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Turkey: Eighth Review Under the Stand-By Arrangement and Request for Waiver of Nonobservance of Performance Criterion

Author(s):
International Monetary Fund
Published Date:
May 2005
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I. Recent Developments

1. Turkish financial markets have steadied following a brief episode of market turbulence (Figure 1). Global market sentiment towards emerging markets worsened in early April, with high debt countries such as Turkey most affected. Domestic developments in Turkey added to investor concerns. These included a widening current account deficit and mixed signals from the government over the future course of fiscal policy. Following the market correction—the lira declined by 15 percent in a month and benchmark bond yields rose by 7 percentage points—conditions have stabilized.

Figure 1.Turkey: Financial indicators, 2003-04

(in percent, unless otherwise indicated)

Source: Data provided from the Turkish authorities.

2. Despite this turbulence, demand for Turkish assets has held up well (Figure 2, Tables 14). The increase in Turkish lira deposits has continued apace, as has demand for government paper from mutual funds and the public. Dedollarization has also persisted, with foreign currency deposits declining in U.S. dollar terms. Foreign holdings of treasury bills—now about US$4½ billion—have also held up.

Figure 2.Turkey: Money and Credit, 2001-04

Source: Central Bank of Turkey.

Table 1.Turkey: Quantitative Targets and Structural Conditionality Relevant for the Eighth Review
ActionType 1/Status
I. Quantitative Targets
Meet (i) performance criteria on primary balance, contracting or guaranteeing of external public debt, issuance of short-term external public debt, net international reserves, and base money, and (ii) indicative targets on primary and overall balances, net domestic assets and privatization proceeds (all end-April).PCAll end-April targets were met, except for base money.
II. Structural Conditionality
Prior actions for the Eighth Review
Write over to the central government budget cumulative TL1.2 quadrillion of special revenues in the period January-June 2004PAMet.
April
Announcement by the SDIF of a new strategy for asset resolution.BMMet with delay. Settlement offer to borrowers at end-May. Auction strategy announced in June.
Assessment of the banking system prior to lifting of blanket guarantee.BMMet.
May
Submission to Parliament of tax administration reform legislation, making the GDR a semi-autonomous agency within the Ministry of Finance.BMDelayed to July.
Prepare report outlining key elements of state enterprise governance strategy.BMMet. Inter-agency committee completed study end-May.
June
Improve the public sector personnel system, including passage of legislation to establish a code of ethical conduct for civil servants and public administrators (previous target end-December 2003).BMMet. Legislation was passed in May 2004.
Make public key elements of the new strategy for state banks and a timetable for the action plan (mid-June).BMPartially met. Strategy for Halk-Pamak announced and related legislation is expected to be approved by Paliament shortly. Ziraat strategy prepared and will be announced in July.
All excises will be adjusted to be brought in line with budget assumptions.BMPartially met. June 29 increases brought excises close to budget assumptions.
July
Passage by Parliament of tax administration reform legislation, making the GDR a semi-autonomous agency within the Ministry of Finance, as defined in paragraph 10 of the Letter of Intent.BMDelayed due to heavy legislative agenda. Reset as new performance criterion for end-October 2004.

PA=prior action, PC=structural performance criterion, and BM=structural benchmark.

PA=prior action, PC=structural performance criterion, and BM=structural benchmark.

Table 2.Turkey: Selected Indicators, 2000-05
Projections
200020012002200320042005
(In percent)
Real sector
Real GNP growth rate6.3-9.57.95.95.05.0
GNP deflator50.955.344.422.511.510.1
Nominal GNP growth rate60.440.555.829.717.115.6
WPI (12-month, end-of-period)32.788.630.813.914.28.0
CPI (12-month, end-of period)39.068.529.718.412.08.0
Average nominal treasury bill interest rate38.099.163.544.124.819.0
Average ex-ante real interest rate 1/-9.535.530.328.612.812.1
(In percent of GNP)
Central government budget
Primary balance 2/3/4.64.82.45.05.05.0
Net interest payments 4/15.824.717.516.113.610.4
Overall balance-11.2-20.0-15.1-11.1-8.6-5.3
Consolidated public sector
Primary balance 3/3.05.54.16.36.56.5
Net interest payments 5/21.926.616.116.113.510.3
PSBR (including CBT profits)18.921.112.09.87.03.7
Operational balance-6.9-4.7-4.4-4.8-2.9-1.0
Net debt of public sector57.493.978.870.570.364.7
Net external19.037.732.122.222.720.1
Net domestic39.356.246.748.347.744.6
Net debt of public sector (in percent of centered GNP) 6/52.475.668.765.965.758.9
External sector
Current account balance-4.92.4-0.8-2.8-3.6-3.0
Gross external debt59.079.072.161.853.251.2
Net external debt38.853.854.645.140.739.7
Short-term external debt (by remaining maturity)21.722.717.917.516.216.1
Monetary aggregates
Seignorage 7/1.81.11.01.21.40.5
Nominal growth of M2Y broad money (in percent)40.287.525.413.020.813.5
(In billions of U.S. dollars, unless otherwise indicated)
Privatization proceeds3.32.80.50.33.03.0
Net external financing of central government4.1-2.3-1.4-1.4-0.1-0.3
Amortization6.27.86.88.98.68.6
Gross borrowing10.35.55.37.58.58.3
Of which: Eurobond issues7.52.23.35.35.05.0
GNP201.3144.0182.7238.5
GNP (in quadrillions of Turkish lira)125.6176.5275.0356.7417.6482.8
Sources: Data provided by Turkish authorities; and IMF staff estimates.

Average of monthly nominal interest rate divided by 12-month ahead CPI inflation. With average maturity of newly issued debt less than one year, and with FRNs paying quarterly coupons, this measure overstates the effective real interest rate when inflation is declining.

On a commitment basis, excluding profit transfers from the CBT, interest receipts, and privatization proceeds.

For 2004 and 2005, program projections.

Interest payments minus interest receipts plus profit transfers from the central bank.

Interest payments minus interest receipts plus CBT profits before transfers to the government.

Defined as the sum of quarterly GNP in the last two quarters of the year and in the first two quarters of the following year.

Change in reserve money in percent of GNP, where reserve money is defined as currency issued plus reserve requirements.

Sources: Data provided by Turkish authorities; and IMF staff estimates.

Average of monthly nominal interest rate divided by 12-month ahead CPI inflation. With average maturity of newly issued debt less than one year, and with FRNs paying quarterly coupons, this measure overstates the effective real interest rate when inflation is declining.

On a commitment basis, excluding profit transfers from the CBT, interest receipts, and privatization proceeds.

For 2004 and 2005, program projections.

Interest payments minus interest receipts plus profit transfers from the central bank.

Interest payments minus interest receipts plus CBT profits before transfers to the government.

Defined as the sum of quarterly GNP in the last two quarters of the year and in the first two quarters of the following year.

Change in reserve money in percent of GNP, where reserve money is defined as currency issued plus reserve requirements.

Table 3.Turkey: Monetary Aggregates, 2000-04(In quadrillions of Turkish lira)
2004
2000200120022003Mar.Jun.Sep.Dec.
Projected
Broad money (M2Y)56.8106.6133.7151.0153.8165.8174.5182.4
Lira broad money (M2)31.947.261.982.792.697.1102.6106.9
Foreign exchange deposits 1/24.959.371.868.361.368.771.875.5
Repos6.02.82.83.13.13.13.23.4
Broad liquidity62.8109.4136.4154.1156.9168.9177.7185.9
Base money5.87.810.414.916.918.820.920.9
Net foreign assets 1/2.8-1.9-6.3-4.0-4.6-1.30.2-2.6
(in billions of U.S. dollars)4.1-1.3-3.9-2.9-3.5-0.90.1-1.6
Net domestic assets54.1108.5140.0155.0158.4167.1174.2185.0
Net claims on government31.689.7122.8138.9141.4149.5154.8163.3
Claims on business sector 2/31.738.742.058.059.961.564.367.6
Turkish lira claims22.323.124.539.742.844.546.649.0
Foreign exchange claims (est.) 1/9.415.617.518.417.117.017.818.7
Other items (net)-9.1-20.0-24.8-41.9-42.9-43.9-44.9-45.9
Memorandum items:(annual percent change)
Broad money (M2Y)40.287.525.413.016.327.826.720.8
Lira broad money (M2)42.548.031.033.745.143.236.929.3
Foreign exchange deposits 1/37.3137.921.0-4.9-10.611.014.510.6
Claims on business sector 2/73.022.38.438.427.329.926.016.5
(billions of U.S. dollars)
Broad money (M2Y)84.674.081.8108.2117.3108.1110.9112.6
Lira broad money (M2)47.532.837.959.370.663.365.266.0
Foreign exchange deposits37.141.243.948.946.744.845.646.6
Net claims on government47.062.375.199.5107.897.598.4100.8
Credit to the private sector47.126.925.741.645.740.140.941.8
(in percent share)
Base money/GNP 3/4.64.43.84.24.64.95.35.0
Broad money (M2Y)/GNP 3/45.360.448.642.342.043.544.043.7
Lira broad money (M2)/GNP 3/25.426.822.523.225.325.425.925.6
Private credit/GNP25.221.915.316.316.416.116.216.2
Foreign currency deposits/M2Y43.955.753.745.239.841.441.241.4
Money multiplier
Broad money (M2Y)9.813.712.810.29.18.88.48.7
Lira broad money (M2)5.56.15.95.65.55.24.95.1
Sources: Central Bank of Turkey and Fund staff projections.

Monetary authorities and deposit money banks; evaluated at current exchange rates.

Includes credit to local governments and state economic enterprises.

Evaluated as percent of nominal GNP over previous four quarters.

Sources: Central Bank of Turkey and Fund staff projections.

Monetary authorities and deposit money banks; evaluated at current exchange rates.

Includes credit to local governments and state economic enterprises.

Evaluated as percent of nominal GNP over previous four quarters.

Table 4.Turkey: Central Bank Balance Sheet, 2000-04 1/
20002001200220032004
Dec ActualDec ActualDec ActualDec ActualMar ActualApr ActualAug ProjectedDec Projected
1. Central Bank Balance Sheet(in quadrillions of Turkish lira) 1/
Net foreign assets3.3-12.73.98.88.09.212.810.7
Gross foreign assets15.628.637.742.540.541.242.538.4
Gross foreign liabilities12.341.233.833.632.532.029.727.7
International reserve liabilities3.120.711.59.88.38.05.83.5
Other reserve liabilities 2/4.910.113.214.514.914.914.914.9
Banks’ FX deposits with CBT4.310.49.19.39.39.09.09.3
Net domestic assets2.520.66.56.09.08.57.710.2
Base money5.87.810.414.916.917.820.520.9
Currency issued3.85.37.610.711.613.014.814.7
Banks’ lira deposits at the CBT2.02.52.84.25.34.85.76.1
(in billions of U.S. dollars)
CBT gross international reserves23.219.826.229.528.128.629.626.7
at current cross rates:19.828.135.2
CBT gross international liabilities18.328.623.523.422.622.220.719.2
CBT net foreign assets4.9-8.82.76.15.56.48.97.4
plus CBT forward position0.00.00.00.00.00.00.00.0
plus other reserve liabilities7.37.19.210.110.410.410.410.4
minus Dresdner one year deposits0.60.71.42.12.22.22.22.2
minus defence fund0.40.40.40.40.40.40.40.4
CBT net international reserves11.1-2.910.013.613.314.216.715.2
Treasury net international reserves 3/-1.3-14.7-14.2-14.1-14.6-15.2-15.8
Net international reserves (Treasury plus CBT)-4.2-4.6-0.5-0.8-0.41.5-0.5
(in quadrillions of Turkish Lira, program exchange rate)
Net foreign assets (Treasury)-1.8-21.1-20.4-20.3-21.0-21.8-22.7
Net foreign assets (Treasury plus CBT)-14.5-17.2-11.6-12.4-11.7-9.0-12.0
Net domestic assets (Treasury) 4/1.821.120.420.321.021.822.7
Net domestic assets (Treasury plus CBT)22.427.626.429.329.529.532.9
Base money (Treasury plus CBT)7.910.414.916.917.820.520.9
Exchange rate (TL per US dollar, in millions)0.671.441.631.401.311.44
Sources: Central Bank of Turkey; Fund staff projections. Although program targets for base money and NDA are five day averages, all observations in this table are end of period.

Except for 2000, all foreign currency aggregates are valued at end-December 2001 exchange rates (program exchange rates).

