Turkey
Recent Economic Developments
Author:
International Monetary Fund
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Publication Date:
03 Dec 1996
eISBN:
9781451837988
Language:
English
Keywords:
ISCR; CR; central bank; exchange rate; Turkish lira; private sector; wholesale price index; long-term debt; debt service; credit rating; balance of payments; gross investment; nominal wage
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This paper reviews economic developments in Turkey during 1992–96. The Turkish economy rebounded in 1995, with real gross national product rising by 8.1 percent, reversing the decline of 6.1 percent in 1994. A strong pickup in activity in the second and third quarters of 1995 more than compensated for the continued weakness in the first quarter and a slight decline in the fourth quarter caused by uncertainty in the run-up to the elections. Industry performed strongly, with a growth rate of 12.1 percent, followed by services (6.4 percent) and agriculture (2.6 percent).

Abstract

This paper reviews economic developments in Turkey during 1992–96. The Turkish economy rebounded in 1995, with real gross national product rising by 8.1 percent, reversing the decline of 6.1 percent in 1994. A strong pickup in activity in the second and third quarters of 1995 more than compensated for the continued weakness in the first quarter and a slight decline in the fourth quarter caused by uncertainty in the run-up to the elections. Industry performed strongly, with a growth rate of 12.1 percent, followed by services (6.4 percent) and agriculture (2.6 percent).

I. The Real Economy

In recent years, the Turkish economy has experienced sharp fluctuations in growth, and high and persistent inflation. In April 1994, a stabilization program, precipitated by a financial and exchange market crisis in the early months of the year, led to a marked reduction in aggregate demand, output, and inflation as substantial fiscal and monetary tightening coincided with the onset of a sharp recession. However, heavy public borrowing in the narrow domestic financial market, coupled with an erratic exchange rate policy, pushed up interest rates and rekindled the inflationary process in the latter part of the year. The program for 1995 introduced a crawling peg to check inflation but again the initial reduction in inflation was reversed after a few months as continued high domestic interest rates attracted large short term capital inflows, resulting in a rapid expansion in money and domestic demand. In conjunction with a reversion to backward indexation of the exchange rate, inflation picked up again in the second half of the year.

1. Domestic output

The Turkish economy rebounded in 1995, with real GNP rising by 8.1 percent, reversing the decline of 6.1 percent in 1994. A strong pickup in activity in the second and third quarters of 1995 more than compensated for the continued weakness in the first quarter and a slight decline in the fourth quarter caused by uncertainty in the run-up to the elections. Industry performed strongly, with a growth rate of 12.1 percent, followed by services (6.4 percent) and agriculture (2.6 percent) (Table A1).

Table A1.

Turkey: GNP and its Components

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Source: Data provided by the Turkish authorities.

After a decline of 8.3 percent in 1994, the manufacturing sector turned around in 1995, recording a growth rate of 13 percent. Private sector manufacturing, which had been badly affected by the recession in 1994, enjoyed a strong recovery across all sectors as both exports and domestic demand picked up. Private industrial production rose by 18.8 percent and manufacturing capacity utilization 1/ increased from 70.9 percent in 1994 to 77.8 percent in 1995 (Tables A2 and A4). By contrast, the public manufacturing sector, which had been less affected by the recession in 1994, managing a 2.6 percent growth in industrial production, saw output fall in 1995 by 1.3 percent.

Table A2.

Turkey: Production Index of Manufacturing Industry, 1991-95

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Source: State Institute of Statistics.

Beginning in 1993, changes based on 1992 = 100.

Table A3.

Turkey: Production of Major Industrial Commodities

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Source: State Planning Office, Main Economic Indicators, April 1996.

Pithead production.

Public sector.

Table A4.

Turkey: Rate of Capacity Utilization in Manufacturing Industry 1/

(Weighted by production value)

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Source: Data provided by the Turkish authorities.

Data on capacity utilization are collected from monthly and quarterly surveys. The quarterly series is based on a larger sample, hence it is not directly comparable with the monthly series. The annual figures in this table are averages of the quarterly data.

Provisional

Available data for 1996 show total industrial output increasing by 8.4 percent in the first quarter compared with the same period in 1995, when the economy was still in recession. Although industrial output in April 1996 was 1.6 percent lower compared with April 1995, when production rebounded strongly from the recession, output in May 1996 increased by 15 percent over the same month of the previous year. Over the five-month period of January to May 1996, the manufacturing sector grew by an average of 7.4 percent: machinery production grew by an average of 30.3 percent, the production of electricity, gas, and water increased by an average of 12.2 percent, and mining production increased by an average of 4.8 percent.

The share of agriculture in GNP has held steady at around 15 percent in recent years. Value added in agriculture (in constant prices) grew by 2.6 percent in 1995 after two consecutive years of decline, as the output of cotton, beans, and oilseeds recovered from previous troughs (Table A5). However, this outcome was below expectations as unfavorable weather conditions affected several industrial crops as well as fruits and nuts: the output of hazelnuts, sugar beet and olives plunged, and wheat production (18 million tons) was also disappointing in terms of quality as well as quantity.

