Chapter

Economic Stabilization and Structural Adjustment: The Case of Turkey

Editor(s):
Mohsin Khan, Morris Goldstein, and Vittorio Corbo
Published Date:
September 1987
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Author(s)
Rusdu Saracoglu

The Fund symposium on growth-oriented adjustment policies is very timely given recent economic developments throughout the world and, in particular, the problems faced by a number of developing countries. Inevitably the pressures on heavily indebted countries that face continuing imbalances, both domestic and external, force such countries to seek assistance from competent international organizations such as the International Monetary Fund and the World Bank. It is therefore quite appropriate that this symposium was organized under the joint sponsorship of the two most highly regarded international financial organizations of the world. I am confident that the proceedings will add to our understanding of the issues and assist policymakers as well as the staff of the two institutions in preparing future adjustment programs.

Let me also express my sincere appreciation that Turkey was chosen as a case worth studying. It has always been our belief that Turkey’s experience since 1980 with adjustment and stabilization policies merits careful analysis by scholars as well as policymakers of other countries. We believe that the lessons that we have learned from our experience, whether positive or negative, should be publicly available. I must add here that we feel that much of what we have to offer constitutes a positive lesson.

Adjustment policies together with a set of major reforms has been a continuous process since 1980 albeit with varying intensity. Our efforts, policies, structural reforms, successes, and setbacks together with economic performance under the program are detailed in various Fund-Bank documents. It would be impossible to condense that history into a brief presentation. Consequently in my presentation today I intend to concentrate on a limited number of policies and structural reforms that are of major significance and lie at the heart of our adjustment strategy. Often these policies were considered impossible to implement. They were meant to change, in a fundamental way, the orientation of the economy and the growth strategy pursued for many decades. In concentrating on a few policies, I hope to bring them into sharper focus for discussion here.

In my presentation, I will first give some background information in order to put Turkey’s adjustment strategy into a historical context. It is essential that the participants appreciate the economic philosophy prevailing in Turkey at the time, the economic developments leading to a crisis, and the political turmoil that existed in the country when the adjustment program was initiated. Following this background, I will discuss in two separate sections economic stabilization policies and structural adjustment policies. I feel that discussing the two sets of policies in separate sections will facilitate understanding, even though both sets of measures were taken more or less contemporaneously and implemented in a mutually supporting manner. The discussion of policies is followed by an admittedly sketchy presentation of economic performance under the program, highlighting successes as well as weaknesses that were, or need to be, corrected. Finally, I present some conclusions that may be of value in designing adjustment programs, incorporating structural reforms aimed at enhancing productivity and long-term sustainable rates of growth.

Background

Since the formation of the Republic of Turkey in 1923, the Government has always played a significant role in economic activity. Following decades of wars with foreigners and unfortunate experiences with foreign powers that led to the War of Independence, Turks have had for a long time maintained strong feelings of mistrust toward foreigners, particularly toward Europeans, and economic policies associated with them.

Although the founding fathers tried to experiment with liberal economic policies immediately after the formation of the Republic, the experiment was short-lived owing, in part, to international economic developments leading to the Great Depression. The Turkish Government reacted to these developments by discontinuing liberal economic policies and instituting protectionist policies. Initially, the protectionist policies were viewed as temporary measures designed to isolate Turkey from the harmful impact of the Great Depression and trade cycles. Nevertheless, these protectionist policies proved to be more in accord with the general philosophy of the Turkish administration, and the temporary measures gained permanence. It is worth noting, for example, that a temporary law on the Protection of the Value of the Turkish currency passed in 1930 for three years is still in effect, and over the decades it was used by successive governments to institute protectionist policies, to restrict or regulate domestic and external trade, to restrict external payments, and in general to interfere in and to control the economy, at times with a very heavy hand.

Under protectionist economic policies, the state was assigned to play the role of the locomotive of the economy. The Government created economic enterprises to solve critical supply problems and to accelerate industrialization. Initially few in number and operating in critical sectors, these economic enterprises proliferated rapidly and accounted for a major share of the domestic production. With the advent of economic planning in the 1960s the State Economic Enterprises (SEEs) gained even more prominence as vehicles of industrialization and accelerated capital formation in Turkey. Import substitution was a major objective of the economic policy and was adopted, with some political overtones, in order to assure the “economic independence” of Turkey.

All instruments of economic policy were used in support of import substitution. The trade regime was rendered excessively restrictive through licensing requirements, quotas, tariffs, and other levies. The payments regime was also extremely restrictive with surrender requirements on external receipts, foreign exchange allocation schemes, and excessively voluminous and complex foreign exchange regulations. The financial system was repressed and highly regulated in order to assure financial support for import substitution activities. Nevertheless, through these policies the SEEs were able to deliver what was expected of them, and Turkey was able to maintain moderately high growth rates throughout much of the 1960s and early 1970s, notwithstanding a balance of payments crisis in 1969, which resulted in even more tightening of the trade regime.