Mainly Dresdner deposit liabilities.

Equals borrowing from IMF plus short-term foreign currency denominated liabilities.

Since the Treasury cannot create base money, equals negative of Treasury net foreign assets.

Sources: Central Bank of Turkey; Fund staff projections. Although program targets for base money and NDA are five day averages, all observations in this table are end of period.

Except for 2000, all foreign currency aggregates are valued at end-December 2001 exchange rates (program exchange rates).

Mainly Dresdner deposit liabilities.

Equals borrowing from IMF plus short-term foreign currency denominated liabilities.

Since the Treasury cannot create base money, equals negative of Treasury net foreign assets.

Yield Curve Developments, 2003-04

(in percent)

3. Credit growth also remained strong, although the pace of increase has moderated in recent weeks (Figure 2). Consumer credit has grown especially rapidly, with consumer loans having increased threefold over the last year, albeit from a low base. However, in recent weeks higher real interest rates have helped moderate credit growth.

4. Macroeconomic developments have remained generally positive:

  • Economic growth appears strong. National accounts data for the first quarter released after the mission indicate year-on-year growth of more than 10 percent, driven by domestic demand. Recent adverse market developments have, however, begun to dampen market sentiment, as reflected in the latest business surveys.

  • Inflation has continued to decline despite the weaker lira. Exchange rate pass- through effects have so far been muted. Monthly wholesale prices declined by 1.1 percent in June. And, with a monthly CPI decline of 0.1 percent, annual inflation remained in single digits, its lowest level for more than 30 years.

5. The one black spot—the large current account deficit—has thus far been comfortably financed by capital inflows, although these are mainly short term (Figure 3):

  • Reflecting strong domestic demand growth, the current account deficit continued to widen. The deficit reached US$5 billion in the first quarter. While exports remain strong, and tourism receipts have rebounded, this has been overshadowed by a broad-based import surge, reflecting high fuel prices and rapid domestic demand growth.

  • In contrast, the capital account has remained strong, albeit tilted towards short- term flows. Portfolio inflows remained strong through April, banks drew down their foreign asset holdings abroad (reflecting dedollarization), and domestic banks’ short- term borrowing increased significantly.

  • Taken together, the overall external position ended up approximately in balance in the first half of the year. Central Bank of Turkey (CBT) foreign exchange purchases of US$5 billion helped to support the reserve position and ensured the program NIR floor was comfortably met.

Figure 3.Turkey: External indicators, 2000-04

(in billions of U.S. dollars; unless otherwise indicated)

Sources: State Institute of Statistics; and Central Bank of Turkey.

6. Meanwhile, political developments have remained supportive. The government’s resolve on Cyprus and other developments—including a revised penal code, and broadcasting in different languages and dialects—are viewed by markets as having enhanced Turkey’s EU prospects. Events in neighboring Iraq, however, have added to uncertainties in recent months.

II. Policy Discussions

A. Macroeconomic Framework

7. Both sides agreed to leave the existing framework broadly unchanged (¶5):1

  • The risks for the growth target of 5 percent are clearly on the upside (Box 1). With a strong first quarter GDP outturn, positive production and demand side indicators, and a large positive growth carryover from 2003, economic growth would likely exceed the 5 percent growth projection. While currency weakness and higher interest rates would likely curb growth in the coming months, they are unlikely to alter the economy’s general direction. And, although consumer confidence had fallen in recent surveys, positive responses still predominated.

  • The end-year inflation target remains achievable despite the weaker lira. Both sides agreed that price pressures would likely increase in coming months. The output gap has narrowed, reflecting rapid demand and credit growth, and exchange rate pass- through effects of the weaker lira remain incomplete. Bringing petroleum excise adjustments in line with the budget would also add to price pressures. However, given the existing cushion—the continuation of the inflation path through May would have seen inflation end up about 3 percentage points below the end-year target—the 12 percent CPI inflation target remains achievable.

  • The current account deficit is expected to widen to some 3½–4 percent of GNP in 2004. This mainly reflects rapid demand-fuelled import growth, twinned with high oil prices. Both sides agreed that the recent lira depreciation should, after a lag, bolster the current account balance. Buoyant tourism receipts would also help. It was agreed, however, that with growth likely to exceed its target and oil prices remaining high, there was a risk that the external accounts could show a further deterioration relative to baseline program projections over the rest of the year.

Box 1.Turkey’s Economic Growth Performance in 2004: Developments and Prospects

Production and demand side indicators both point to strong growth performance so far this year. The industrial production index—the most reliable domestic output indicator in Turkey—increased by more than 14 percent in the first four months over the same period last year. Capacity utilization reached a record high in March, falling in April only because of public sector maintenance in the petroleum sector. On the demand side, surging car and retail sales—following large minimum wage and pension increases, a car tax rebate and booming consumer credit—signal continued strong domestic consumption growth. Imports continue to grow strongly, led by consumer goods but also reflecting strong capital goods imports. Tax revenues, which have so far outpaced program targets, particularly on VAT and motor vehicles taxes, lend further support to the growth story.

Consumer and credit card loans

(y-o-y growth, in percent)

Looking ahead, recent financial market turbulence may temper domestic demand. Reflecting the increase in benchmark bond yields, consumer lending interest rates have risen, and credit growth has begun to decelerate. The impact of higher interest rates and a weaker lira was also seen in the most recent business survey data, which show signs of declining growth expectations.

Three-months forward looking business indicators (CBT business survey)
Jan-04Feb-04Mar-04Apr-04May-04Jun-04
Business confidence 1/26.616.725.526.418.821.5
New orders from domestic market 2/17.223.026.623.213.217.1
Output volume 3/17.625.129.327.918.820.0

“General course of business in your industry” (optimistic - pessimistic)

“New orders received from domestic market, excl. seasonal variations” (optimistic - pessimistic)

“Volume of output, excl. seasonal variations” (optimistic - pessimistic)

“General course of business in your industry” (optimistic - pessimistic)

“New orders received from domestic market, excl. seasonal variations” (optimistic - pessimistic)

“Volume of output, excl. seasonal variations” (optimistic - pessimistic)

Annual growth is, however, well on track to meet the 5 percent target this year, even if growth slows in the second half. The robust growth thus far combined with the positive carry-over effect from 2003 make the annual growth target of 5 percent attainable even with a slowdown in the second half of 2004. By the same token, a quick recovery in confidence and a return to the trend of declining real interest rates would likely see annual growth rising well above the 5 percent program target.

B. Fiscal Policy and Reforms

Fiscal outturns have so far exceeded program targets. But part of this overperformance is expected to be unwound in coming months. Against the backdrop of strong domestic demand growth, discussions focused on compensating for past policy slippages and thereby on allowing automatic stabilizers to work fully. Progress continues to be made on structural reforms, including on social security and tax administration.

8. Fiscal performance has been strong. Fiscal outturns through May have exceeded program targets (Table 6). The performance criteria for the broader consolidated general government were exceeded by ½ percent of GNP in both March and April, with the overperformance about evenly divided between tax revenues and expenditures. Performance in May continued to be strong, with the primary surplus of the consolidated budget overperforming by ¾ percent of GNP.

Table 5.Turkey: Balance of Payments, 2001–05(In billions of U.S. dollars)
20012002200320042005
Current account balance3.4-1.5-6.6-10.1-8.8
Trade balance-4.5-8.3-13.7-19.1-18.8
Exports (f.o.b.)34.439.851.062.968.6
Of which:
Exports (f.o.b.) in trade returns31.335.847.158.664.4
Shuttle trade3.04.14.04.34.3
Imports (f.o.b.)-38.9-48.1-64.7-82.1-87.5
Of which:
Imports (c.i.f.), incl. non-monetary gold-41.4-51.2-68.8-87.2-93.0
Energy imports (c.i.f.)-8.3-9.2-11.4-14.5-14.7
Services and Income (net)4.13.35.16.87.6
Services and Income (credit)18.817.321.325.427.4
Of which:
Tourism receipts8.18.513.216.116.8
Services and Income (debit)-14.7-13.9-16.2-18.6-19.8
Of which:
Interest-7.1-6.4-6.9-7.6-8.4
Private transfers (net)3.63.01.71.91.9
Official transfers (net)0.20.50.30.30.4
Capital account balance-14.61.45.911.59.4
(including errors and omissions)-16.31.310.711.79.4
Direct investment 1/2.80.90.11.61.8
Portfolio investment in securities-4.6-1.21.22.31.6
Public sector (central & local governments& EBFs)-1.90.4-0.70.71.6
Bonds (net)0.11.01.51.22.7
Eurobond drawings2.13.35.35.05.5
Eurobond repayments-2.0-2.3-3.8-3.7-2.8
Loans (net)-2.0-0.7-2.2-0.6-1.0
Loan disbursements1.62.31.02.82.1
Loan repayments-3.6-3.0-3.2-3.3-3.2
Central Bank of Turkey, (Excl. reserve assets, liabilties)0.81.40.60.10.0
Domestic money banks (net)-9.4-1.83.05.01.3
Domestic money banks (FX deposits abroad, -: accumulation)0.90.60.72.1-0.2
Domestic money banks (other, net)-10.3-2.42.32.91.5
Other private sector (net)-2.31.81.71.83.1
Other private sector (medium and long term, net)0.32.71.52.42.3
Other private sector (short term, net)-2.6-0.90.2-0.60.7
Errors and omissions 2/-1.7-0.14.80.20.0
Overall balance-12.9-0.24.11.50.5
Overall financing (NIR change excl. ST liabilities, + denotes decline)12.90.2-4.1-1.5-0.5
Change in net international reserves (+ denotes decline)12.90.2-4.1-1.5-0.5
Change in gross official reserve assets (+ denotes decline)2.7-6.2-4.01.36.3
Change in reserve liabilities (IMF)10.26.4-0.1-2.8-6.9
Purchases11.312.51.71.80.7
Repurchases-1.1-6.1-1.7-4.7-7.6
Memorandum items:
Trade in goods and services
As percent of GNP
Current account balance, incl. shuttle trade2.4-0.8-2.8-3.6-3.0
Trade account balance, incl. shuttle trade-3.2-4.6-5.8-6.8-6.5
Exports of goods and non-factor services36.131.030.031.132.8
Imports of goods and non-factor services32.230.631.033.134.1
Percent change
Value growth in exports of goods (incl. shuttle trade)11.915.828.123.39.1
Value growth in exports of goods (excl. shuttle trade)12.814.131.624.69.8
Value growth in imports of goods-26.823.734.526.76.6
Volume growth in exports of goods16.611.716.314.810.1
Volume growth in imports of goods-22.921.117.815.47.4
Terms of trade1.70.0-0.8-1.20.5
Reserve and debt indicators
Gross foreign reserves (Central Bank of Turkey)
In billions of U.S. dollars19.828.135.233.927.6
Months of goods & NFS imports4.45.45.24.03.1
External debt (end-of-period)
In billions of U.S. dollars113.8130.9147.3149.6148.3
Percent of GNP79.072.161.853.251.2
Percent of exports of goods & NFS218.8232.5205.5170.9156.3
Net external debt (end-of-period) 3/
In billions of U.S. dollars77.599.1107.5114.3115.1
Percent of GNP53.854.645.140.739.7
Short-term debt (end-of-period)
In billions of U.S. dollars16.416.422.926.229.0
Ratio to end-period foreign reserves82.658.465.177.2104.9
Short-term debt plus MLT repayments
In billions of U.S. dollars32.732.541.845.446.6
Ratio to foreign reserves164.7115.4118.8133.9168.8
Debt service ratio 4/41.337.334.929.826.5
Sources: Data provided by the Turkish authorities; and Fund staff estimates and projections.

Including privatization receipts.

For 2004 includes reported data for January-March.

Nonbank external debt less the NFA of the banking system.

Interest plus medium- and long-term debt repayments as percent of current account receipts (excluding official transfers).

Sources: Data provided by the Turkish authorities; and Fund staff estimates and projections.

Including privatization receipts.

For 2004 includes reported data for January-March.

Nonbank external debt less the NFA of the banking system.

Interest plus medium- and long-term debt repayments as percent of current account receipts (excluding official transfers).

