Journal Issue

Turkey: From crisis to recovery

International Monetary Fund. External Relations Dept.
Published Date:
September 2004
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IMF Survey: Turkey has undergone an amazing recovery since the 2001 crisis. What made this possible?

Deppler: Turkey’s growth has averaged 6-7 percent over the past two years, well above the 5 percent forecast under its Stand-By Arrangement with the IMF. Inflation has come down from around 70 percent to single digits reserves are many billions of dollars above what we had programmed; and real interest rates—which are key to confidence—are down from about 30-35 percent to 15 percent. All this has happened because strong policies, together with IMF financing to give the process time, have restored confidence in the economy. People are now investing and spending more. Turkey is, in fact, a classic case of successful stabilization.

Kicking the habit of high inflation


Data: IMF, International Financial Statistics and World Economic Outlook.

Turkey’s central bank has restored credibility in fighting inflation


Note: Expected annual inflation minus the central bank’s announced inflation target.

IMF Survey: What sparked this transformation?

Deppler: The crisis, basically. Economic problems are almost invariably political problems. Societies get themselves into a situation where they accommodate too many rent-seeking activities. When this becomes unsustainable, it results in crisis, which then brings about change. I have seen this in many countries. A case in point is Bulgaria, where a crisis changed the dynamics of what is possible. Turkey is another such case.

IMF Survey: Can you give us a sense of where the Turkish economy has come from and where it is going?

Deppler: Turkey is shifting to a new view of both its place in the world and how it wants to manage its economy and its politics more generally. As part of this, there is much more coherence to the policy package, the policy perspective, and the direction of the economy. That is probably the most significant change to have come out of the crisis, and it gives us reason to hope that Turkey’s performance in the future is going to be significantly better than it has been in the past.

IMF Survey: Fiscal policy has always been Turkey’s Achilles’ heel. What should the government do to put fiscal policy on a sound long-term footing?

Moghadam: The performance of fiscal policy in Turkey has been impressive compared with that in emerging markets around the world. Last year the government ran the highest primary surplus on record in that country—just over 6 percent of GNP.

But if you look more closely at the budget, difficult challenges lie ahead. For example, three-fourths of total spending is nondiscretionary, leaving the government with little flexibility to control expenditures. And because tax rates are already very high, there is little room to increase revenues. International experience shows that sustaining fiscal adjustment depends, to a large extent, on controlling expenditure.

There are other challenges as well. During the crisis, current spending was increased at the expense of capital spending. This must now be reversed to make room for more public investment in infrastructure and social programs. All of this points to the need for structural fiscal reforms to sustain the fiscal performance.

IMF Survey: Paying down Turkey’s debt will be difficult to reconcile with the social demands placed on the state by high unemployment, regional inequality, and population growth. How can the government balance these contradictory demands?

Deppler: With the crisis giving way to recovery, there is clearly a shift to paying greater attention to social issues. Unemployment, in particular, has become a greater concern. Needless to say, this is a concern we share.

The real issue is how to address it. As you suggest, many people see increased public spending as the solution. My answer to them is that Turkey’s very tough fiscal policies have lowered interest rates dramatically, and this has led to very strong economic performance. Real interest rates are still about 15 percent, which, by any standard, is extremely high. Policies that reduce real interest rates to single digits—which are more the norm in emerging market economies—will pay off much more in terms of reducing unemployment and increasing tax receipts to fund social programs than would token spending policies in favor of particular programs. Do not underestimate the growth that can be achieved from sound fiscal and monetary management in a situation like Turkey’s.

IMF Survey: Has Turkey finally kicked the habit of high inflation?

Moghadam: There has definitely been a structural change. For the first time in Turkey’s history, the credibility gap—the gap between market expectations and the inflation target—has turned negative (see chart, this page). This means the central bank has managed to restore credibility in terms of dealing with inflation. Now, the challenge will be to move toward European rates of inflation. Fiscal policy has been key in bringing down inflation, and it will continue to be important. Another important change has been the government’s decision to grant independence to the central bank.

IMF Survey: Turkey is still very vulnerable because of its debt. What can it do to reduce its exposure?

Moghadam: The government is well aware of the need to reduce the debt. In the new member states of the European Union [EU], gross public debt is typically about 40 percent of GDP. At about 80 percent of GDP, Turkey’s gross debt is double that figure. The IMF has done a lot of work in recent years on risks associated with high debt, and the Turkish authorities recognize these risks. So the debt will have to come down, which points to the need for continued large primary surpluses. Structural fiscal reform is therefore essential. As reforms take hold and policy credibility improves, real interest rates will come down, which will help generate a virtuous circle and facilitate further declines in debt.