In the wake of the first round of oil price increases, the Turkish economy remained healthy despite some underlying weaknesses. During 1968-73, real GNP increased at a rate of about 7 percent a year. The current account of the balance of payments improved steadily and recorded a surplus for three years in a row during 1971—73. The current account improvement took place despite the worsening of the trade balance. Extremely buoyant workers’ remittances played a crucial role in financing the trade deficit. The improvements in the current account combined with continuing surplus in the capital account led to a rapid accumulation of foreign exchange reserves. By the end of 1973, Turkey’s gross international reserves stood at $2 billion, which was equivalent to more than 12 months of imports. External indebtedness of the country remained low. At the end of 1973, the total external debt, excluding Fund purchases, was under $3 billion, of which only 8 percent was short term. Moreover, the debt-service ratio, as measured conventionally, was as low as 5 percent.

On the monetary side during 1968-73, both reserve money and M2 expanded at an annual rate of about 25 percent. The rate of inflation, however, averaged only 13 percent owing chiefly to GNP growth (7 percent) and the continuing monetization of the economy (3.5 percent). Public sector finances remained the weakest aspect of the financial environment. Revenues, with a tax burden of 15 percent of GNP, were inadequate to cover expenditures and therefore the public sector ran sizable deficits, forcing governments to resort to Central Bank financing.

In 1974, oil price increases and the consequent acceleration of the rate of inflation in industrial countries led to a sharp and sudden deterioration of the terms of trade for Turkey. While the value of Turkish imports increased rapidly owing to terms-of-trade effect, the onset of recession in industrial countries coupled with the lack of domestic reorientation policies led to a stagnation of exports. The current account of the balance of payments recorded ever-increasing deficits which climbed to over $3 billion by 1977. In tandem with current account deficits, external indebtedness rose rapidly and stood at over $11 billion in 1977, 54 percent of which was short-term debt. These short-term obligations were obtained mainly under a convertible Turkish lira deposit scheme whereby the Central Bank guaranteed the exchange rate.

Although the deterioration of the economic environment originated in the external sector, failure to adopt adjustment policies on time contributed significantly to this deterioration. Particularly important in this respect were the continuation of import substitution policies, which necessitated an overvalued exchange rate of the Turkish lira, and the continuation of the aggressive public investment program, which led to a worsening of the public sector finances. The deficit of the public sector rose to 6 percent of GNP by 1977. Part of the public sector deficits were financed through domestic borrowing. In an attempt to keep the cost of servicing the public debt low, interest rates were kept depressed, and with accelerating inflation, real interest rates became negative. The delay in policy adaptation to meet emerging external difficulties was partly a consequence of the political situation in which no political party had a majority in the parliament and the Government was run by a succession of coalitions.

An attempt to redress the deteriorating economic situation was made starting in late 1977. A number of measures, designed to improve the balance of payments, were implemented and Turkey entered into negotiations with the Fund and foreign creditors. As a result of these negotiations, a stabilization program was developed that formed the basis of a two-year stand-by arrangement that went into effect in April 1978. Nevertheless the program proved to be inadequate to the severity of the economic crisis. Although some improvement took place in the current account, it was achieved by a drastic curtailment of imports and only a minor increase in exports. Moreover, the public sector finances continued to deteriorate mostly owing to a sharp rise in the operating losses of the SEEs.

There were also disappointments in our negotiations with foreign creditors. After entering into a stand-by arrangement with the Fund, the Turkish Government entered into debt rescheduling negotiations with commercial banks and the member countries of the OECD consortium for Turkey. Although the Turkish side tried to convince creditors to accept a maturity structure of ten years, they met with strong resistance. Finally an agreement was reached with maturities ranging from five to eight years and a new money facility of $407 million. However, the effectiveness of the loan commitments of the OECD countries was limited owing to the imposition of special conditions on the utilization of credits.

By the end of 1979 Turkey was in the midst of a severe foreign exchange crisis. The country was unable to import even essential items, such as crude oil. Inflation had accelerated, and unemployment was widespread and increasing. Moreover, there was political turmoil, partly because of economic difficulties and partly because of foreign subversion. During the years in which the crisis was in the making (1974-79), the growth of GNP had declined to an average of 4.4 percent. Public sector deficit expanded rapidly from under 2 percent of GNP in 1974 to over 8 percent in 1979 and averaged 4.5 percent during 1974-79. The Government financed these deficits increasingly through the Central Bank. Reserve money increased at an average annual rate of 40 percent, outstripping the increase in M2 which averaged 36 percent. The rate of inflation followed a similar course, averaging 34 percent a year during 1974-79. Moreover, interest rates became substantially negative in real terms because they were not adjusted to changing conditions. Monetization of the economy was reversed, and a demonetization process took hold during the approach of the crisis.