Table 6.Turkey: Public Sector Primary Balances, 2000-04
20002001200220032004
Prel.Prog.
(In trillions of TL)
Public Sector3,7609,74111,15622,42027,266
Central government 1/5,8318,4206,64417,95420,985
Total revenue30,34644,76663,36990,445104,425
Tax revenue26,51439,76859,63484,33597,927
Direct taxes10,84916,08020,07727,80029,920
Indirect taxes15,66523,68739,55756,53568,007
Nontax revenue 1/5,4637,9169,40214,44616,628
Tax rebates-1,632-2,918-5,666-8,335-10,130
Non-interest expenditure24,51536,34656,72672,49283,440
Personnel9,98215,20423,16030,20035,101
Other current1,1931,4312,5102,5483,432
Defense and security2,3273,5914,4855,6685,895
Transfers8,76312,21819,28926,91132,113
Social security institutions3,3205,9109,94616,22819,468
State enterprises and banks 2/1,2801,7772,2451,9711,500
Agricultural subsidies3591,0331,8682,8053,215
Other transfers3,8043,4995,2305,9077,930
Investment2,2513,9027,2827,1656,899
Rest of the public sector-2,0711,3214,5134,4666,281
EBFs-225149-24939049
Unemployment insurance fund3341,0989621,2281,783
Local governments-28494338-1530
SEEs-1,9201493,1392,4874,099
Social insurance institutions24-170-85530
Revolving funds 3/9995407461350
(In percent of GNP)
Public Sector3.05.54.16.36.5
Central government 1/4.64.82.45.05.0
Total revenue24.225.423.225.325.0
Tax revenue21.122.521.823.623.5
Direct taxes8.69.17.37.87.2
Indirect taxes12.513.414.515.816.3
Nontax revenue 1/4.44.53.44.04.0
Tax rebates1.31.72.12.32.4
Non-interest expenditure19.520.620.720.320.0
Personnel7.98.68.58.58.4
Other current2.82.82.62.32.2
Transfers 2/7.06.97.17.57.7
Investment1.82.22.72.01.7
Rest of the public sector-1.60.71.71.31.5
EBFs-0.20.1-0.10.10.0
Unemployment insurance fund0.30.60.40.30.4
Local governments-0.20.10.10.00.0
SEEs-1.50.11.10.71.0
Social insurance institutions0.0-0.10.00.00.0
Revolving funds 3/0.10.10.10.10.1
Memorandum item:
Social Security deficit (percent of GNP)2.63.33.64.54.7
Source: Turkish authorities; and staff estimates.Note: from end-2003 the figures include special revenues and expenditures. From 2004 the authorities have moved to the GFS 2001 classification.

Excluding privatization proceeds, transfers from the CBT, and interest receipts.

Excluding recapitalization of state banks; including net lending to the private sector.

Added to the public sector balance for 2002. Not included in the 2001 primary surplus calculation.

Source: Turkish authorities; and staff estimates.Note: from end-2003 the figures include special revenues and expenditures. From 2004 the authorities have moved to the GFS 2001 classification.

Excluding privatization proceeds, transfers from the CBT, and interest receipts.

Excluding recapitalization of state banks; including net lending to the private sector.

Added to the public sector balance for 2002. Not included in the 2001 primary surplus calculation.

9. With the overperformance likely to narrow, both sides agreed that caution was warranted. For a start, savings achieved through postponing spending were likely to be unwound as the fiscal year drew to a close. And, on the revenue side, any growth slowdown in the second half of the year would have a negative impact. For these reasons, both the authorities and staff agreed that there was no room to increase budget spending ceilings.

Consolidated Budget Primary Surplus January - May

(percent of annual surplus)
Primary Surplus (program definition)(In quadrillions of Turkish lira)
January-May
Proj.Act.Diff.
Consolidation budget primary surplus9.912.93.0
Revenues39.240.61.4
Primary29.327.7-1.6
Rest of public sector primary surplus (CGS) 1/2.61.8
EBRs-0.10.2
Social security0.30.1
Unemployment insurance fund0.70.5
SEEs1.71.0

April figures. SEE figures are provisional.

April figures. SEE figures are provisional.

10. Staff noted that the fiscal record to date had been helped by strong growth, masking fiscal slippages. The write-over of “special revenues” were well behind target. (“Special revenues” are fees collected by off-budget institutions; these fees are used for off- budget spending by these institutions unless they are transferred to the central government.) This reflected spending pressures arising from the across-the-board spending cuts implemented in March to compensate for the earlier pension and wage increases. In addition, petroleum excises had also been cut to cushion the impact of rising international oil prices.

11. Against a backdrop of strong domestic demand growth, staff urged that past slippages be corrected and automatic stabilizers be allowed to operate freely (¶9). While the authorities argued for some flexibility on budget implementation, staff called for the unimpeded functioning of automatic stabilizers given the strength of demand. This would entail saving any revenue overperformance due to higher growth and keeping spending within budget limits. The authorities noted that the tax incentive scheme for new car purchases had been scaled back. And, to make up for past slippages, they decided to write over to the budget TL 1.2 quadrillion of special revenues and to adjust petroleum pump prices to bring excises in line with budget assumptions (structural benchmark, ¶9). Staff noted the risk that, without flexible pump prices, there was a danger that higher oil prices would hurt excise revenues. Looking ahead, the authorities agreed to adjust all excises to bring them in line with budget assumptions. They also argued that, should oil prices decline, they would not adjust pump prices, de facto achieving an increase in excises and providing a cushion. Finally, the authorities have also implemented an energy market reform, effective January 1, 2005 that completely liberalizes petroleum prices.

12. Looking further ahead, the 2005 budget call, to be issued by end-June, aims at maintaining fiscal discipline:

  • Staff argued unsuccessfully for a budget call announcement that would explicitly include the 6.5 percent primary surplus as a goal. Such a move would have helped reassure markets. The authorities noted that a decision on next year’s primary surplus target had not yet been taken.

  • Both sides agreed, however, on the need for non-interest current spending to decline in real terms. This would help compensate for the loss of temporary tax measures and reduced financial intermediation taxes, and would make room for an increase in investment.

13. To lay the basis for sustained medium-term fiscal consolidation, further progress is being made on the structural side (¶10):

  • With social security reform preparations now at an advanced stage, it is expected that draft legislation will be submitted to parliament by mid-December. The authorities explained that the planned administrative reform, aimed at combining and unifying the three existing pension systems, would be the most critical element in reducing the social security outlays in the long run. The main effects of this unification would be to reduce the generosity of the civil service pensions. Both sides agreed that parametric changes beyond current administrative reforms are also needed to put the social security deficit on a firmly declining path. The political sensitivity of such reforms called for continued careful preparations. With the technical work over, a White Paper was being prepared to explain the reform proposals; this was expected to be ready this summer. After consulting with interested parties, a final decision would be made by the Council of Ministers on the proposal for reform in September (new structural benchmark). Draft legislation would then be sent to parliament in December (new performance criterion), with the aim of securing parliamentary approval by early 2005.

  • Draft tax administration legislation has been completed in line with international best practice but its parliamentary passage has been delayed due to a heavy legislative agenda. The draft law, which is now expected to be submitted to parliament in July (delayed May benchmark) and passed by end-October (new performance criterion), will create a semi-autonomous tax administration, to be structured along functional lines, and reporting directly to the Minister of Finance. Local tax offices will be directly under the control of the new entity and tax policy responsibilities will be shifted elsewhere in the Ministry of Finance. The authorities and staff agreed that, while the transition would be difficult, the move would usher in improved tax administration and tax compliance. As a further step, staff suggested to consider unifying all tax auditing functions under the new entity after it had become fully operational.

  • Further expenditure reforms are being considered for next year’s budget. The authorities recently received technical assistance from the Fund on short-term expenditure reforms. While the authorities are considering including some of the recommendations in their 2005 budget, they felt that the budget call did not require such details, and that further time was needed to build consensus in certain critical areas. Staff urged the authorities to undertake the reforms as soon as possible, especially those measures designed to curb the public wage bill and address the special tax treatment of civil servants and pensioners.

  • Progress is being made on improving public sector governance. The civil servant code of conduct was approved by parliament in May 2004. The commission report on strengthening SEE governance was also completed in May. Following consideration of the report’s recommendations, and a consultative process with interested parties, the authorities intend to prepare draft legislation, which is expected to be sent to parliament by end-2004.

14. Both sides agreed that tax incentives should be avoided. While the authorities had broached the idea of possible investment tax incentives—to attract foreign investors and level the playing field with other countries in the region—staff argued against this, since it would represent a move away from the direct tax reforms of April 2003 and from the general strategy of simplifying the direct tax system, widening the tax base, and lowering overall tax rates. Further, ad hoc policy changes would also undermine policy credibility. In the end, the authorities decided to pursue the avenue of comprehensive, rather than piecemeal, tax policy reform. They initiated a study covering comprehensive direct tax reform; in this context, the authorities requested early technical assistance from the Fund.

15. To keep wider public sector balances under control, the authorities have taken steps to limit local government and SEE borrowing. The authorities intend to issue a circular requiring SEEs to provide prior notification to Treasury of their borrowing plans. In preparation for decentralization, the authorities are embarking on an important legislative agenda to define local authority responsibilities and financing arrangements.

  • The authorities indicated that they would set strict borrowing limits for local governments, a major improvement on current practice where there are no limits. The debt stock of municipalities and provinces will be limited to no more than their annual revenue, while for larger metropolitan municipalities the limit will be 1.5 times annual revenue. New domestic borrowing of all local governments will be limited to 10 percent of annual revenue. Staff agreed that the new limits and new data reporting requirements were indeed an improvement. However, the staff would have preferred a uniform debt limit equivalent to annual revenue. The authorities pointed out that the debt stock of most of the larger metropolitan municipalities already exceeded 1.5 times annual revenue and therefore borrowing would be strictly limited.

  • Staff recommended close monitoring of the larger municipalities with an eye to tightening the debt limits in the future if needed. The forthcoming public administration framework law (PAF) could transfer more expenditures to the local governments and therefore a stronger system could be needed in future to deal with debt and arrears problems. The authorities agreed that after the PAF is approved and in the context of new legislation setting out fiscal intergovernmental relations, the debt limits of the large municipalities could be tightened further.

  • The staff warned against any restructuring of local government arrears that could give the impression of an amnesty and create a negative incentive structure for local authority fiscal control in the future. The authorities explained that all local authority external debt arrears have been fiscalized already and are included in the public sector debt statistics. They had decided to create a commission that would restructure arrears on a case-by-case basis. Both sides agreed that arrears restructuring be guided by ability to pay, contain adequate safeguards, and be conducted in a transparent manner.

C. Monetary and Exchange Rate Policy

16. Both sides agreed on the need for continued caution in setting base money targets (¶11). Falling inflation and inflation expectations and strengthening real activity had increased demand for currency and TL deposits. The mission therefore agreed to revise the base money targets to accommodate the base money increase through May. But several factors had made the end-year inflation target more challenging (see above). And the recent increase in market interest rates and currency depreciation should help slow money demand (as well as helping to slow bank credit expansion and to contain the current account deficit). Base money targets for the rest of the year were therefore increased only in line with nominal activity. This would require continued caution in reducing overnight rates, which in any event were now below treasury bill rates. The staff also welcomed the central bank’s intention to announce steps aimed at increasing the transparency of its monetary policy operations.

17. The floating rate regime had illustrated its effectiveness during the recent episode of market turbulence. It was agreed that, while the CBT’s modest sales of foreign exchange had helped stabilize markets in May, discretionary intervention would remain strictly limited. Staff took issue with the frequent changes to foreign exchange purchase arrangements in recent months, as this had confused financial market participants, possibly adding to recent market volatility. The authorities argued that they needed to respond to changing market conditions, while acknowledging that fewer changes would be desirable.

18. The mission also argued that the buildup in international reserve should resume as soon as market conditions permit (¶12). While the CBT has built up its reserve position by intervening, including through auctions, Turkey’s external obligations remained large, and the CBT should restart its purchases of foreign exchange in a predictable and transparent manner once the balance of payments position allows. Staff also noted that Treasury should overborrow and deposit the proceeds at the CBT once market conditions settle. This would lower Treasury exposure to shifts in market sentiment (see below), but would have the indirect benefit of helping the CBT in its sterilization operations.

D. Financial Sector Reform (¶14)

19. Following a major review of the Banking Act, the authorities have prepared a new draft Credit Institutions law. The new legislation, which is expected to be passed by parliament by November (a new structural performance criterion), will bring the legal framework more closely in line with EU standards. Areas that received particular attention in the review included the scope of the legislation, “fit and proper” criteria, licensing process, related party lending, on-site supervision, legal protection for Bank Regulation and Supervision Agency (BRSA) and Savings Deposit Insurance Fund (SDIF) staffs and boards and the delineation of responsibilities between the two institutions. These are all covered in the draft law. The exclusive right of Sworn Bank Auditors to conduct on-site supervision will be reviewed to permit the BRSA to engage off-site personnel and outside experts as needed.

