- Mohsin Khan, Morris Goldstein, and Vittorio Corbo
- Published Date:
- September 1987
International Monetary Fund
I must begin by expressing my appreciation for the study which has been presented by Dr. Rusdu Saracoglu, Deputy Governor of the Central Bank of the Republic of Turkey. The paper is mainly descriptive, clear, and comprehensive. For additional background and analysis, I have consulted a study by Mr. George Kopits (a member of Fund staff) published as Structural Reform, Stabilization, and Growth in Turkey, IMF Occasional Paper No. 52 (Washington: International Monetary Fund, 1987), which was presented at a Fund-sponsored seminar that was held in June. I found Mr. Kopits’s paper, as well as other internal staff papers on Turkey that I have also consulted, most enlightening.
Recent adjustment efforts in Turkey go back to early 1979 when the authorities adopted fairly tough demand-management policies, which included a devaluation of 23 percent in that year and another devaluation of 44 percent in 1979. The Fund supported these policies through two annual stand-by arrangements, and early in 1979 the major Western nations pledged $1 billion in special economic assistance to Turkey. By June 1980, when Turkey entered into a three-year stand-by arrangement with the Fund, the imbalances in the economy as well as its structural constraints had been under attack for some three years.
Real GNP had fallen by 1 percent in 1979 (the first time for over two decades) and was to fall again by another 1 percent in 1980. Despite a devaluation of 23 percent effected at the beginning of 1980, the current account of the balance of payments recorded a deficit of $3.4 billion or 5.8 percent of GNP owing largely to a doubling of oil prices. Central government expenditure stood at 24.2 percent of GNP, the fiscal deficit at 5.3 percent of GNP, and inflation at 104 percent. State economic enterprises were a major drain on the central budget as they continued to provide goods and services at highly subsidized prices. Terms of trade had deteriorated by 20 percent by the end of 1980 and were to deteriorate further by 10 percent by 1985.
In addition to stand-by arrangements with the Fund, Turkey also embarked on a structural adjustment program with the World Bank. The main purpose of the programs of the two Bretton Woods Institutions as well as of the many bilateral donors that supported Turkey’s adjustment efforts was to restore “market signals as a principal guide to economic policy decisions.” In more specific terms, the purpose was to bring Turkey toward balance of payments viability over the medium term, remove the various imbalances in its economy, and put the country on the path toward self-sustaining growth.
As a result of various energetic measures, Turkey was able to make an impressive turnaround in 1981. Real GNP grew by more than 4 percent, inflation fell to 42 percent, the national savings rate increased by 3 percentage points to 18.6 percent of GNP, and the current account deficit was reduced to $0.9 billion as exports more than doubled. Similar progress continued to be made in subsequent years, but the most remarkable transformation occurred in sharply raising exports of nonagricultural products. In 1980 agricultural commodities accounted for 58 percent of export value, while industrial products stood at 21 percent. By 1985 industrial products had more than trebled to 77 percent of export value.
Another indicator of positive change is that in 1985 the current account deficit stood at $1 billion or less than 2 percent of GNP as against 5.8 percent in 1980. There was also good improvement in the fiscal position brought about through a combination of tax reform and revenue enhancement measures. But the main burden of fiscal adjustment was borne by expenditure cutbacks at the rate of 1 percent a year, as a result of which in 1985 total central government expenditure stood at 19.2 percent of GNP as against 24.2 percent in 1980.
There can be no doubt therefore that during the 1980-85 period Turkey made impressive gains in improving its current account of the balance of payments, in reducing its fiscal deficits, in raising its rate of growth above the average for non-oil developing countries and in other areas as well. Can it be viewed as a model for others to follow in comparable circumstances?
My own conclusion is that the case of Turkey is exceptional because of the very magnitude of external resources injected into the country to bring about its turnaround. During 1980-85, the Fund, the World Bank, and concessional bilateral donors injected a total of $5.1 billion into the country. Second, Turkey was granted debt relief by official creditors and commercial lenders (both medium- and short-term) to the tune of $6.5 billion. As part of this massive financing effort, Turkey, despite the eruption of the debt crisis in August 1982, was able to raise commercial loans for balance of payments support on a spontaneous basis in an amount of $1 billion over the period 1983-85.
It is clear, therefore, that these massive capital inflows virtually ensured the success of the adjustment effort. It means that the scale of adjustment did not have to be compressed over a very short time frame as was the case in other heavily indebted or low-income countries.