The inflationary environment also resulted in progressively excessive wage settlements. It was not uncommon for collective bargaining processes to result in wage and benefit increases in excess of 100 percent. These wage increases further deteriorated the SEE finances, which were then reflected as increases in the public sector borrowing requirement. The competitiveness of exports eroded further.

Thus, Turkey faced the second round of oil price increases with an extremely weak economy, a grossly overvalued exchange rate, virtually no foreign exchange reserves, highly negative real interest rates, a very high rate of inflation, widespread unemployment, stagnant output, political turmoil, and an external debt in excess of $13.5 billion, more than a quarter of which was short term.

Economic Stabilization

Faced with the most severe economic crisis in the history of the Turkish Republic, the Government finally became convinced of the need to undertake fundamental reforms that would alter the structure of the Turkish economy. On January 24,1980 the Government initiated a major change in the orientation of economic policy and introduced a comprehensive set of economic stabilization and structural adjustment measures. Simultaneously the Government entered into negotiations with the Fund on the one hand and official and private creditors on the other. Negotiations with the Fund resulted in a three-year stand-by arrangement in June 1980. Later in 1980, the stand-by arrangement with the Fund, and more important, the strength of the underlying economic program, helped to convince the OECD governments to reschedule for ten years principal and interest payments falling due between 1980-83. Eventually, in 1981, commercial banks agreed to extend maturities of the rescheduled bank debts from seven to ten years.

The program was based on principles of a free market economy. Import substitution was discarded as the basic strategy for economic growth. Instead the Government adopted an outward-oriented growth strategy based on export promotion. With the change in economic philosophy came additional measures regarding the role of the exchange rate and the interest rate as tools of economic policy. The economic function of the SEEs was reevaluated together with their pricing policies. However, the most urgent task facing the Government was the stabilization of the economy; a task that was accomplished in a relatively short period of time because the Government made efficient use of every policy instrument at its disposal. Particularly important in this regard was the efficient and flexible utilization of the exchange rate and interest rate in a mutually supporting manner.

Until January 24, 1980 utilization of the exchange rate as a flexible instrument of economic policy was impossible owing to the politically sensitive nature of this instrument. Every devaluation in Turkey had created political problems for the Government. Consequently governments were reluctant to take appropriate action on the exchange rate until the excessive overvaluation of the domestic currency and the ensuing balance of payments problems forced them to act. Naturally excessive overvaluation necessitated a larger devaluation, which would compound the political problem of the Government. After January 24, 1980 the Government, in an attempt to maintain external competitiveness and depoliticize the exchange rate, began to undertake devaluations more frequently and by smaller amounts. The frequency of these mini-devaluations were increased continuously until May 1981 when the Central Bank started to adjust the exchange rate daily.

Throughout the program the exchange rate has been used and is being used as a central stabilization instrument. It was used, on the one hand, to restrict domestic demand and thus take the pressure off the prices. On the other hand it was used to change relative prices and thereby encourage a shift in production away from the domestic market towards exports. Indeed, the flexible exchange rate policy that was adopted and the ensuing gradual real depreciation of the Turkish lira provided the greatest incentive for Turkish exporters while at the same time helping to contain imports.

Since January 1980 the Turkish lira depreciated continuously against major currencies in order to offset relative price developments and to maintain the competitiveness of Turkish exports. Real effective exchange rate depreciated by about 30 percent in 1980, 15 percent in 1981, 12 percent in 1982, 1 percent in 1983 and 1984, 6 percent in 1985, and 12 percent in 1986. Notwithstanding this continuous depreciation, real effective exchange rate displayed wide swings in the short run owing to fluctuations in international financial markets and, at times, owing to concern for its inflationary consequences.

The second instrument that was used effectively for stabilization purposes was the interest rate. Until June 1980, deposit rates and, to a large extent, lending rates of the banking system were determined directly by the Central Bank. During the 1970s only modest increases were granted, and with the acceleration of inflation rates, they became increasingly negative in real terms. The velocity of circulation increased, and the role of the banking system in financial intermediation began to be undermined with the emergence of non-bank financial institutions not subject to interest-rate regulations. In response to these developments and in particular to arrest the increase in the velocity of circulation, interest rates were liberalized in July 1980. Initially the banks decided to act in unison through a “gentlemen’s agreement” and limit the increase in interest rates. However, the competitive pressures from within the banking system and from other sources led to sharp increases in deposit rates by January 1981.