Table A5.

Turkey: Agricultural Production, Major Crops, 1991-95

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Source: State Institute of Statistics.

Agricultural policy in Turkey has several objectives, including stabilizing the prices of agricultural goods and meeting the nutritional needs of the population, while ensuring steady, adequate incomes for farmers and promoting the export potential of the agricultural sector. These objectives are pursued primarily through domestic price support schemes, import controls, concessional credits, 1/ and input (e.g., fertilizer) subsidies. 2/ The implementation of these measures involves a large number of organizations, including several SEEs, Agricultural Sales Cooperative Unions (ASCUs), agricultural credit cooperatives, state-owned banks, and other agencies.

Prior to the 1994 stabilization program, approximately 20 agricultural products were covered by agricultural support schemes. Since then, the coverage has been reduced to nine, the major ones being cereals, tobacco, and sugar beet. The support schemes for cereals, sugar and tobacco are administered by TMO (the state cereals board), TSFAŞ (the state sugar producing firm, also known as ŞEKER), and TEKEL (the state tobacco and alcoholic beverages monopoly). 1/ These three are the largest and most influential agricultural SEEs. Their statutes charge them with providing price support through intervention purchases and stockpiling, as well as with other responsibilities such as determining the level of production through forward contracts with growers, handling sales and marketing activities, disbursing subsidies, and administering investment, import and export policies. For other crops, such as hazelnuts, cotton and sunflower seeds, the price support schemes are administered by Agricultural Sales Cooperative Unions (ASCUs), which are commercial organizations formed by an association of three or more agricultural sales cooperatives, authorized to set prices for their members’ commodities.

Factors such as the level of production, the international price, consumer demand, and the rate of inflation are taken into consideration in setting the support price for a commodity. Support prices are announced every year–in February for tobacco, around the end of May in the case of wheat, and in September for sugar beet–and are adjusted each month in line with market conditions (Table A6). Support prices have tended to be highly variable, and the support schemes have traditionally been a financial burden for the agricultural SEEs, as high support prices often meant that they were obliged to purchase large quantities from farmers and hold substantial inventories. However, the situation was quite different in 1995 as, because of low domestic production, TMO and TSFAŞ found themselves with insufficient inventories and had to resort to importing wheat and sugar to satisfy the domestic market. Due to the poor wheat harvest in Turkey in 1995 and the increase in global wheat prices, TMO purchased only about 30,000 tons of domestically grown wheat (compared to its usual 1.5 million or so tons) despite a nominal doubling of the wheat support price, as most of the wheat was sold to the private sector at a higher price.

Table A6.

Turkey: Selected Agricultural Support Prices, 1991-95

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Source: State Planning Organization.

The price support schemes are funded in different ways, depending on the administering agency. TMO, TEKEL and TSFAS purchase the cereal, tobacco, and sugar beet output from farmers using their own resources, and then charge the Treasury what is termed “duty loss,” i.e., the amount of the purchase plus a 10 percent margin. Compensation is made from a budget appropriation after approximately twelve months, upon completion of an audit. 2/ In recent years, the support purchases by these SEEs have imposed substantial costs on the budget (see the chapter on fiscal developments). The ASCUs which administer price support schemes are funded by the Turkish Agricultural Bank, which extends credit at below-cost interest rates to these cooperatives during times of need. As explained further below, from time to time, these loans have been assumed by the Treasury.

2. Domestic demand

After a marked decline in 1994 and in the first quarter of 1995, domestic demand picked up strongly in the second and third quarters of 1995. (Table A7). Imports mirrored this trend, growing by 30 percent in 1995 after a 22 percent decline in 1994.

Table A7.

Turkey: Aggregate Demand and GNP

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Source: State Planning Organization.

Changes as percent of previous year’s GNP.

The recovery in domestic demand was driven primarily by private sector investment and consumption. Private sector Stockbuilding was a major contributor to growth in 1995, as inventories were replaced following the 1994 recession when production and imports fell dramatically and stocks were run down. The contribution of Stockbuilding in the private sector to growth was as much as 3.4 percent in 1995, compared with -2.8 percent in 1994. Private fixed investment, which fell by 5.7 percent in 1994, recovered by 11 percent in 1995, despite an environment of high real interest rates; imports of investment goods rose to US$10.5 billion, a 52 percent increase over the previous year. The upsurge was facilitated by generous investment allowances 1/ and optimism surrounding Turkey’s entry into a customs union with the European Union. The value of foreign direct investment approvals grew from US$1.5 billion in 1994 to US$2.9 billion, a 93 percent increase, although actual foreign investment inflows were only US$0.9 billion.