20. Responding to industry concerns, the original timetable for the new legislation has been extended. Given the fundamental reforms envisaged, the banking sector community had urged that more time be allowed for consultation. The authorities and staff agreed on the need to proceed carefully. The authorities now plan to submit the draft law to parliament by end-September 2004.

21. A comprehensive strategy has finally been developed for restructuring and privatizing state banks.

  • In a move welcomed by staff, a strategy has been formulated for the integration of the intervened Pamuk with state-owned Halk. The combined bank is expected to become fully operational by end-October. Integration of the two banks should lead to operational and financial synergies, including on IT, the customer base, and branch networks. Given these synergies, staff urged the authorities to aim at privatizing the new bank by end-2005. The authorities would not commit to a fixed timetable to doing this, preferring to wait until market conditions were supportive. Staff regretted that the resolution of Pamuk had taken more than two years to bring to closure.

  • A comprehensive restructuring plan for Ziraat is being developed with the assistance of international consultants.

  • The due diligence of Vakif has been further delayed. The authorities noted that the terms of reference has now been drafted, and that a consulting firm would be hired shortly. The assessment was expected to be completed by end-October.

22. Unfortunately, the SDIF asset sales strategy continues to proceed slowly:

  • The SDIF has relaunched last December’s failed auction, with winning bids to be selected by end-August, but its prospects remain uncertain. After the auction announcement, SDIF made a general discount offer to all its debtors, ending mid- July. The offer includes loans in the portfolio currently being auctioned. Staff noted that with high-quality borrowers more likely to accept the offer, the quality of the portfolio being auctioned and the price likely to be offered may deteriorate. Staff nevertheless stressed the importance of a successful auction, indicating that another failure would deter potential investors.

  • Staff urged the SDIF to sell its assets through regular auctions with successive loan portfolios being put up for sale until the sales process is complete. It was agreed that the reassessment of SDIF asset valuations should foster a better understanding of recovery rates and allow more realistic auction reservation prices. Staff indicated that bilateral deals with individual borrowers should take place only after seeking outside expert opinion, with the general terms of each deal being made public.

23. Another unwelcome development is recent court rulings on Demirbank and Kentbank. In April the courts made a ruling that BRSA’s intervention in Demir and Kent had been unlawful. This could have implications for future bank intervention strategy. However, the new Credit Institutions legislation will help address existing legal shortcomings.

24. Looking ahead, staff stressed that the removal of the blanket guarantee on bank liabilities, implemented on July 5, warranted careful monitoring. The BRSA indicated that the TL 50 billion guarantee would cover almost 99 percent of bank accounts (64 percent by value). They were also confident that the banking sector was ready and had presented a detailed assessment to the government, and issued a press release confirming the banking system’s ability to deal with the abolition of the guarantee. More generally, the authorities indicated their preparedness for the move and stressed that individual bank liquidity was being monitored closely. Staff urged the authorities to continue to pay close attention to monitoring individual banks, and to follow up on any disparities between deposit rates offered.

E. Other Structural Reforms

25. Despite recent setbacks, the authorities remain committed to privatization (¶17). A recent procurement law amendment had removed an important bottleneck, by facilitating the hiring of consultants. Preparations for the sale of Tϋrk Telekom are advancing, against a backdrop of strong foreign and domestic investor interest. Public offerings are also planned for PETKIM (petrochemicals) and Turkish Airlines by end-year, and financial consultants have already been appointed. Several smaller companies have already been sold, including the alcohol arm of TEKEL, with cash proceeds through June totaling US$475 million (against an end-June indicative target of US$500 million). Staff noted the judicial system as a major hurdle. With the privatization of TUPRAŞ in doubt, following a recent court ruling, the US$3 billion end-year privatization proceeds target might be difficult to achieve.

26. Responding to business concerns that follow up to the Investment Advisory Council (IAC) was moving slowly, the authorities have taken further steps to improve the business climate (¶15). These include the preparation of draft legislation on streamlining investor approval procedures, and for a new Investment Promotion Agency. The authorities committed to providing a progress report to the Prime Minister and IAC members by October.

III. Financing Issues

27. With comfortable rollover needs for the rest of this year, the staff urged the authorities to build up a cushion for a more challenging environment next year. Treasury had managed, until recently, to improve its borrowing terms with rollover rates of about 90 percent. Baseline projections of rollover requirements over the rest of the year are lower. Depending on market conditions, Treasury should use this opportunity to build its deposits at the CBT and prepare for tighter medium-term financing requirements (see the Article IV staff report).

28. To help address rollover concerns, the authorities have agreed to address remaining impediments to Treasury and CBT coordination (¶13). The authorities agreed to identify remaining practical obstacles to Treasury deposit buildup and to prepare an action plan, by end-September, for their removal (new structural benchmark). Staff noted that borrowing limits, appropriations for interest payments, payment terms on government deposits, and the taxation of CBT money market securities should all be covered in the plan.

29. Discussions continued on relations with the Fund after the program expires (Box 2).

  • The authorities have developed comprehensive medium-term macroeconomic scenarios covering the balance of payments, national accounts, and the budget, along with detailed alternative financing projections. Although financing requirements look tight (see the Article IV staff report), the authorities have not yet decided on what form of relationship they wish to pursue once the current program expires.

  • The authorities also expressed their intention to announce their post-program plans by September. Staff indicated that, should the authorities decide to opt for a successor arrangement, any request for a future program would have to be considered under exceptional access procedures and would depend not only on Turkey’s financing needs, but also on it large outstanding obligations to the Fund. Discussions would continue during the Ninth Review against the backdrop of the budget preparation process. While reasonably satisfied with the announcement timetable, staff nevertheless urged the authorities to announce their policy plans for 2005 promptly, including on the primary surplus. The authorities were not yet in a position to do this, however, and wanted to consider the options carefully before making an announcement.

IV. Program Modalities

A. Program Monitoring

30. Quantitative performance criteria. The attached Letter of Intent describes progress in implementing the program supported by the Stand-By Arrangement and requests completion of the Eighth Review.

  • The authorities request a waiver of nonobservance of the base money ceiling performance criterion for end-April. Given the small size of the deviation, staff supports the waiver request.

  • Annex B of the Letter of Intent outlines the updated program. The new performance criteria are unchanged from the indicative targets set in the Seventh Review, apart from the base money ceilings (see above).

Box 2.Post-Program Considerations

This box lays out some key considerations should the authorities seek a successor arrangement.1/

A successor program could be either disbursing or precautionary. By seeking a precautionary arrangement, the authorities could benefit from continued market confidence while signaling that Fund resources were no longer necessary. The external outlook is, however, difficult without additional official financing. With large repayments falling due to the Fund, baseline program projections show a loss of reserves of one-third over 2004-06. While the possibility of extending expected repurchases falling due in 2006 helps, the baseline financing assumptions themselves are subject to downside risk.

Under either a precautionary arrangement or a disbursing stand-by, the aim should be to reduce Fund exposure. With the Fund so heavily exposed to Turkey, prudential considerations call for a reduction in Fund exposure over the program period. Directors have called for reduced exposure, and the authorities themselves have also signaled publicly that they would favor a continuation of net repayments to the Fund. At the same time, Turkey faces large financing needs. For the public sector, external medium- and long-term debt amortization is projected to reach US$26 billion in 2005-06, with more than half falling due to the Fund even after allowing for an extension of 2006 repurchases (see figure).

Gross Public External Debt Amortization

(US$ billions)

An ambitious reform program is needed, however, if Turkey is to build on its recent achievements. Besides continuing with the program’s macroeconomic stabilization, including on the primary surplus and inflation, critical structural reforms are required in banking (state banks, intermediation taxes, legal reforms), fiscal (quality of adjustment, social security, streamlining of taxes, tax administration, expenditure policy), and monetary (the move to inflation targeting and coordination between Treasury and the CBT).

1 With Turkey’s high outstanding Fund access post-program monitoring (PPM) would be needed even if Turkey chose to graduate. Given its vulnerabilities, and high outstanding access, frequent (possibly quarterly rather than the usual bi-annual) PPM would appear to be appropriate.

31. Structural performance criteria. The performance criteria on banking and on social security reform legislation have now been specified. A new performance criterion is also proposed on the parliamentary passage of tax administration reform legislation.

32. The prior action for completion of the Eighth Review is:

  • Write over to the central government budget TL 1.2 quadrillion of special revenues.

B. Data Issues

33. The authorities are continuing their efforts to disclose in-kind foreign financed defense spending (whose exclusion from reported fiscal data for past test dates may have resulted in misreporting). The plan is to use estimates of this spending from reported debt stock movements to determine, by end-July, whether a noncomplying purchase may have taken place in the period January 2000 to June 2003.

V. Staff Appraisal

34. Despite recent market turbulence, Turkey’s macroeconomic outlook remains positive. Political conditions have remained supportive, and, on the economic side, both the float and strong fiscal outcomes have aided the adjustment process. With few signs of flagging activity, economic growth looks likely to exceed this year’s 5 percent program target. The 12 percent inflation target remains achievable, although recent currency weakness, high oil prices, rapid credit growth, a narrowing output gap, and prospective administered price increases make this task more demanding.

35. The immediate macroeconomic challenge is the widening current account deficit, which reflects rapid domestic demand growth. So far the financing of the deficit has not been a problem, although capital flows have been mainly short-term. Recent currency and interest rate movements, together with rebounding tourism revenues, should help narrow the trade and services deficit over time. Other steps have also been taken to address the deficit. State banks have reined in their lending. Lower car tax incentives and the operation of automatic fiscal stabilizers should also help dampen import demand. The situation warrants continued close monitoring, however, and additional corrective measures, including on the fiscal side, may need to be taken promptly.

36. Against this backdrop, the government needs to maintain strict fiscal discipline. Rapid growth had masked slippages in budget implementation, but the authorities have since taken remedial actions. Looking forward, the government needs to allow automatic fiscal stabilizers to function unimpeded, and save any revenue overperformance. With the current account widening, for example, the authorities’ focus on pump prices, rather than excises, is misplaced. The failure to adjust automatically to world oil prices amounts to a de facto tax cut when world oil prices are rising. The liberalization of pump prices should, therefore, be allowed to take effect next year as planned. It is also important to avoid new tax incentives and to keep a lid on spending. Finally, it is unfortunate that the budget call did not include an explicit commitment to a 6½ percent primary surplus target for next year. A clear commitment to maintaining this target would ease market concerns about financing needs and the pace of debt reduction.

37. The decentralization process entails many risks and needs to proceed carefully. The government’s intention to introduce explicit debt and borrowing limits for local authorities as well as new reporting systems is welcome. While the local authority debt and borrowing limits appear on the whole prudent, the larger debt ceiling for the major metropolitan municipalities could have been avoided by providing a transition period for those whose debt exceeded the new limits. An amnesty of local government arrears should also be avoided to ensure an appropriate incentive structure for the future. While the authorities’ intention to deal with arrears on a case-by-case basis is welcome, the process needs to be dealt with in a transparent manner.

38. On the structural side, the government is to be commended for working to improve the underpinnings of its fiscal policy. Notwithstanding some delays, its efforts to improve tax administration and the social security system are especially welcome in this respect.

39. This year’s monetary goals are challenging, but achievable. Although consumer price inflation is now in single digits, possible pass-through from the recent depreciation and high oil prices need to be contained. Accordingly, the central bank, which deserves continued credit for its conduct of monetary policy, should stick closely to its revised base money targets and to a prudent interest rate path. Incomes policy, including limiting the increases in the minimum wage and for government workers, would also need to be kept tight.

40. The floating exchange rate had worked well as a safety valve during the recent bout of market turbulence. While the float remains essential, Turkey’s external obligations are large. Foreign exchange reserves buildup should therefore resume as soon as market conditions allow, but in a predictable and transparent manner. Recent turbulence served as a reminder of the need for continued close coordination between the central bank and the Treasury in their operations.

41. The banking reform agenda is challenging but critical to the success of the program. State bank reform has been long-awaited. Another priority is to continue with the close monitoring of individual banks following the transition to the limited deposit guarantee in early July. It is also important to regain momentum on SDIF asset sales, including by setting realistic price expectations. Any bilateral loan restructuring deals should be handled professionally and transparently.