Increase in interest rates led to a very sharp increase in the demand for money and consequently reduced the pressure on prices to increase. More important, the increase in the demand for money allowed a sharp increase in bank credit necessary to finance increased economic activity and exports, without rekindling inflationary pressures. During 1981-82, broad money and quasi-monetary aggregates increased rapidly while at the same time the rate of inflation came down significantly. Monetization of the economy and financial deepening had started once again.

Following the liberalization of interest rates there was a massive flow of funds to the banking sector. Realistic interest rate policy combined with the realistic exchange rate policy brought the outflow of capital to a halt and reversed the flow. The Government felt that owing to the volatile nature of capital flows and the revealed inability of governments to prevent such flows through regulation, it was best to provide an environment of confidence and to assure a rate of return for such funds that is sufficiently high in view of international interest rates and the perceived element of risk.

Although interest rate policy played a major role in the stabilization of the economy and was perhaps the single most important factor in lowering the rate of inflation, the system of free interest rates did not work perfectly. There was competition for deposits and real interest rates climbed to excessively high levels on both deposits and credits, exacerbating financial difficulties of many firms. Banks were forced to roll over their credits and capitalize interest payments. In mid-1982, there was a financial crisis in which a number of non-bank financial intermediaries went bankrupt. These events forced the Government to reconsider its interest rate policy, and it was decided to bring the rates under control once again.

Another problem created by interest rate liberalization was the fact that it made the conduct of monetary policy very difficult. From the start of the program, monetary policy was assigned a prominent role in stabilizing the economy. Monetary policy was conducted through quantitative limits on Central Bank credit derived from broad money targets. These targets and limits on Central Bank credit constituted the performance criteria under the stand-by arrangement with the Fund. With the liberalization of interest rates, the reserve money multiplier tended to increase over and beyond what was projected owing to a shift from currency to deposits and increased efficiency in the utilization of reserves by commercial banks, thus leading to monetary growth in excess of programmed rates.

In evaluating the Turkish adjustment program it is necessary to take into account the prevailing external environment. In 1980 oil prices more than doubled, resulting in a severe deterioration in the terms of trade. At the same time interest rates in the international financial markets reached unprecedented highs. The unfavorable economic environment in industrial countries and the significant deceleration in the volume of world trade during 1980-82 rendered an export-based growth strategy much more difficult to implement. Turkey was able to expand its exports rapidly partly because of appropriate policies and partly because of its proximity to the Middle East markets. Since 1983, however, the economic recovery in industrial countries and a more favorable economic environment have not been reflected in the export performances of Turkey. In this regard I would like to bring to your attention the fact that, in response to the success of our export drive, several European countries and more recently the United States have imposed quantitative restrictions on imports from Turkey, particularly on those commodities where we are internationally competitive. The impact of these restrictions on Turkish exports is significant.

I mentioned earlier that on the strength of the underlying economic program Turkey was able to convince the OECD governments to reschedule its debt. Naturally, regardless of how strong the program was, our adjustment efforts would not have been successful without the necessary balance of payments financing. Both the Fund and the Bank provided very sizable assistance to Turkey in support of our program. The Fund approved a three-year stand-by arrangement in the amount of SDR 1,250 million in June 1980. It was followed by two one-year arrangements in 1983 and 1984, both in the amount of SDR 225 million. The Bank on the other hand provided $1,600 million through five structural adjustment loans (SALs) during 1980-85 in support of wide-ranging structural reforms, from rationalization of industrial production to public finance and from external debt management systems to financial sector restructuring. In addition to SALs the Bank also had a very large project lending program in place. Finally, both the Bank and the Fund staff had a significant impact on the details of our policies and related technical matters.

In addition to balance of payments loans from the Fund and the Bank, Turkey received assistance in the form of debt relief and debt rescheduling from the OECD consortium and private creditors. Under the OECD agreement $3 billion of principal and interest was rescheduled and subjected to bonification. Soon this was followed by the rescheduling of commercial claims under similar conditions.

With regard to commercial claims I would like to briefly touch upon a specific measure that turned out to be highly successful and innovative. In rescheduling of our external debt, negotiations regarding the nonguaranteed trade arrears proved to be most difficult to resolve. Finally it was agreed that we give these creditors the option of receiving the amounts due to them in Turkish liras, instead of foreign exchange, at a much more accelerated pace, which then they could convert into investments in Turkey. Many of our creditors found the option attractive and chose to take advantage of it. Out of a total $1,215 million debt $900 million was paid in Turkish liras of which $300 million was used for capital investment, $200 million was used for prefinancing of exports, and $400 million was used as domestic credit for Turkish importers.

