Turkey: Concluding Statement of the 2017 Article IV Mission

IMF News, November 4, 2016

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Output growth is projected to decline to 2.9 percent in 2016, following a strong performance last year, due to weak business confidence and negative domestic and external shocks.
The unemployment rate is high and rising.
Credit growth has slowed significantly.
Uncertainty has increased due to geopolitical tensions and the July 15 failed coup attempt and its aftermath.
Inflation has declined somewhat but is expected to remain well above the authorities’ five percent target; the 30 percent minimum wage increase and sticky expectations are likely to keep inflation at about 8 percent in 2016 and 2017.
The current account deficit is projected at 4½ percent of GDP in 2016; the external position remains weaker than the level consistent with medium-term fundamentals and the current account deficit is expected to widen in 2017 due to higher projected oil prices and a wider fiscal deficit.
Significant external financing needs remain; despite some increase in average maturity of external debt, annual rollover needs remain close to a quarter of GDP.
Recent rating downgrades contributed to an increase in the cost of foreign funding.
Favorable external conditions have helped, but external financing needs limit fiscal space.

Main challenge: avoid an excessive slowdown that could trigger a deleveraging cycle.
Use favorable external financing conditions to:
- rebuild buffers,
- reduce inflation,
- address external imbalances.

A moderate fiscal loosening is appropriate, accompanied by a credible medium-term consolidation plan.
- For 2017, a discretionary expansion of about ½ percent of GDP would support domestic demand without contributing significantly to external imbalances.
- Authorities could consider an extension of the minimum wage subsidy at a reduced level to support employment.
- Increase in public investment is welcome but should be directed towards high return projects.
- Newly introduced project-based incentives may not meet expectations given uncertainty and elevated private debt burden.
- The envisioned fiscal consolidation in the Medium-Term Plan should be backed by credible measures.
Enhance management of fiscal risks as PPP portfolio and related guarantees expand and contingent liabilities increase.
- Stronger central oversight, approval, and disclosure are needed, covering guarantees issued by entities other than the Treasury.
- Passage of a comprehensive PPP framework law would help.
- Governance of the sovereign wealth fund should be aligned with international best practices.

Maintain the current monetary stance without further easing to balance containing inflation against a slowing economy.
Simplify the monetary framework so that all liquidity is provided at the policy rate to improve transmission.
Gradually withdraw the enhanced provision of Lira liquidity that followed the failed coup attempt.
Increase reserves further; the CBRT’s focus on boosting net reserves should be maintained.
- Although the economy has buffers to sustain short-lived moderate capital outflows, Lira depreciation puts pressure on nonfinancial corporate sector balance sheets.
- Suspension of regular foreign exchange auctions is welcome.

Bank capital levels remain high, although some buffers are decreasing; indicators of asset quality have deteriorated, especially in the household and SME sectors.
Regulatory changes enable banks to restructure loans in tourism and energy sectors, as well as consumer loans and credit cards.
Build on the enhanced legal framework for financial regulation by further strengthening supervisory processes and governance standards in banks.
Strengthen macroprudential measures to lower foreign exchange risk in the economy.
- The economic slowdown is increasing these risks.
- Macroprudential measures should not be relaxed for demand management purposes.

Rebuild business confidence and ensure public institutional capacity.
Continue improving the investment climate by simplifying procedures for starting a business and enhancing the efficiency of the legal system.
The new pension auto-enrollment law is a welcome step, but its impact on aggregate savings is likely to be small and the reform has a few design shortcomings which could impede its effectiveness.
Labor market reforms should aim at boosting productivity and participation:
- Ease labor market rigidities (e.g., recent amendments to the labor law on flexible employment) to help reduce informality and encourage higher labor force participation.
- Accelerate reform of the severance pay system.
- Future minimum wage increases should be in line with expected inflation and productivity gains.
- The cost of labor should be appropriately differentiated according to regional economic developments.
Better integration of refugees would provide stronger economic benefits:
- Legislative changes of January 2016 allow Syrian refugees to apply for work permits, but uptake has been low in part due to skill mismatches.
- A simplified application process together with an effective communication strategy could improve integration into formal employment.
- Mobilizing international assistance would improve access to education, health care, and public utilities.

Concluding statement of the IMF mission to Turkey, November 4, 2016.