42. The authorities need to gain momentum in privatization and improve the business climate. With the recent setback on TUPRAŞ, the end-year privatization receipt target will be difficult to achieve. But recent steps, including the procurement law amendments and the preparation of large companies for sale, are welcome. Looking ahead, the authorities need to ensure that sales preparations are as thorough as possible and designed in ways that minimize the scope for court challenges. The follow-up work to the March inaugural Investment Advisory Council needs to be accelerated.

43. Against this background, the staff recommends the completion of the Eighth Review and approval of the authorities’ request for a waiver. Turkey has a good program implementation record, including for the current review, and deserves the support of the international community. The authorities have also taken some steps to address the risks to the external outlook, the clearest near-term risk. On this basis, the staff recommends the granting of the waiver on base money and the completion of the review.

Table 7.Turkey: Banking System—Selected Indicators, 1999-2004(in trillions of Turkish lira)
1999200020012002200320032004
Dec.Dec.Dec. 1/Dec.Sep.Dec.Mar.
Banking System
Total assets79,763117,649179,675212,681225,097249,693255,974
Cash and claims on CBT5,0976,23512,55813,87213,86614,96214,941
Claims on other banks7,76613,59919,87115,40111,07615,14112,159
Securities portfolio22,04031,25170,02686,10596,129106,844113,159
Loans, net22,60135,78941,05852,93258,76467,21072,407
Other assets22,25830,77536,16244,37145,26145,53643,308
Total liabilities79,763117,649179,675212,680225,097249,693255,974
Deposits48,27268,143110,298137,973141,872155,312158,756
Borrowing from banks10,07015,99623,79821,96722,32925,91825,508
Repos7,64512,84310,7766,1617,28411,24110,698
Other liabilities9,53912,20720,52721,35121,07721,68322,134
Shareholders’ equity (incl. profits)4,2348,46114,27625,22832,53435,53938,878
Memorandum items:
Capital adequacy ratio (%)17.315.325.331.430.932.1
NPLs (%) total loans9.79.229.317.613.811.510.2
Provisions (%) NPLs61.959.847.164.277.588.589.8
Net profit (loss) after tax-305-888-9,9102,3364,4105,678921
ROA (%)-0.4-0.8-5.51.12.02.30.4
ROE (%)-7.2-10.5-69.49.313.616.02.4
Share in assets (%)100100100100100100100
Share in deposits and repos (%)100100100100100100100
Private Banks
Total assets42,16556,17997,930119,471125,925142,270142,621
Cash and claims on CBT2,7073,3628,4349,3569,1409,8689,488
Claims on other banks5,3869,76910,4947,6235,2556,3695,420
Securities portfolio14,33513,49127,14639,81944,47151,48550,174
Loans, net12,44519,58726,50635,75240,72946,40249,759
Other assets7,2929,97125,35026,92126,33128,14627,781
Total liabilities42,16556,17997,930119,471125,925142,270142,621
Deposits23,16030,82767,22380,62979,75888,18085,518
Borrowing from banks6,50810,04515,58513,70316,08018,15818,141
Repos4,6543,9181,8034,0744,3968,1037,870
Other liabilities3,0363,5035,7795,8716,9906,8727,902
Shareholders’ equity (incl. profits)4,8067,8867,54015,19418,70120,95823,191
Memorandum items:
Capital adequacy ratio (%)18.39.019.6423.523.524.7
NPLs (%) total loans3.53.527.68.97.76.56.2
Provisions (%) NPLs62.263.031.053.067.580.081.1
Net profit (loss) after tax1,6181,276-7,3832,4102,0242,917772
ROA (%)3.82.3-7.52.01.62.10.5
ROE (%)33.716.2-97.915.910.813.93.3
Share in assets (%)52.947.854.556.255.957.055.7
Share in deposits and repos (%)49.742.957.058.856.457.855.1
State Banks
Total assets27,10440,65557,58367,83176,14083,13489,335
Cash and claims on CBT1,9992,5883,5444,0004,2834,5894,912
Claims on other banks1,0881,6395,0963,9962,8095,3653,894
Securities portfolio4,6718,13932,75639,24544,30247,71655,104
Loans, net6,52110,0259,1778,80410,15812,20214,325
Other assets12,82518,2657,01111,78614,58913,26311,099
Total liabilities27,10440,65557,58367,83176,14083,13489,335
Deposits19,20427,60637,25848,48955,11559,86266,098
Borrowing from banks6301,3392,3812,2301,4722,3382,103
Repos1,9224,9493,8441,0229351,018897
Other liabilities4,3175,6599,7079,3439,63310,3429,825
Shareholders’ equity (incl. profits)1,0311,1014,3936,7478,9869,57410,411
Memorandum items:
Capital adequacy ratio (%)7.934.050.262.056.356.2
NPLs (%) total loans9.111.137.337.431.926.223.5
Provisions (%) NPLs35.130.36374869897.8
Net profit (loss) after tax284-177-6811,0561,4711,790182
ROA (%)1.0-0.4-1.21.61.92.20.2
ROE (%)27.6-16.1-15.515.716.418.71.7
Share in assets (%)34.034.632.031.933.833.334.9
Share in deposits and repos (%)37.840.233.934.437.636.639.5
SDIF Banks
Total assets5,48012,91211,0359,3106,9197,0756,825
Cash and claims on CBT2481034562435235
Claims on other banks211535874619307456545
Securities portfolio2,5118,5728,4514,6554,9094,9644,942
Loans, net1,0522,5336021,8891,042910655
Other assets1,4581,1691,0642,085618693647
Total liabilities5,48012,91211,0359,3106,9197,0756,825
Deposits5,3638,8273,5665,7704,1904,1333,994
Borrowing from banks2638192,0201,274479837837
Repos1,4263,9935,0231,0241,8532,0251,896
Other liabilities9681,3298142,3381,164927995
Shareholders’ equity (incl. profits)-2,540-2,056-388-1,096-767-847-897
Memorandum items:
Capital adequacy ratio (%)-17.8-7.6-16.6-21.6-25.6
NPLs (%) total loans61.941.467.369.458.153.828.6
Provisions (%) NPLs75.380.389.160.570.875.467.9
Net profit (loss) after tax-2547-2314-2,344-1,6773212726
ROA (%)-46.5-17.9-21.2-18.04.63.80.1
ROE (%)-153.0-41.8-32.1-0.7
Share in assets (%)6.911.06.14.43.12.82.7
Share in deposits and repos (%)12.115.87.14.74.13.73.5
Foreign and Investment Banks
Total assets5,0147,90313,12616,06816,11217,21317,194
Cash and claims on CBT143182535454400454506
Claims on other banks1,0821,6573,4083,1642,7062,9512,300
Securities portfolio5231,0491,6732,3862,4482,6802,939
Loans, net2,5833,6454,7736,4876,8357,6957,668
Other assets6831,3702,7383,5773,7233,4343,781
Total liabilities5,0147,90313,12616,06816,11217,21317,194
Deposits5468822,2523,0862,8103,1373,145
Borrowing from banks2,6703,7923,8124,7614,2984,5854,427
Repos-357-17105401009536
Other liabilities1,2181,7164,2273,7983,2903,5423,412
Shareholders’ equity (incl. profits)9371,5292,7304,3835,6145,8546,173
Memorandum items:
Provisions (%) NPLs31.351.881.269.384.885.586.0
Net profit (loss) after tax340328498548594698-39.2
ROA (%)6.84.13.83.43.74.1-0.2
ROE (%)36.321.418.212.510.611.9-0.6
Share in assets (%)6.36.77.37.67.26.96.7
Share in deposits and repos (%)0.31.11.92.22.01.91.9
Sources: Data provided by Turkish authorities; and Fund staff estimates

Data for December 2001 onward reflect the results of the audits conducted during the first half of 2002.

Sources: Data provided by Turkish authorities; and Fund staff estimates

Data for December 2001 onward reflect the results of the audits conducted during the first half of 2002.

Table 8.Turkey: External Financing Requirements and Sources, 2000-05(In billions of U.S. dollars)
200020012002200320042005
Gross financing requirements39.939.037.445.949.949.8
Current account deficit (excluding official transfers)10.0-3.22.06.910.59.3
Amortization on debt securities (bonds)1.72.12.73.93.73.2
Of which:
Public sector1.42.02.33.83.72.8
Medium and long-term debt amortization (loans)13.814.313.415.015.514.5
Of which:
Public sector 1/3.63.63.03.23.33.2
Short-term debt amortization14.325.819.320.020.222.9
Public sector (net)1/-1.01.00.00.00.00.0
Trade credits 2/20.217.917.922.323.524.2
Banks and other private (net)-4.96.91.5-2.3-3.2-1.3
Available financing39.939.037.445.949.949.8
Foreign direct investment (net)0.12.80.90.11.61.8
Debt securities (bonds)3.4-1.74.27.97.68.1
Public sector7.52.13.35.35.05.5
Medium and long-term debt (loans)18.113.215.714.116.114.8
Of which:
Public sector 1/3.43.22.90.72.72.1
Short-term trade credits, currency and deposits17.913.216.022.925.725.2
Official transfers0.20.20.50.30.30.4
Other 3/-2.8-1.7-0.14.80.20.0
Net reserves (+/- = decrease/increase)3.012.90.2-4.1-1.5-0.5
Accumulation of gross reserves-0.42.7-6.2-4.01.36.3
IMF (net)3.410.26.4-0.1-2.8-6.9
Purchases3.411.312.51.71.80.7
Repurchases-0.1-1.1-6.1-1.7-4.7-7.6
Memorandum item:
Net public sector financing (incl. IMF, excl. reserves)9.410.27.8-0.7-1.9-4.9

General government and Central Bank of Turkey.

Series reflects gross flows of short term trade credits, and stocks of credits to the banking sector.

Errors and omissions.

General government and Central Bank of Turkey.

Series reflects gross flows of short term trade credits, and stocks of credits to the banking sector.

Errors and omissions.

Table 9.Turkey: Indicators of Fund Credit, 2000–08 1/
200020012002200320042005200620072008
Outstanding Fund credit (end of period)
In billions of SDRs3.211.216.216.214.39.61.90.70.1
In percent of quota3331,1651,6851,6821,4831,000195687
In percent of exports of G&NFS82737322415310
In percent of GNP210121075100
In percent of public sector external debt72024242316410
In percent of overall external debt41316151410210
In percent of end-period foreign reserves1872756462521440
Repurchases of Fund Credit
In billions of SDRs0.10.94.91.23.25.17.81.20.6
In percent of quota79051012732853180612662
In percent of exports of G&NFS02112581121
In percent of GNP014123410
In percent of public sector external debt service193611273951147
In percent of overall MLT external debt service0522615233273
In percent of start period foreign reserves0532613224294
In percent gross public sector ext. financing 2/02221719394374
Net Fund Resource Flows 3/
In billions of SDRs2.57.74.4-0.7-2.5-5.4-8.1-1.3-0.6
In percent of quota259798455-73-258-556-844-133-64
In percent of exports of G&NFS61910-1-4-8-12-2-1
In percent of GNP2730-1-3-4-10
In percent of public sector external debt service338033-6-21-41-53-14-7
In percent of overall MLT external debt service164220-4-12-24-33-7-3
In percent start period foreign reserves144229-3-10-23-44-9-1
In percent gross public sector ext. financing 2/1819319-4-15-41-45-7-4
(In percent of total)
Public debt to preferred creditors/public debt13273231
Collateralized & securitized public debt/public debt353028293136444749
Debt service: public debt to preferred creditors/public debt8184421
Debt service: collateralized & securitized public debt/public debt283024403829255057

Projected on an expectations basis, except repurchase expectations on purchases made between February 2002 and July 2003 falling due in 2004-05, which are projected on an obligations basis.

Consolidated government and CBT. Includes reserve accumulation before repurchases.

Net purchases less repurchases and charges.

Projected on an expectations basis, except repurchase expectations on purchases made between February 2002 and July 2003 falling due in 2004-05, which are projected on an obligations basis.

Consolidated government and CBT. Includes reserve accumulation before repurchases.

Net purchases less repurchases and charges.