Overall Turkey received over $6 billion in debt relief which was crucial in reducing the need for foreign exchange at the start of stabilization and provided a much needed breathing space for the economy.

Structural Adjustment

The 1980 adjustment program aimed to achieve both the immediate goal of stabilizing the economy and the long-term objective of restructuring the economy to assure steady growth under the principles of free market economy. To accomplish the latter the Government, over the years, undertook a number of reforms with major implications for economic management and the structure of the economy. Areas that were subject to major reforms included general pricing policies, trade policies, foreign exchange policies, fiscal reforms, and financial sector reforms.

As the most important aspect of the 1980 stabilization package was a greater reliance on market mechanism, it was only natural for this principle to be applied in the determination of key economic prices, including commodity prices, interest rates, wages, and exchange rates.

Almost all price controls on various commodity prices were removed through the abolition of the Price Control Commission, and the determination of private sector commodity prices was liberalized. The main purpose of the move was to prevent the misallocation of resources owing to distortions and to eliminate the black market that emerged as a result of serious commodity shortages, especially after 1978. More important, the new economic policy involved a significant adjustment of the public sector prices (ranging from 100 percent to 400 percent), and the number of subsidized basic commodities subject to price controls was reduced drastically. SEEs producing non-basic commodities were instructed to set their prices on commercial principles. The new pricing policy allowed SEEs to reduce their operating losses and therefore relieved pressure from the budget.

The new pricing policies, particularly of SEE products, necessitated an overhaul of the SEE operations in order to restructure and streamline these enterprises to become productive and profitable ventures. New measures taken under the program opened SEEs to competition and at the same time freed their managers to adopt pricing policies based on commercial principles. To solve their inherited structural problems, however, a major reform was necessary. The managers were allowed to pursue an independent strategy in administrative, financial, and operational matters and were given flexibility in determining wages and salaries. Decisions regarding investment expenditures were constrained by their ability to finance these expenditures. Personnel expenditures were reduced by restricting new positions, a political impossibility in the past. New personnel can be hired, however, on a contractual basis, allowing SEEs to compete for skilled people with the private sector.

An important new element of the SEE reform package is the Government’s intention of a partial privatization of selected SEEs. The privatization policy involves the transfer of the selected SEEs to the Public Participation Fund which would restructure them and subsequently offer their shares to the public.

There was also a major reform of agricultural pricing policies. Price controls on agricultural products, with few exceptions, were gradually lifted and most goods were eventually taken off the controlled list and prices of those few items that were kept controlled were determined by taking into consideration factors such as the world prices, input prices, stability of products’ prices and producers’ income, domestic inflation, etc. In determining the support prices for exportable products, world prices play a key role, while domestic demand and relative productivity factors are significant for products that are domestically consumed. The subsidies to agricultural input prices have been gradually reduced as well. In this new agricultural pricing policy, the major consideration was to reduce the burden on the government budget and to finance these purchases from sources other than the Central Bank.

These reforms improved the financial position of SEEs significantly. Their expenditures rose less than their revenues which rendered substantial profits for the first time in a long while. The borrowing requirement of SEEs fell in proportion to GNP, and the share of Central Bank borrowing and budgetary transfers fell significantly although their foreign and other domestic borrowing increased in the last few years.

A second area of reform, that of trade policies, can be described concisely and precisely as the liberalization of exports and imports. The move was extremely significant in view of Turkey’s historical experience with an excessively restrictive trade regime. As the adjustment program placed a major emphasis on export promotion, policies that were necessary to promote exports were implemented rapidly. Initially, in order to give momentum to export activities, a number of incentives, in addition to realistic exchange rate policy, were offered to exporters. Exporters were given generous tax rebates and had access to preferential credit through the Central Bank. The Central Bank also extended credit to export supporting activities and export-related investments. Moreover, exporters were allowed to import raw materials and semi-finished products without customs duties.

As export activity gained momentum in 1981, the Government gave additional incentives for exports of industrial goods and, in order to boost exports in general, provided further tax rebates. In response to incentive schemes, exports increased rapidly through 1982 but stagnated in 1983 owing to slippages in policies. Starting in 1984, the newly elected government decided to shift the emphasis on export promotion away from direct subsidies and toward a more aggressive utilization of exchange rate policy. Tax rebates were gradually lowered, and the Central Bank discontinued the preferential export credit facility in January 1985 and recently replaced it with an alternative facility in which the interest rate is no longer subsidized but is lower than the commercial bank rates.

