Turkey: Staff Concluding Statement of the 2021 Article IV Mission
IMF News, January 25, 2021
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- Published: January 25, 2021
Mission Concluding Statement — key points
- Pandemic inflicted a heavy human and economic toll on Turkey.
- Policy reaction focused on monetary and credit expansion, producing a strong rebound in growth after the initial shock but exacerbating pre-existing vulnerabilities and leaving the economy more susceptible to domestic and external risks.
- Recent policy pivot away from rapid money and credit growth is welcome.
- Rebuilding buffers could be faster if the pivot persists and is combined with:
- additional pandemic-focused fiscal support that is temporary and targeted;
- a credible plan for medium-term fiscal consolidation;
- focused financial sector and structural reforms.
- Structural reforms should mitigate long-term adverse pandemic effects and include:
- targeted measures to support the most vulnerable;
- measures to encourage labor market flexibility;
- measures to facilitate corporate debt relief.
The Covid-19 shock: impact and policy response — findings
- Pre-existing vulnerabilities entering 2020:
- Growth over the past decade driven largely by externally-funded credit and demand stimulus.
- Resulting vulnerabilities: elevated external financing needs, declining reserves, high inflation, and increasing dollarization.
- Human and health impact:
- "Almost 25 thousand Turkish people have died and 2.4 million have been infected."
- Initial policy response and macro outcome:
- Early stimulus relied primarily on rapid monetary and credit expansion, including policy rate cuts, cheap and rapid lending growth by state-owned banks, and administrative and regulatory measures to boost credit.
- Direct fiscal measures amounted to just 2.5 percent of GDP, mainly tax deferrals and some employment support.
- Combined measures helped economic activity rebound strongly in Q3 2020 to above pre-pandemic levels; Turkey was among the few countries estimated to have posted positive overall growth in 2020.
- Adverse side-effects of the initial response:
- Inflation remains well above target, weighing on policy credibility.
- Increased dollarization, relatively high imports, and financial outflows triggered large-scale foreign exchange intervention aimed at stemming lira depreciation.
- Recent policy pivot (from late-2020):
- Monetary policy tightening, easing of ad hoc regulatory measures, and marked slowdown in state-owned bank lending helped contain lira pressure and rebuild confidence.
- Gross reserves have broadly stabilized but remain well below the recommended range and well below most peers.
- Net international reserves (NIR) remain positive, but once central bank FX swaps are subtracted, the net position is negative.
Outlook — projections and risks
- Growth:
- "Turkish GDP is expected to expand by about 6 percent in 2021."
- From 2022 onwards growth projected to settle back to trend: "about 3½ percent."
- Inflation and current account:
- Inflation expected to fall modestly by end-2021, and remain well above target.
- Current account deficit expected to fall to "3½ percent of GDP," driven largely by lower gold imports and modest tourism recovery.
- Employment: expected to continue to recover slowly as the pandemic subsides.
- Risks from low buffers:
- Low foreign exchange reserves, high external financing needs, and high domestic FX deposits leave the economy vulnerable to shocks and changes in sentiment.
- Under the current policy set, buffers will be rebuilt gradually.
Policy recommendation overview — further shift needed
- A further sustained rebalancing of policies would underpin more durable medium-term growth.
- Maintain a firm monetary stance while deploying additional pandemic-focused fiscal support that is temporary and targeted to achieve a broadly neutral but better calibrated policy stance.
- Reforms should rebuild credibility and buffers while addressing pandemic-related human and economic needs.
Monetary policy — actions to strengthen credibility and buffers
- Maintain a firm monetary policy stance; "further measured monetary policy tightening likely needed should inflation expectations fail to stabilize."
- Avoid premature easing; follow recent CBRT forward guidance to better anchor inflation expectations, sustain capital inflows, and address dollarization.
- Actions would help achieve a stronger lira and higher reserves, especially when combined with broader reforms including:
- steps to underpin CBRT independence;
- a timely technical review of the monetary policy framework.
