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Turkey is Recovering

A Commentary
By Michael Deppler
Director, European I Department
International Monetary Fund

Financial Times
August 14, 2001

Having wrestled with the problem for decades, Turkey is at last getting to grips with its persistent high inflation. The markets may not yet believe it but economic reform is beginning to work.

The reform programme, as reformulated in May, is extremely ambitious. It had to be, after the jolt to inflation that followed February's devaluation and the worsening banking situation. Many urged the Turks to restructure their debt but they stuck with their market-oriented approach, doing what was needed to stabilize the economy.

Stabilisation has required a huge effort. The primary budget surplus (excluding interest payments) is to reach 5½ per cent of gross national product this year and 6½ per cent next. This represents an underlying strengthening of the budget position of about 9 per cent of gross national product over two years, an extraordinary achievement.

Turkey has also shifted to a floating exchange rate and inflation targeting. While the lira has fluctuated a great deal, the exchange rate is acting as a shock absorber and giving the authorities time to adjust policies and persuade markets. The new framework is markedly more resilient than the earlier, pre-announced crawling peg arrangement. The move to inflation-targeting this northern autumn - enabled by a law already passed that gives the central bank operational independence - will add impetus to the effort to cut inflation.

At the same time, there have been a series of structural reforms of great strength, with banking sector reform the most impressive.

The main change is in governance. Banks are now responsible to independent and professional bodies - a big change from the past when both public sector banks and insolvent private banks taken over by the public sector were controlled either directly or indirectly by politicians. The same applies to the regulation and supervision of the system. This is a sea change in Turkish banking.

The changes that have taken place in governance have been complemented by three other essential steps: a complete financial restructuring of the system, so as to protect depositors and creditors and permit parts of the system to return to viability; a complete real restructuring, forcing banks to get rid of unprofitable activities; and a marked toughening of supervision to ensure that past problems do not recur.

Moreover, Turkey has moved to boost efficiency elsewhere in the public sector and to remove obstacles to privatisation. This has involved a change in the board of Turk Telekom and various changes in the sugar and tobacco industries.

Finally, to protect the poor and most vulnerable from the short-term costs of adjustment, the Turkish authorities are strengthening social protection programmes, with the support of the World Bank.

The plan is clearly a strong one and fully on track. But it is not viewed that way by markets. Why?

First, markets worry that the programme is being implemented reluctantly. There have been political controversies, to be sure. But these have not prevented passage of a truly massive legislative agenda and full implementation of the programme. Indeed, the political controversies mask the strength of the consensus in favour of the basic economic objectives of the policies, which are the same as those enunciated in the government's original coalition agreement.

Second, markets fear that the government will not be able to roll over its debt. This is a serious issue, partly because Turkey has a high debt but partly also because such concerns are, to an extent, self-fulfilling.

However, it is for this very reason that the programme is structured with a view to ensuring the rollover of the public debt. It does so through two principal channels. The first is tough fiscal adjustment, which implies declining debt ratios in the medium term for a wide range of growth and interest rate combinations. This should ensure "solvency". The second is the latitude the authorities have for the central bank to lend the foreign exchange reserves received from the International Monetary Fund to the government to satisfy up to a third of its domestic financing requirements.

One reason why these fundamentals have yet to convince the markets is that it takes time for them to show up in the data. Another is that it has been Turkey's misfortune to make radical changes in its economy at a time when the world economy is not supportive, when capital markets are casting a sceptical eye on emerging markets generally.

It may well be just a matter of time for the markets to appreciate Turkey's stronger fundamentals. Already, inflation is slowing, the current account is swinging sharply into surplus and growth appears to be turning on the strength of booming exports and tourism. With disciplined implementation, this is a programme that is on the verge of paying off.




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