Policies aimed at export promotion were effective not only in increasing the volume of exports but also in shifting its composition toward manufactured goods. The share of manufactured goods rose from 35 percent in 1980 to 75 percent in 1985. There was also a diversification of markets. Although Turkish exports to traditional markets, such as Europe, expanded somewhat, the major market penetration was achieved in the Middle East and North Africa.

On the import side, adjustment policies aimed at a less restrictive import regime by permitting a much larger number of items that can be legally imported. Competition from the flow of imports was expected to reduce oligopolistic and monopolistic tendencies, especially in small domestic markets. In the first year of the program, import guarantee deposit rates were reduced. Around 100 items were transferred from the liberalization list II to the less restrictive liberalization list I and stamp duty charges on imports were reduced from a maximum of 25 percent to 1 percent.

In January 1981, global quotas were abolished and goods subject to quotas were transferred to liberalization lists. Liberalization policy continued in 1982 with the transfer of 200 more items from list II to list I. Also, some items were transferred to a new list called the fund list. Starting in 1983, all import transactions were required to be in convertible foreign currencies and the import guarantee deposit rates were lowered again from 20 percent to 15 percent for importers and from 10 percent to 7.5 percent for industrialists.

It must be emphasized, however, that notwithstanding this gradual liberalization, the operational principle remained of a positive list under which, if an item was not on the list, its importation was prohibited.

The major move for import liberalization came in 1984. The newly elected government changed the operational principle to one of a negative list under which, if an item was not on the prohibited list, it could be imported. The 1984 import regime classified imports under the prohibited list, imports subject to approval or license, liberalization list, or fund list.

A comparison of the 1984 import program with that of 1983 reveals the dramatic effect of the policy change. The number of liberalized items increased from 1,000 to 2,500 in one year; the prohibited list shrank from 1,800 items to 459. The approval list (former liberalization list II) was reduced from 1,300 items to 1,000. The number of items contained in the fund list increased from 40 to 100, some of which were consumption goods included in the list in order to prevent price increases because of supply bottlenecks. In May 1985 goods that were formerly included in the prohibited list were transferred to the license list, excluding narcotics, weapons, and related goods.

Another significant aspect of the 1984 import regime was the reduction in tariffs and other levies on imports.

Since December 5, 1985, the right to import from countries where foreign trade is state controlled was extended to companies holding investment certificates in addition to public institutions and export trading companies (with exports exceeding $50 million over the year).

Hence, under this program substantial liberalization of imports was achieved. Although this led, inevitably, to a higher import bill, economic benefits resulting from a more liberal trade regime easily justified the move. Particularly, since 1984, Turkish producers faced with foreign competition took measures to rationalize and streamline their operations and they increased the quality of their products markedly.

As I indicated earlier, the monetary policy was assigned a pivotal role in the stabilization program. During the implementation stage the fragility and the results of decades of financial repression of the Turkish financial markets became painfully clear. Negative real rates, credit rationing, lack of competition, excessively high intermediation costs, and lack of diversity of financial institutions and instruments were all part of the scene. Financial markets were almost completely dominated by commercial banks with high concentration. They were protected and accustomed to non-price competition.

The need for financial reforms became immediate when the financial system was severely shocked by the widespread failures of brokerage firms, which adversely affected the liquidity position and the health of the entire banking system. In 1982 the transition to positive real interest rates proved to be harder than expected for Turkish financial markets.

Financial reform had two objectives. First, it was necessary to develop adequate instruments of the monetary policy and to improve the effectiveness of the existing ones. Second, the allocational and the operational efficiency of the money and capital markets needed to be drastically improved.

Earlier I pointed out the difficulties we had in controlling monetary aggregates. Bank credits have been historically controlled by controlling the size and composition of assets of the banking system. New policies, however, were directed to exercise monetary control through the liabilities of banks. With this new philosophy in mind the Central Bank initiated changes in the management of required reserves and liquidity of commercial banks. Reserve ratios were already unified and simplified in 1983. A complex and tiered system of reserve ratios for preferential credits was either abolished or streamlined, and compliance periods were reduced. Access to the discount window was restricted, and the scope of preferential credit facilities was narrowed.

In April 1986 the Central Bank, as part of its program of extending the instruments of monetary policy, organized an interbank market, which operates like the U.S. Federal Funds market and which conducted the first open market operations in February 1987.

A new banking law was enacted with extended provisions on capital requirement, contingency reserves for problem loans, a new deposit insurance scheme, unified accounting and reporting standards, and a requirement for external auditing. The Central Bank instituted a new bank supervision system. All these innovations are expected to make the banking sector financially healthier and also more resilient in the conduct of monetary policy. In order to improve efficiency and competition in the banking sector, foreign commercial banks were allowed to enter the market.