As a share of GNP, private investment increased from around 16 percent in the early 1990s to 20.9 percent in 1995 (Table A8). Since the late 1980s, the government has stepped up its efforts to encourage private manufacturing investment by expanding the range of investment incentives. The main incentives include: complete or partial exemption from customs duties and other surcharges for imported investment goods; tax credits allowing a certain percentage of the initial investment to be deducted from the tax base; VAT refunds for domestically produced capital goods and equipment; and exemptions from building and construction charges. 2/ To qualify for these incentives, potential investors have to apply to the Undersecretariat for the Treasury and Foreign Trade for an investment incentive certificate. Prior to 1993, incentive certificates were issued on sectoral criteria, but since then, incentives have been region- rather than sector-specific. To date, some 44,000 incentive certificates have been issued. Applications for textile and clothing investments have grown particularly rapidly, accounting for over 45 percent of all incentive certificates awarded in recent years. In 1995, a record 4,954 certificates were issued, based on a total investment value of over TL 2,000 trillion (US$44 billion). Data on investments realized with these certificates are not available, 1/ although it is estimated that some 60 percent of all certificates issued to date are still open.

Table A8.

Turkey: Macroeconomic Balances

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Source: State Planning Office

Contribution to GNP growth.

Private consumption, which fell by 6 percent in 1994, rebounded in 1995, rising by 7.7 percent in real terms. Although the real growth of private consumption between 1994 and 1995 was lower than the real growth of GNP, the share of private consumption in GNP (measured in current prices) rose from 66.3 percent in 1994 to 69 percent in 1995. This reflected the strong growth in consumer prices relative to the GNP deflator. Private disposable income increased in real terms by 8.7 percent in 1995, even though real wages were almost unchanged and remained below their 1993 levels. Wages are relatively small as a share of national income, accounting for around 25 percent of total income in 1994.

Public sector fixed investment increased from 1991 to 1993, although less rapidly than private investment, but fell by 43.4 percent in 1994 and further by 2.3 percent in 1995. The declines mainly reflected cuts in investment outlays in the context of the 1994 stabilization program. In contrast to the private sector, the public sector reduced inventories in 1995, as poor harvests led the agricultural SEEs to run down their stocks.

Fiscal tightening during the initial stages of the 1994 stabilization program reduced public consumption expenditure by 5.6 percent in 1994, but this was largely reversed in 1995 when public consumption grew by 4.5 percent. As a share of GNP, public disposable income and public consumption fell from 9.5 percent and 10.8 percent, respectively, in 1994 to 8.6 percent and 9.8 percent, respectively, in 1995.

3. Price developments

During the period 1990-1995, inflation in Turkey averaged 75 percent a year. Inflation has been driven by persistent public sector deficits, coupled with the policy of real exchange rate targeting in pursuit of external competitiveness, and sustained by deep-rooted public skepticism about the durability of any fiscal adjustments (see Appendix IV for a study on inflation determinants in Turkey). Following large price adjustments made in the context of the April 1994 stabilization program, the sharp recession and favorable seasonal conditions slowed monthly inflation during the summer of 1994. However, following a shift in exchange rate policy during the third quarter, inflation picked up briskly in the last quarter to above program targets. Overall, in the 12 months from January to December 1994, wholesale prices rose by 149.6 percent and consumer prices by 125.5 percent (Table A9).

Table A9.

Turkey: Wholesale and Consumer Price Index

(Percentage change over same period of the previous year)

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Source: Data supplied by the Turkish authorities.

The wholesale and consumer price indices exhibit a high degree of seasonality as agricultural developments have significant effects during the summer months. Looking at seasonally adjusted data, inflation remained pronounced in the first quarter of 1995, with wholesale prices increasing by 18 percent, seasonally adjusted, during January to March. During the second quarter, inflation moderated somewhat to 11.7 percent, seasonally adjusted, although the decline was well short of the program target. However, the rapid growth of domestic demand, the accelerated depreciation of the lira, and the weakening of fiscal policy toward the end of the year, opened the way for a resurgence of inflation in the latter half of the year. By year-end, wholesale prices were increasing by around 4 percent a month, seasonally adjusted, partially held in check by the postponement of key public sector price adjustments until after the December elections. Over the 12 months from January to December 1995, wholesale and consumer prices rose by 64.9 percent and 78.9 percent, respectively. However, trend inflation 1/ was closer to 80 percent by end-year (Table A10).

Table A10.

Turkey: Price Indices and Trend Inflation

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Source: Staff estimates.

Annualized rate of increase of an index constructed from the seasonally adjusted WPI and CPI.

Available data for 1996 show an acceleration in inflation: wholesale prices increased by 43.7 percent (48.8 percent, seasonally adjusted) in the first 6 months, while 12-month inflation reached 79.8 percent (79.9 percent, seasonally adjusted) in June, with trend inflation around 90 percent. (The government’s end-year wholesale price inflation target is 65 percent). Public sector prices rose by 54.7 percent and private sector prices by 40.8 percent in the first 6 months of 1996, the former reflecting adjustments to public sector prices (of electricity, cigarettes, alcohol, and tea) delayed from 1995, as well as higher petroleum and sugar prices.

4. Employment

Turkey’s labor force has increased at an average annual rate of 1.7 percent since 1992, reaching 21.7 million in April 1995. The labor force participation rate has declined steadily from 58 percent in 1989 to 55 percent in 1992 and 53.9 percent in April 1995, mainly as a result of increased schooling rates 2/ and migration from the rural areas to urban centers, where the participation rate for women is substantially lower (around 16 percent, compared to over 50 percent in the rural sector, where many women are classified as unpaid family workers).