Yet, despite these capital inflows, adjustment was neither plain sailing nor uninterrupted. In 1983, for instance, the Turkish economy suffered a reversal with real GNP falling by 1.3 percent, and the current account deficit rose by $1 billion owing to a decline in agricultural output and a fall in export earnings. Fortunately, this setback was overcome in 1984 when real GNP grew by 6 percent and the external current account was reduced to less than 2 percent of GNP. At this moment, we do not fully know the precise performance of the Turkish economy in 1986 but there are indications that it was mixed. If this should turn out to be so, Turkey’s adjustment progress could be said to be still fragile in line with general performance of other developing countries.
My other reasons for considering Turkey’s case as exceptional is its special geopolitical position and its membership in the North Atlantic Treaty Organization (NATO). It also has special historical and religious ties with the countries of the Middle East to which it sold a major part of its fast-growing nontraditional exports and also found a ready market for its expanding service sector. Turkey is also among about half a dozen countries, a substantial portion of whose labor force is employed outside its borders from whom regular remittances constitute a valuable source of foreign exchange but also complicate macroeconomic management.
Turkey, in order to strengthen its balance of payments, took special measures to attract the savings of its nonresident nationals. All were allowed to open foreign currency deposit accounts with Turkish banks, and interest was paid on these accounts in foreign exchange and at higher rates than those prevailing in the Euromarket. Reserves for these deposits that commercial banks are obliged to hold with the Central Bank are interest earning as against reserves for local currency, which earn no interest. Residents who can prove a source of foreign exchange earnings may also open deposit accounts in foreign currency. While these deposits clearly provide a useful source of foreign exchange, there is no doubt that they are highly volatile and have serious implications for the financial system.
Having made these critical remarks, let me hasten to endorse some basic statements proposed by Dr. Saracoglu. He says “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 high by governments.” Second, he lays stress on “two policy instruments that played a crucial role in the case of Turkish stabilization and adjustment effort: the exchange rate and the interest rate.” I concur with both.
Finally, let me say it would have been most helpful if an example had been presented to the symposium of the responsiveness of low-income countries to the application of exchange rates, reform of public enterprises, market-determined interest rates, and other supply-side measures. What capacity do such countries have to respond to traditional instruments of adjustment, and how does one reduce their structural fragility? The case of Turkey shows that despite several years of adjustment, the economy has yet to attain durable self-sustaining growth. I wish it well.
Juergen B. Donges
Kiel Institute of World Economics
Dr. Saracoglu gives a good presentation of a country which, having become over-indebted during the 1970s and falling virtually into bankruptcy in 1978, mended its ways afterwards, achieving remarkable economic growth, export expansion, and decelerating inflation. On the basis of this performance international creditworthiness was restored. Hence, Turkey has been properly chosen for the concerns of this symposium, though there is always a tendency, in some quarters, to downplay a success story on the ground that it is a unique case (economically, socially, culturally, institutionally, historically, geopolitically), and therefore that this case is unrepresentative of what has been done. In a sense, all countries are special. But I think that lessons from the Turkish experience are equally valid for Latin American debtor countries.
Turkey is an interesting counter-example to these countries. The key difference seems to be that Turkey, unlike the debt-ridden Latin American countries, made a major effort not only to curb rampant inflation, but also to break with its long tradition of autarky and etatism, which had deeply distorted cost and price structures and undermined working habits in the population. It is often argued that Turkey was in a much better situation to embark upon reforms than Latin America because it enjoyed sizeable capital inflows and therefore could continue to run a balance of payments deficit on current account (though at a smaller magnitude as a percentage of GDP than prior to the reforms). This may be true, but one could also reckon that Turkey received such external support in exhange for the government’s determination to attack the sources of the economic crisis rather than for just dealing with its symptoms.
It should be recalled that Turkey’s external debt crisis broke out at a time when four of the international macroeconomic causes that are generally emphasized to explain the outburst of the Latin American debt crisis in the early 1980s were not yet at work. The rates of real interest had not increased (they were negative), the world economy was not in a recession (there was a boom), the U.S. dollar was not appreciating (it was depreciating), nor had OPEC caused the second oil price hike (in real terms the oil price remained more or less constant after the first explosion in 1973-74). Thus, Turkey’s debt problem was not so much exogenously determined as self-inflicted; that is, it was the consequence of ill-conceived economic policies over the decades. The manifestation of this is familiar (typical also for many Latin American countries): large budget deficits along with runaway inflation; a chronic overvaluation of the domestic currency along with an incessant capital flight; a remarkable growth of public enterprises along with a low productivity of investment in the economy; and excessive import substitution sheltered by high protection along with limited export activity.
