Recent Economic Developments

This paper reviews economic developments in Turkey during 1992–95. Economic activity expanded sharply in 1993, sustained by buoyant domestic demand that was underpinned by expansionary fiscal and monetary policies, but accompanied by a large deterioration in the current account position. The unsustainability of this policy stance resulted in an exchange and financial market crisis in the first months of 1994. In April 1994, the authorities announced a comprehensive stabilization program that included substantial fiscal retrenchment, monetary tightening, and a structural reform agenda intended to strengthen the adjustment effort over the medium term.


This paper reviews economic developments in Turkey during 1992–95. Economic activity expanded sharply in 1993, sustained by buoyant domestic demand that was underpinned by expansionary fiscal and monetary policies, but accompanied by a large deterioration in the current account position. The unsustainability of this policy stance resulted in an exchange and financial market crisis in the first months of 1994. In April 1994, the authorities announced a comprehensive stabilization program that included substantial fiscal retrenchment, monetary tightening, and a structural reform agenda intended to strengthen the adjustment effort over the medium term.

Turkey: Selected Economic Indicators

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

1994 program estimates are nominal targets divided by realised GNP.

M2 plus resident foreign exchange deposits.

Three-month Treasury bill rate, annual average.


Medium- and long-term debt service as percent of current receipts excluding interest and official transfers.

I. The Real Economy

Economic activity expanded sharply in 1993, sustained by buoyant domestic demand that was underpinned by expansionary fiscal and monetary policies, but accompanied by a large deterioration in the current account position (Chart 1). The unsustainability of this policy stance resulted in an exchange and financial market crisis in the first months of 1994. In April 1994, the authorities announced a comprehensive stabilization program that included substantial fiscal retrenchment, monetary tightening, and a structural reform agenda intended to strengthen the adjustment effort over the medium term. These policies resulted in a sharp contraction in aggregate demand, a sizable decline in output, and a large improvement in the current account position. Initial success in reducing inflation proved transitory, however, and inflation over the year as a whole reached record levels.

Chart 1
Chart 1


Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Sources: Data provided by the Turkish authorities; and staff estimates.1/ Authorities’ program.

Analysis of economic activity in Turkey is complicated by the fact that a sizable portion of economic activity goes unrecorded. About 38 percent of the population live in rural areas where autoconsumption is predominant; another 15 percent, mainly recent immigrants to urban areas, engage primarily in barter transactions. In addition, there exist a host of informal activities, e.g., small service businesses, street vendors or family workshops that are not adequately captured in official output statistics. According to the State Institute of Statistics (SIS), the size of this unmeasured economic activity could reach as high as 60-70 percent of recorded GNP. 1/ In the face of adverse economic shocks, resources shift from the formal to the informal sector, implying that official data likely overestimate the extent of the contraction in output and living standards.

1. Domestic output

Real GNP grew by 7.6 percent in 1993 (Table A1). Industry and services performed strongly—increasing by 8.2 percent and 10.0 percent, respectively—while agricultural output declined by 2.2 percent. These trends were reversed in 1994, when real GNP declined by an estimated 5.9 percent, with agriculture down by 2.8 percent, industry by 5.0 percent and services by 6.3 percent. In the first quarter of 1994, growth was still brisk—4.3 percent year-on-year—but in the second quarter the combined effect of a sharp devaluation, a cut in real wages, and the credit crunch following the exchange and financial market crisis led to a 10 percent drop in consumer spending and a 22 percent drop in investment. Aggregate domestic demand fell by 19 percent over a year earlier, contributing to a decline in real GNP of 11.3 percent over the same period in 1993. The depressed economic conditions persisted in the third quarter when real GNP was still 7.9 percent lower than a year before, although some recovery, sustained by brisk external demand, was recorded (Chart 2).

Chart 2
Chart 2


Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Sources: Data provides by Turkish authorities; and staff estimates.1/ December 1994 estimate is based on data for two months.

Manufacturing industry experienced a sharp output decline in 1994 (Table A2). In the first ten months of 1994, the manufacturing production index fell by 7.2 percent, with machinery industry output dropping by 31.0 percent, textile output by 6.9 percent, and automotive production by 50.1 percent. Among the sectors that nonetheless recorded positive growth in this period were chemicals (+0.1 percent), iron and steel (+2.0 percent), and food and beverages (+1.7 percent). In general, export-oriented sectors were able to cushion the impact of the crisis, while sectors producing durable and investment goods were severely distressed. The energy industry was only mildly affected by the recession: its growth rate slowed from 9.6 percent in 1993 to 6.2 percent in the first ten months of 1994. 1/

The capacity utilization index—which, being based on a larger sample of firms, is a more reliable indicator than the industrial production index—fluctuated around 80 percent in 1993 and reached 83.0 percent in January 1994 (Table A3). With deteriorating domestic demand conditions, the index fell to 69.5 percent by May, recovering in ensuing months to reach 77.1 per cent in October. Capacity utilization had followed a similar pattern in both the public and private sectors during 1993, but in 1994 patterns were considerably different: capacity utilization in the private sector fell sharply to a low of 61.3 percent in July before recovering partially in ensuing months, while capacity utilization rates in the public sector were less markedly affected by the economic crisis.

Value added in agriculture at constant prices declined for two consecutive years, by 2.2 percent in 1993 and by an estimated 2.8 percent in 1994. The share of agricultural production in GNP fell from 14.3 percent in 1993 to an estimated 13.1 percent in 1994. Considering that in 1985 agriculture accounted for about 20 percent of GNP, the decline in the last two years represents the continuation of a secular process common to all OECD countries. The acceleration of this downward trend in the last two years stems mostly from acreage restrictions and meteorological factors. In 1993, weather conditions affected mainly cotton, sunflower seeds, tobacco and hazelnuts, while cereal output was robust (Table A4). In 1994, by contrast, output of cereals plunged, as did that of tobacco and sunflower seeds, while output of hazelnut, cotton, cotton seed, and citrus fruits recovered from 1993 troughs.

Agricultural support prices alleviated in part the effects of poor harvests on farm income (Table A5). The level of transfers to agriculture, as measured by producer subsidy equivalent (PSE), rose from an average of 29 percent in the period 1987-90 to 39 percent in 1991-93 as the number of products covered and the amount of subsidies increased. In 1993, support prices were adjusted in line with inflation but in 1994, as part of the stabilization program, some of the support schemes, notably for sunflower seeds, cotton, fruit, and nuts, were eliminated; the support prices that remained in place (for cereals, tobacco and sugar beet) were reduced in real terms; the PSE is estimated to have declined by some 5-7 percentage points.

2. Domestic demand

Aggregate domestic demand rose by 11.9 percent in 1993 (Table A6), fueled by high levels of public expenditures, notably on agricultural support prices and increases in public sector wages. The surge in demand was reversed in 1994, with contractionary fiscal policies, high interest rates, and the turbulence in financial markets contributing to a decline in demand of some 11.7 percent. Imports of goods and services moved in step with domestic demand, growing by 35.8 percent in 1993 and then falling by 23.8 percent in 1994.

In 1993, total consumption rose by 7.3 percent and private consumption by 8.1 percent; estimates for 1994 indicate declines of 6.1 percent and 6.6 percent, respectively. In turn, public consumption grew by 3.7 percent in 1993 (down from 9.4 percent in 1992) and declined by an estimated 3.6 percent in 1994. As a share of GNP, however, total consumption increased from 78.1 percent in 1993 to 79.2 percent in 1994, the same level of 1992. Similarly, private disposable income went up from 88.6 percent in 1992 to 90.1 percent in 1993 and further to 91.2 percent in 1994 (Table A7). 1/ The change in public disposable income in 1994 was positive (+6.0 percent) for the first time since 1987, having fallen by 13.0 percent in 1993.

Investment had grown by close to 28 percent in 1993. However, the uncertainty following the financial crisis of early 1994 and the credit crunch that virtually paralyzed long-term private borrowing caused investment to drop by an estimated 28.2 percent to 19.9 percent of GNP, compared with 26.6 percent the year before. The downturn is attributed mainly to public investments—a decline of 48.5 percent in 1994 versus an increase of 16.2 percent a year earlier—although private investment also declined by 20.7 percent in 1994, after increasing by 32.6 percent in 1993. Given the large reduction in inventories, fixed investment in 1994 is projected to have dropped by only 17 percent, with public fixed investment down by 33.1 percent and private fixed investments down by 10.6 percent. The largest drops in private investment took place in transportation, manufacturing, and agriculture; investment actually increased in housing and mining. Public investment, however, decreased at rates of 30-40 percent in almost all sectors.

3. Price developments

Average yearly inflation in Turkey has been consistently high but surprisingly stable, at around 60-70 percent a year during 1988-93. The inflationary process in Turkey can be viewed as a fiscally driven process, in which the inflationary consequences of lax fiscal policies have only occasionally been held in check by episodes of monetary tightening.

The crisis of early 1994 pushed up the CPI and the WPI inflation rates to 125 percent and 149 percent, respectively in the 12 months to December (Table A8 and Chart 3). 1/ After increasing by 26 percent in the first quarter of 1994, prices received a sharp boost from some of the measures—such as the devaluation and the adjustment of administered prices—included in the stabilization program; as a consequence, wholesale prices increased by close to 45 percent in April and May alone. 2/ The favorable effect of the stabilization measures on expectations, the sudden contraction of demand, and positive seasonal factors contributed to a sharp fall in inflation in the summer months: from June to August, consumer and wholesale prices increased by less than 2 percent a month.

Chart 3
Chart 3

TURKEY PRICE INFLATION, 1994 (Monthly Percentage Increase)

Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Sources: Data provided by Turkish authorities and staff estimates.

The substantial success in reducing inflation during the first months of the program, coupled with the suspension of pressure on the CBT to monetize fiscal deficits, appeared to lay the basis for sustained progress in reducing inflation during the second half of the year. However, prices rose sharply from September onward, increasing on average by 7.2 percent per month during the final quarter of the year. The resurgence of inflation was in part due to adverse supply shocks in agriculture and seasonal factors but foremost to a premature easing of interest rates aimed at decreasing public debt service, which contributed to a further depreciation of the lira and eroded public confidence in the sustainability of the anti-inflation program. The relatively passive response of policymakers to the revival of inflation, due at least in part to reluctance to raise interest rates, provided some vindication for public skepticism about the priority given to reducing inflation, and highlighted the need for placing anti-inflation policies at center stage if a long-established pattern of chronic inflation is to be permanently broken.

4. Labor force and employment

The Turkish labor market reflects the influence of three main factors: a high population growth rate, the existence of a large informal sector, and a large share of employment in agriculture.

Between 1980 and 1990 the population grew by 2.4 percent a year, subsequently declining slightly to about 2.2 percent. In 1993, on a population estimated at about 60 million people, the labor force was 20.2 million and the employed were 18.3 million (Table A9). For 1994, these figures are projected at 20.4 million and 18.2 million, respectively. The participation rate—54.2 percent in 1993 and 53.2 percent estimated for 1994—is much larger for males (76.5 percent) than for females (32.3 percent). This difference is due to the low participation rate of women in urban areas (17 percent, versus 50 percent in rural areas) where regular employment opportunities for women are much scarcer. Labor force participation has been decreasing over recent years, due to longer duration of schooling and rapid urbanization; this trend is expected to revert around the year 2000 as the currently growing student population enters the labor force and young urban females are more likely to seek a job.

The unemployment rate in 1993 is estimated at 7.6 percent, but official statistics report that a further 6.9 percent of the labor force were recorded as underemployed. 1/ In 1994, the unemployment rate is projected to reach 10.5 percent and the underemployment rate 9.3 percent. These figures must be treated with caution: on the one hand the Survey on Labor and Occupation is conducted only twice a year by the SIS and is based on a sample whose structure has not been updated in a number of years; on the other, self-employment in agriculture, still the predominant occupation, is virtually unaffected by the economic cycle.

Industrial employment is decreasing as a result of increasing labor productivity and investments in labor-saving technology: the index of employment in industrial firms with over 50 employees (which account for 90 percent of manufacturing) went from 102.0 in 1990 to 82.0 in 1993 and to 75.2 in the third quarter of 1994. The index of production hours likewise declined from 99.6 in 1990 to 79.9 in 1993 to 72.8 in the third quarter of 1994. Meanwhile the manufacturing production index increased from 125.1 in 1990 to 142.9 in 1993 but declined to 134.3 in the third quarter of 1994.

Industry accounted for 15.3 percent of total employment in 1990, and this figure remained virtually constant until 1994 when it was 15.7 percent. The share of employment in the service sector has been growing in recent years, from 37.1 percent in 1990 to 39.5 percent in 1993, and is projected around that level in 1994. The share of agriculture in total employment remains high, albeit on a decreasing trend, amounting to about 45 percent of the workforce in 1994. Official statistics do not reflect the fact that many people registered as employed in agriculture work—possibly part time—in other occupations. Productivity in agriculture is about one-fourth to one-fifth that in manufacturing.

Data on wages in the private sector refer only to workers covered by collective agreements (Table A10). The ratio between net and gross wages is about 65 percent for minimum wage earners. Health insurance, maternity, social security contributions, and accident insurance together represent 14 percent of the gross wage for a minimum wage earner; other workers pay these contributions in proportion to their income, but only up to TL 7.3 million per month. In addition, the employer pays a contribution that varies between 19.5-27.0 percent of the gross wage. After a sizable real increase in 1991, gross wages in the private sector have moved more or less in line with inflation. Data for wages in most industrial sectors are not yet available for 1994, but it is likely that real wages have declined following the surge in inflation. The net nominal wage of civil servants increased by 69.6 percent in 1993 and by 60.9 percent in 1994, when CPI inflation turned out to be 125 percent. Other employees in the public sector, mainly in the SEEs, fared somewhat better; their gross nominal wages went up by 86.5 percent in 1993 and by 89.9 percent in 1994.