Data from the bi-annual Household Labor Force Survey (HLFS) 1/ show that employment increased at an average rate of 2 percent a year between 1992 and 1995 (Table A11). A significant proportion of this employment is concentrated in the informal sector: agriculture accounts for as much as 46.6 percent of total employment, followed by services (37.9 percent) and industry (15.5 percent). Of the total labor force, about 40 percent—some 8 million people–are wage earners. Around two thirds of these are insured, i.e., registered with a social security institution.

Table A11.

Turkey: Labor Market Developments 1/

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Source: State Planning Organization.

Based en results of the State Institute of Statistics’ Household Labor Force Survey (revised series).

Population over 15 years of age.

Open unemployment stood at 7.2 percent in April 1995 and 6.6 percent in October 1995. In the urban areas, unemployment averaged 11.9 percent in 1994, 2/ falling to 10.6 percent in April 1995 as economic activity picked up. Rural unemployment was estimated at 4.4 percent in April 1995. Educated youths (aged 15-24, with a high school or university degree) in search of appropriate jobs accounted for about 30 percent of the unemployed in the urban areas.

The large agricultural and informal sectors in Turkey appear to serve as a cushion for employment during periods of low activity. In 1994, when GNP declined by 6 percent and the number of layoffs in the formal sector jumped sharply, HLFS data (Table A11) indicate that unemployment rose by only 0.4 percent, and employment actually increased compared with the previous year. Part of the explanation for this may be due to shifts from the formal sector to agriculture and the informal sector (mostly petty trade, which is classified under “services.”)

Employment creation is viewed as a major challenge in the coming years, given the rapid rate of population growth (2 percent a year) and the age structure of the population (35 percent is under 14 years of age). The problem may be even more difficult to the extent that, in line with trends in Europe and the rest of the world, economic growth in future will be driven by technology- rather than labor-intensive investment. Hence, the government is looking to small-and medium-sized enterprises (SMEs) to be the driving force behind employment creation. Policies for boosting employment creation, particularly in SMEs, include: providing preferential financing and other support to encourage SMEs; mobilizing local resources and creating rural industries so as to discourage rural-urban migration; reducing the cost of employment by eliminating certain taxes and charges (such as contributions to the Housing Fund and the Saving Fund); and implementing training policies to raise the presently low skill level of the workforce.

5. Wages and industrial relations

The approximately 5.5 million insured workers comprise about 1.5 million civil servants, 1 million public sector workers, and 3 million private sector employees. Civil servants include the staff of ministries and municipalities, certain technical and administrative personnel, and employees of some public enterprises. They are considered a separate category of workers, not a subcategory of public sector workers. Civil servants are distinct from public sector workers in several respects, e.g., they subscribe to their own pension fund, they may not engage in collective bargaining (although they are allowed to form unions), and their wage increases are set unilaterally by the government in the budget decree. In the rest of this section, references to the public sector apply only to public sector workers, and not to civil servants.

Almost all of the insured public sector workers have signed collective wage agreements, with the exception of contractual workers and workers in certain subsectors of the defense and petroleum industries. By contrast, fewer than half of the 3 million or so insured private sector workers are covered by collective agreements.

According to the Ministry of Labor, some two thirds of all insured workers in the formal sector are members of trade unions. This number may be an overestimate as unions have an incentive to overstate their membership so as to obtain the right to sign collective agreements. (Only unions with memberships representing at least 10 percent of the workforce in a sector or 50 percent of the workforce in a single factory may engage in collective bargaining). Collective wage agreements are made on an enterprise basis; however, trade unions may be formed on a sectoral basis. In the public sector, workers’ unions negotiate with the Public Sector Employers’ Union, which represents the management of state owned enterprises. A wage contract, once signed, is usually valid for two years. Prior to April 1994, wage contracts in the public sector were de jure backward indexed and included an extra “welfare” component determined by the rate of economic growth. The 1994 stabilization program eliminated both practices. Thus, there is no wage indexation, and wage increases over the two year period are spelt out in the contract. Aside from the base wage, other elements such as bonuses and benefits are also subject to negotiation.

According to the available information, nominal and real wage growth appear to have slowed in recent years after a sharp rise in 1989-91. 1/ Indeed, since 1993, nominal wage increases appear to have been generally below the inflation rate, resulting in real wage losses for some workers (Table A12). The 1995 public sector workers’ wage agreement, concluded after an extended strike, specified an average increase of 51.6 percent in 1995 and 39.4 percent in 1996. In real terms, public sector workers* wages fell by 21.7 percent in 1995. According to partial data, the private sector fared slightly better, with an overall real wage increase of 1.6 percent in 1995. (This figure covers data on only 240,000 of the 3 million insured private sector workers).

Table A12.

Turkey: Wages and Labor Costs, 1991-95

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Source: State Planning Organization.

Average over the calendar year. (The minimum wage set each year is effective from September to the following August).