When an economic crisis is largely self-inflicted, logic demands that the way out of the impasse has to be effected by the national government in the first place. The international environment, of course, also matters, as does the size of financial assistance received from the Fund, the World Bank, foreign-country donors, and commercial banks. But the main responsibility lies with the home government, Turkey’s experience strongly buttresses this proposition: exchange rate policy has become more rational; a reasonably outward-looking approach was adopted with regard to trade; interest rates now reflect better the relative scarcity of capital; many commodity price controls have been removed; the tax system has been made to yield higher revenues; and the budget deficit as a percent of GNP has been substantially reduced. Though external circumstances were also adverse for this country and not just for Latin America during the 1980s, notable progress was made. Turkey has not become a free-market economy, but, on the whole, the Turkish economy now operates under an unprecedented structure of market-determined incentives. Hence, the achievement of self-sustaining growth is a real possibility provided reforms are carried on over time.
The intriguing question is how the reorientation of domestic economic policies could happen in Turkey (while it seems so difficult to accomplish in the heavily indebted Latin American countries). After all, the reforms were bound to cause a redistribution of incomes and opportunities. Received theories of the political economy would tell us that it would pay for the main beneficiaries of the previous policy regime (such as the least competitive import-substituting industries, the urban labour aristocracy, the domestic banks, and the bureaucrats issuing power through controls) to invest into policy continuity. In Turkey, as elsewhere, there was (and still is) opposition to the new economic course. The best known example, mentioned in passing in Dr. Saracoglu’s paper, refers to the country’s private and public banks: they colluded to fix interest rates in defiance of the government’s freeing of those rates in late 1980, thereby contributing to the deep domestic financial crisis of summer 1982. Since then, interest rates have been controlled administratively once again (though at positive levels in real terms).
A reasonable explanation for the relative success in keeping most special-interest opponents of liberalization at bay may be two handed. On the one hand, the traumatic economic crisis at the end of the 1970s made it clear to the Turks at large that continuation of bad economic policies would end up in an overall disaster and that a “muddling-through” approach, as so often applied in the 1950s and 1960s, was no longer a viable solution. On the other hand, the government made a strong political commitment to the shift in economic policies and pursued its objectives with determination, aiming at both changing the expectations of economic agents and eliciting financial support from abroad. As rapid successes could be shown (the rates of inflation went down, exports expanded fast, and per capita income increased, while unavoidable cost of unemployment could be kept within limits), the reform package was regarded by the public as sensible and realistic. Both conditions are necessary in order to bring about economic policy change. A comparison with Latin American countries would no doubt reveal that, at best, only the first condition (the public awareness of an imminent economic collapse) was fulfilled on the southern continent, but not the second condition (political determination).
Having said this, I would like to point out that Turkey is still only half way down the road to a full restructuring of the economy. At the end of his paper, Dr. Saracoglu made some vague remarks in this sense, but the most pressing issues that have to be tackled domestically could have been mentioned more explicitly. Six areas for further policy action come immediately into mind. To begin with, the rate of inflation is still high (currently at about 30 percent), so that coordinated monetary and fiscal policies to reduce that inflation further are indispensable. Second, import tariffs will have to be overhauled with a view to lowering them and reducing their inter-sectoral dispersion (the paper unfortunately does not provide updated evidence on nominal and effective rates of protection). Third, the newly created free-trade zones (in Adana, Antalya, Izmir, and Merzin) must soon prove their viability and effectiveness or be closed down. Fourth, the public sector enterprises will have to become more efficient and some of them could perhaps be privatized. Fifth, the remaining domestic capital market imperfections have to be urgently eliminated, if more domestic financial resources are to be mobilized and the allocation of savings is to become more productive. And last but not least, the conditions for greater private foreign investment inflows should be improved, which might require also a more receptive attitude of the Turkish authorities.
Domestic adjustment policies along these lines should receive adequate support from abroad by two means. One possibility is for the World Bank and other multilateral institutions, as well as bilateral donors, to provide financial and technical assistance. Technical assistance could be of great help in achieving an effective implementation of the various measures; injections of funds would strengthen domestic investment, support the balance of payments, and provide credibility to the adjustment programs. The other means is for the industrial countries to keep their markets open for foreign suppliers (from Turkey and elsewhere), rather than succumbing to the protectionist temptation. Dr. Saracoglu rightly worries about this latter danger. After all, without adequate access to large markets, a debtor country is bound to face serious difficulties in earning foreign exchange to service the interest payments on its external debt, and without a reasonable degree of certainty about the openness of foreign markets, both policymakers and investors will lose faith in being able to reap the benefits attributable to outward-oriented economic development.