Table 10.Turkey: Indicators of External Vulnerability, 2000–05 1/(In percent, unless otherwise noted)
Projections
200020012002200320042005
CPI inflation (end year)39.068.529.718.412.08.0
Public sector borrowing requirement (percent of GNP)18.921.112.09.87.03.7
Net debt of the public sector (percent of GNP)58.393.978.870.570.364.7
Export volume (percent change)6.616.611.716.314.810.1
Import volume (percent change)29.5-22.921.117.815.47.4
Current account balance, in percent of GNP-4.92.4-0.8-2.8-3.6-3.0
Capital account balance (in billions of US$)6.8-16.31.310.711.79.4
Of which: Foreign direct investment0.12.80.90.11.61.8
Foreign portfolio investment-5.2-4.6-1.21.22.31.6
Gross official reserves, in billions of US$ 2/23.219.828.135.233.927.6
In months of imports of goods and NFS4.04.45.45.24.03.1
In percent of broad money27.426.834.432.630.122.8
Gross total external debt, in billions US$118.7113.8130.9147.3149.6148.3
In percent of GNP59.079.072.161.853.251.2
In percent of exports of goods and NFS225.0218.8232.5205.5170.9156.3
Gross short-term external debt, in billions US$ 3/43.732.732.541.845.446.6
In percent of gross total external debt36.828.724.828.430.431.4
In percent of gross official reserves188.4164.7115.4118.8133.9168.8
Debt service 4/36.941.337.334.929.826.5
REER appreciation (CPI based, period average)11.1-18.29.58.9
REER appreciation (CPI based, end of period) 5/15.5-21.25.013.41.4
Capital adequacy ratio 6/17.315.325.329.6
State banks7.934.050.259.8
SDIF banks..-17.8-7.6-9.6
Private banks18.39.019.622.3
Foreign banks29.441.048.454.9
Nonperforming loans (in percent of total) 6/9.229.317.615.3
Real broad money, percentage change 7/0.811.2-3.3-6.67.45.1
Real credit to the private sector, percentage change 7/24.5-27.5-16.516.96.95.1
Banks’ net foreign asset position, in billions of US$-5.82.43.12.0
Banks’ net open exchange position, in billions of US$ 8/-5.4-0.1-0.4-0.3-0.5
Spread on Turkish dollar Eurobonds (in basis points) 9/800707693309463
Sources: Data provided by the Turkish authorities; and IMF staff estimates and projections.

For 2004-05, program projections.

As of June 18, 2004, reserves stood at US$34.0 billion (at actual exchange rates).

By residual maturity.

Interest plus medium- and long-term debt repayments as percent of current account receipts (excl. off. transfers).

For 2004, as of May 2004.

For end-2001 Pamuk Bank is treated as a private bank, for 2002 as an SDIF bank.

Deflated by the CPI.

For 2004, as of June 18, 2004

For 2004, as of June 21, 2004.

Sources: Data provided by the Turkish authorities; and IMF staff estimates and projections.

For 2004-05, program projections.

As of June 18, 2004, reserves stood at US$34.0 billion (at actual exchange rates).

By residual maturity.

Interest plus medium- and long-term debt repayments as percent of current account receipts (excl. off. transfers).

For 2004, as of May 2004.

For end-2001 Pamuk Bank is treated as a private bank, for 2002 as an SDIF bank.

Deflated by the CPI.

For 2004, as of June 18, 2004

For 2004, as of June 21, 2004.

APPENDIX I Turkey: Fund Relations

(As of May 31, 2004)

I. Membership Status: Turkey became a member of the Fund on March 11, 1947. It has accepted the obligations of Article VIII, Sections 2, 3, and 4 as of March 22, 1990.

II. General Resources Account:

Millions of SDRsPercent of Quota
Quota964.00100.00
Fund holdings of currency16,136.301,673.89
Reserve position in Fund112.7811.70

III. SDR Department:

Millions of SDRsPercent of Allocation
Net cumulative allocation112.31100.00
Holdings1.681.50

IV. Outstanding Purchases and Loans:

Millions of SDRsPercent of Quota
Stand-by Arrangements15,194.701,576.21
First credit tranche90.389.38

V. Latest Financial Arrangements:

TypeApproval DateExpiration DateAmount ApprovedAmount Drawn
In millions of SDRs
Stand-By02/04/0202/03/0512,821.2011,460.40
Stand-By12/22/9902/04/0215,038.4011,738.96
Of which: SRF12/21/0012/20/015,784.005,784.00
Stand-By07/08/9403/07/96610.50460.50

VI. Projected Payments to Fund (Expectations Basis)2

(In millions of SDRs; based on existing use of resources and present holdings of SDRs)

Forthcoming
20042005200620072008
Principal1,890.335,158.077,556.20595.4285.05
Charges/Interest323.03514.54191.6013.982.86
Total2,213.355,672.617,747.80609.4187.91

Projected Payments to Fund (Obligations Basis)3

(In millions of SDRs; based on existing use of resources and present holdings of SDRs)

Forthcoming
20042005200620072008
Principal284.384,925.726,930.552,463.95595.42
Charges/Interest334.83613.81307.1555.5413.61
Total619.215,539.537,237.702,519.49609.04

VII. Safeguard Assessments:

Under the Fund’s safeguards assessment policy, the Central Bank of the Republic of Turkey (CBT) is subject to a full safeguards assessment with respect to the SBA arrangement, which was approved on February 04, 2002 and is scheduled to expire on December 31, 2004. A safeguards assessment was completed on April 4, 2002 and staff’s findings and recommendations are reported in Section IV of IMF Country No. 02/137. The CBT authorities have implemented all of the measures recommended by staff.

VIII. Exchange Rate Arrangement:

For the period January 1, 2000–June 30, 2001, the lira was to have depreciated against a basket comprising US$1 and € 0.77 along a daily path pre-announced by the central bank. The preannouncement was for the 12-month period, and was updated quarterly. There would not be an exchange rate band around the pre-announced path during the first 18 months of the program. Thereafter—that is, from July 1, 2001—a symmetrical intervention band was to have been introduced around the central parity rate, with the total width of the band increasing gradually at a rate of 15 percentage points per year. This exchange rate arrangement was in place until February 22, 2001, when the government decided to float the currency.

IX. Article IV Consultations:

The 2002 Article IV staff report (IMF Country Report No. 02/137) was issued on April 4, 2002, and the accompanying Statistical Appendix (IMF Country Report No. 02/138) was issued on April 8, 2002. Board discussion took place on April 15, 2002.

X. ROSCs

Standard or Code AssessedDate of IssuanceDocument Number
Fiscal TransparencyJune 26, 2000SM/00/139
Corporate Governance (prepared by the World Bank)December 11, 2000
Data ROSCMarch 14, 2002Country Report No. 02/55

XI. Technical Assistance: (1993–present)

DepartmentTimingPurpose
MAEJuly 1994Banking sector reform
MAEJuly 1995Inflation accounting
FADSeptember 1995Taxation of petroleum products
FADOctober 1995Assistance to IBRD Public Financial Managing Project; 8 FAD missions since 1994, assignment of 5 resident experts, mainly focused on customs modernization
STAFebruary 1997Balance of payments compilation
PDR/EU1/MAEDecember 1998Short-term debt monitoring
MAEJune 1999Basel Core Principles
MAEAugust 1999Debt management policies
MAEOctober 1999Banking sector reform
MAEMarch 2000Banking sector reform
FADApril 2000Fiscal transparency
FADApril 2000Tax policy
MAEApril 2000Banking sector reform
MAEMay 2000Banking sector reform
MAEJuly 2000Inflation targeting
STASeptember 2000Balance of payments statistics
MAESept. 2000–April 2001Banking sector reform
MAEApril 2001Debt management
FAD/STAMay 2001Fiscal accounting and reporting
MAE/RESSeptember 2001Inflation targeting
STAOctober 2001Data ROSC
STAApril 2002National accounts statistics
MAE/RESApril/May 2002Inflation targeting
STAJuly 2002Public finance statistics
FADJuly 2003Social security
FAD/MFDSeptember 2003Taxation of Financial Intermediation Direct Tax Reform
MFDDecember 2003Banking legislation
FADDecember 2003Informal sector and tax administration reform
MFDMarch 2004Currency reform
STAApril 2004Consumer and wholesale price indices
STAMay 2004National account statistics
FADMay 2004Public expenditure analysis
FADJune 2004Tax policy reform
APPENDIX II Turkey: IMF–World Bank Relations

Partnership in support of Turkey’s Development Strategy

1. Turkey’s vision is of a modern and secular participatory democracy, fully integrated into the European community, playing a critical role in the regional context, with an export- oriented, highly competitive production structure. The priorities of the government are spelled out in the program presented to parliament in March 2003 and in the associated Urgent Action Plan.

2. The IMF and World Bank teams have collaborated closely in Turkey, and standard working arrangements already broadly follow the guidelines for enhanced Bank-Fund collaboration. This has included regular participation of Bank staff in the meetings with government on the Fund’s program review missions, and IMF staff has been invited to Bank review meetings and meetings with government. The IMF has taken the lead in macroeconomic stabilization and the World Bank in social and structural areas, with close collaboration in structural areas that have a particular impact on macroeconomic stability. The Bank’s dialogue and conditionality has maintained consistency with the macroeconomic framework endorsed by the IMF.

World Bank Country Assistance Strategy (CAS)

3. The objectives of the CAS, discussed by the Executive Directors on November 6, 2003, are to help Turkey reduce economic vulnerability and achieve high and stable growth, and continue the process of addressing some long neglected social and environmental problems. The last CAS focused heavily on crisis management. This CAS aims at reducing the risk of reemergence of crises and helping Turkey address the many economic challenges of preparing for EU membership. The planned assistance program for FY04–06 is structured around four development themes: (i) sound macroeconomics and governance; (ii) equitable human and social development; (iii) attractive business climate and knowledge; and (iv) strong environmental management and disaster prevention.

4. Under the program to promote sound macroeconomics and governance, the first priority will be the final loan in the Programmatic Financial and Public Sector Adjustment Loan (PFPSAL) series, PFPSAL III. Going forward, programmatic lending will be split between public sector and financial sector components reflecting the more specialized nature of the second generation of reforms. These will include fiscally sustainable reform of the social security system, continued support for the ongoing agenda of public sector reforms, and beginning to shift the emphasis from reforms to measurable improvements in public service delivery. The Bank will support the Government’s activities in the legal and judicial reform area initiated under the Urgent Action Plan through improvements in the legal framework and in judicial reform. Finally, under this heading, the Bank will help Government to develop a local government reform strategy with the objective of providing better local infrastructure services (water, roads, transport, solid waste management etc.) to the urban population that represents about 70 percent of the population. Analytical support under the sound macroeconomics and governance heading include development of a Computable General Equilibrium (CGE) model to study impact of the financial sector on growth and employment; a Country Economic Memorandum on EU accession; and a new Public Expenditure and Institutional Review, Country Financial Accountability Assessment, and Country Procurement Assessment Report.

5. Bank support for equitable human and social development will focus on secondary education, a radical reform of the health sector and assistance for social protection. Under the previous CAS, support had begun on primary education. Work will now begin on secondary education reform, in close coordination with EU-financed activities. Significant reforms are planned in the health sector to streamline service provision, do away with arbitrary differences in the provision of health care, and extend health insurance to the entire population in a fiscally responsible manner. Health insurance is only part of a planned reform of the entire social protection system including pensions, health insurance, social assistance and unemployment insurance. The Bank is providing intensive support for this process including analytical support through a Poverty Assessment, Labor Market Study, and projections on pensions, health insurance and unemployment insurance.

6. To help improve the business climate, the Bank will continue to support financial sector reform with a focus on the legal and regulatory framework for banking, the privatization of state banks, and regulatory issues related to capital markets, insurance and other nonbank financial institutions. A knowledge economy project will help position Turkey in the global economy. The real sector will be supported through an export finance loan. IFC will continue to finance viable private sector export-oriented projects including small and medium enterprises, and MIGA will offer guarantees to Turkish firms. Bank assistance in agriculture will focus on increasing productivity by addressing issues of human capital and through diversification in rural areas. A renewable energy project and railway restructuring project are planned. Analytical work will be on financial sector reform, a recently completed knowledge economy assessment, and a rural development strategy.

7. Environmental management is a high priority since Turkey is seeking to adopt European Union environmental standards. Bank lending support will focus on micro- watershed management and a contribution to a regional effort to reduce chemical run-off into the Black Sea. The Bank will also continue to support disaster management through a project to mitigate seismic risks.