5. Labor relations

The labor market in Turkey is subject to little regulation: labor contracts can be designed in almost complete freedom as regards duration (30 days is the minimum), part-time, quantity arrangements (very rare outside the textile sector), working hours, and salary. Employers tend to pay the core of their workforce according to collective contracts and hire additional workers through individual contracts and team contracts—which are typically more flexible—to accommodate fluctuations in demand. No collective contracts exist for agricultural laborers.

About 2.6 million employees (excluding civil servants) are union members. Although civil servants are not effectively forbidden to join a union, the law forbids them to go on strike and their representatives de jure cannot sign collective agreements. In practice, their wages are informally negotiated by union representatives.

Only 1.5 million workers are covered by collective contracts. Negotiation is in general decentralized, so the agreements are signed at the enterprise level. Although in Turkey there exist 116 trade unions, only about 40 of them effectively bargain collective agreements. In fact only those unions whose members represent at least 10 percent of the labor force in a sector (productive activities are classified into 28 sectors) and at least 50 percent of the workforce in a single factory are entitled to conduct the negotiation. Therefore, every collective agreement is negotiated by one union in each enterprise and applies only to its members; the other employees can obtain the same benefits as the union members, provided that they pay a “solidarity fee”, thereby becoming virtually nonvoting members. All other workers and employees negotiate their contract individually or—as it is increasingly common—as members of a team in charge of particular operations. These team workers are, in practice, external contractors with very few rights and below average salaries.

Even if, formally, collective agreements are signed at the enterprise level, in some sectors, notably steel and textile (to a lesser extent in food processing), centralized negotiation has taken place between the employer association and the most representative unions. Once the major enterprises have agreed, the others tend to follow, with the exception of the small firms. Collective contracts last for two years and establish pay increases to occur every six months; in the first year they are based on projected inflation; in the second year a first increase guarantees a gain in real terms on the basis of realized inflation; the last pay raise de facto represents a 100 percent adjustment to past inflation.

Workers who perform crucial tasks in a factory (e.g., furnace laborers in a steel mill) are forbidden from joining a union and cannot be covered by collective agreements. In some cases they are also forbidden from striking. In the public enterprises this is more common, for example it is estimated that in large steel mills the percentage of workers with limited rights is close to 50 percent. These unprotected workers earn on average less than their colleagues with similar qualification and seniority.

In the public nongovernment sector the major trade union represents 85 percent of the employees, and about 600,000 of them are covered by the collective contract. The trade union negotiates a national framework agreement with the Government. Supplementary provisions are bargained at sectoral and enterprise level with government-appointed representatives of the Public Employers Association. In the government sector about 260,000 workers are hired through individual contracts renewed annually: although they cannot be laid off as all other civil servants, they are forbidden from joining a union and their salary is decided unilaterally by the Government.

II. Public Finances

1. Overview

The nonfinancial public sector in Turkey consists of five main subsectors: the central government (also known as the consolidated budget, and including the central government proper, the incorporated extrabudgetary funds, and the annex budget); extrabudgetary funds (EBFs); local governments; social security and revolving funds; and nonfinancial state economic enterprises (SEEs). The former four constitute the general government.

Weak financial performance of the public sector, reflected in large deficits and heavy domestic borrowing, has been a defining feature of Turkey’s macroeconomic performance in recent years. Following some retrenchment in 1988, the public sector borrowing requirement (PSBR) increased substantially in each succeeding year, reaching 11.2 percent of GNP in 1992, up more than 6 percentage points from the 1988 level (Table A11, Chart 4). 1/ Key factors contributing to the widening deficits included a growing public sector pay bill and poor financial performance of the SEE sector, where problems of low productivity and weak management were exacerbated by sizable wage increases and political pressures to contain rises in public sector prices. 2/ Sustained growth in the PSBR created pressures on the Central Bank of Turkey (CBT) to provide direct financing to public entities, a practice that had been effectively curtailed in 1989-90: advances from the CBT financed about one third of the consolidated budget deficit in both 1991 and 1992, while the Soil Products Office (TMO), a major agricultural sector SEE, also received preferential loans from the CBT during this period. 3/

Chart 4
Chart 4

TURKEY FISCAL INDICATORS, 1989-1994 (In percent of GNP)

Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Sources: Data provided by the Turkish authorities; and staff estimates.1/ Excluding revenues allocated to EBF expenditures.2/ Excluding expenditures allocated to EBFs.3/ Operating surplus before depreciation and provisions.

The Government’s macroeconomic program for 1993 envisaged a substantial reduction in the PSBR during the year, to be achieved through a combination of expenditure restraint and revenue increases. However, substantial overshooting of expenditure targets, notably in relation to personnel outlays, ensured that the primary deficit declined only modestly despite significant revenue growth. The improved performance at the primary level was more than offset by a surge in interest expenditures, which increased by almost 2½ percentage points of GNP. With the PSBR reaching a record level of 12.5 percent of GNP, the Treasury sought to limit its interest bill through increased recourse to low-interest borrowing from the CBT; by the fourth quarter of the year, advances from the CBT were financing more than 40 percent of the deficit of the consolidated budget. 4/ During the first quarter of 1994, the deterioration in the public finances continued apace, with the deficit of the consolidated budget reaching almost 10 percent of quarterly GNP (as compared with less than 7 percent for 1993), financed in the main by borrowing from the CBT. The evident unsustainability of this policy stance was a central factor contributing to the financial market crisis during the first four months of the year.

The stabilization program announced on April 5, 1994 included a package of fiscal measures, public sector price adjustments, and privatization commitments intended to reduce the PSBR in 1994 to 6.2 percent of GNP, a cut of more than 6 percentage points of GNP. Substantial progress was made in pursuit of this goal during the ensuing months, with the PSBR declining from 12.5 percent of GNP in 1993 to 8.0 percent in 1994; key in this regard was the cut in expenditures of the general government of some 4 percentage points of GNP (Tables A12 and A13). Failure to meet the original program target for the PSBR was due in large part to the lengthy delay in implementing the privatization component of the April 5 package, with unexpectedly high interest payments also being of significance. 1/ The fiscal retrenchment under the April 5 program was accompanied by a return to market-based financing by the Treasury, which successfully re-established its presence in the market by offering short-term securities at initially very high interest rates; public sector borrowing from the CBT remained at modest levels throughout the second half of the year. Despite the sizable reduction in public sector borrowing needs, the sharp fall in net foreign financing of the public sector (down from 1.6 percent of GNP in 1993 to -1.3 percent in 1994) implied that domestic borrowing by the public sector declined only modestly in relation to GNP.

2. Consolidated budget

The 1994 budget originally approved by Parliament contemplated little change in the budget deficit from the level of 6.9 percent of GNP recorded in 1993, but was soon rendered irrelevant by the financial crisis during the first quarter of the year. The budgetary measures contained in the April 5 stabilization program sought a sharp reduction in the budget deficit to 2.6 percent of GNP, which was deemed to require achieving a primary surplus equivalent to 4.7 percent of GNP (Table A14).

Even prior to the April 5 measures, revenues had been expected to increase in real terms during 1994 because of an increase in the standard VAT from 12 percent to 15 percent, an increase in the banking and insurance tax, and administrative improvements. 2/ The April 5 package contained a package of additional measures intended further to bolster revenues that included: (i) an increase from 50 percent to 70 percent in the share of the fuel consumption tax transferred to the budget; (ii) an increase in the levy on the Fuel Stabilization Fund from 10 percent to 25 percent; (iii) substantial increases in the prices of alcohol and tobacco; and (iv) increases in the levies on telephone charges and electricity tariffs (10 percent of gross sales of TEK and 6 percent of gross sales of PTT, respectively). Combined with steps to improve tax administration, these measures were projected to raise revenues of TL 57.5 trillion (2 percent of GNP) in 1994. In addition, Parliament in early May passed a bill that introduced several one-time tax measures for 1994, including a 10 percent surcharge on personal and corporate income taxes; 1/ a 1.5 percent net asset tax on businesses, including banks; and supplements to both the real estate and motor vehicles taxes. The Hay tax package also included permanent increases in stamp taxes, various fees, and excise taxes on fuels. In sum, this supplementary revenue package was projected to yield TL 64 trillion (2.2 percent of GDP) in 1994, and a further TL 8 trillion during the first half of 1995. Revenues in relation to GNP, however, were projected to show only a minor increase in 1994 (Table A15), because of the anticipated adverse effects on real tax collections of the increase in average inflation, the targeted cut in real wages, and the projected decline in economic activity and imports (despite the positive impact on revenues of the devaluation). 2/

Nontax revenues were projected to increase by almost TL 40 trillion or 1.1 percent of GNP mostly on account of an increase in privatization proceeds from TL 2.0 trillion in 1993 to TL 30 trillion in 1994, of which TL 26 trillion would derive from sales of public enterprises. 3/ With a decree passed by the Government, the functions of the privatization council were strengthened and its operations streamlined. Special revenues and funds’ revenues were increased by TL 20 trillion, compared with the budget, to TL 120 trillion, in part because the withholding rate from the extrabudgetary funds was raised to 9 percent from 3 percent. It was also the result of the imposition of a 6 percent levy on gross sales of the telecommunications firm (PTT), of a 10 percent levy on gross sales of electricity by Turkish electricity, and of the increase from 10 percent to 15 percent in the levy accruing to the Petroleum Price Stabilization Fund.

On the expenditure side, transfers to state enterprises were to be cut by TL 16 trillion from the originally budgeted level. This would be made possible by the substantial increase introduced at the outset in the prices of many goods produced by public enterprises, and by the containment of wage outlays and capital expenditures. Personnel outlays in the budget were to be held to the originally budgeted amount despite the much higher inflation rate now projected. This was projected to result in a cut in real terms in average salaries of some 26 percent (measured in terms of the GNP deflator) or some 18 percent in terms of the CPI index. Further savings were to be made by limiting the use of temporary workers. Other current expenditures (excluding interest) were also to be cut in nominal terms from the originally budgeted level. Other transfers were projected to be reduced by 23 percent in real terms compared to 1993, as a result of the improvement projected in the financial position of the extrabudgetary funds. Finally, capital expenditure was curtailed by almost 32 percent compared to the real level in 1993. As a result of these measures, primary expenditures as a share of GNP were programmed to fall by 4.3 percentage points to about 15 percent in 1994.

The initial implementation of the program exceeded expectations, with a surplus of TL 5.3 trillion recorded in the second quarter, against a program limit of a deficit equivalent to TL 10.8 trillion. However, this over-performance was gradually eroded by both expenditure, pressures and revenue shortfalls, resulting at year’s end in a deviation from the program targets of some TL 40 trillion, or 1 percent of GNP. 1/ Nonetheless, the budget deficit in 1994 was reduced to 3.8 percent of GNP, an adjustment of almost 3 percentage points from 1993. At the primary balance level, the adjustment exceeded 4 percent of GNP, but this was partly offset by an increase in interest payments equivalent to 1.6 percent of GNP, which reflected both the larger amortization component due to the acceleration in inflation and the higher real interest rates on securitized debt.

a. Revenues

The revenue shortfall, which accounted for virtually the whole deviation in the budget outcome, resulted mostly from lower-than-expected nontax revenues due to delays experienced in the privatization process (TL 24 trillion less), but it was exacerbated by problems in the transfers to the state budget of excise taxes due by the State Monopoly (TEKEL), and by cuts in the levies charged on petroleum derivatives. The VAT, customs duties, stamp tax, and the permanent motor vehicles tax (an indirect tax on the sale of new cars) were all negatively affected by the unexpectedly large slowdown of the economy. The payment of a special levy from the telecommunications and electricity companies was also below scheduled levels. Finally, the strong decline in imports was reflected in lower proceeds to the Mass Housing Fund from the associated levy. These negative trends were offset in part by the better-than-projected outcomes of the corporate and personal income taxes, as well as the net wealth, economic balance, and supplementary motor vehicle taxes, which may be attributed to stronger than originally assumed corporate profits for 1993, and higher real wages in the nongovernment sector. An increase in compliance, particularly for the personal income tax, may also have played a role.

As mentioned, lower privatization proceeds caused a shortfall in nontax revenues, but these were also affected by the underperformance of the funds and grants included in the budget (by TL 19 trillion), on account of the negative impact of the shortfalls in the revenues from some co-participated taxes, the elimination of the levy on petroleum derivatives programmed to accrue to the Petroleum Stabilization Fund, and the decline in imports, which resulted in lower proceeds to the Mass Housing Fund.

b. Expenditures

Expenditures exceeded programmed levels only by some TL 4 trillion (0.1 percent of GNP). Primary outlays were actually less than program targets as unscheduled increases in wages and salaries (for TL 8 trillion), higher military outlays (TL 7 trillion), and nonplanned transfers to the social security funds (TL 18 trillion), were more than offset by lower investment outlays (TL 13 trillion) and by the full use of the revenues the program had left unallocated as a contingency reserve. Interest payments, on the other hand, exceeded program projections because, due to shortfalls in external disbursements, 1/ the Treasury had to rely more extensively than planned on domestic borrowing—which carried a much higher interest rate. In addition, the Treasury allowed for overfunding in the early part of the program so as to repay some TL 30 trillion in advances from the Central Bank.

