Public Information Notices
Turkey and the IMF
IMF Concludes Article IV Consultation with Turkey
On December 22, 1999, the Executive Board concluded the Article IV consultation with Turkey.1
High inflation and volatile economic growth have been an indelible feature of the Turkish economy over the last few decades. There have been at least 5 attempts to address this in the 1990s, but these attempts have all failed to bring about a lasting decline in the rate of inflation which has averaged more than 80 percent over the last 10 years. Stabilization has been elusive because fiscal tightening has not been underpinned by structural reforms and the absence of a credible nominal anchor to coordinate inflation expectations and permit a decline in interest rates.
In the early months of the most recent disinflation attempt, which started in early 1998, there were some notable achievements. Inflation was reduced from over 100 percent in January 1998 to 85 percent in July 1998 and to below 70 percent by end-1998. The primary position of the central government budget improved sharply in 1998, supported by expenditure compression and tax increases. These policies engendered some confidence, and sizable capital inflows were evident in the first half of 1998. The publication of the authorities' Memorandum of Economic Policies under the Staff Monitored Program (SMP) in July 1998 also provided a positive fillip to the disinflation effort.
As in past disinflation attempts, however, the strong improvement in the position of the primary balance was not sufficient to bring about lower interest rates. Indeed, having averaged 21 percent in the second half of 1997, ex-post real interest rates on government securities increased to 27 percent in the first half of 1998, and rose further in the aftermath of the Russian crisis. This undermined the tightening of fiscal policy and also reduced private sector demand. As a result, GNP growth (quarter over quarter, seasonally adjusted) slipped from an average of 2 percent in 1997 to 1 percent in the first half of 1998, and turned negative in the second half. The impact of tighter domestic policies on growth was compounded by the real consequences of the Russian crisis, and in particular the slowdown of demand for Turkish exports from BRO countries.
Over the last two years, the external accounts have remained in approximate balance. Largely because of the recession, the current account balance showed a surplus of close to 1 percent of GNP in 1998. The slowdown in exports to Russia and other neighboring republics starting the latter half of the year has been off-set by a large decline in imports. The current account is projected to register a small deficit of about 0.5 percent of GNP in 1999. This deterioration is mostly due to the loss of tourism revenues-related to security concerns and to the earthquake. With regard to the capital accounts, foreign direct investment remains very low. Following the hump in repayments in 1998, net external borrowing by the public sector (exclusive of state economic enterprises) turned positive in 1999 by a modest US$550 million. Net external borrowing by banks and the rest of the private sector is expected to decline substantially this year, largely because of the lower level of economic activity, and especially the decline of exports.
With the weakening of economic activity and the announcement of early elections, fiscal policy turned more expansionary during the second half of 1998, and the burden of maintaining the gains on inflation shifted to monetary policy. The relaxation of fiscal policy became increasingly evident in early 1999, as the primary balance started to deteriorate sharply, partly exacerbated by cyclical revenue losses, and later in the year, the effect of the Marmara earthquake. The weak primary position was compounded by the large increase in the burden of interest payments due to the rise in interest rates required to defend the Turkish Lira in the aftermath of the Russian crisis. Notwithstanding the strong effort of the newly elected government to rein in expenditures in the second half of 1999, the primary surplus of the central government is projected to fall from 3.6 percent of GNP in 1998 to 0.9 percent of GNP in 1999, and the overall deficit to increase from 7.7 percent of GNP in 1998 to 12.1 percent this year. The deterioration in the accounts of the public sector (which in addition to the central government includes the extrabudgetary funds, the non-financial state enterprises, the local governments, the central bank, the quasi-fiscal losses of the states banks—"upaid duty losses") has been even more pronounced. As a result, the public debt to GNP ratio increased from 44.5 at end-1998 to a projected 58 percent in 1999.
In response to this clearly unsustainable trend in public finances, the newly elected government has developed a comprehensive macroeconomic stabilization program which will be supported by the International Monetary Fund through a three-year stand-by arrangement.
A point of departure for this ambitious program (outlined in greater detail in the Letter of Intent) is its design to achieve credibility early and its breadth of scope. In particular, to avoid the difficulties encountered in previous disinflation attempts, under the program:
The highly front-loaded nature of the strategy has already enabled interest rates to decline significantly. This, coupled with increased business confidence that will be brought about by the decline in inflation and the sizable interest payments that will continue to accrue to the private sector is projected to facilitate a pick-up in economic growth. While growth through year 2000 (that is between the last quarter of 1999 and the last quarter of 2000) is projected to be a conservative 2 percent, the average is projected to be in the region of 5-5.5 percent for the year partly reflecting the rebound from negative growth in 1999.
Executive Board Assessment
Executive Directors observed that structural weaknesses, external shocks, and inadequate macroeconomic policy design had put Turkey in a vulnerable situation, with high real interest rates, a sharp economic downturn, and rapidly rising public debt ratios. They saw these trends as clearly unsustainable, and welcomed the Turkish authorities' decision to build on the disinflation gains achieved during 1998-99, by adopting a bold program of disinflation, fiscal stabilization, and structural reform. They regarded Turkey's program as deserving Fund support.
