of public spending outside the budgetary process and its governance could be refined to limit potential conflicts of interest.
Financial and Corporate Sector Policies: Stability and Rebalancing
- Clean up bank and corporate balance sheets to support financial stability and resilient growth:
- Review banks’ impairment and restructuring practices to support durable and sustainable loan repayments.
- Further pursue efforts to strengthen the current resolution regime.
- Conduct an early comprehensive third-party asset quality review (AQR) and ensuing stress tests, and implement follow-up measures as needed to shore up market confidence.
- Credit growth:
- Limit actions aimed at expanding lending, including through state banks and the CGF, ensuring credit is provided only to viable borrowers.
- Be prepared to use macro-prudential tools to rein in excessive and/or imprudent credit growth.
- Revisit recent changes that incentivize private bank lending with reserve requirements.
- Insolvency and restructuring:
- Build on ongoing reforms to strengthen the insolvency regime and out-of-court restructuring.
- Tighten NPL classification and enforcement to inform better pricing of NPLs and increase the attractiveness of out-of-court solutions.
Structural Reforms: Boosting Productivity
- Focused reforms to raise sustainable growth and resilience:
- Enhance product market efficiency by simplifying business entry and exit, addressing barriers to competition, and allowing automatic energy pricing adjustments.
- Raise the quality of human capital by upgrading education and on-the-job training.
- Expand early childhood education and childcare to increase female labor force participation.
- Improve labor market flexibility by eliminating backward-looking public wage indexation and aligning minimum wages with expected inflation and productivity.
- Reform severance pay to encourage labor mobility.
- Governance improvements:
- Improve regulatory predictability and simplify administrative procedures to help the business environment and investment climate.
- Minimize regulatory forbearance to enhance transparency.
- Governance improvements would magnify structural reform payoffs.
Source: Turkey: Staff Concluding Statement of the 2019 Article IV Mission (September 23, 2019).