3. Extrabudgetary funds (EBFs)

There are currently 107 EBFs, of which 12 are considered to be significant. In 1993, 62 of the 107 EBFs were consolidated in the central government budget. 2/ Of the large EBFs, only the Defense Industry Support Fund (DlSF) and the Social Solidarity Fund (SSF) were not consolidated. However, some funds have only been partially consolidated, in the sense that some of their operations, normally related to investment, are not included in the consolidated budget. These operations, together with those of the nonconsolidated funds are accounted for in the financial position of the EBFs, in the context of the calculation of the PSBR. The operations of the consolidated funds are now monitored by the Treasury, although they retain a separate legal personality. The authorities’ goal is to bring all the EBFs into the budget and gradually to eliminate them. As a first step, in 1995, 13 funds have been “financially eliminated” as their global appropriation in the budget totals TL 1 million.

Special tax revenues, import levies, and user charges on public infrastructure are earmarked to finance the funds. However, the earmarked revenue remains subject to a clawback rate, which differs slightly amongst funds, and may also be related to the level of expenditures appropriated in the budget law (the lower the expenditures of the EBFs, the higher the amount of clawback). Beyond that, the EBFs (both consolidated and nonconsolidated) generate revenue from their own operations to which the clawback does not apply. Only three funds, the Mass Housing Fund (MHF), the Public Participation Fund (PPF), and the Defense Industry Support Fund (DISF), may borrow, domestically or abroad.

According to the program, the EBFs were required to improve substantially their financial position in 1994, while at the same time their tax revenues were reduced because the central government was assigned a larger share of the petroleum consumption tax (Table A16). The projected improvement in the fund’s financial position was to be made possible by TL 14 trillion in proceeds from privatization, but also by containment of personnel, other current and capital expenditures. Total revenues of the nonconsolidated funds were expected to be TL 123.3 trillion or 3.1 percent of GNP, and total expenditures only slightly more, ensuring the achievement of financial equilibrium. In the event, the financial position of the EBFs did not improve compared to 1993, rather the deficit has slightly worsened to the equivalent of about 0.7 percent of GNP. This was due to a revenue shortfall attributable to the same reasons that explain the lower-than-programmed fund revenues to the consolidated budget (see above) particularly the temporary elimination of the levy for the Petroleum Price Stabilization Fund, and including the shortfall in privatization proceeds.

Local governments and the social security system

The borrowing requirement of local governments has been gradually growing as a consequence of rising personnel and investment expenditure. By 1993, the deficit of the local governments had reached the equivalent of 0.8 percent of GNP. Their financial position is estimated to have improved in 1994, to a deficit of 0.4 percent of GNP—still above the level targeted in the program—as a result, among others, of an increase in environmental taxes and in the assessed values and rates of local real estate taxes (Table A17).

There are three social security funds: 1/ the Social Security Organization for Craftsmen and Tradesmen and Other Self-Employed, the Pension Fund (for civil servants), and the Social Insurance Institution (for all other employees). They cover about 44 million persons, with about 8-9 million as active participants, 3-4 million pensioners, and the rest dependents. The social security system is currently experiencing financial difficulties, in part as a result of a law passed in 1992 allowing men to retire after 25 years of service and women after 20 years, regardless of age. Consequently, the number of new applicants for pensions more than doubled between 1991 and 1992. The financial deterioration of the social security funds was further amplified by poor collection performance—many enterprises (including SEEs) evade full payment of the contributions they owe—by the poor rate of return they earn on their assets, both financial and real, and by the low number of contributors relative to beneficiaries (i.e., a high dependency ratio). The system as a whole first went into a deficit in 1991 and by 1993 the deficit of the three funds had risen to 1.4 percent of GNP on a net-of-budget-transfers basis—0.6 percent of GNP including said transfers. The situation seems to have remained stable in 1994, with an improvement in the borrowing requirement (inclusive of transfers) to 0.5 percent of GNP, entirely explained by an almost equivalent increase in government transfers.

In 1993, the Government took several measures to improve the financial position of the social security system. The funds were allowed to raise rents on their real estate assets and some real estate was also sold. Employers were forbidden to deduct social security taxes from income for the purpose of the income tax unless the social security taxes were actually paid. The number of social security inspectors was increased. Part of the income of civil servants was made subject to regular social security contributions. The authorities are considering a drastic overhaul of the social security system and are working with the World Bank in this regard.

5. State economic enterprises

There are some 50-odd nonfinancial state economic enterprises (SEEs) who collectively account for some 3 percent of aggregate employment and 7 percent of aggregate fixed investment in the Turkish economy. 1/ Some three quarters of these SEEs, accounting for five-sixths of SEE employment, report to line ministries and the Undersecretariat of the Treasury, and operate under a special legal framework (Decree Law 233) promulgated in 1984. The remainder have been converted into commercial enterprises reporting to the Privatization Administration (PA), which is charged with the task of privatizing them as soon as circumstances permit. 2/

The financial performance of SEEs has deteriorated substantially in recent years, with the borrowing requirement increasing from 1.8 percent of GNP in 1989 to 4.5 percent of GNP in 1992 (Tables A18-A20). Underlying the rising borrowing needs was a sustained deterioration in operating performance, attributable in turn to growing personnel outlays and weak revenue performance: between 1989 and 1992, personnel expenditures increased from 3.2 percent of GNP to 5.2 percent, despite a modest decline in employment levels, while revenues declined in relation to GNP, reflecting in part noneconomic pressures to limit price increases. Poor financial performance in recent years is underlined by comparison with the situation in the mid-1980s, when sizable borrowing requirements reflected high levels of investment rather than operational losses.

The Borrowing Requirement of the SEEs

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During 1993, the borrowing requirement of the SEEs amounted to 3.6 percent of GNP, down some 0.9 percentage points of GNP from the preceding year in large part because of rising budgetary transfers. Financing came from net deferred payments, equivalent to 1.9 percent of GNP and consisting primarily of overdue payments to government entities and accrued expenses; and cash financing, equivalent to 1.7 percent of GNP, coming from domestic banks and the Treasury (the latter in the form of extrabudgetary bond transfers).

Measures to ensure improved financial performance of the SEEs were an important element of the stabilization program introduced in April 1994; wage restraint, increases in administered prices, and cutbacks in investment were expected to produce a reduction in the borrowing requirement of some 1.3 percentage points of GNP, notwithstanding a cutback in budgetary transfers of close to 1 percent of GNP. These short-term measures to improve performance were to be buttressed over time by privatization of many state enterprises and increased commercialization and improved governance in those enterprises intended to remain under state ownership. 1/

Preliminary data indicate that the financial position of the SEEs improved significantly during 1994, albeit less than had been projected. The borrowing requirement declined by some 0.9 percentage points of GNP compared with 1993, with reduced investment outlays (down 1.4 percentage points of GNP) and improved operational performance (up 0.7 percentage points) being only partially offset by a sizable reduction in budgetary transfers. The decline in investment was somewhat larger than expected, due in the main to unexpectedly low stock accumulation by agricultural sector SEEs. Declining personnel costs, down 0.9 percentage points of GNP, more than account for the improved operating performance.

Decline in the borrowing requirement during 1994 was accompanied by a sharp reduction in cash financing to 0.4 percent of GNP, almost all of which took the form of government bonds transferred to the SEEs outside the budgetary framework; domestic bank borrowing contracted sharply to a level where modest net repayments were made, while net foreign borrowing was also negative. 2/ Net deferred payments increased relative to 1993 levels, reflecting in the main the accumulation of unpaid liabilities to the Treasury and other government entities.

6. Debt stock of the central government

Domestic debt of the central government consists of securitized debt (Treasury bills and bonds) and nonsecuritized debt, almost all of which is owed to the CBT); in addition, the central government has a substantial amount of medium and long-term debt to foreign creditors. The ratio of this stock of debt to GNP fluctuated significantly between 1990 and 1993, then rising by almost 8 percentage points in 1994, an increase due in large part to the effect of substantial real exchange rate depreciation (Table A23).

In recent years, the average maturity of domestic debt has shortened substantially: by end 1994, almost 60 percent of securitized debt was of less than 12 months’ maturity, as compared with shares of 20-40 percent during 1990-93. As a result, the need to roll over a large share of the total domestic debt exerts sustained pressure on the still relatively narrow capital markets. The persistence of relatively low levels of debt despite continued large borrowing needs and the sustainability of debt levels given maintenance of current policies is examined in Appendix III. A general conclusion of that analysis is that maintenance of a modest primary surplus will be sufficient to limit the growth of debt stocks to acceptable levels over the medium term.

7. Tax legislation in 1993-94

At the end of 1993, major legislative changes were introduced aimed at simplifying the tax system and streamlining its administration. Corporate income tax rates were decreased from 46 percent to 25 percent, but with an additional minimum rate of 20 percent withholding on all after-corporate-tax income (for private corporations). Most of the existing exemptions from the corporate income tax were abolished. Special reduced corporate income tax rates were virtually eliminated. The withholding rate for corporate dividends and retained profits was set at 10 percent for public enterprises and, as mentioned, at 20 percent for private firms. Investment allowance provisions were tightened considerably. However, full deductibility of (nominal) interest payments has been left virtually untouched. At the same time, enterprises are entitled to revaluate their fixed assets frequently, leading to high depreciation allowances, which also results in substantial revenue losses for the budget. Change in this area has proven difficult.

A special annual tax refund system under the personal income tax for salary and wage earners has replaced the previous system based on partial deductibility of the VAT paid by consumers as certified by the invoices obtained at the time of purchase. The new system allows taxpayers to deduct one third of expenses incurred personally or by their dependents, on such items as education, health care, food, and clothing. The brackets of the personal income tax have been raised to take account of past inflationary developments (thus reducing bracket creep), while the highest marginal rate has been increased to 55 percent from 50 percent (Table A24). The advance payment rate, defined as a fraction of the most recent annual income tax liability, has been raised for the personal income tax from 30 percent to 50 percent and from 50 percent to 70 percent for the corporate income tax.

The value-added tax deferment on inputs of capital goods (in connection with investments for which investment incentive certificates have been issued) has been abolished. Taxes on the sales of motor vehicles have been increased by 100 percent.

The authorities intend to make further reductions in the scope of the tax incentives in 1995 with a view to limiting this program to few and qualified recipients from 1996 onward. A special consumption tax to be levied on specified luxury goods will be introduced; this tax is intended to replace the import duties that are being reduced in preparation for the move to a customs union with the EU in 1996. A draft bill including wide-ranging modifications to tax administration procedures has been passed by Parliament. It streamlines auditing procedures and the interest rate applied to tax arrears (including tax penalties themselves) has been increased.

III. Money and Banking

1. Introduction

Recent years have witnessed substantial turbulence in the Turkish financial system, as a period of unsustainably rapid credit growth and substantial external sector borrowing gave way to a financial and exchange market crisis in the first months of 1994. The macroeconomic adjustment program announced in April 1994 contributed to a stabilization of the lira and a restoration of public confidence in the domestic banking system, but achieving only transitory success in curbing inflation. By sharply curbing the pressure on the Central Bank of Turkey (CBT) to monetize public sector deficits, and scaling back the quasi-fiscal lending operations of state banks, the authorities have laid the basis for sustained progress in taming inflation and ensuring an efficient allocation of societal savings. But ongoing implementation of these reforms, coupled with progress in implementing privatization and commercialization of state banks, will be needed to realize these gains.

2. The banking system

a. Structure

Turkey’s banking sector consists of some 60 deposit-taking banks, of which 6 are state-owned and 20 are foreign-owned. In addition, there are 12 development and investment banks (3 state-owned, 3 foreign-owned) that do not take deposits. Turkish banks are “universal banks” that are permitted to engage in virtually all types of financial activities, including insurance, brokerage, and underwriting.

The state-owned banks play a central, albeit declining, role in the banking system. State-owned banks accounted for some 46 percent of total banking system assets at end-March 1994, down from just over 50 percent in 1990. The state-owned banks are, on average, larger than their private sector competitors; employ more staff in relation to the size of total assets; and undertake substantial amounts of lending at preferential terms. 1/ The scale of preferential lending by state banks is reflective of their role as agents of government policy in selected sectors of the economy, notably agriculture (Ziraat Bank), artisans and small businesses (Halk Bank), and housing and property development (Emlakbank). Foreign-owned banks play a relatively modest role in the banking system, accounting for 3.5 percent of assets and 1.8 percent of deposits at end-March 1994.

Competitive pressures in the banking system have intensified during the last ten years, as evidenced by the decline in concentration ratios. 1/ Measured profitability of banks has tended to increase over this time period, a trend due in part to the distortionary effects of high and variable inflation; equity capital expressed as a share of total liabilities actually declined significantly from 1990 to 1993, having risen modestly through the 1980s. Bank profitability deteriorated sharply during 1994, reflecting the impact of large exchange rate depreciation and surging interest rates. 3/

Weakening public confidence in the integrity of the banking system resulted in a run on deposits during the first part of 1994, with particularly adverse effect on the small- and mid-sized banks, three of which were forced to close in April. The Government’s decision to provide 100 percent backing to all household deposits with domestic banks effectively halted the process of deposit withdrawals, albeit at the cost of introducing significant problems of moral hazard that would distort the role of competitive pressures in the banking system if maintained over the longer term. In ensuing months, high interest rate spreads and a surprisingly modest growth in nonperforming loans allowed banks to improve their profitability and capital base significantly, but (unweighted) capital-asset ratios for a significant number of banks remained below 8 percent at end-September 1994.

b. Regulation and prudential supervision

Banking sector legislation in Turkey has evolved over time in line with developments in the financial system. The longer-term goal of legislative and regulatory reform is to bring Turkish laws and practices into line with those of the European Union (EU), albeit with a transition path that makes due allowance for the specific conditions of the Turkish banking system and its developmental needs. Important legislative reforms were introduced in September 1993 with Decree Law (DL) 515, but this legislation was deemed to be flawed by the Constitutional Court in December 1993. The reforms were given a firmer legal basis with the promulgation of DL 538 in June 1994, at the end of the six-month grace period for DL 515 provided by the Court.