IMF Survey: Why is there still so little foreign direct investment [FDI] in Turkey?

Moghadam: Historically, FDI has been low in Turkey, for understandable reasons. If you have a lot of policy volatility and macroeconomic instability, then you cannot expect FDI to be high. But Turkey has gotten over the first hurdle—creating a stable macroeconomic environment—and FDI is picking up as a result. The potential of the country—with a population of almost 70 million, a vibrant economy, and a geographical position that has Europe, Asia, and North Africa in close proximity—means prospects are excellent.

The government is aware of the need to increase FDI. In recognition of that, the prime minister recently invited about 20 top business people from around the world to discuss what is holding it back. They pointed to macroeconomic stability as being key, but also said the government must address corruption, improve the judicial system, upgrade its infrastructure, and remove red tape.

IMF Survey: Weak banks contributed to the crisis in 2001. Has banking reform corrected these failures?

Moghadam: Banking reform has been impressive, but it has come at a heavy price. The cost of cleaning up the banking system has been close to $50 billion and is the key reason for the increase in public debt. The banking system is in a far stronger position than it was three years ago, and the government is working on a new banking law that will bring the supervisory regime closer to EU standards. However, asset recovery has been disappointing and needs to be accelerated to recoup some of the costs incurred.

IMF Survey: Turkey is awaiting a decision from the EU in December on whether it will be allowed to start accession talks. How important will this be for Turkey’s economic future?

Deppler: We agree with the authorities that, regardless of what happens, the present economic strategy needs to continue. That said, there is no question that joining the EU would be a major boost to Turkey’s prospects. The EU has been a beacon for sound policies throughout Eastern Europe over the past 10 to 15 years, and it will serve the same role in Turkey. In terms of economic payoffs, I would have the greatest hopes for improving the business climate—through judicial reform and moving toward greater respect for the law—where clearly there are problems of corruption. These issues are difficult to address, and the prospect of EU accession would help propel change.

IMF Survey: The IMF has tremendous exposure to Turkey. The country owes $23 billion, which accounts for one-fourth of total IMF lending. How does this affect the IMF’s relations with Turkey?

Deppler: Needless to say, it focuses the mind and the attention of senior staff, management, and Executive Directors. But if you think about big programs in the IMF, Turkey is not among the more controversial ones. So while there is much attention, it has been relatively benign.

IMF Survey: Many people have criticized the IMF for the way it handles financial crises. But, in stark contrast to what happened in Argentina, Turkey managed to avoid default and has experienced growth since then. What went right in Turkey?

Deppler: To my mind, Turkey is much more the normal case than the IMF is typically given credit for: given a supportive political environment, programs generally succeed. What happened in Turkey is what the IMF always tries to do—and often succeeds in doing. Countries are generally very reluctant to default. In my experience, when countries come to the brink and must decide, they generally resist default. Hungary and Bulgaria in the 1990s come to mind.

IMF Survey: The government announced in August that it would seek a new program with the IMF once the current one expires in February next year. What will the new program seek to achieve?

Deppler: There is no question that, although Turkey is doing much better than in the past, it remains quite vulnerable. Its debt is far too high for an emerging economy. It also preempts too much of the national savings needed to finance a growing economy. Turkey must therefore continue its debt reduction strategy at a pronounced pace.

The purpose of the new program, as we understand it from our discussions with the authorities, is to continue reducing the debt, strengthen the economy, and make fiscal policy compatible with both debt reduction and a vibrant private sector. This means tax and other reforms. Together with continuing efforts to strengthen the banking sector, these are the key features of the future program, which would basically extend the existing arrangement.

IMF Survey: You have followed Turkey for many years. Where do you see the country in 20 years?

Deppler: In 1980, Turkey went through a bout of liberalization and reform. At the same time, it initiated 20 years of erratic and cumulatively harmful macroeconomic policies. If Turkey had simply liberalized and continued with sound policy management, it would have enjoyed some of the highest growth rates in the world. Instead, it performed slightly above average. There is a good chance now that Turkey will continue to pursue not only market-oriented policies but also sound macroeconomic policies. Such policies would enable the private sector to respond strongly and allow Turkey to enjoy growth that is well above average over the next 20 years. I think there is a strong prospect of that, and this is encouraging.

The IMF’s Turkey team is led by Reza Moghadam and comprises Mark Griffiths, Donal McGettigan, and Christian Keller. For more information on the IMF’s recent appraisal of the Turkish economy, please refer to the statement “IMF Concludes 2004 Article IV Consultation with Turkey” on the IMF’s website (

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