Directors praised the strength and the design of the authorities' economic program, and, in particular, the number of fiscal and structural measures that they had already taken, which indicated the authorities' intention to make a decisive break from the past. They viewed these measures, together with the firm commitment to a predetermined exchange rate path, as pledges of the authorities' resolve to achieve disinflation. This enhanced the program's credibility, and should facilitate the rapid decline in interest rates that is needed to stabilize the debt ratios and lead Turkey out of the current recession.
Directors welcomed the forward-looking strategy with respect to the exchange rate, under which the hard peg policy of the stabilization phase will be gradually replaced by a more flexible one over the three years of the program. They agreed that preannouncing the exchange rate path during the disinflation stage would likely provide an effective anchor for inflation expectations. In this regard, they welcomed the up-front fiscal adjustment, and the ambitious structural reforms, which are needed to ensure the continuing viability of the authorities' exchange rate framework. These elements, together with the flexibility of the Turkish labor market, reduced the risks of an unsustainable real appreciation in the near future. As to the medium term, Directors concurred that the transparent exit strategy included in the program limited the risks encountered in some other countries with exchange rate-based monetary policies, namely that of sticking too long to their exchange rate commitments in the face of mounting competitiveness problems. Directors emphasized the need to design soon, and make public, the monetary policy framework that will replace the exchange rate mechanism when it is phased out.
Directors regarded the primary fiscal adjustment envisaged in the program as impressive, while expressing some concern about the heavy reliance on revenue measures, as opposed to expenditure cuts. Directors urged that this early reliance on one-off fiscal measures, mainly on the revenue side, be remedied in the following years, including by keeping the real growth of public expenditure in 2001 and 2002 well below that projected for the economy.
Directors found the structural reform agenda comprehensive and far reaching. This agenda, together with the ambitious privatization program, not only supported the medium-term sustainability of the fiscal adjustment, but also contributed to increased economic efficiency and growth. The pension reform also represented a major turning point, even though it might require further adjustments over the medium to long term. Reforms of agricultural policies would achieve important efficiency gains and allow the government to keep their fiscal costs in check. Directors recommended that the authorities minimize the extent of indexation in incomes policy. Finally, Directors welcomed the authorities' intention to request a fiscal transparency review.
Directors saw a sound banking system as a precondition for a sound currency and emphasized that the program's strong structural reforms in the area of banking were essential. They welcomed, in particular, the recent amendments to the banking law and the strengthening of loan classification and provisioning rules and other bank supervision regulations, which should address long-standing weaknesses in the banking system. Nevertheless, Directors noted that, in addition to a good legislative framework, there was an urgent need to improve the implementation of existing bank supervision regulation, which had been lax in the past. In this respect, Directors commended the Turkish authorities for their decisiveness in addressing the problems of some banks thought to be insolvent, and recently taken over by the Saving Deposits Insurance Fund.
Directors welcomed the progress achieved since the last Article IV consultation in addressing data weaknesses particularly in the area of public finance, which made it possible to monitor in the program a broader fiscal aggregate than that monitored under the 1998-99 staff monitored program. Nevertheless, they encouraged further progress, including in the fiscal area, so as to not only improve the monitoring of the program, but also to facilitate macroeconomic surveillance and the provision of information to the markets.
|Turkey: Selected Economic Indicators|
|Real economy (change in %)|
|Unemployment rate (in %)||6.0||6.4||5.9||...||...||...||...|
|Gross national saving 1/ 2/||18.9||20.8||23.2||20.0||20.4||19.5||19.5|
|Gross domestic investment 1/ 2/||23.4||24.6||23.9||22.8||24.4||23.3||23.2|
|Public finance (in % of GNP)|
|Central government debt||48.0||48.4||48.5||60.5||60.1||58.8||57.0|
|Consolidated public sector|
|Consolidated net debt||46.5||42.9||44.5||58.0||57.9||56.6||54.6|
|Money and credit (end-year, % change)|
|Broad liquidity 3/||113.1||117.6||76.0||82.6||41.1||28.9||22.0|
|Credit to private sector||120.5||125.8||81.7||58.3||38.0||28.9||22.0|
|Interest rates (year average)|
|Treasury bill rate 4/||132.4||105.2||115.7||106.2||...||...||...|
|Overnight money market rate||115.8||101.4||111.9||107.0||...||...||...|
|Balance of payments|
|Trade balance 1/||-5.7||-8.0||-7.0||-5.8||-7.1||-7.2||-7.0|
|Current account balance
shuttle trade) 1/
|Reserves (US$ billions, end-of-period)||17,695||19,575||20,112||...||...||...||...|
|Reserve cover (in months of imports of GNFS)||3.9||3.8||4.0||...||...||...||...|
Sources: Turkish authorities; and Fund staff estimates.
|1/ In percent of GNP.|
|2/ Difference between balance of payments and the national income accounts comes from the treatment of shuttle trade and related services receipts.|
|3/ Includes foreign currency deposits and repos.|
|4/ Simple average across maturities ranging from three-months to one-year, net of tax.|
1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
IMF EXTERNAL RELATIONS DEPARTMENT