Key elements of the reforms included: (i) a substantial increase in the minimum paid-up capital required to open a bank, now set at TL 1 trillion; (ii) a tightening of the limits imposed on credits extended to related parties; 1/ (iii) tighter limits on equity participation in nonfinancial institutions and on investments in real estate; (iv) stronger public disclosure requirements; 2/ and (v) the imposition of tighter internal control procedures for extending large credits to clients, defined as loans in excess of TL 10 billion. In addition, the legislation established procedures formalizing the respective roles of the Treasury and the Savings Deposit Insurance Fund in intervening in the affairs of financially troubled banks, and in managing the rehabilitation, restructuring, or closure of banks deemed unable to rehabilitate themselves. The need for effective procedures to initiate early intervention in dealing with troubled banks was given added emphasis by the bank closures in April 1994.

The losses incurred by banks during the first half of 1994 as a result of the sharp decline in the exchange rate highlighted the limitations of the regulations governing banks’ exposure to foreign exchange (FX) risk, which specified limits on the ratio of FX-denominated assets to FX-denominated liabilities rather than limits linking net exposure to bank capital. Following consultations between government agencies and commercial banks, the CBT and the Treasury, in February 1995, announced new regulations limiting the net open position of banks to not more than 50 percent of their capital base. 3/ A transition period allowing banks not currently in compliance with this regulation to restructure their balance sheets is to last through end-March 1996.

Significant changes in the legal framework governing the operations of the CBT were introduced in April 1994, shortly after the announcement of the authorities’ stabilization program. These included measures intended to strengthen the autonomy of the CBT in implementing monetary policy, notably imposing tighter limits on the extension of short-term advances to the Treasury by the CBT and introducing limits on the provision of central bank credit to nonbudgetary government entities, which had previously been unconstrained. 4/ The reforms also provided for the establishment of a formal lender-of-last-resort facility by the CBT, enabling it to extend credits for up to one year to troubled banks in an amount up to twice the size of the bank’s paid-in capital; 1/ prior to this, the CBT could only extend what were in effect bridging credits of not more than four months duration to banks encountering liquidity problems.

c. Reserve and liquidity requirements

Banks in Turkey are subject to both reserve and liquidity requirements on their deposit, and more recently non-deposit, liabilities. Banks are required to hold reserves against both Turkish lira (TL) deposits and foreign exchange (FX) deposits in special blocked accounts at the CBT; they are also subject to liquidity requirements, which mandate that a fraction of deposit and deposit-like liabilities be held in the form of specified forms of government paper, unremunerated deposits at the CBT, and vault cash.

Having remained substantially unchanged from September 1991 through March 1994, the CBT introduced a comprehensive reform of the reserve and liquidity requirements in April 1994, aimed at eliminating the incentives for banks to concentrate unduly on expanding their non-deposit liabilities. 2/ The key principles underlying the design of the reforms were (i) equal treatment of new funds derived from deposit and non-deposit sources and (ii) reduced requirements on increases in deposits from current levels, thereby ensuring a decline in average requirements over time. The reforms appear to have significantly reduced the importance of non-deposit domestic financing for banks; by September 1994, the stock of securities issued by banks had fallen to 4 percent of the stock of time deposits, having risen from 5 percent to 13 percent during 1993.

The impact of the reforms on the cost of financial intermediation was more modest, albeit in line with the intentions of the authorities. The effective required reserve ratio on lira deposits declined from 10.8 percent at end-March to 9.3 percent in October-November, and, in the absence of further reforms, would have approached 8 percent over time. CBT estimates suggest that the wedge introduced between lending and borrowing rates as a result of the reserve requirements declined from 9.7 percent at end-March to some 6 percent in November, but this decline reflects in part the fall in market interest rates during this period; comparison of the decline in the size of the wedge at given (November) interest rates is more modest, a decline from some 7.1 percent to 6.0 percent. 1/

In January 1995, the CBT announced increases in both reserve and liquidity requirements, intended to absorb liquidity and to increase the demand for longer-term government securities. Reserve requirements on new lira liabilities were raised from 8 percent to 9 percent, with an increase from 10 percent to 13 percent in the case of new FX liabilities. In addition, 3 percent of these additional funds are to be held in the form of indexed government bonds. The increase in reserve requirements on lira deposits reversed approximately half of the decline in the wedge between borrowing and lending rates recorded in the wake of the March 1994 reforms.

3. Goals and instruments of monetary policy

Inflation in Turkey has usually been viewed as a fiscally-driven process in which ongoing pressure to monetize public sector deficits forced the CBT to adopt an accommodative monetary stance, thereby sustaining the inflationary process over time. In the absence of fiscal restraint, the CBT had relatively little room for manoeuver in pursuing anti-inflationary policies, and was forced instead to focus on a narrower range of policy targets, including inter alia the level of the real exchange rate and its holdings of external reserves. 2/ Following the implementation of a major fiscal adjustment as part of the April 5 stabilization program, the CBT’s policy choices appeared to widen significantly, although pressures remained that would significantly undermine the anti-inflationary stance of monetary policy.

The CBT relies primarily on indirect instruments of monetary control in seeking to control the growth of banking system liquidity and credit. Tools used by the CBT for liquidity management purposes include sales and purchases of government securities, repos and reverse repos, foreign currency swaps, borrowing and lending in the interbank market, and foreign exchange market intervention (see Appendix V). 3/ Adjustments to reserve and liquidity requirements have typically been employed for purposes other than monetary management; however, the increase in reserve requirements announced in late January 1995 was motivated in part by the perceived need to absorb excess liquidity.

Implementation of effective short-term monetary management by the CBT has been impaired by the thinness of markets in government securities, the substantial fluctuations in short-term advances to the Treasury, and the preference for avoiding interventions that directly raise the cost of borrowing by the Treasury. The CBT purchases government securities either through direct participation in the Treasury auction or through small volume purchases in the Istanbul financial markets; this secondary market is thin, with the CBT being unable to purchase or sell large volumes (in excess of TL 1 trillion) without causing large jumps in prices. The CBT can also sell securities by announcing its own auction in Treasury securities; in practice, such auctions create difficulties because of the adverse effect they have on prices paid in Treasury auctions, and hence are usable only in those periods where the Treasury is not actively conducting auctions.

The Treasury’s short-term advances account at the CBT is an overdraft facility; the balance in this account at end-1994 was some TL 122 trillion, equivalent to two thirds of the stock of reserve money (Table A25). This overdraft facility is the Treasury’s main operational account, through which the bulk of payments and receipts associated with current and capital transactions are processed. There is a legal upper-bound on the amount of credit allowed to the Government under this facility, which acts as a semi-hard constraint on Treasury financing policies; 1/ given that this limit is not violated, the balance in the account can fluctuate in an otherwise unconstrained manner from day to day and week to week. 2/ The Treasury pays only a nominal rate of interest on the credit it receives through this facility, ensuring that, from a narrow Treasury perspective, this overdraft facility is the cheapest source of funding available.

Fluctuations in the short-term advances account can be sizable and difficult to predict, due in large part to uncertainty surrounding the financing strategy that the Treasury will adopt from week to week. 3/ Effective management of reserve money in the face of these fluctuations requires coordination of CBT intervention measures with Treasury cash management and financing strategies. On occasion during 1994, concerns with minimizing the borrowing cost of the Treasury hampered this coordination, contributing to an unintended weakening of the monetary stance and raising doubts about the authorities’ willingness to raise interest rates to defend the lira. These concerns were partially allayed by the vigorous coordinated response of the CBT and the Treasury to a mini-foreign exchange crisis during the first days of 1995, when market concern about a likely surge in CBT advances to the Treasury triggered an incipient run on the lira.

4. Monetary developments in 1993 and 1994

The Turkish economy began 1993 with output growing at a rapid pace and wholesale prices rising at a monthly rate of some 4 percent. During the first six months of the year, banking system credit to the private sector expanded at a monthly rate of close to 6 percent, well in excess of monthly inflation (Table A26). 1/ Underpinning this rapid growth was significant net foreign borrowing by the commercial banks, expansion of consumer loans financed through the issuance of marketable asset-backed securities, and an easing of monetary conditions, reflected in declining interest rates (Chart 5). CBT credit to the Treasury increased only modestly during this period, with much of the growth in reserve money being accounted for by increases in CBT refinancing credits to banks and an unwinding of the CBT’s debtor position in the interbank market (Table A27). Broad money stocks expanded at a pace slightly lower than inflation, with the share of FX deposits in M2X (broad money inclusive of residents’ FX deposits) remaining substantially unchanged.

Chart 5
Chart 5


(Percent; annualized)

Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Sources: Data provided by Turkish authorities; and staff estimates.1/ Annualized inflation in month t is derived from the change in the wholesale price index between t-2 and t+1.2/ There were no significant auctions of 3-month Treasury bills in the period from November 1003 to April 1994.

During the second half of 1993, pressures to finance a weakening fiscal position emerged, contributing to a doubling of banking system credit to the public sector between June and December. Although private sector credit growth eased somewhat, aggregate domestic credit growth increased, reaching a monthly rate of 8.4 percent during the final quarter. With net foreign borrowing of the banking system declining significantly from the levels of the first half of the year, domestic credit expansion was financed through accelerated monetary growth, with M2X increasing at some 4.9 percent per month, up from 3.6 percent during the preceding semester and some 0.7 percentage points in excess of contemporaneous inflation. During the final months of the year, the Treasury increased its reliance on CBT financing and scaled back its market-based borrowing, thereby seeking to limit the pressure of its heavy financing needs on its own interest bill; the CBT in turn sought to limit the impact of this financing shift on monetary growth through foreign exchange sales, increased borrowing on interbank markets, and reverse repo operations. Domestic interest rates remained substantially unchanged during these months while inflation began to ease upwards (Chart 6); against this background, the share of M2X held in the form of FX deposits increased at a steady pace from July onwards (Chart 7), contributing to a significant increase in the banks’ net open foreign exchange position.

Chart 6
Chart 6


(Percentage Increase Per Quarter)

Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Source: Fund staff estimates.1/ Percentage increase in price of U.S. dollar.
Chart 7
Chart 7


Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Sources: IMF, International Financial Statistics; data provided by Turkish authorities; and staff estimates

The exchange market crisis of January 1994 resulted in a depreciation of the lira of some 16 percent over the month. With fiscal problems remaining unaddressed, and the Treasury continuing to borrow heavily from the CBT, the remainder of the first quarter was characterized by substantial turmoil in financial markets: overnight interest rates reached five-digit annualized rates on many occasions, lira deposits declined sharply in real terms as asset-holders shifted into FX deposits, and the lira continued to depreciate despite heavy intervention by the CBT in foreign exchange and money markets (Table A28). Later, concerns about the integrity of the banks and the commitment of the authorities to maintaining the liberal policy regime governing residents’ FX deposits led to heavy withdrawals of FX deposits from the banking system; the stock of FX deposits fell by almost 20 percent in dollar terms during April, a fall contributing to, and then enhanced by, the failure of the three banks during the second half of the month. Prices rose by some 67 percent during the first four months of the year, reflecting both sustained exchange rate depreciation and large adjustments in public sector prices in April.

Announcement of the April 5 package did little initially to quell market uncertainties: the lira depreciated by almost one-third during April, while average overnight interest rates (annualized) remained in excess of 1000 percent in both April and May (Table A29). Key policy actions contributing to the stabilization of financial markets, both occurring in May, were the resumption of market-based financing by the Treasury, at “shock” interest rates of 50 percent for three-month paper (an annualized rate of some 400 percent), and the expansion of the pre-existing deposit insurance system to cover all household deposits. 1/ With interest rates on lira deposits at historically high levels (Table A30) and strengthened government backing for the commercial banks, the flight from money recorded during the first four months of the year was reversed: during May-July, M2 expanded at a monthly rate of some 15 percent, while the sustained shift into FX deposits underway from mid-1993 was partially reversed. The reverse capital flight financing the growth of deposits contributed to strong upward pressure on the lira, eased only in part by, heavy purchases of FX by the CBT; the impact of these purchases on reserve money was partially offset by a sizable fall in CBT credit to the government, facilitating the CBT’s effective withdrawal from short-term intervention in money markets. 2/ Inflation declined sharply during the summer months, reflecting both the scale of the demand shock associated with implementation of the April 5 program and the stabilization and, later, modest appreciation of the exchange rate.

While domestic confidence in the domestic banking system revived in the months from May onwards, foreign creditors’ willingness to maintain their exposure in Turkey remained substantially impaired as a result of the financial crisis and the downgrading of Turkey’s credit rating. Facing a drying-up of short-term external credit lines, which declined by almost one-third from end-1993 levels, domestic banks sought to curtail their domestic lending and further strengthen their net foreign exchange position (Table A31). At the same time, the cutoff in new external financing to the government, coupled with large scheduled external debt repayments, ensured that government domestic borrowing needs remained substantial, notwithstanding the large fiscal tightening effected under the stabilization program. With the Treasury offering attractive yields on its paper, banks concentrated much of their asset growth in government paper, leaving private sector borrowers “crowded out” of the limited available credit growth; as a result, the stock of credit extended to the private sector declined, in real terms, by over 30 percent between March and September (Table A32 and Chart 7). Notwithstanding this sharp curtailment in credit to the private sector, which occurred in conjunction with a surge in borrowing rates, nonperforming loans increased only modestly as a share of total bank lending.