8. As of June 30, 2004, the portfolio of World Bank financed projects in Turkey consists of 16 active projects. These include 13 investment loans, one programmatic adjustment loan (PFPSAL 3), and two grants. Total net commitments amount to about $4.3 billion. While net IBRD commitments are lower than in the previous two fiscal years, reflecting the recent closure of large loans, about $1.6 billion was approved in FY04, compared to $300 million in FY03. New approvals include a $1.0 billion programmatic adjustment loan, as well as loans in the health, energy and financial sectors.

9. The International Finance Corporation (IFC) has been active in the financial sector, manufacturing, oil and gas, infrastructure and health and education. As of May 31, 2004, IFC’s total portfolio in Turkey was US$881 million of which $33 million is equity. With a gross exposure of US$185 million as of April 30 2004, Turkey is an important country for MIGA. The total amount of foreign direct investment facilitated by MIGA is estimated at approximately US$1 billion.

IMF-World Bank collaboration

10. Areas where the Fund leads. The Fund takes the lead in macroeconomic stabilization including macro-fiscal policy, monetary policy, exchange rate policy and financial stability and risk management.

11. Areas in which the World Bank leads. The Bank has taken the lead in structural areas where both institutions have conditionality including bankruptcy reform, corporate sector restructuring, social security reform, regulatory and market reforms in telecommunications and energy, agriculture reform, and privatization. The Bank is also in the lead in areas such as health, education, infrastructure, governance and environmental management.

12. Areas of shared responsibility. The work on public sector management and governance has focused on strengthening public expenditure management system while maintaining fiscal discipline. The Fund has taken the lead in the short-term measures needed for the fiscal adjustment such as incomes policy, urgent revenue and expenditure measures, and budget monitoring and reporting. The Bank has taken the lead in assisting government on the medium-term public expenditure management strategy, rationalization of the public investment program, public procurement reform, accounting reform, and public liability management. Public employment policy, medium-term tax strategy, anti-corruption strategy and civil service reform are further areas of Bank involvement.

13. The challenge facing Turkey in the financial sector has been to address the banking crisis and putting in place an appropriate legal and regulatory framework that would minimize the risk of future crises. The Bank has taken the lead in reform of the legal framework and regulations for bank supervision, the institutional development of the Banking Regulatory and Supervisory Agency (BRSA) and Saving Deposit Insurance Fund (SDIF), and the structural reforms required to guide the restructuring and improve the governance of the state banks, as well as work on Non-Bank Financial Institutions (NBFI). The Fund has taken the lead in assessing the soundness of the banking system and where there was an immediate fiscal impact such as the re-capitalization of the state banks, the closing of insolvent banks, and the private bank recapitalization scheme. On the state banks agenda and resolution of private banks the Fund and Bank have worked closely as a team. The Bank intends to continue its support for financial sector reform in Turkey including the development of the NBFI for which a major study has recently been concluded.

Ankara, July 15, 2004

Mr. Rodrigo de Rato

Managing Director

International Monetary Fund

Washington, D.C., 20431

U.S.A.

Dear Mr. de Rato,

1. Adherence to our macroeconomic program has enabled Turkey to ride recent market turbulence with limited adverse effects. Our floating exchange rate regime as well as our strong fiscal position have helped us adjust promptly to a combination of tighter international capital markets and pressures on the current account balance resulting from strong import demand and higher oil prices. We have continued to experience broad-based growth from the production side as well as the demand side, and we confidently expect to meet, or exceed, our program projection of 5 percent growth this year. Consumer price inflation has fallen to 9 percent, a new decades-long low.

2. We are determined to end the “stop-go” economic policies of past years. The recent pace of consumer demand growth as well as related imports, if continued, could have posed risks for the sustainability of our growth trajectory. However, a rise in market interest rates and slowing of credit growth should contain domestic demand while lira depreciation will impact the current account balance. The over performance of budget revenue should help to dampen demand pressures.

3. In order to sustain rapid growth over the medium term we are also pressing forward with our ambitious economic policy agenda.

  • We have met or exceeded most fiscal and monetary targets set under the program. The primary surplus targets for March and April have been comfortably exceeded, as has the target for net international reserves. The base money target for April was missed by the narrowest of margins.

  • In the area of structural policies, we have moved forward decisively in most areas although some unavoidable delays have arisen (Annex A). BRSA has assessed the strength of the banking system prior to replacing the blanket guarantee with a more limited deposit protection scheme. SDIF has revalued its assets and announced a new strategy for asset sales, excess capital in state banks has been removed and key elements of a strategy for restructuring and eventual privatization will be announced shortly. The wholesale revision of the Banking Act, however, is delayed to ensure adequate consultation with stake holders and will be passed on to parliament in September. We have also driven forward our fiscal reforms: draft revenue administration restructuring legislation has now been completed and will be submitted to parliament shortly; the Commission on SEE governance has completed its work; and, the code of conduct for civil servants was approved by parliament on May 25. We have continued to refrain from introducing any new amnesty on public sector receivables, meeting a continuous performance criterion.

4. In light of this strong performance, we request the completion of the Eighth Review under the Stand-By Arrangement. Based on our exceptional record in reducing inflation and the resulting increase in currency demand, we request a waiver of nonobservance for end-April 2004 base money performance criterion. Performance criteria for the remainder of the program are set out in Annex B. We will continue to consult the Fund about the progress being made in implementing policies supported by the Stand-By Arrangement, and in advance of any changes to these policies.

Macroeconomic framework

5. We remain on course to achieve our macroeconomic objectives for 2004. Consumer price inflation has fallen to single digits, while growth in the first part of the year has been stronger than anticipated. Although higher world oil prices and the depreciation of the exchange rate in April and May could raise the level of consumer prices temporarily, we are well on track to meet our target of 12 percent inflation at end-year. These same factors, together with the recent increase in interest rates, should slow domestic demand growth in the coming months, bringing output growth more closely in line with the 5 percent program projection. On the external side, we expect a current account deficit of some 3½-4 percent of GNP with strong exports and tourism receipts in large part offsetting higher imports. In light of strong net capital inflows early in the year our net international reserves position will be maintained.

6. For 2005 and beyond, our emphasis will be on maintaining disinflation and debt reduction through sustaining our high primary surplus. This environment should permit growth to continue at around 5 percent. We expect inflation to further slow to 8 percent by end-2005. In order to continue reducing real interest rates we will maintain our tight fiscal policy in 2005. Our 2005 budget call will be consistent with our medium term debt reduction strategy.

7. We are finalizing our medium-term program aimed at accelerating economic convergence with the European Union. Our economic policy priorities ahead are focused on tax reform – aimed at base broadening and rate reductions, affordable health and social security reform, and completing restructuring of the banking sector. We will continue our close policy dialogue with the Fund in 2005 and beyond.

Fiscal policy

8. Fiscal policy remains on track to meet, or exceed, our 6.5 percent of GNP public sector primary surplus target in 2004. Strong revenues as well as expenditure shortfalls have contributed to this performance through end-May. We intend any revenue over performance to provide a cushion to help ensure that the 2004 budget can be fully implemented.

9. To ensure full implementation of the approved budget and an appropriate fiscal stance we have:

  • Scaled back tax incentives for automobile purchase. From May, the automobile excise deduction available for new car purchase has been cut from TL4.5 billion to TL2.3 billion.

  • Written over to the budget TL 1.2 quadrillion of special revenues cutting the scope for extra budgetary spending appropriations as a prior action for this review. While this amount is slightly lower than previously envisaged, our intention remains to transfer TL2.5 quadrillion special revenues for the whole year.

  • Increased petroleum excises. In light of the exceptional increase in world oil prices in recent months, excises were lowered temporarily to limit the pass through to domestic prices. As oil price increases now appear not to be temporary, we have increased petroleum excises effective June 29, only narrowly falling short of budget assumptions (structural benchmark for the review). Adjusting excises in line with budget assumptions remains a structural benchmark. The petroleum product market will be liberalized on January 1, 2005 with prices determined by market forces.

  • Maintained our incomes policy consistent with our inflation objective. Public sector wages and salaries have been increased in line with the inflation target. The Minimum Wage Commission announced the minimum wage for the remainder of 2004, with an increase in line with those of public workers and civil servants and with no budget compensation for employers.

  • Submitted the draft decree to the Council of Ministers to eliminate the RUSF levy on commercial credits later this month as a further step to reduce financial intermediation costs.

  • Finally, significant future changes in tax policy will be aligned with the budget cycle.

10. We are moving forward in implementing our structural reform program to support a sustained improvement in Turkey’s fiscal performance.

  • Draft revenue administration restructuring legislation, including provisions to make GDR a semi-autonomous agency within the Ministry of Finance, reorganization along functional lines, and to move tax policy functions into the Ministry of Finance has been finalized. The draft legislation will be submitted to Parliament before end- July (structural benchmark). However, parliamentary passage (July structural benchmark) has been delayed due to a heavy legislative agenda. Passage is now expected by end-October 2004 (new structural performance criterion).

  • Our strategy for enhancing state enterprise governance (May benchmark) is complete. The strategy entails introducing performance targets, strengthening the accountability and efficiency of management, and allowing performance and financial auditing by external auditors. We will complete the legislative changes in line with the strategy by end-2004.

  • We have improved our public sector personnel system, through passage of legislation to establish a code of conduct for civil servants and public administrators (June benchmark).

  • The Ministry of Labor has developed a framework for analyzing social security reforms. Over the Summer we will work on a range of reform options. We will decide our preferred pension system reform strategy by end-September 2004 (new structural benchmark). This strategy will include unification of the existing three pension institutions and an objective to place the pension deficit on a firm downward path by 2007 and to reduce it to 1 percent of GNP over the long term. In the area of health insurance, we plan to have a phased introduction of universal health coverage with any additional expenditures covered by compensatory measures. We will submit this reform package to parliament in mid-December 2004 (performance criterion) with a view to passage by January 2005 and a phased implementation during 2005-07.

  • In the context of preparing legislation for the decentralization of some central government functions to municipalities and special provincial administrations we will ensure that budgetary discipline is maintained. The legislation will limit municipalities and special provinces debt stock to no more than annual revenue. Metropolitan municipalities debt stock will be limited to 1.5 times annual revenue. Debt limits will be reviewed and tightened, if necessary, in the context of forthcoming legislation concerning intergovernmental relations. New domestic borrowing of all local governments in excess of 10 percent of annual revenues will require central government authorization. The legislation will also require local governments to disseminate timely and accurate fiscal data to enable monitoring and will be complemented by separate legislation that clarifies intergovernmental fiscal relations. A committee is preparing a comprehensive report on the current level of local government debt, including enterprises under local government control.

  • Arrears of local governments, including penalties and interest, will be dealt with on a case by case basis by a newly created Commission empowered by law to restructure claims, subject to Council of Ministers’ approval. Formal settlements will be guided by the ability to pay, contain adequate safeguards for repayment including claw back of central government transfers, and will be made public.

Monetary policy

11. Monetary policy remains focused on achieving this year’s 12 percent inflation target, and reducing inflation over the medium term. With inflation falling faster than anticipated, demand for base money has again exceeded our projections, causing the end- April performance criterion on base money to be missed by a fractional amount. In light of this increase in money demand we have raised our base money targets for the remainder of the year (Annex B). While our policy of implicit inflation targeting has been successful, we are making progress toward the eventual adoption of formal inflation targeting.

12. The floating exchange rate regime remains central to our ability to adjust promptly to changing global circumstances. At end-April we terminated foreign exchange purchase auctions in response to a decline in foreign exchange supply occasioned by banks closing their positions and a reversal of hitherto strong portfolio inflows. Since then we have intervened once in a small amount to dampen excessive exchange rate volatility, and such discretionary intervention will continue to be strictly limited. The recent exchange rate depreciation represents a correction largely in response to tightening global capital markets and a weakening of the current account balance. Its impact on the price level should be contained, and monetary policy will aim to limit second-round effects on inflation.

13. Coordination between the Treasury and the CBT in their respective policy areas of debt management and monetary policy has been strengthened. Coordination at the operational level, on a daily basis, is working well. To further enhance the effectiveness of policy coordination we will prepare a joint CBT-Treasury action plan, by end-September 2004, to address remaining legal, regulatory or procedural obstacles (a new structural benchmark).

Financial sector reform

14. Our efforts to strengthen the financial system continue to move ahead across several fronts. In particular, through strengthening the legal framework for banking activities, disposing of assets of liquidated and intervened banks, and restructuring state banks for privatization.