Represents only the wages of workers covered by collective labor agreements.

Based on data provided by the Public Sector Employers’ Union.

Nominal wages deflated by the consumer price index.

As noted above, civil servants’ wage increases are set unilaterally by the government in the budget decree. The wage increases are usually implemented in two stages, the first in the beginning of January and the second in the middle of the year. In 1995, there were three wage increases: 19.6 percent in the first quarter, 36.2 percent in the second quarter, and an additional 57.6 percent in the fourth quarter. As a result, only one increase is scheduled in 1996, recently set at 50 percent. The government has frozen the number of civil service positions at the existing level of 1.5 million for the next five years.

Minimum wages are set by the Minimum Wage Commission, which convenes once a year, usually in April. The announced (legal) minimum wage is effective from September to August of the following year, and is currently TL 8.5 million (about US$105) a month. Real minimum wages rose by some 50 percent between 1989 and 1993 (Table A12) but more recently, the increases in the minimum wage have not kept pace with the inflation rate–in real terms, the minimum wage fell by 22 percent in 1994, and by 5.3 percent in 1995. There are no precise estimates of the number of people earning the minimum wage. Although some 1.5 million are declared minimum wage earners, this figure may be an overestimate as it is a common practice for workers to under-report their income so as to reduce their social security contributions.

The wage gaps between the formal and informal sectors, and between the private and public sectors, are reported to be substantial, although no detailed data are available on the extent of wage dispersion across industries and regions. As noted earlier, the private sector wage data are based on a small sample of 240,000 out of 3 million. The workers excluded from the sample–mostly those in the informal sector–earn much lower wages than those reported in the sample.

Studies on income distribution in Turkey are few and far between. The most recent surveys on income distribution were conducted in 1978 and 1987. The State Institute of Statistics has completed a new survey but the results have not been published yet. However, indications are that income inequality has widened in recent years. The share of wages and salaries in national income fell from 35 percent in 1993 to 25 percent in 1994, whereas the share of interest in national income rose from 10.3 percent in 1993 to 14.3 percent in 1994.

Under Turkish laws on employment protection, workers may be dismissed for economic reasons or for disciplinary reasons. However, firms making mass dismissals for economic reasons are not allowed to hire replacements until after at least six months have passed. Turkey recently signed ILO agreement No. 58, which states that every dismissal may be brought before a local tribunal. There is, at present, no unemployment insurance in Turkey. However, workers who are dismissed for economic reasons are entitled to lump sum severance pay amounting to at least one month’s salary for each year worked in the same company, at the wage level prevailing at the time of separation, subject to a ceiling based on the retirement bonus for the highest state official under the Civil Servants Act.

II. Public Finances

1. The structure of the nonfinancial public sector

The nonfinancial public sector in Turkey consists of five main subsectors: the consolidated budget which includes the central government proper, the budgetary funds, and the annex budget; extrabudgetary funds (EBFs); local governments; the social security institutions and revolving funds; and nonfinancial state economic enterprises (SEEs). The first four constitute the general government.

The consolidated budget includes the legislative, judicial and executive organs of the state, certain budgetary funds, and some autonomous organizations, for which resources are provided in the annex budgets. Extrabudgetary funds (EBFs) include entities operating in several areas: administration of the privatization program, development of infrastructure, social programs, provision of export and investment incentives, and the Turkish defense industry. Revenues of these funds come principally from earmarked taxes, trade related levies, user’s charges, and direct transfers from the central government. The Privatization Agency (PA) resources come primarily from privatization proceeds, the bulk of which has been used to subsidize companies in the PA portfolio pending their final sale (see Appendix I).

Since 1993, efforts have been underway to improve supervision of the EBFs. A new centralized cash management system, the Joint Fund Account (JFA), has been set up at the central bank and incoming and outgoing flows from the Treasury to the EBFs are recorded. Further progress in strengthening controls is expected under the Public Financial Management Project, an IBRD-funded project in which the IMF is also assisting the authorities: a computerized accounting system is to be put in place to allow a more comprehensive monitoring of budgetary and funds operations. Local governments include provincial governments, municipalities, special status cities, a few enterprises operated by local authorities, such as local water and sewerage systems, and a provincial fund. Financial resources for local government are provided through earmarking of tax revenue; these resources are supplemented through local real estate taxes, tourist taxes, nontax revenues from sales of business licenses, and municipal fees and fines. The social security system, consisting of the Social Security Organization for the Craftsmen, Tradesmen and Other Self-Employed (BAG-KUR), the Pension Fund for civil servants (EMS) and the Social Insurance Institution for employees (SSK), is described in Appendix II and further below. The Revolving Funds mainly cover departmental sales of goods and services, the most important of which are generated by hospitals, universities, military barracks, and certain ministries. There are presently over 3,000 revolving funds; the amount of resources passing through these funds is not known with any precision because they are not subject to budgetary control procedures. A pre-specified amount of their gross revenue averaging 10 percent of gross income is transferred to the budget.