The rapid growth in lira deposits came to a sudden halt in the first weeks of August, and was followed by a period of several months during which lira deposits remained almost flat in nominal terms while FX deposits increased at a steady pace, both in dollar terms and as a share of M2X. Factors contributing to the revival of currency substitution included declining domestic interest rates, 1/ eroding public confidence in the sustainability of the anti-inflation program, and a mini-exchange rate crisis at the end of August that saw the exchange rate depreciate by some 8 percent over a four-week period. This process continued until mid-November, when some recovery in domestic interest rates led to a stabilization of the share of FX deposits in M2X. The CBT sought to limit the impact of the exchange market crisis in August by maintaining tight control over reserve money, but reluctance to raise interest rates prevented more vigorous action to reverse the de facto step depreciation of the lira. In ensuing months, the CBT succeeded in tightly limiting the growth of reserve money, which remained substantially unchanged from mid-September through the end of the year; with demand for lira money stagnating, however, this represented a minimalist response to the acceleration of inflation.

IV. External Sector Developments

1. External account

During the five years preceding 1993, the external current account was broadly in balance, notwithstanding a deteriorating fiscal position. This was facilitated by significant gains in competitiveness stemming from the real effective exchange rate depreciation and real wage compression that occurred in the mid 1980s. Sizable tourism receipts and workers’ remittances as well as strong export market demand also contributed to this trend. However, in 1993, reflecting a substantial buildup of domestic demand pressures, a tendency of the real effective exchange rate to appreciate, and weakness in export markets, the current account registered a deficit of US$6.4 billion (3.6 percent of GNP).

The deterioration in the current account in the context of substantial external debt service payments scheduled for the next few years caused a major shift in financial market sentiment concerning the sustainability of Turkey’s external position and precipitated a foreign exchange crisis in early 1994. In response, the authorities implemented a significant tightening of domestic demand in the context of a macroeconomic adjustment and structural reform program. The program, combined with a sharp depreciation of the real effective exchange rate and a pickup in external demand, resulted in a marked turnaround in the external current account to a surplus of US$2.8 billion (2.1 percent of GNP) in 1994 (Table A33 and Chart 8).

Chart 8
Chart 8


Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

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

a. Trade

Export performance in 1994 was strong. Despite a 5.2 percent decline in export prices, a nominal increase of 17.3 percent was realized over 1993, implying a volume increase of some 23.3 percent (Table A34). The strength in exports was broad-based, with agricultural products, textiles, industrial goods (petrochemicals and iron and steel) all posting impressive gains. The depreciation of the Turkish lira early in 1994 had a favorable impact on unit labor costs in industry, which were estimated to have declined by 31 percent in U.S. dollar terms in 1994. Recovery of demand conditions in major industrial country markets and increased border trade in food products were additional contributing factors in the robust export performance.

The structure of Turkish exports remained broadly unchanged in 1994 despite a slight increase in the share of industrial products in total exports (from 83.2 percent in 1993 to 85.1 percent in 1994). Over a longer period, however, this trend appears more pronounced with the share of industrial products rising from 79.3 percent of total exports in 1990. Gains in the shares of textiles, iron and steel, processed agricultural products, metal products and machinery, and chemicals were the main contributors. The bulk of Turkish industrial exports, nevertheless, remained concentrated in processed agricultural products, textiles, and iron and steel which together accounted for some 60 percent of total exports (Table A35).

OECD countries continue to constitute the main market for Turkish exports, although trade with developing and transition economies is increasing in importance (Table A36). Based on data for the first eight months of 1994, the OECD share of exports declined from 63.5 percent in 1993 (68.0 percent in 1990) to 59.5 percent in 1994. Recessionary conditions in several European countries seem to have been the primary reason for this development. Middle Eastern and North African countries are the next largest market for Turkish exports; their share in total exports has also declined in recent years—from 19.3 percent in 1990 to 16.5 percent in 1994—partly due to the loss of exports to Iraq. By contrast, shares of Eastern European and all other countries has increased from 7.6 percent and 5.1 percent in 1990 to 11.8 percent and 12.3 percent, respectively, in 1994. 1/ These trends also reflect active export promotion by Turkey in the states of the former Soviet Union, supported by extension of credits through the EXIM Bank.

There was a sharp contraction of imports during 1994, largely reflecting the steep decline in economic activity as well as retrenchment from the unusually high level attained in 1993. Substantial destocking following the exchange market crisis in early 1994 also served to hold down imports. Overall, imports in 1994 fell by 21 percent in nominal terms, with the decline occurring across-the-board in consumer and investment goods as well as in raw materials. The reduction in import volume was somewhat lower, as suggested by an estimated decline in import prices of 1.1 percent in 1994. The decline was sharper in non-oil imports, given an estimated 7.9 percent fall in the volume of oil imports.

There was little change in the structure of imports which remained concentrated in industrial products in 1994 including mainly raw materials, machinery, and other durables (Table A37). Over a slightly longer time horizon, however, the share of industrial goods in total imports rose from 76.2 percent in 1990 to 84 percent in 1993 before declining to 82.4 percent in 1994. This compositional shift was heavily concentrated in the rising proportion of motor vehicles and metal and machinery products, spurred by the consumption boom until 1993.

As in the case of exports, OECD countries continued to be the main suppliers of imports accounting for some 67 percent of total imports in 1994 as compared to 67.9 percent in 1993 and 63.9 percent in 1990 (Table A38). More than two thirds of Turkey’s imports originate in the EU and inroads made by these countries in the Turkish market were evident in the increase in their share of Turkish imports from 41.9 percent in 1990 to 45.1 percent in 1994. In addition to reductions in tariffs vis-à-vis the EU, generous export credit facilities provided by many EU countries to promote exports in the wake of recessionary conditions at home were important factors contributing to this trend. Middle Eastern and North African countries were also significant suppliers, primarily of petroleum and petroleum products. In 1994 they accounted for 14.5 percent of total imports of Turkey compared to 12.0 percent in 1993 and 12.7 percent in 1990. The strengthening trade links with Eastern European countries were also evident on the import side, with their share in Turkey’s imports rising from 9.9 percent in 1990 to 11.4 percent in 1993 before declining to 10.4 percent in 1994.

b. Services and transfers

In 1994 the services balance remained unchanged at a surplus of about US$4 billion (Table A33). Tourism receipts registered an increase of 9.8 percent, despite weakness in the first half of 1994 due to terrorist incidents. Activity, however, picked up substantially in the latter part of the year and was closer to historical trends. Tourist arrivals from OECD and eastern European countries declined significantly in 1994, but were more than offset by an increase in tourists from Asian countries. Estimated average expenditure per tourist declined slightly across all nationalities in 1994, possibly reflecting delays in the passthrough effects of exchange rate changes in the services sector.

Net interest payments in 1994 rose from US$2.3 billion to US$3.0 billion despite a significant reduction in the short-term exposure of foreign commercial banks. This reflected the drawdown of Turkish foreign assets in early 1994, a rise in interest rates on the variable component of external debt, and the rundown in debt contracted earlier at lower interest rates. The beneficial effects of lower freight and insurance payments associated with the decline in imports was also partly offset by a decline in receipts from other services, including contractors’ fees and other investment income, which had performed strongly until 1993 (Table A39).

Workers’ remittances during 1994 were 9.9 percent lower than in 1993. The decline reflected uncertainties about the exchange rate during the first half of 1994 as well as declining trend in remittances owing to the adverse effects of high unemployment and tightening immigration policies abroad on outward migration from Turkey. Net official transfers in 1994 were US$360 million lower in 1994 compared with 1993, reflecting delays in receipt of foreign economic assistance.

2. Capital account

A net outflow of US$2.6 billion occurred in the capital account during 1994. Quarterly flows in this period were subject to considerable volatility with most of the outflows taking place in the first half of the year, followed by a recovery, mainly of short-term inflows, in the second half of the year. The overall developments also reflected sizable scheduled repayments of medium- and long-term debt, substantial retirement of credits by commercial banks, and volatile movements in other short-term capital (mainly relating to resident foreign currency deposit accounts). Disbursements of medium- and long-term capital also fell short of expectations as a result of the uncertainties following the exchange market crisis of early 1994.

a. Direct and portfolio investment

Net direct investment in 1994 was estimated at US$482 million—about US$150 million lower than in 1993 and some US$300 million lower than the peak level of 1991 (Table A40). Financial and exchange market instability, political uncertainties, and depressed economic activity, particularly in the private sector, contributed to this outcome. In addition, delays in the implementation of the authorities’ privatization program had an adverse effect. In recent years, the structure of Turkey’s capital account has increasingly reflected its development as an emerging market, with net portfolio inflows growing rapidly from US$650 million in 1991 to US$3.9 billion in 1993 (Table A41). Portfolio inflows in 1994, amounting to US$1.0 billion, were substantially below the levels achieved in 1993. Expectations of further portfolio inflows associated with the privatization program did not materialize due to the delay in passing the privatization law. Realized net inflows included proceeds of a Samurai bond issue of US$721 million, proceeds from the sale of shares of TOFAS of US$316 million, and inflows due to net liquidation of foreign securities of US$275 million effected by commercial banks on behalf of the private sector. 1/ Partly offsetting these were outflows relating to repayments of Treasury bonds (US$310 million).

b. Long-term capital

Disbursements of long-term credits during 1994 amounted to US$3.3 billion, compared to US$4.9 billion in 1993. Some US$800 million in loans were disbursed to the public sector, mainly in the form of project-related credits from bilateral and multilateral sources. The private sector accounted for the rest, including US$1.4 billion in ongoing credits obtained by the nonfinancial private sector (project lending and suppliers’ credits), and US$350 million in long-term borrowing by commercial banks. Another US$624 million was realized in the form of leasing arrangements associated with aircraft purchases by Turkish Airlines. Apart from disbursements from the pipeline of existing loan commitments, new medium- and long-term borrowing dried up, reflecting the risk perceptions of foreign lenders which were ratified by the downgrading of Turkey’s credit rating by international rating agencies in early 1994.

The backlog of committed but undisbursed funds rose further in 1994 as the pace of project implementation slowed in line with the sharp contraction in economic activity. Of the committed but undisbursed loans at the end of the third quarter of 1994, some US$3.4 billion were attributable to multilateral sources, including IBRD and other official creditors, and US$6.8 billion to bilateral creditors, mainly OECD countries (including private suppliers’ credits).

Amortization payments in 1994 amounted to US$5.4 billion as against US$4.4 billion in 1993. Of this, the public sector accounted for US$3.9 billion, with the remainder attributable to the private sector and commercial banks. 1/ Public sector repayments included US$732 million by the SEEs and US$722 million by the Extra Budgetary Funds and local administrations. 1994 marked the beginning of a three-year period of relatively large amortization payments on medium- and long-term loans and the maturing of the Treasury’s early bond issues in international markets. Scheduled repayments and bond redemptions during 1994-96 are on the order of US$6-8 billion per year.

c. Short-term capital

As with portfolio inflows, Turkey’s growing integration with international capital markets has increased the magnitude and volatility of short-term capital flows, with sizable acquisitions and liquidations of short-term foreign assets, as well as of short-term foreign liabilities by Turkish residents (banks and nonbank—Table A42).

The year 1994 was characterized by large and partly offsetting movements in various categories of short term-capital, resulting in a net outflow of US$3.3 billion (compared with a net inflow of US$780 million in 1993). As the worsening in domestic and external imbalances in 1993 became fully evident, it caused a major retrenchment in foreign creditors’ short-term exposure in Turkey. Following a rapid buildup in their stock of short-term foreign liabilities in 1993, the commercial banks repaid US$7.7 billion in their outstanding foreign exchange obligations in 1994. Data for the first 11 months of 1994 indicate that US$5.7 billion of this represented banks’ retirement of foreign credits obtained abroad, US$1.2 billion was due to repayments of trade credits on behalf of the private sector, and the remainder was attributable to the drawdown in banks’ foreign currency deposit liabilities. On the asset side, commercial banks met their short-term obligations by a US$3.2 billion drawdown in their holding of reserve assets abroad. In addition, US$1.4 billion was realized in other net short-term inflows captured in errors and omissions, partly representing the increase in surrender requirements in 1994 for nonbank authorized dealers. As a result of these developments, the commercial banks’ foreign asset-liability ratio improved from 65 percent at year-end 1993 to 77 percent at end-November 1994. Similar improvement was evident in their foreign asset-short-term liability ratio which rose from 71 percent at year-end 1993 to 84 percent at end-November 1994.

d. Net international reserves

Reflecting the turnaround in the current account position and offsetting net capital flows, the overall balance showed a small surplus and a corresponding accumulation in international reserves of US$223 million in 1994. The overall picture masked sharp swings in the reserves position during the year, with a US$2.9 billion loss in the first quarter being offset by accumulations of US$0.8 billion and US$2.1 billion in the second and third quarters, and US$0.2 billion in the fourth quarter of 1994. Including purchases from the Fund, the change in grass international reserves during 1994 was US$556 million. At year-end 1994 gross reserves (including gold) stood at US$8.6 billion (Table A43). Gross reserve coverage as a ratio of imports of goods and services at end-1994 rose to 3.4 months after declining to 2.5 months at end-1993 from 3.0 months in 1992.

