Turkey: Staff Concluding Statement of the 2018 Article IV Mission
IMF News, February 16, 2018
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- Published: February 16, 2018
Recent developments, outlook and risks
- Growth was very strong in 2017, with growth estimated at about 7 percent in 2017, well above potential; the output gap now appears positive with symptoms of associated imbalances.
- Under staff’s baseline, growth is expected at 4 percent this year, reflecting in part a weaker policy-driven impulse.
- Inflation is well above target and, without further interest rate increases, is likely to end the year once again in double digits.
- The external current account deficit looks set to stay above 5 percent of GDP.
- Last year’s wider current account deficit reflected higher fuel prices, strong demand-led and gold import increases, despite sharply higher exports.
- Financing for the deficit was mainly by Eurobond issuance, other portfolio inflows, and by reserve drawdowns; foreign direct investment (FDI) inflows remain short of desirable levels.
- Reserves remain relatively low, covering only around half of Turkey’s gross external financing needs.
- Areas of risk include large external financing needs, limited foreign exchange reserves, increased reliance on short-term capital inflows, high corporate exposure to foreign exchange risk, and signs of possible oversupply in the building and construction sector.
- Risk triggers could stem from domestic developments, regional geopolitical developments, or changes in investor sentiment towards emerging markets.
Monetary and financial sector policies
- Reining in inflation is the most important challenge for monetary policy.
- The Central Bank of the Republic of Turkey (CBRT) effective interest rate hikes of almost 500 bps over the past year have not been enough to contain inflation and prevent inflationary expectations from increasing.
- Staff recommends a front-loaded monetary tightening as part of a recalibrated policy package to secure CBRT credibility and to move closer, over time, to its 5 percent inflation target.
- A credible tightening might also allow the CBRT to increase its international reserves against the backdrop of still-favorable global liquidity conditions.
- Simplification of the monetary framework over time would be welcome.
- Recent measures to address foreign exchange (FX) borrowing risks to small- and medium-size enterprises (SMEs) are a step in the right direction.
- Banks rely heavily on wholesale FX funding and the corporate FX debt burden is high.
- Recent calibrated moves to limit FX borrowing of unhedged corporates are generally aligned with staff’s past recommendations.
- Further tightening of regulations on corporate FX borrowing would mitigate vulnerabilities from open FX positions of some large corporates.
- The authorities’ decision to better target the Credit Guarantee Fund (CGF) is welcome.
- Last year’s CGF expansion supported confidence and growth but put pressure on bank funding costs and could have been more targeted.
- Current signs of overheating argue for a gradual phase-out of this support mechanism, along with planned targeting of the unused portion of the facility.
- Macroprudential tools need to keep their focus on preserving financial stability.
- Macroprudential policy changes should be guided by longer-term considerations of maintaining financial stability and building buffers, rather than for demand management purposes.
- Policies that eased consumer and corporate borrowing, which began in 2016, should be revisited.
Fiscal policy
- Turkey’s strong fiscal anchor has played a critical role over the years.
- Authorities need to guard against: the growing gap between primary spending and tax revenue amid growing rigidities in the budget; and a narrowing of fiscal space through increasing contingent liabilities.
- This requires careful setting of fiscal and quasi-fiscal policies, including limiting guarantees for long-term development projects to those that appear most viable.
- Steady and measured fiscal consolidation would help reduce imbalances and bolster investor sentiment.
- The expiration of temporary tax breaks and the introduction of new tax measures—such as the corporate income tax rate increase, reductions of income tax exemptions, and an increase in consumption taxes on motor vehicles—are welcome.
- These have been accompanied by new tax exemptions and employment subsidies; further measures are needed to bring the general and central government balances to primary surpluses of about ½ percent of GDP by 2019.
- Recommended measures include broadening the revenue base, raising direct taxation, improving the efficiency of the value-added tax (VAT) system, limiting budget rigidities (principally by not further encumbering the wage bill), strengthening budgetary discipline by containing ad-hoc subsidies and setting credible time limits on such subsidies, and providing transparent and timely costing.
- The authorities’ ongoing efforts to reform the VAT system are welcome.
- Fiscal transparency and fiscal risk management reforms are in train but need further improvement.
- Public-private partnerships (PPP) activity has risen sharply, as have related and other contingent liabilities.
- Staff welcomes measures to strengthen the PPP risk management and reporting framework, supported by IMF and World Bank technical assistance.
- The scope and role of extra-budgetary and other non-central government entities, and institutions such as the newly created Turkish sovereign wealth fund (SWF), need to be carefully defined and monitored, with the maximum degree of transparency.
Structural policy
- Focused structural reforms would help underpin medium-term growth.
- Total factor productivity growth has been lackluster over the past decade; recent growth has reflected mainly increased capital and labor inputs.
- Current strong cyclical growth conditions should be used to implement needed reforms.
- Labor market reform is crucial.
- There is a skills gap that risks undermining Turkey’s demographic advantage.
- Improving, but still low, female labor participation needs to be addressed to raise potential growth.
- Further reforms could focus on improving educational outcomes through tertiary level and further supporting vocational training; enhancing opportunities for flexible and part-time work, as well as child-care facilities; and reforming the severance pay system.
- Other structural reforms to help growth prospects include improving the investment climate and institutional capacity, and fostering higher participation in the voluntary private pension system.
Data
- Some enhancements to further strengthen Turkey’s economic statistics would be helpful.
- Staff welcomes authorities’ plans to introduce further refinements to high frequency indicators, and to provide a breakdown between private and public investment in the national income accounts this year.
- Staff urges swift completion of these refinements to bolster transparency.
Refugees
- Turkey’s generosity in hosting refugees serves as a global example.
- The introduction of work permits for those under temporary protection is welcome, recognizing that the informal sector has been a main mode of employment for refugees.
- To ensure further formal labor market integration of refugees, the application process for work permits and business creation could be simplified further.
IMF Staff Concluding Statement, February 16, 2018.