2. Overall trends

During 1991-93, fiscal policy was strongly expansionary, with the public sector borrowing requirement (PSBR) increasing from 10.7 percent of GNP in 1991 to 15.0 percent in 1993 (Table A13). 1/ The increase in the PSBR was due in the main to a rapid rise in expenditures of the general government, notably personnel and transfer payments. Implementation of a major stabilization program in April 1994 yielded a drop of almost 6 percentage points in the PSBR in 1994, with reduced borrowing needs being achieved in all major components of the public sector, including the consolidated budget and the SEEs. In 1995, the deficit of the general government increased modestly, but further reduction in the borrowing needs of the SEEs ensured an additional decline in the overall borrowing need of the public sector, from 9.3 percent in 1994 to 8.3 percent in 1995. 2/

Table A13.

Turkey: Breakdown of the Public Sector Borrowing Requirement, 1991-95

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Sources: SPO; and Fund staff estimates.

Sum of individual components may not be equal to total due to rounding.

Throughout the period, the PBSR was financed almost entirely through domestic borrowing. Net external financing averaged 1 percent of GNP in 1992-93, but turned negative in 1994-95 when Turkey’s access to international capital markets was temporarily interrupted. Access was partially restored from April 1995 onwards, but net external financing remained negative, at 1.0 percent of GNP for the year as a whole.

3. The general government

The financial position of the general government has varied markedly during 1991-95, with the deficit increasing by 5 percentage points of GNP between 1991-93, falling by some 4.4 percentage points in 1994, and then increasing slightly during 1995, with further increases expected in 1996 (Tables A14, A15 and Chart 3). The changing position of the consolidated budget has been the primary factor accounting for these fluctuations; however, the financing need of other government entities (e.g. the social security institutions) have had a significant indirect role on government finances, through the pressure they place on the budgetary position.

Table A14.

Turkey: General Government and Public Sector Borrowing Requirement, 1991-96

(In billions of Turkish liras)

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Source: State Planning Organization; and Fund staff estimates.

The consolidation methodology has been modified for the period 1993-96 in order to present all the operations on a gross basis. The data for the period 1991 and 1992 is not strictly comparable.

Budgetary data have been modified to include quasi-fiscal outlays and off-budget transfers to entities outside the general government. Quasi-fiscal operations for 1996 including capitalized interest of TL 95 trillion made early in 1996.

SEEs transferred to EBFs pending privatization are shown under SEEs.

Table A15.

Turkey: General Government and Public Sector Borrowing Requirement, 1991-96

(In percent of GNP)

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Sources: State Planning Organization; and Fund staff estimates.

Budgetary data have been modified to include quasi-fiscal outlays and off-budget transfers to entities outside the general government; for. 1996 quasi-fiscal outlays includes capitalized interest of TL 95 trillion.

SEEs transferred to EBFs pending privatization are shown under SEEs.

CHART 1
CHART 1

TURKEY: MAIN DEVELOPMENTS, 1989-1995

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Sources: Data provided by the Turkish authorities.
CHART 2
CHART 2

TURKEY: OUTPUT TRENDS, 1994-95

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Data provided by Turkish authorities.
Chart 3
Chart 3

Turkey: General Government and Public Sector Borrowing Requirement

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Sources: Undersecretariat of the Treasury; and staff estimates.

a. Central government budget operations 1991-95

The deficit of the consolidated central government budget, adjusted for off-budget transfers and quasi-fiscal operations (mainly debt issues to cover losses of state banks and central bank losses from open market operations), declined from 9.6 percent of GNP in 1993 to 6.2 percent in 1994 but increased again to 7.5 percent of GNP in 1995 (Tables A16 and A17). The sizable reduction in the deficit in 1994 reflected the package of revenue and expenditure measures taken in the context of the stabilization program of April 1994. These measures included a 10 percent surcharge on personal and corporate income, a net assets tax on all types of businesses (at rates varying from 0.75 percent to 2 percent of gross revenues) and a supplementary wealth tax on luxury automobiles, boats, and aircraft. Noninterest expenditure (mainly personnel, transfers and investment outlays) was reduced by over 3 percent of GNP from 1993 to 1994, more than offsetting the rapid rise in interest payments. The indexation of salaries was eliminated, and personnel expenditure declined in real terms, as did public investment outlays. The widening of the deficit in 1995 mainly resulted from a decline in revenues as the once-off measures of 1994 lapsed.

Table A16.

Turkey: Consolidated Budget, 1991-96

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Sources: Undersecretariat of the Treasury; and Fund staff estimates.

Includes capitalized interest of TL 95 trillion.

Table A17.

Turkey: Consolidated Budget, 1991-96

(In percent)

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Sources: Undersecretariat of the Treasury; and Fund staff estimates.

Includes capitalized interest of TL 95 trillion in 1996.

In percent of end-year GNP.

The financing pattern of the consolidated budget also underwent a substantial change during this period. With net external financing declining, adjusted net domestic financing increased from 5.0 percent of GNP in 1991 to 8.5 percent in 1993 and remained at very high levels in both 1994 and 1995.