3. External debt

Despite a heavy debt service burden in 1994 and reduced capital inflows, Turkey was able to maintain its record of timely external debt repayments. These amounted to US$9.2 billion in 1994—accounting for 30.1 percent of current account receipts—including US$3.9 billion in interest and US$5.4 billion for amortization (Table A43). In addition, payments of US$310 million were made to foreign creditors as a result of their exercise of put options on outstanding Turkish Treasury bonds. The general rise in international interest rates in 1994 had only a moderate effect on total interest obligations since a significant proportion of the debt was contracted at fixed interest rates. The retirement of substantial short-term obligations by commercial banks also served to hold down the interest bill in 1994. Nevertheless, the rise in the risk premium demanded by foreign lenders caused spreads on new borrowing to increase to some 2-3 percentage points over LIBOR. In addition, there has been a growing tendency on the part of foreign intermediaries toward upfront charges and fees contributing to an increase in the average effective interest rate in 1993—a trend that is likely to have continued in 1994.

At end-September 1994, Turkey’s stock of external debt stood at US$64.8 million, representing some 49 percent of GNP (Table A45). Large net repayments of external debt in 1994 were partly offset by cross-currency valuation effects on the stock of external debt since 35.8 percent of it was denominated in U.S. dollars, 32.0 percent in deutsche marks, 20.5 percent in Japanese yen, and 11.7 percent in all other currencies. The maturity profile of external debt was heavily skewed toward medium- and long-term debt, with such debt accounting for 81.2 percent of the total at the end of the third quarter of 1994 (Table A46). A large proportion of medium- and long-term external debt represented public sector foreign borrowing, accounting for 90 percent of all such obligations. The share of public sector borrowing in total short-term debt was relatively small, largely representing short-term deposit liabilities of the Central Bank of Turkey under the Dresdner scheme; the public sector accounted for 6.6 percent of total short-term debt outstanding at the end of the third quarter of 1994.

4. Other developments 1/

On March 6, 1995 the Association Council of the EU approved the draft declaration specifying the modalities of the final stage of the achievement of a customs union with the EU by the end of 1995. Considerable progress toward this end had already been achieved with the reductions in tariffs implemented in recent years. In 1995, further progress has been announced in aligning customs duties with the Common Customs Tariff (CCT) of the EU for the 12- and 22-year lists as specified in the Additional Protocol. As a result, 90 percent of the alignment with the CCT was achieved for the 12-year list and 85 percent was achieved for the 22-year list. Full compliance is expected by 1996 which would involve eliminating tariffs vis-à-vis the EU for goods on the 12- and 22-year lists in two installments in 1995 from the prevailing weighted average duty rate of 12.85 percent. A similar schedule is to be followed for alignment of tariffs vis-à-vis third countries which were expected to be lowered to a weighted average of 6.83 percent. The customs union would also require removal of the Mass Housing Fund levy by the end of 1995; this is to be implemented in three installments during 1995 with full elimination by the end of the year.

In addition to tariff reductions, the authorities are implementing an ambitious agenda for harmonizing Turkey’s legal system with that of the EU. In this context the following steps have been taken:

  • The Law on Protection of Competition came into force in December 1994.

  • Draft laws on patents, protection of consumers and copyrights were submitted to the Turkish National Assembly.

  • Work was initiated on a draft law on trademarks and industrial designs.

  • Steps were taken toward the adaptation of protection measures of the EU’s Common Trade Policy, such as monitoring of imports and tariff quotas.

  • A draft customs law in line with the EU Customs Code has been submitted for comment to relevant agencies.

In recent years, Turkey has been the subject of several anti-dumping and anti-subsidy investigations by the EU (Table A47). As of November 1994, investigations were still underway regarding dumping of bed linen, cotton fabric, and cement. However, a majority of such investigations have tended to be concluded without the imposition of anti-dumping duties.

APPENDIX I: Revisions to the National Income Accounts 1/

In 1987, the State Institute of Statistics (SIS) introduced a number of changes in the methodology employed in constructing the national income accounts. The pre-existing methodology dated back to 1968, and was based on approximations, aggregation methods, and production weights that reflected the structure of the Turkish economy at that time; with the sustained structural change recorded in the ensuing two decades, estimates produced using this methodology had become increasingly imprecise as measures of growth rates and trends. The new methodology was employed in estimating growth rates in the years from 1987 onward, but, as an interim measure, these growth rates were applied to the “old” estimates for preceding years in developing new GNP estimates. In addition, an estimate of GNP, developed from scratch with the new methodology, was calculated and used as a supplementary measure to the official GNP series in analyzing economic developments. In November 1994, the SIS published a revised set of national accounts constructed using the new methodology, covering the period 1968-1993. As shown below, the revised estimates of GNP are some 30 percent higher than the “old” estimates for recent years: however, differences in the estimated growth rates of real GNP and the GNP deflator are quite modest.

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A sectoral breakdown of 1990 GDP, as estimated using “old” and “new” methods is contained in Table I.1.

Table I.1.

Turkey: Alternative Estimation of GDP in 1987

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Source: State Institute of Statistics.

Changes in Methodology

The main changes and improvements associated with the new methodology are as follows:


Under the old methodology, the value of subsidized crops was calculated on the basis of support prices, while the value of nonsubsidized production was estimated using 1968 prices increased in line with the wholesale price index; vegetable production and fishing output were determined using a single average price for all products and varieties. The revised estimates are based on producer prices received from the provincial offices of the Ministry of Agriculture or from data collected in compiling the monthly wholesale price index. They also include the value of floral production, poplar wood production, and illegal firewood cutting, which were omitted in the old series. In addition, output of the livestock sector, whose contribution to GNP in the past was estimated from the State Planning Organization (SPO) Annual Program growth rate, is now calculated using actual prices collected by the Ministry of Agriculture.


Under the old methodology, value added in manufacturing, mining, and public utilities was obtained by applying an estimated growth rate for each subsector to data for value added in a base year. The new series is based on data taken from annual surveys of producers, supplemented with a census of industry completed every five years. The new series includes data from firms with nine employees or less, which had previously been omitted; and also covers segments of the quarrying subsector (sand, pebble, brick, tile soil, building stones etc.) that were previously overlooked.

Significant changes were introduced in relation to measuring construction sector activity. The methodology for measuring output has been modified to capture better private sector construction activity by relying more heavily on data derived from building and occupancy permits; notwithstanding these improvements, a sizable share of buildings erected without legal permits remains unaccounted for. In addition, unit costs of construction are now estimated using a basket of 122 products; previously, the basket included only 15 products.


Input-output relationships used in estimating output of trade, tourism, transport, and communication, which dated back to 1973, have been updated.

The methodology for measuring value-added from financial services, which relied on annual surveys and base year data from 1973, has been extended to cover better the wide range of financial services now provided.

Estimates of imputed housing rents have been substantially modified. Estimates had previously relied on 1968 rent estimates, extrapolated forward using the consumer price index; under the new methodology, data are derived from the Household Income and Expenditure Survey.

Data on government services were previously based on budget plans, but now reflect actual outcomes.

APPENDIX II The Financial Performance of Selected State Economic Enterprises 1/

Given the importance attached to strengthening the financial performance of the state economic enterprises (SEEs), the stand-by arrangement concluded with the Turkish authorities in July 1994 included end-year targets relating to the borrowing operations of seven major SEEs. These seven enterprises (the SBA-7) collectively accounted for 35 percent of revenues, 43 percent of fixed investment, and 46 percent of personnel outlays for the SEE sector as a whole in 1994. They also received 87 percent of the budgetary transfers to SEEs, while their borrowing needs represented 64 percent of the total SEE borrowing requirement.

1. The seven enterprises

The SBA-7 includes three enterprises linked to the agricultural sector (TMO, TEKEL, and TSFAS), three industrial sector enterprises (TEK, TDCI, and TTK), and the national railway company (TCDD).

TMO is the state cereals board, responsible for grain procurement, storage, and sales, and charged with the task of executing the Government’s price support program for cereals. TMO’s borrowing requirement in 1994 amounted to 0.5 percent of GNP. Its financial difficulties stem from its mandate to support prices paid to farmers, even if it must later sell at a lower price: revenues were a mere 55 percent of costs in 1994. 2/ TMO is the only SEE that continues to receive credit directly from the Central Bank, although the additional credit extended in 1994 represented, in the main, capitalization of interest payments due.

TEKEL is the state tobacco and alcoholic beverages monopoly, which, as one of its mandates, is charged with the task of executing the Government’s price support program for tobacco. TEKEL has produced a modest operating surplus in recent years, with borrowing needs being accounted for by increases in stocks, much of which may reflect the valuation effects of inflation; its borrowing requirement in 1994 amounted to 0.2 percent of GNP. TEKEL accumulated large liabilities to the Treasury in the form of unpaid taxes and associated penalties, but also built up large claims on the Treasury representing payments due to TEKEL within the framework of the price support program. At end-1994, an agreement was under negotiation to write off some TL 40 trillion of TEKEL’s liabilities to the Treasury against Treasury payments due to TEKEL for the price support program.

TSFAS is the state sugar producing firm, responsible for executing the price support program for sugar beet. Borrowing needs in 1994 were modest (TL 3 trillion, less than 0.1 percent of GNP), reflecting in part an accumulation of inventory financed by payments to farmers that are spread into 1995, a normal payment practice.

TEK is the state electricity company, which was split into separate generation (TEAS) and distribution (TEDAS) companies during the summer of 1994. The consolidated accounts of the two entities indicate a significant surplus from operations in 1994, but a larger funding need for fixed investments (equivalent to 0.6 percent of GNP). The borrowing requirement during 1994 was some TL 9 trillion (0.2 percent of GNP), financed in the main by substantial arrears to nonbudgetary public institutions.

TDCI is a state iron/steel corporation that operates a number of plants, including the Karabuk iron and steel works that was in the process of being transferred to private ownership in early 1995. TDCI had an operating loss of some TL 15 trillion (0.4 percent of GNP) in 1994, with revenues covering only 60 percent of costs; personnel and interest expenses alone accounted for 80 percent of revenues. TDCI received budgetary transfers of TL 2.2 trillion and government bond transfers of a further TL 2.9 trillion in 1994; investment outlays were small. The borrowing requirement adjusted for these transfers was some TL 10.3 trillion (0.3 percent of GNP) in 1994; accumulation of arrears to the Treasury and the social security institutions are the main financing mechanisms.

TTK is a hard-coal producer, employing some 25,000 workers, many of whom work on a part-time (seasonal) basis. Current revenues are a mere 30 percent of costs; wages and salaries were more than twice the size of total revenues in 1994, although some improvement is forecast for 1995. Budgetary transfers amounted to TL 6.7 trillion in 1994 (as against revenues of TL 5.8 trillion); TTK also received a government bond transfer of TL 1.3 trillion. Financing of the residual borrowing requirement of some TL 4 trillion (0.1 percent of GNP) came from arrears to the social security institutions and other SEEs.

TCDD is the state railway company which, jointly with TDCI, is the largest lossmaker in the SEE sector. Operating losses are large: revenues covered less than 40 percent of costs in 1994, with the wage and salary bill alone being some 30 percent larger than revenues. Budgetary transfers amounted to TL 7.6 trillion (0.2 percent of GNP), with bond transfers providing a further TL 1.7 trillion. The borrowing requirement net of these transfers was some TL 10 trillion (0.3 percent of GNP); key financing items in 1994 were the accumulation of taxes payable and accrued expenses.

2. Financial performance in 1994

The borrowing requirement of the SBA-7 during 1993 amounted to 1.8 percent of GNP, with an operating deficit (0.7 percent of GNP) and significant investment outlays (2.2 percent of GNP) being partially offset by budgetary transfers equivalent to 1.0 percent of GNP. Cash financing needs (as distinct from financing through deferred payments) amounted to 0.5 percent of GNP, consisting mainly of transfers of government bonds outside the budgetary framework. 1/

The targets for 1994 developed as part of the stabilization program envisaged an unchanged borrowing requirement from 1993 levels, with improved operating performance and a modest decline in investment compensating for a decline in budgetary transfers of some 0.5 percentage points of GNP. Preliminary estimates of the outturn for 1994 indicate a borrowing requirement in line with program targets, albeit with no improvement in operating performance; unexpectedly low accumulation of stocks compensated for this slippage. Cash financing of the borrowing requirement amounted to 0.45 percent of GNP, somewhat below expectations, with domestic bank lending (notably from the Central Bank to TMO) and transfers of government bonds being only partially offset by net repayment of external debt.

The stand-by arrangement approved by the Executive Board in July 1994 included limits on the financing of these seven enterprises as a performance criterion for end-December 1994. The limits covered the sum of (i) borrowing from the central bank and the state banks (on a net basis), (ii) net external borrowing, (iii) increases in arrears to the social security institutions and to the tax authorities, and (iv) extrabudgetary lending to the SEEs by the central government. Borrowing in these categories was not to exceed TL 55 trillion (1.4 percent of GNP) during 1994; this limit adhered to, albeit by a modest margin. Arrears on tax liabilities and net lending by the central bank to TMO accounted for the bulk of the borrowing in these categories.

APPENDIX III Central Government Debt and Fiscal Sustainability 1/

1. Composition of the debt stock of the central government

Domestic debt of the consolidated budget consists of a securitized component (short-term certificates, or bills, and certificates with maturities of one year or more, or bonds), and a nonsecuritized component, primarily advances from the Central Bank. Bills and bonds are Issued by the Treasury at weekly (or bi-weekly) auctions. Two main types of issues exist: “tap” issues and “public” issues. Tap issues are reserved for the Central Bank and some important commercial banks; consol bonds and other securities issued on these occasions are used for specific purposes foreseen by commercial law, such as meeting legal reserve requirements. 2/ Public issues are offered to all the interested parties, including “financial retailers.”