- Develop and implement a transparent reserve accumulation strategy as conditions allow:
- Reserve buildup should increasingly occur through transparent reserve purchase auctions and be accompanied by consistent and clear communication.
- Gradual removal of remaining administrative measures designed to support the lira as conditions allow.
Fiscal policy — addressing pandemic-related needs and medium-term consolidation
- Short-term fiscal support:
- Deploy additional targeted and temporary fiscal support in 2021; Turkey has some fiscal space, "possibly in the order of 1 percent of GDP."
- Additional social transfers to vulnerable households and informal workers recommended; further support should be considered if economic conditions deteriorate.
- Medium-term consolidation:
- Outline a credible and detailed plan for fiscal consolidation now, to be enacted when post-pandemic recovery is well under way.
- "Consolidation of about 1.5 percent of GDP over the medium term should help put debt again onto a declining path."
- Consolidation measures could be legislated now and enacted from 2022 onwards and might include:
- streamlining VAT exemptions;
- rationalization of ad hoc transfers and subsidies;
- rationalizing investment incentives.
- Complementary efforts to find efficiencies in spending are important.
- Fiscal structural reforms:
- Publish a fiscal risk statement and comprehensive information on quasi-fiscal operations of all SOEs to bolster transparency and credibility.
- Finalize efforts to strengthen oversight and management of Public Private Partnerships (PPPs), including publishing a monitoring report and finalizing a new PPP law that integrates PPPs with the overall budgetary process (appraisal and authorization).
- Continue strengthening budget execution.
- Extra-budgetary institutions:
- Carefully define and monitor the scope and role of extra-budgetary and other non-central government entities with maximum transparency and strong governance.
- Refine Turkey Wealth Fund’s governance to limit potential conflicts of interest.
- Debt management:
- Continue strengthening debt management by lengthening borrowing maturities and lowering reliance on domestic FX borrowing; recent moves along these lines are welcome.
Financial sector policy — reining in credit and strengthening balance sheets
- Credit normalization:
- Continued normalization of credit growth is positive; credit growth has slowed as policy rates increased and lending-incentivizing regulations were removed.
- Credit provided through the Credit Guarantee Fund (CGF) was expanded beyond SMEs during the pandemic; going forward such credit should be limited to SMEs in line with the CGF’s original mandate.
- Bank balance sheet issues:
- Legacy issues on banks’ balance sheets should be more fully recognized over time.
- As the pandemic recedes, strengthen prudential standards to incentivize recognition of loan losses and proactively draw down capital and liquidity buffers.
- Phase out forbearance measures and loan deferrals to encourage debt restructuring.
- Conduct a comprehensive third-party asset quality review and ensuing stress tests to strengthen confidence and develop the market for distressed assets.
- Avoid delays in proposed revisions to the Banking Law to strengthen BRSA independence and reform resolution frameworks.
- Authorities intend to proceed with a new Financial Sector Assessment Program in 2021; this is welcomed.
- FX risks:
- Bank FX liabilities warrant careful monitoring even if regulatory requirements are met.
- Continue to monitor FX liquidity risks carefully and strictly enforce regulatory limits on open FX positions.
Mitigating long-term effects of the pandemic — labor markets and corporate distress
- Labor market policies:
- Address risks to labor markets through targeted measures that support labor market flexibility while providing a sufficient safety net to aid resource re-allocation and job creation.
- Emphasize female labor force participation, youth unemployment, and informality.
- Corporate debt and restructuring:
- Corporate debt distress is expected to increase; viable but temporarily-insolvent firms should be quickly restructured as 'going concerns' while unviable firms should be efficiently wound down.
- 'Out-of-court' restructuring mechanisms are key in current circumstances.
- Combined, these policies would help form the basis for a more durable and inclusive recovery.
IMF Staff Concluding Statement — January 25, 2021