After the collapse of the brokerage firms, known as the bankers’ crisis in Turkey, there was a need to reinstate confidence in financial markets. Furthermore, in order to provide risk capital and long-term funds for the financially weakened Turkish industry, capital markets needed to be developed. The Capital Markets Board, established in 1981, assumed the responsibility of safeguarding the capital markets. After a slow start and despite the high and variable rate, corporations have made increasing use of the corporate bond market, indicating that the crisis of confidence is over and that the capital markets will eventually be able to channel long-term funds to Turkish industry and bring a healthy competition to the banking sector. In order to foster further development of equity markets, the Istanbul Stock Exchange was reorganized as a modern stock exchange, and it has already completed its first successful year of operation.

New and successful financial instruments have been introduced both in money and capital markets. Revenue participation bonds by the Public Housing and Public Participation Fund have been well received by savers. Financial deepening continued with the successful introduction of weekly auctions of Treasury securities with various maturities in money markets. The commercial paper market is expected to be a widely used tool of the money markets soon, as the regulatory framework has been recently completed and approved.

Although the developments in new institutions and instruments in Turkish financial markets are modest in comparison with those in developed markets, they are indeed impressive when one remembers that we reached this stage from a brink of a financial collapse only five years ago. It appears now that the financial industry in Turkey is poised to be the fastest growing sector of the economy.

As most sections of the Turkish economy were undergoing a thorough structural change, the country’s tax system had to be improved. Rising inflation rates caused a serious bracket creep for wage earners, who constituted about two thirds of the personal income taxpayers. Increased marginal tax rates adversely affected the work and saving habits of wage earners. Antiquated and weak tax collection administration further exacerbated the problems as tax collections were delayed and tax evasion became a common practice. In order to improve the equity and efficiency of the tax system, authorities launched a major tax reform as a part of the comprehensive structural adjustment program in 1981.

The most important feature of the 1981 income tax reform was the adjustments in the tax brackets for corporations and individuals. Personal income tax brackets were initially adjusted upward, and marginal rates were restructured, providing for a gradual reduction of all rates over the next four years. Corporate income tax was unified. New taxes were introduced to broaden the revenue base.

The Government introduced tax rebates to individuals whose wages and salaries are subject to withholding tax. The purpose was to provide a partial offset to the increased tax rates and to induce compliance among business taxpayers through collection of receipts by wage earners to qualify for tax rebates.

In January 1985 Turkey instituted by far the most comprehensive tax reform in Turkish history in an attempt to broaden the tax base and introduced a 10 percent value-added tax (VAT). The VAT substituted for various production taxes and other duties that had been imposed at various rates on certain groups of commodities and services. The implementation of VAT has been very successful even though there were some operational problems at the outset, as expected. Proceeds from the VAT far exceeded expectations both in 1985 and 1986.

Economic Performance Under the Program

The economic program has resulted in a remarkable improvement in the economic situation in Turkey. The most striking feature of the recovery has been the dramatic growth of exports of goods and services. The rapid growth of exports has been indeed at the heart of the outward-looking, export-led growth strategy adopted since 1980. The value of the merchandise exports jumped by 173 percent from $2.9 billion in 1980 to almost $8 billion in 1985. As a percentage of GNP, exports rose steadily from an average of roughly 4 percent between 1975-80 to over 15 percent. A realistic exchange rate policy, with the ensuing gradual depreciation of the Turkish lira, has been the major cause of this favorable outcome.

The performance of Turkish exports becomes even more notable if the slowdown in world trade during the 1980s is considered. Under the unfavorable conditions of economic recession and the protectionist barriers, particularly in the industrial world, Turkey initiated a dynamic trade policy and penetrated successfully into the Middle Eastern and North African markets. The share of these countries in total Turkish merchandise exports rose from 23 percent in 1980 to 42 percent in 1985. Within this group Iran and Iraq have shown the sharpest growth.

In addition to the increase in the total volume of exports, there was also a major change in the commodity composition of exports in favor of industrial goods. Although the share of industrial exports continually increased over the last twenty years, the growth in industrial exports has been far more pronounced since 1980. By the end of 1985 industrial products accounted for 75 percent of the total exports while they constituted only 35 percent in 1980. Perhaps more encouraging was the significant growth in exports of capital goods as well.

Nevertheless, 1986, like 1983, appears to have been a year of interruption in the advances scored in exports during the last six years. For the ten months to October 1986, exports were 8.5 percent lower than in the corresponding period of 1985. This fall was mainly the result of the decline in oil revenues in some Middle Eastern countries but also of buoyant domestic demand. The resumption of export growth in coming years seems to be closely tied to the economic recovery in the OECD countries as well as to the impact of recent policy measures planned to be implemented in 1987 to boost exports, such as the export credit and insurance system.