In addition to issuing debt to finance budget deficits, the Treasury engages in debt restructuring operations with other public entities, including the Central Bank. Extrabudgetary debt operations allow resources to be transferred to state enterprises (SEEs), the social security funds, and other state entities against equivalent obligations to the Treasury, typically to service debt obligations toward third parties. These extra-budgetary issues amounted to TL 14 trillion in 1992, TL 19 trillion in 1993, and TL 57 trillion in 1994 (1.5 percent of GNP). Most of the extrabudgetary issues of securities take the form of “financially indexed bonds,” that is, bonds which carry a variable rate of interest equal to the interest rate of the one-year bond of the previous year.

The devaluation account, where the Central Bank accumulates its losses incurred in foreign exchange transactions, is recognized as a liability of the central government at the end of each year to avoid a decapitalization of the monetary authorities’ balance sheet. This liability carries no interest. However, during the year a gradual securitization of the devaluation account occurs, whereby government bills are Issued by the Treasury and given to the Central Bank in lieu of the nonsecuritized liability represented by the devaluation account. These bills carry interest (currently 35 percent coupon per annum), and are converted later in the same year into one-year renewable bonds that are rolled over automatically for 10 years. The bills and bonds are used by the Central Bank in its open market operations.

“Consolidation bonds” include those issued by the central government to replace the losses incurred by the Central Bank in its open market operations with Treasury securities. They normally carry 20 percent interest on their face value. Other “consolidation bonds” include those issued in the context of the consolidation of nonperforming debts of public entities adopted in 1991 and 1993 (which carry a 30 percent coupon and a 20 percent coupon, respectively). Most of these bonds, notably those related to the consolidation account of the Central Bank, have one-year maturity and are continually rolled over.

To summarize, the Government provides three types of securities to the Central Bank; these honor claims Jig a ins t the Treasury arising from (i) the losses incurred by the CBT as a result of exchange rate depreciation, (ii) the losses incurred by the CBT as a result of trading in government paper, and (iii) conversion of CBT claims on SEEs into claims on the Treasury as a result of debt consolidation laws passed in 1984 and 1993. The stock of these securities in December 1994 amounted to TL 88.7 trillion, accounting for 14.4 percent of the domestic debt stock of the Treasury. Of this, some TL 63.5 trillion represented securities issued against devaluation losses and/or against losses incurred on open market operations by the CBT, and the remaining TL 25.2 trillion were attributable to debt consolidation operations.

In recent years, the composition of debt has shifted progressively toward shorter maturities: at the end of 1994, almost 60 percent of the securitized debt stock was of less than 12 months’ maturity (mainly three-month paper), compared with some 20-40 percent in the years 1990-93. Thus, even though the level of domestic debt is not particularly high, the need to roll over a large share of the total debt stock almost continuously exerts pressure on the still relatively narrow financial markets.

2. Evolution of the debt stock

Table III.1 shows the evolution of the stock of debt (end-of-period) from 1985 to 1994. During this period the stock of domestic debt remained virtually constant at about 20 percent of GNP, while the external debt/GNP ratio increased by some 7 percentage points, to 28.6 percent of GNP. The lack of growth of the domestic debt and the modest increase in the external debt are prima facie surprising, if one considers that each year the budget registered deficits in amounts that fluctuated between 1*1-3 percent of GNP in the period from 1985 to 1990, moving up to 6h percent of GNP by 1993, before declining to under 4 percent in 1994.

Table III.1.

Turkey: Stability of Central Government Debt

(In percent of GKP)

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Source: Data provided by the Turkish authorities; and staff estimates.

End of period.

Total interest payments divided by debt at beginning of period.

Primary/overall balance plus debt stock operations.

The slow growth of the public debt, notwithstanding large deficits and high market Interest rates, is attributable to the large recourse in these years to monetization of the deficits. The large share in the total debt of obligations to the Central Bank at zero or low nominal interest rates resulted in the effective nominal interest rate on government debt being strongly negative in real terms. 1/ Thus, the necessary condition for self-generating debt growth—a real interest rate higher than the real rate of growth of output—did not obtain. Indeed, given inflation and the interest rates the Government was effectively paying, the real value of the domestic debt would have been substantially eroded, in spite of the deficits that were registered. The fact that, notwithstanding the above, the domestic debt maintained its share in terms of GNP is a consequence of the “stock operations” that were undertaken. These operations related to the extrabudgetary debt operations with other entities of the public sector mentioned above (and largely reflected the internalization of the rest of the PSBR into the Treasury’s debt). These stock operations represented sizable amounts, fluctuating between 10-20 percent of GNP each year.

The negative value of the real effective interest rate paid on the Government’s debt implied that the Government could have registered some primary deficit and still have been in a position to maintain a constant debt to GNP ratio. In other words, the erosion of the real value of the debt would have offset the primary deficit. Given the effective interest rates and the growth rates of nominal GNP that prevailed in the 1985-94 period, the debt-stabilizing primary deficit (i.e., the primary deficit consistent with a constant debt ratio) 2/ was actually quite high during this period, in the range of 10-20 percent of GNP. The actual primary deficit (adjusted for stock operations) 3/ fluctuated also in about the same range, being in many years lower than the debt-stabilizing deficit and causing the debt ratio in these years to decline. Indeed, the primary gap (the difference between the actual adjusted primary balance and the debt-stabilizing primary balance) was positive in 6 out of the 10 years, contributing to slow-down the upward drift of the debt ratio.

3. Operational balance

The operational balance measures the fiscal stance after adjusting for the amortization component in nominal interest payments associated with inflation compensation. In the case of Turkey, the Government’s high recourse in the past to low-interest advances from the Central Bank was reflected in low average nominal interest rates on the Government’s debt. On average, real interest rates were sufficiently negative that an operational surplus was registered in virtually every year in the 1985-94 period (Table III.2). This is another way of showing that, in the absence of stock operations, the debt would have continuously declined, in real terms.

Table III.2.

Turkey: Central Government Operational Balance, 1985-94

(In percent of GNP)

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Source: Data provided by the Turkish authorities; and staff estimates.

A broader interpretation of the concept of operational balance would seek to measure the fiscal stance under the counterfactual of zero inflation. In a Turkish context, there are two main corrections that must be made to the conventionally measured overall balance of the central government: elimination of the amortization component of the interest bill and of the seigniorage revenues transferred to the Government by the Central Bank in the form of low interest credits that would not be forthcoming under zero inflation. An estimate of a modified operational balance, obtained by making both these corrections, is shown also in Table III.2.

4. Fiscal sustainability, 1995-2993

Table III.3 shows a possible scenario for the future evolution of the stock of public debt as a share of GNP. The projection of domestic interest payments is based upon a formula which considers both the initial stock of securitized debt and the average addition to this stock in future years. The Interest rate applied to the initial stock of securitized debt in any given year is a weighted average of the rates charged on the annuities of securitized debt in the years in which they were issued. The interest rate applied to the average addition to the stock is determined by compounding assumed inflation with a projected level of the real interest rate. The formula when simulated on recent past years has worked well, in the sense of reproducing fairly closely the actual interest obligations faced by the Treasury. The projection for other forms of domestic debt (e.g., central bank advances) is based on the known facts regarding these specific forms of financing. The projection for external interest payments is consistent with the medium-term scenario elaborated by the staff for the balance of payments.

Table III.3.

Turkey: Fiscal Sustainability, 1995-2005

(In percent of GNP)

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Source: Data provided by the Turkish authorities; and staff estimates.

Under the assumptions made in the context of the discussions on the program for 1995, e.g., declining (average) inflation from 70 percent in 1995 to 30 percent in 1996 and further to 5 percent by 2002-03; real effective interest rates 1/ of about 30 percent per year in 1995, declining to about 17 percent per annum in 1996 and further to 5 percent per annum in the long-run; real growth of 3 percent in 1995 and 4.5 percent henceforth; and an exchange rate set constant in real effective terms at programmed 1995 levels, a primary balance of the central government that starts at 6 percent of GNP in 1995 and is gradually reduced to 1.5 percent of GNP by 2003, would be consistent with a decline in the debt to GNP ratio, from about 50 percent of GNP in 1994 (on an end-of-period basis) to about 24 percent of GNP in the year 2003. In fact, stability of the debt ratio over the medium term would require a more modest primary surplus, i.e., a surplus that already drops below 1½ percent of GNP after 1998. As mentioned, this projection is consistent with the external financing flows and servicing obligations of the medium-term balance of payments; it also posits falling nominal domestic interest rates, in line with the convergence of inflation to industrial country levels, but average effective ones that are positive in real terms from 1995 onward. Central bank advances would decline in line with legal limits through 1997 and would be of negligible importance thereafter.

The stock of domestic debt would reach its peak relative to GNP in 1994 (20 percent of GDP) and would then initiate a gradual decrease, attaining 8.4 percent of GDP in 2003. Correspondingly, the share of interest expenditures in total expenditures would also contract from the estimated 34 percent in 1994 and almost 40 percent in 1995 to around 8 percent in 2003 and beyond. The nominal rate of GNP growth assumed in later years is close to the effective rate of nominal interest on the aggregate of external and domestic debt. Thus most of the assumed primary surplus goes toward the reduction of the debt stock.

One important assumption in generating this result is that stock operations beyond 1996 are limited to those associated with the valuation effects due to the depreciation of the exchange rate. No extrabudgetary issues of debt are included. While this assumption may be consistent with positive developments on the structural front that would lead to improvements in the financial position of the rest of the public sector (such as privatization and social security reform), recent experience sounds a cautionary note in this regard, since these transactions have been a major contributor to the growth in the levels of domestic and overall debt. The implicit level of the debt-stabilizing primary balance would be about 1.5 percent of GNP higher than indicated in the paragraph above (i.e., 2-2*1 percent of GNP), if extrabudgetary issues of debt similar in size to those observed or programmed in 1994-95 were to occur.

APPENDIX IV Recent Changes in Reserve and Liquidity Requirements 1/

Banks in Turkey are subject to reserve requirements and liquidity requirements on their deposit, and more recently nondeposit, liabilities. These requirements are imposed on both lira-denominated and foreign currency-denominated liabilities. Having remained substantially unchanged from September 1991 through March 1994, the Central Bank (CBT) implemented a comprehensive reform of the reserve and liquidity requirements in April 1994; additional changes were introduced in January 1995.

1. Turkish lira liabilities

Prior to April 1994, banks were required to hold 16 percent of lira deposits with term of one month or less and 7.5 percent of lira deposits with longer maturities as statutory reserves in a noninterest bearing account at the CBT. 2/ Banks were also required to hold 30 percent of deposits in the form of government bonds and Treasury bills with a weighted-average date to maturity of at least 210 days; and 5 percent of deposits in the form of either free deposits at the CBT or vault cash, with the former amounting to at least 2 percent of deposits. Nondeposit liabilities were not subject to these requirements, creating strong incentives for banks to raise funds in a form other than bank deposits; mechanisms favored by banks included the issuance of asset-backed securities and repurchase arrangements with major clients.

The reforms implemented in April 1994 sought to eliminate the discriminatory treatment of deposit and nondeposit liabilities, while laying the basis for a sustained reduction, over time, in the burden imposed by these requirements on financial intermediation. The new requirements drew a distinction between stocks of liabilities at end-March 1994 and the increase in liabilities above these levels thereafter; and between deposit and non-deposit liabilities. For deposits, reserve requirements on the stock of deposits held at end-March 1994 remained unchanged; as deposits increased from the end-March levels, banks were required to hold 8 percent of increment as statutory reserves. Liquidity requirements on the end-March 1994 stock were modified only slightly, with the form of government paper acceptable in meeting the requirement being changed to include only a specific type of one-year government bond, indexed to the wholesale price index and bearing an interest rate of 6 percent. 1/ 2/ Increases in deposits above the end-March 1994 level were not subject to a liquidity requirement.

Legal restrictions prevented the imposition of formal reserve requirements on nondeposit liabilities: hence, the requirements governing nondeposit liabilities are technically described as liquidity requirements, although they resemble reserve requirements in nature. All liabilities excluding (i) capital and reserves, (ii) liabilities to the CBT and domestic commercial banks, (iii) deposits, and (iv) some minor accounts were subject to a liquidity requirement. Banks were required to hold 8 percent of the amount of such liabilities in excess of the end-March 1994 stock in the form of unremunerated reserves at the CBT. 3/ As a result, new inflows of deposit and nondeposit liabilities were subject to similar requirements: 8 percent of the inflow had to be held in a noninterest bearing account at the CBT.

On January 5, 1995, the CBT announced that (i) deposit liabilities in excess of the end-March 1994 stock, and (ii) nondeposit liabilities in excess of the end-March 1994 stock were subject to a 3 percent liquidity requirement, to be met through holding one-year lira-denominated indexed government bonds of the type used to meet the pre-existing liquidity requirement on the March 1994 stock of deposits. These changes maintained the principle of treating new inflows of deposit and nondeposit liabilities in an even-handed manner.

On January 27, 1995, the CBT announced an intensification of its regulations. The required reserve ratio was increased by 1 percent for all deposits (both the March 1994 stock and the flow increase since then), raising the reserve requirement on new funds raised through deposits from 8 percent to 9 percent. Similarly, the so-called liquidity requirement on non-deposit liabilities in excess of end-March 1994 levels was increased from 8 percent to 9 percent, again maintaining the principle of equal treatment of deposit and non-deposit funding sources.

The regulations governing reserve and liquidity requirements on Turkish lira liabilities as of March 1995 are contained in tabular form in Table IV. 1. Reserves held at the CBT do not earn Interest, with the exception of reserves held as a result of the policy changes announced in January 1995, which are to earn interest at an annual rate of 37 percent, to be paid at the end of the year.