  • We have completed a comprehensive review of the Banking Act and prepared a new draft Law on Credit Institutions to bring the legal framework more closely in line with EU standards. The law will place particular emphasis on strengthening the legal framework in the following areas: (i) “fit and proper” criteria for bank owners; (ii) on-site inspections; (iii) lending to related parties; (iv) legal protection for BRSA and SDIF board members and staff for actions taken in good faith during the course of their duties; and (v) delineating the responsibilities of BRSA and SDIF respectively and providing for their effective coordination. By end-September, 2004, we will conduct seminars for the banking community and other stakeholders to help contribute to the understanding of the new law’s principal objectives and features. We will submit the draft law to Parliament by end-September 2004. We expect Parliament to pass the Law on Credit Institutions with the features above by end- November 2004 (new structural performance criterion). We are committed to maintain the operational and financial independence of the BRSA and the SDIF in the new banking act and other relevant legislation.

  • Regulation and supervision of non-bank financial institutions will be transferred from the Treasury to the BRSA by January 1, 2005.

  • The Imar bank inquiry is underway. The commission was appointed in late April and is expected to present its findings to the government in a final report, to be made public by end-August 2004 (performance criterion).

  • We have reassessed the value of SDIF asset holdings to foster a better understanding of the recovery rates that might be expected from asset sales. To this end, for each intervened bank the SDIF will, in mid-July, announce the value of assets taken over at the time of intervention, accrued interest based on market rates as of end-June 2004, estimated market values (or recovery rates), and the costs borne by SDIF for restructuring or liquidating banks.

  • Our new strategy for SDIF asset resolution has been announced (structural benchmark for April 2004). The main features are: (i) at end-May 2004, an offer was made to all borrowers except bank owners and individual borrowers to repay all outstanding debt by July 15 with a discount of 50 percent applied to principal and discounted interest, or to pay a 20 percent down payment with a discount of 30 percent on the remaining balances paid in installments over a 24-month period; (ii) in mid-July will re-launch the auction that was cancelled in December with bids to be submitted by August 16 and the winning bid to be selected by end-August (new structural benchmark); (iii) thereafter, new portfolios will be put up for sale by auction periodically until all assets have been disposed; (iv) for assets sold individually SDIF will always obtain a third party opinion about the price; and (v) all asset sales will be conducted transparently ensuring a fair and equal process.

  • Our plan for the resolution of Treasury receivables from the SDIF arising from financing the restructuring of the banking system by end-2004 is on track.

  • The blanket guarantee was lifted on July 5, 2004 and replaced with a limited deposit protection scheme protecting savings deposits up to TL 50 billion. Before the replacement, the BRSA undertook a thorough assessment of banking system soundness (April structural benchmark). A brief summary of the assessment has been published. In parallel, the CBT also assessed the effect of the abolition of the blanket guarantee on the Turkish payments system.

  • The key elements of our new strategy for state banks will be announced shortly (a June structural benchmark). Legislation for the integration of Pamukbank into Halkbank is expected to be approved by Parliament shortly. All legal, managerial and financial issues regarding the integration, will be completed by end-August 2004 (a new structural benchmark). The integration is expected to be completed by end- October 2004. Treasury will recapitalize Pamukbank and eliminate the negative net worth before integrating Pamukbank and Halkbank. Over time, Treasury will also replace Halkbank’s holding of non-marketable securities with securities issued on market terms. The strategy for Ziraat bank has been developed and will be announced by end-July. Our objective remains to privatize these banks as soon as the restructuring is complete and when market conditions permit.

  • The due diligence for Vakifbank has been delayed. The terms of reference have been finalized, the bank is in the process of hiring a consultant, and the due diligence will be completed by end-September 2004 (new structural benchmark).

Private sector development

15. As a follow up to the Investment Advisory Council (IAC) meeting in March, we have prepared draft legislation to streamline permission and approval procedures for investors. Moreover, we revised the draft law on establishing an Investment Promotion Agency and reflected the views of the various stakeholders. Our work also extends to the effective protection of intellectual property rights enforced by new legislation. We will submit a progress report to the Prime Minister and IAC members by October 2004.

16. Our privatization program is delivering good results and we have made progress on some legal and procedural issues. In the first quarter, cash receipts from privatization reached U.S.$3 11 million, exceeding the indicative benchmark. We have amended public procurement legislation to simplify the hiring of advisors, and are preparing legislative amendments to facilitate sales of minority holdings.

17. Due to a legal ruling halting the sale of TÜPRAŞ we may fall short of our annual privatization receipts target of U.S. $3 billion, though we are determined to maintain forward momentum. To this end, a law enabling the sale of more than 45 percent share of Tϋrk Telekom to foreigners is approved and we expect to launch the tender process before the end of the year. We are also planning public offerings for 10-15 percent shares of PETKIM (petrochemicals) and Turkish Airlines. Privatization of the National Lottery is pending parliamentary approval of the legal framework, and then we will proceed to a request for proposals.

Very truly yours,

/s//s/
Ali BabacanSüreyya Serdengeçti
Minister of State for Economic AffairsGovernor of the Central Bank of Turkey

ATTACHMENT ANNEX A Turkey: Structural Conditionality, April-December 2004

ActionType 1/Status
Prior actions for the eighth review
Write over to the central government budget cumulative TL1.2 quadrillion of special revenues in the period January-June 2004.PAMet.
April
Announcement by the SDIF of a new strategy for asset resolution.BMMet with delay. Settlement offer to borrowers at end- May. Auction strategy announced in June.
Assessment of the banking system prior to lifting of blanket guarantee.BMMet.
May
Submission to Parliament of tax administration reform legislation, making the GDR a semi-autonomous agency within the Ministry of Finance.BMDelayed to July.
Prepare report outlining key elements of state enterprise governance strategy.BMMet. Inter-agency committee completed study end- May.
June
Improve the public sector personnel system, including passage of legislation to establish a code of ethical conduct for civil servants and public administrators (previous target end-December 2003).BMMet. Legislation was passed in May 2004.
Make public key elements of the new strategy for state banks and a timetable for the action plan (mid-June).BMPartially met. Strategy for Halk-Pamuk announced and related legislation is expected to be approved by Parliament shortly. Ziraat strategy prepared and will be announced in July.
All excises will be adjusted to be brought in line with budget assumptions.BMPartially met. June 29 increases brought excises close to budget assumptions.
July
Passage by Parliament of tax administration reform legislation, making the GDR a semi-autonomous agency within the Ministry of Finance as defined in paragraph 10 of the Letter of Intent.BMDelayed due to heavy legislative agenda. Reset as new performance criterion for end-October 2004.
August
Publication of final report on the independent inquiry into the Imar bank case in accordance with the terms of reference.PCOngoing
Complete legal, managerial and financial procedures for integration of Halkbank and Pamukbank.BMOngoing.
Select winning bid for relaunched SDIF asset auction.BM
September
Finalize an action plan to address remaining legal, regulatory or procedural obstacles to Central Bank-Treasury coordination on monetary policy and debt management.BM
Completion of due diligence for Vakifbank by a consultancy firm.BMOngoing
All excises will be adjusted to be brought in line with budget assumptions.BM
Decide on preferred pension system reform strategy.BM
October
Passage by Parliament of tax administration reform legislation, making the GDR a semi-autonomous agency within the Ministry of Finance as defined in paragraph 10 of the Letter of Intent.PC
November
Passage by Parliament of Credit Institutions Law that strengthens the legal framework as defined in paragraph 15 of the Letter of Intent.PC
December
Submission to Parliament by December 15 of social security reform legislation, as defined in paragraph 10 of the Letter of Intent.PC
Continuous
No new amnesties of arrears on public sector receivables.PCMet

PA=prior action, PC=structural performance criterion, and BM=structural benchmark.

PA=prior action, PC=structural performance criterion, and BM=structural benchmark.

ATTACHMENT ANNEX B Turkey: Quantitative Performance Criteria and Indicative Targets for 2004

Ceiling/FloorOutcomeCeiling/FloorOutcomeCeiling/FloorOutcomeCeiling/FloorOutcomeCeiling/FloorOutcomeCeiling/FloorOutcome
I.Quantitative performance criteriaMarch 31, 2004April 30, 2004June 30, 2004August 31, 2004September 30, 2004December 31, 2004
1.Floor on the cumulative primary balance of the consolidated government sector since January 1, 2004 (in trillions of TL)5,4207,61814,10022,95026,200
2.Floor on the cumulative primary balance of the consolidated government excluding SEEs sector since January 1, 2004 (in trillions of TL)6,3008,94819,00022,900
3.Ceiling on contracting or guaranteeing of new external public debt with original maturities of more than one year (in millions of US$) 1/7,0003,38213,0005,22716,00017,500
4.Ceiling on the stock of external public debt with original maturities of up to and including one year (in millions of US$) 2/1,00001,00001,0001,000
5.Floor on level of net international reserves of CBT and Treasury combined (in billions of US$)-2.000.75-2.001.79-2.00-2.00
6.Ceiling on base money (in quadrillions of Turkish lira)16.116.917.517.520.520.9
II.Indicative targets
1.Floor on the cumulative overall balance of the consolidated government sector since January 1, 2004 (in trillions of Turkish lira)-11,420-6,084-20,000-29,300-35,440
2.Ceiling on the stock of net domestic assets of the CBT and Treasury combined (in quadrillions of Turkish lira)29.627.331.626.134.635.0
3.Privatization proceeds cumulative from January 1, 2004 (in millions of US$)1003115001,0003,000
4.Number of employees hired at non-financial state enterprises4,000

Applies to nonconcessional external debt with an original maturity of more than one year from end-December 2003. Excludes purchases from the IMF, adjustment lending from the World Bank, and other external program financing, long-term liabilities of the Central Bank and sales of treasury bills and bonds denominated in TL or Fx to nonresidents in either the domestic primary or secondary markets.

Stock of debt of maturity of one year or less, owed or guaranteed by the consolidated government sector. Excludes external program financing, sales of treasury bills denominated in TL or foreign exchange to non residents in either the domestic primary market or the secondary market, normal import-related credits, reserve liabilities of the Central Bank, and forwards contracts, swaps and other futures market contracts.

Applies to nonconcessional external debt with an original maturity of more than one year from end-December 2003. Excludes purchases from the IMF, adjustment lending from the World Bank, and other external program financing, long-term liabilities of the Central Bank and sales of treasury bills and bonds denominated in TL or Fx to nonresidents in either the domestic primary or secondary markets.

Stock of debt of maturity of one year or less, owed or guaranteed by the consolidated government sector. Excludes external program financing, sales of treasury bills denominated in TL or foreign exchange to non residents in either the domestic primary market or the secondary market, normal import-related credits, reserve liabilities of the Central Bank, and forwards contracts, swaps and other futures market contracts.

ATTACHMENT ANNEX C Turkey: Performance Criteria Test Dates and Review Schedule, 2004

ReviewPurchase

(SDR millions)
Primary balance of the CGS and external debtPC Test Dates Primary balance of CGS minus SEEsNIR, Base MoneyEarliest Possible Purchase Date
Actual purchases11,460.4
8th Review453.6April 30, 2004April 30, 2004June 15, 2004
9th Review 1/453.6June 30, 2004August 31, 2004August 31, 2004October 15, 2004
10th Review 1/453.6September 30, 2004December 31, 2004December 31, 2004January 15, 2005
Total Purchases12,821.2

The June 30, 2004 and September 30, 2004 test date ceilings for the CGS primary balance and external debt performance criteria become applicable for purchases 45 days after the actual test date in view of the time required to report comprehensive monitoring data.

The June 30, 2004 and September 30, 2004 test date ceilings for the CGS primary balance and external debt performance criteria become applicable for purchases 45 days after the actual test date in view of the time required to report comprehensive monitoring data.

¶refers to the relevant paragraph in the attached Letter of Intent.

This schedule presents all currently scheduled payments to the IMF, including repayment expectations and repayment obligations. The IMF Executive Board can extend repayment expectations (within predetermined limits) upon request by the debtor country if its external payments position is not strong enough to meet the expectations without undue hardship or risk (see repayment schedules and IMF lending for details).

This schedule is not the currently applicable schedule of payments to the IMF. Rather, the schedule presents all payments to the IMF under the illustrative assumption that repayment expectations—except for SRF repayment expectations—would be extended to their respective obligation dates by the IMF Executive Board upon request of the debtor country (see repayment schedules and IMF lending for details). SRF repayment expectations are shown on their current expectation dates, unless already converted to an obligation date by the IMF Executive Board.

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