In addition to efforts to increase exports, Turkey has fundamentally altered and liberalized her import regime, particularly since January 1984, with a view to opening up the economy to international competition. With the exception of a slight decline in 1982, Turkey’s imports of merchandise increased throughout the period, though at a lower rate than her exports. These increases in imports provided the necessary inputs to the industrial modernization of the country. The rapid decline in oil prices during 1986 has contributed to a lessening of the growth of the import bill of Turkey. The figure for the first ten months of 1986 has shown an increase in imports of only 0.7 percent compared with the corresponding period of 1985. Much of the decline in the oil bill was compensated by increased imports of capital goods, reflecting an estimated 8 percent growth of the economy.

Improvements in the external performance led to a restoration in the creditworthiness of the country. Project related borrowing and trade credits expanded substantially since 1982, as well as syndicated medium-term balance of payments support loans.

An attempt has been made to raise the international competitiveness of the economy over the longer term by encouraging the inflow of foreign investment. To this end a number of measures have been introduced. However, direct investment inflows have not yet shown a significant expansion. Almost half the increase in direct foreign investment during the period was related to the option scheme presented to foreign creditors, as earlier discussed.

Regarding economic growth, for the 25 years from 1954 through 1978 Turkey enjoyed positive rates of growth every year. The years 1979 and 1980 were the first successive years of decline in GNP. Improvement in external performance after 1980 contributed to the resumption of growth albeit at moderate rates compared with the early 1970s. However, the growth in output in Turkey after 1980 was at much higher levels than that of comparable developing countries, averaging 4.5 percent during 1981-86 and over 6 percent since 1984.

One of the major objectives of the adjustment program was to reduce the rate of inflation, which had peaked at over 100 percent in 1980. In response to appropriate policies, the rate of inflation started to decline in the second half of 1980 and continued to decline through early 1983. Some slippages in policy during 1983, particularly in fiscal and monetary policies, fueled inflation once again, and prices increased at an accelerated rate through 1984, although in 1985 the deceleration started once again. The rate of inflation continued to decline throughout 1985-86 and by the end of 1986 stood at 25 percent; substantially below that of 1984 but still too high by international standards. In fact, throughout the program inflation proved to be the most difficult issue to deal with because a rapid decline in inflation necessitates a fiscal stance often considered to be too harsh by the governments. When the fiscal stance is not appropriately tight, undue pressures on monetary policy are exerted and Central Banks can withstand such pressures with only a limited success.

Conclusions

First and foremost I would like to stress the fact that it is possible, in a relatively short time, to change the orientation of an economy from one that is severely repressed and restricted to one that is moderately liberalized and operating on the basis of free market principles. The economic stabilization measures and structural reforms undertaken in Turkey since 1980 indicate that with appropriately timed and mutually supporting policies, an economy can be transformed into a state of equilibrium. Our experience suggests that the task is not easy, and a lot of experimentation may be necessary. It is also essential that the policymakers be pragmatic and creative in proposing solutions to existing problems and be courageous in undertaking the necessary measures.

Although each country will necessarily decide on the appropriate instruments in overcoming various economic difficulties, I must stress two policy instruments that played a crucial role in Turkish stabilization and adjustment: the exchange rate and the interest rate. We are convinced that the appropriate and prudent use of these two policy instruments is absolutely necessary in any “growth-oriented adjustment strategy.” Equally important are policies aimed at containing domestic demand and enhancing supply, particularly the supply of tradables.

The commitment and the determination of the political authority to carry through the adjustment program is also an essential ingredient in the success of any program. It was fortunate that Turkey had governments with the political will necessary to implement and carry out the stabilization measures and to reorient the economy on the basis of free market principles. The confidence of the public in economic leadership made the adjustment process acceptable although it was made clear by the authorities that results might not be quickly forthcoming.

Another factor that needs to be mentioned is the importance of the availability of, and easy access to, new export markets. In this regard, it is unfortunate that some countries, while they preach an outward-looking adjustment strategy for developing countries, also erect barriers to exports of developing countries. I believe that these countries could be of great assistance to adjustment efforts by assuring an easier access to their domestic markets by developing countries.

Finally, I would like to mention that prompt and sufficient assistance in the form of debt relief, as well as fresh financing, is essential for the success of any adjustment effort. In this regard multilateral institutions like the Fund and the Bank play an extremely important role both as providers of funds and as catalysts in assuring finance from commercial banks. Nevertheless, commercial banks should also assist in the adjustment efforts of developing countries by at least not reducing their exposure and, when the strength of the adjustment effort merits it, by increasing their exposure as a matter of supporting the adjustment effort; and not because the country in question happens to be a special case!

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