Table IV.1.

Turkey: Reserve and Liquidity Requirement Ratios As of March 1995

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Source: Central Bank of Turkey (CBT).

Capital, reserves, and inter-bank liabilities are not subject to liquidity requirements.

2. Foreign currency liabilities

Prior to April 1994, banks were required to hold 9.5 percent of foreign currency (FX) deposits with a term of one month or less and 11.5 percent of deposits with longer maturities in FX in a statutory reserve account at the CBT. In addition, banks were required to hold lira deposits (8 percent for short-term deposits, 3 percent for longer-term deposits) as statutory reserves against their FX deposits at the CBT. FX deposits earned interest at rates specified by the CBT, but linked loosely to market rates; lira deposits held at the CBT were noninterest bearing.

The reforms enacted in April 1994 were similar in design to those implemented in relation to lira-denominated liabilities. For deposits, reserve requirements for the stock of FX deposits held at end-March 1994 remained unchanged; 1/ for deposits held in excess of the end-March 1994 level, banks were required to hold 10 percent of the deposits (regardless of maturity) in FX in a statutory reserves account. For nondeposit liabilities, banks were required to hold 9 percent of the amount in excess of the end-March 1994 level in the form of non-statutory reserves at the CBT, a regulation that is formally described as a liquidity requirement.

The changes in liquidity requirements announced on January 5, 1995 also covered FX-denominated liabilities. As of the beginning of March 1995, banks are required to hold 3 percent of (1) all FX deposits and (ii) the increase in FX non-deposit liabilities above end-March 1994 levels in the form of government bonds (with a maturity at issue of at least one year), indexed either to the wholesale price index or to a foreign currency. In addition, the intensification of reserve requirements announced on January 27, 1995 required banks to increase their statutory reserves against FX deposits by 1 percent of the end-March 1994 stock and 3 percent of the increase from the end-March 1994 level; and to increase their non-statutory FX reserves at the CBT by 3 percent of the increase in nondeposit liabilities from the end-March 1994 stock.

The regulations governing reserve and liquidity requirements on foreign currency liabilities as of March 1995 are outlined in Table IV. 1. The payment of interest on statutory FX reserves was eliminated on December 1, 1994.

3. Summary

Banks raising additional lira funding, either through deposits or through nondeposit liabilities, are now required to deposit 8 percent of the funds raised in noninterest-bearing accounts at the CBT, and 1 percent in a CBT account that pays 37 percent annual interest. Banks raising additional funds in the form of FX deposits are required to deposit 13 percent of these funds in a noninterest bearing account at the CBT; for nondeposit liabilities, the corresponding requirement is 12 percent of the funds. Regardless of the funding source, 3 percent of the funds raised must be used to purchase indexed government bonds. The burden imposed by these requirements on banks expanding their funding base is significantly less than was the case in March 1994, but represents a substantial-tax” on financial intermediation in a time of high nominal interest rates and inflation.

APPENDIX V Instruments of Liquidity Management 1/

Tools used by the CBT for liquidity management purposes include sales and purchases of government securities, repos and reverse repos, foreign currency swaps, overnight borrowing and lending in the interbank market, and foreign exchange market intervention.

1. Purchases and sales of government securities

As of December 1994, the CBT held government securities with a book value of some TL 60 trillion, equivalent to 31 percent of the current stock of reserve money. This stock consisted primarily of one-year renewable bonds supplied to the CBT by the Treasury when unsecuritized debts to the CBT were securitized, notably those arising from the CBT’s devaluation account. 2/

CBT sales of the one-year renewable bonds supplied to it by the Treasury have a number of distinctive features. First, sales of these securities create a paper loss for the CBT because the market value of the securities is substantially less than the book value at which they are first recorded in the CBT balance sheet; at the end of the year, losses of this type become a claim on the Treasury and are securitized. Second, sales of these securities are in fact repurchase operations, since the CBT is required to repurchase the paper at maturity (at which point the security is then renewed by the Treasury). Hence, sales of this type of government paper are best understood as a form of medium-term sale and repurchase agreement, to be contrasted with the reverse repo operations described below, which are typically of short maturity.

The CBT undertook substantial purchases of government paper during the first three months of 1994, the maturity of which varied from overnight/one-month to 9-to-12 months; 3/ these purchases were usually direct from the Treasury. Purchases in the period from May onward consisted almost exclusively of “repurchases” of previously sold one-year renewable bonds at maturity. Sales of government securities were on a more modest scale for much of 1994; exceptional months were July, when the CBT sought to sterilize the effects of heavy foreign exchange purchases, and November-December, when liquidity conditions were tightened.

2. Repos, reverse repos and foreign currency swaps

“Repos” are two-part transactions in which the CBT purchases securities from banks with an agreement to sell back the paper on a specified date; they are employed as a tool for temporary injections of liquidity into the market. The CBT undertook substantial volumes of repo transactions during February 1994 (almost exclusively of maturities less than 15 days); no repos have been carried out since May 1994.

“Reverse repos” are two-part transactions in which the CBT sells securities to banks with an agreement to repurchase them at a set date in the future; they are used as a tool for temporary withdrawals of liquidity from the market. The CBT undertook substantial amounts of reverse repos in February 1994 and again in April, almost entirely with a maturity of less than 15 days. Since May 1994, the CBT has employed reverse repos on three occasions, two of which (late-August and late-November) were in weeks immediately prior to periods of large scheduled debt repayments by the Treasury. During the exchange market crisis in the first days of 1995, the CBT used large volumes of overnight reverse repos to absorb liquidity, an operation maintained until excess funds were absorbed through large sales of Treasury bills.

“FX swaps” are two-part transactions in which the CBT purchases FX from banks, with a commitment to sell back the FX at a set date in the future; these operations are in effect lira loans from the CBT to banks that are fully collateralized with foreign exchange deposited at the CBT. This facility was used only occasionally during 1994.

3. Overnight borrowing and lending

There is an active interbank money market, in which the CBT quotes interest rates at which it is willing to borrow and lend funds; the spread between the CBT’s borrowing and lending rates is large, to allow market determination of interest rates. Transactions in this market are primarily overnight, although there are occasionally transactions with a term of seven days or longer. CBT lending in the overnight market is sometimes used to provide short-term liquidity to selected state banks, whose liquidity difficulties are deemed to be a result of the bank’s role as government payments agent. The overnight market is characterized by substantial trading volumes, averaging TL 25-30 trillion per business day during the fourth quarter of 1994.

4. Foreign exchange intervention

Foreign currency surrender requirements ensure a steady sale of foreign exchange to the CBT that, over time, is largely offset by sales of foreign exchange to the Government for external debt repayments. Intervention in FX markets has been used occasionally to smooth fluctuations in exchange rates, and, less frequently, as a means of absorbing liquidity and defending the lira under circumstances where other instruments are deemed inadequate for these purposes (notably during the final quarter of 1993 and first quarter of 1994). Intervention in the form of FX purchases has been used to prevent what the CBT deems to be excessive nominal appreciation of the lira; on these occasions, the CBT has sought to sterilize, at least partially, the impact of this intervention through offsetting open market operations.

APPENDIX VI External Debt 1/

During 1989-1993, Turkey’s external debt grew at a rapid pace, reaching US$67.4 billion at end-1993. 2/ The buildup was particularly pronounced in 1993 when the large current account deficit and the depreciation of the U.S. dollar against some currencies contributed to an increase of US$11.8 billion in outstanding external debt. The maturity structure of the debt increasingly shifted toward short-term obligations, with the proportion of short-term debt rising from 13.8 percent in 1989 to 27.4 percent at end-1993 (Chart VI.1). Following the financial crisis of early 1994, a process of adjustment in Turkey’s external obligations began. Total external debt declined to US$64.8 billion by the end of the third quarter of 1994 despite upward adjustments due to cross-currency effects. Substantial net retirement of short-term obligations was the primary factor explaining this decline and the proportion of short-term debt in the total fell to 18.8 percent.

Chart VI.1
Chart VI.1

Turkey: External Debt by Maturity

(in millions of U.S. dollars)

Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Source: Data provided by Turkish authorities.1/ As of September 30, 1994.

The external debt to GNP ratio has been influenced heavily by movements in Turkish lira-dollar exchange rates in particular years. As a result, the debt/GNP ratio behaved somewhat erratically during 1989-1994 depending on whether exchange rate movements lagged behind or were catching up with inflation. The ratio declined from 38.5 percent in 1989 to 32.2 percent in 1990 despite a significant increase in external borrowing. It rose gradually to 38.4 percent in 1993, largely reflecting the buildup in the debt stock in that year. However, despite a decline in debt outstanding in 1994, the debt to GNP ratio rose further to 48.6 percent primarily because of the sharp depreciation of the lira. After falling from 39 percent of current account receipts in 1989 to 27.5 percent in 1993, the debt service ratio (interest and amortization on medium- and long-term debt) rose to 30.1 percent in 1994.

1. Structure of external debt

Turkey’s coming of age as a borrower in international markets in recent years is evident in the changing structure of its external obligations (Chart VI.2). In 1989, bilateral and multilateral official creditors accounted for 48.2 percent of total external debt—a proportion which declined to 39.8 percent by end-1993. In particular, concessional borrowing from multilateral agencies, such as the World Bank, declined from 14.7 percent of the total in 1989 to 8.1 percent in 1993. By contrast the share of borrowing from private sources increased from 51.8 percent in 1989 to 60.2 percent in 1993. This reflected a rise in short-term borrowing from commercial banks and other private lenders, as well as increased reliance by the Treasury on financing through bond issues in international capital markets. Total Turkish bond issues outstanding at end-1989 amounted to US$5.2 billion (accounting for 12.4 percent of total external debt); by end-1993, this rose to US$12.6 billion (or 18.7 percent of total external debt). Among private creditors, commercial banks’ exposure increased from US$6.9 billion at end-1989 to US$12.6 billion at end-1993. Within this, banks reduced their long-term exposure from US$5 billion to US$3.1 billion, while increasing their short-term exposure from US$1.9 billion to US$9.5 billion.

Chart VI. 2
Chart VI. 2

Turkey: Medium-Long Term External Debt (in millions of U.S. dollars)

Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Source: Data provided by Turkish authorities.1/ As of September 30, 1994.

The bulk of the borrowing from international financial markets was undertaken by the public sector (Chart VI.2), with the financing of the consolidated budget and other public sector entities accounting for the major proportion of total medium- and long-term borrowing during 1989-1993. The stock of such borrowing increased from US$34.3 billion at end-1989 to US$42.8 billion by end-1993. However, the share of public sector debt declined from 95 percent of total medium- and long-term debt at end-1989 to 87.7 percent of such debt at end-1993. 1/

Despite an increase in medium- and long-term external borrowing of the private sector—which increased from US$1.6 billion at end-1989 to US$6 billion by end-1993—the bulk of private sector borrowing remained concentrated in short-term credits. Such credits rose from US$5.7 billion at end-1989 to US$18.5 billion at end-1993, largely representing obligations of deposit money banks—their share of such debt rose from 54.4 percent at end-1989 to 60 percent at end-1993 (Chart VI.3). Of the US$11.7 billion in short-term liabilities of deposit money banks at end-1993, US$8.6 billion was in the form of foreign exchange credits received from abroad and most of the remainder was in the form of nonresident foreign exchange deposits. The nonbank private sector accounted for most of the remaining short-term debt, mainly in the form of acceptance credits and pre-export financing. 2/

Chart VI. 3
Chart VI. 3

Turkey: Short Term External Debt (in millions of U.S. dollars)

Citation: IMF Staff Country Reports 1995, 043; 10.5089/9781451837971.002.A001

Source: Data provided by Turkish authorities.1/ As of September 30, 1994.

2. Debt service

As mentioned above, Turkey’s external debt service ratio fell during 1991-93. However, the bunching of maturities of medium- and long-term debt and bond issues in 1994-96 would result in a rise in external debt service ratio to some 35 percent of current account receipts. Staff’s medium-term projections, consistent with the medium-term macroeconomic flows shown in Table 9 of EBS/95/63 and based on the interest rate assumptions incorporated in the latest World Economic Outlook, indicate that Turkey’s debt service ratio would steadily decline to under 20 percent of current account receipts by the end of this decade. The sizable debt repayments during 1994-96, along with a prudent borrowing strategy assumed in this scenario, would also contribute to a steady decline in the debt to GNP ratio from an estimated 48.6 percent in 1994 to some 30 percent by 2000. Such an evolution of external debt and debt service is predicated on continued fiscal restraint and accommodation of rising private investment as reflected in moderate external current account deficits in the neighborhood of 1 percent of GNP toward the end of the decade. In addition, it is consistent with the maintenance of a reserve-import coverage ratio of 3.0 months of imports of goods and services throughout the projection period.

3. External debt management

Approval of the Ministry of Finance is required for any foreign borrowing by the public sector. Preparation of the public sector’s borrowing plans for project purposes is undertaken by the State Planning Organization in the context of its public investment plan. All other external borrowing by the private sector is to be reported to the Treasury which maintains a database on all forms of external borrowing by Turkish residents. However, with the growing complexity and sophistication of the financial system, delays have been experienced in the recording of external borrowing. Under a World Bank financed project, an upgrading of the debt recording and associated computer system is currently underway.


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Under the Law, No. 474, custom duties are levied at different rates.

Table A1.

Turkey: GNP and its Components

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Source: Data provided by the Turkish authorities.


Percentage change.

Table A2.

Turkey: Production Index of Manufacturing Industry, 1988-94

(Weighted by value added at constant prices, percentage change over previous year)

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Source: State Institute of Statistics.