(1) Revenue trends

Total revenue collections of the consolidated central government rose steadily from 15.3 percent of GNP in 1991 to 19.1 percent of GNP in 1994, with a particularly sharp rise in the latter year as a result of the introduction of several once-off tax measures in April 1994, mentioned above (Tables A16 and A17).

Direct taxes averaged 6.5 percent of GNP between 1991 and 1993, rose to 7.3 percent of GNP in 1994, falling back to 6 percent of GNP in 1995 (Table A18). Withholding taxes on salaried personnel constitute the bulk of personal income tax, while self-employed and independent professionals largely escape taxes. Since 1993, efforts have been underway to reduce tax evasion among independent professionals by introducing taxpayer identification numbers and limiting the type of businesses subject to lump-sum taxation, but these measures have not yet had a noticeable impact on revenue collection.

Table A18.

Turkey: Consolidated Budget Tax Revenue, 1991-96

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Source: General Directorate of Revenue, Ministry of Finance.

At around 1 percent of GNP, the yield of the corporate income tax is relatively low. This reflects weak tax administration, inadequate inflation adjustments to the tax base, and generous investment incentives that erode the corporate income tax base. With regard to personal income tax, the tax brackets have been adjusted faster than inflation in recent years (Table A18). Even so personal income tax collections declined by about 1 percent of GNP in 1994-95, in line with the reduction in real wages in the public sector, as well as increased deductions and exemptions.

Collections of indirect taxes increased steadily from about 6 percent of GNP in 1991 to 8.2 percent of GNP in 1995. This increase mainly reflected increases in the various VAT rates of 2-3 percentage points effected in 1993 and changes in the distribution of petroleum consumption tax which reduced the share earmarked for extrabudgetary institutions and local governments and raised the share accruing to the budget from less than 50 percent in 1993 to 90 percent presently. The contribution of VAT and petroleum consumption tax to total indirect taxes rose from 62 percent in 1991 to close to 74 percent in 1994 and 1995. Collections of the supplementary excise taxes on tobacco and alcoholic beverages have been negligible since 1991 due mainly to difficulties in collecting this tax from TEKEL, the state monopoly on tobacco and alcoholic products. Customs duties on imported goods have remained fairly stable, averaging 0.7 percent of GNP between 1991 and 1995 despite wide fluctuations in imports. Duties are expected to decline to 0.4 percent of GNP in 1996 with the reduction in tariff rates upon Turkey’s entry into the customs union with EU.

Other revenues, which includes tax revenues assigned to EBFs, increased from 2.9 percent of GNP in 1991 to 4.4 percent in 1993 but declined in 1994 and further in 1995 to 3.8 percent of GNP (Table A16). These developments mainly reflect changes in the share of taxes earmarked to the budgetary funds noted earlier. Nontax revenue stagnated throughout the period at around 1 percent of GNP reflecting mainly reduced profitability of public entities.

Total revenue of the consolidated budget in 1995 was about 0.4 percent of GNP lower than programmed. In nominal terms, however, the consolidated budget tax revenues exceeded the program projections by some TL 88 trillion. Indirect taxes (especially domestic VAT) did not increase in line with inflation and the pickup in economic activity. Also delays in adjusting retail petroleum prices resulted in a shortfall in petroleum consumption tax. In contrast VAT on imports and corporate income taxes were slightly better than anticipated, reflecting the jump in imports and better-than-expected company profitability.

(2) Expenditure trends

Budget expenditure rose from around 20 percent of GNP in 1991-92 to 24.3 percent in 1993, mainly on account of sharply increased transfers and interest payments (Table A17 and Chart 3). The April 1994 stabilization program included a major effort to contain expenditure on wages and salaries, and cutbacks in investment outlays and transfer payments. Personnel expenditure declined from 8.5 percent of GNP in 1993 to 6.6 percent in 1995 through the elimination of wage indexation, wage restraint and improved control of contractual workers wages. The reduction in transfer payments was shortlived as the growing social security deficit and subsidies to exporters and agriculture caused transfer payments to rise again in 1995.

Interest outlays more than doubled in relation to GNP between 1991 and 1994, as the large and growing budget deficits were increasingly financed with short-term government securities at rising interest rates. Interest payments declined slightly during 1995, from 7.7 percent of GNP to 7.5 percent, and were substantially less than programmed, despite higher-than- programmed interest rates. The decline resulted from an unexpected lengthening of maturities on government paper during March-September 1995, which had the effect of deferring a sizable volume of interest payments into 1996. The share of interest expenditure in total expenditure increased from about 19 percent in 1991 to about 30-32 percent of total expenditure in 1994 and 1995.

Defense-related expenditures reported in the budget are estimated to have decline in terms of GNP initially in 1992 but have since stabilized in 1994 and 1995 to around 3 ½ percent of GNP or 15 percent of consolidated budget expenditure (Table A20). Capital expenditure dropped from an average of 2.7 percent of GNP during 1991-93 to 1.2 percent of GNP in 1995, from around 13 percent of consolidated budget expenditure to around 5 percent. Off-budget transfers (mainly issues of Treasury paper to cover debt service payments, losses of SEE’s, and social security and subsidies to exporters) and quasi-fiscal outlays (paper issued to cover losses of state banks and the central bank) (Table A21) averaged 2.5 percent of GNP from 1992-1994 and rose to 3.6 percent of GNP in 1995 in part to cover losses of agricultural banks and central bank losses from sterilization operations.

Table A19.

Turkey: Income Tax Brackets, 1991-95

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Sources: OECD, Economic Surveys; and data provided by the Turkish authorities.
Table A20.

Turkey: Estimates of Budgetary Defense and Security-Related Expenditures, 1991-96

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Source: General Directorate of Budget and Finance.

The information available on military expenditure does not cover off-budget military expenditure

Table A21.

Turkey: Composition of Off-Budget Transfers and Quasi-Fiscal Operations, 1992-95

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Source: Undersecretariat of the Treasury.

Expenditure pressures emerged in the fourth quarter of 1995 as a consequence of unscheduled increases in wages and salaries and deterioration in the financial position of the social security system. During the course of the year, wages of civil servants were raised on three occasions by 19.6 percent, 36.2 percent, and 57.6 percent in January, April, and November, respectively, for a cumulative increase of 157 percent. Wages of hourly-paid government contractual workers were raised by 150 percent retroactive to July 1995 settling at the same time the collective bargaining process which was delayed from December 1994. In addition, the pace of investment expenditures accelerated significantly toward the end of 1995.

(3) Financing

The consolidated budget borrowing requirement adjusted for off- budget transactions and quasi-fiscal operations rose from 5.3 percent of GNP in 1991 to 9.6 percent of GNP in 1993 (Table A17). During 1991-1993 external borrowing provided net inflows to finance the budget, but foreign financing turned negative in 1994-95, requiring heavier reliance on financing from the domestic market. The net sales of government securities, which accounted for about 50 percent of domestic financing in 1991 rose to 82 percent by 1995, as financing from central bank advances was cut back and as a result, the composition of domestic debt shifted progressively toward short-term debt instruments (Table A22). In 1995, almost 70 percent of the securitized debt stock was of less than 12-month maturity. Soaring deficits and difficulties in rolling over the maturing short-term debt have worsened the debt dynamics in 1995 and early 1996. The quarterly average weighted borrowing cost of the Treasury is shown in Chart 4.

Table A22.

Turkey: Central Government Debt, End-Year Stocks

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Source: Undersecretariat of the Treasury; and Fund staff estimates.

End-of-period stock divided by period GNP.

Chart 4
Chart 4

Turkey: Borrowing Cost and Principal Payments

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Generate Directorate of Public Debt, Undersecretariat of the Treasury

In its 1995 financing program, the Treasury sought to extend maturities on government paper over the course of the year, and to resume external borrowing during the second half of the year. Substantial success was achieved in pursuing these objectives, with the Treasury selling unexpectedly large volumes of nine-month and one-year paper in the first half of the year, thereby shifting a considerable portion of the interest burden in 1996 and reducing its borrowing need during the second half of the year. However, with the heightened uncertainties created by the unexpected fall of the government in September, borrowing costs rose sharply during the last quarter and into 1996, while the maturities on new sales of government paper shortened considerably (see chapter 3 below).

(4) The 1996 consolidated budget

The draft 1996 budget was approved by Parliament in April 1996 to replace the temporary spending bill covering the first four months of the year. The budget targets an improvement in total revenues of 1.4 percent of GNP compared to 1995 outturn and projects an increase in expenditure of 1.7 percent of GNP. Including off-budget expenditure, an overall deficit of 9.3 percent of GNP is projected (Tables A16 and A17). Although net external financing is projected to improve slightly compared to 1995, total adjusted domestic borrowing would rise further to over 10 percent of GNP as against 8.5 percent in 1995. This can be expected to increase pressures on real interest rates and lead to continued increase in the burden of domestic debt service.

Indirect taxes are projected to increase by 1 percent of GNP, mainly as a result of adjustments in retail prices of petroleum products made early in the year and higher petroleum consumption tax rates. Direct taxes are also projected to register a small improvement in 1996 resulting from strong corporate profits in 1995. The entry into force of the customs union in January 1996 is estimated to have a negative impact on revenues (accruing to budgetary funds) equivalent to 0.6 percent of GNP. Nontax revenues are projected to increase by 0.7 percent in 1996 due mainly to the imposition of a special levy on certain SEEs that would yield 0.4 percent of GNP; this levy has not yet been imposed. Extrabudgetary funds will also be required to transfer a higher portion of their earmarked revenues to the budget.

In 1996, noninterest expenditure of the consolidated budget is projected to increase by about 1.7 percentage points to 16.4 percent of GNP. This was predicated on limiting salary adjustments to no more than 30 percent in the second half of the year, which would keep personnel outlays about stable in relation to GNP; in the event, salary increases of some 50 percent were announced in early July. Transfers payments are projected to rise to 5.7 percent of GNP, from 5.1 percent in 1995, mainly as a result of the widening deficit of the social security system which would require transfers equivalent to 2.1 percent of GNP (Table A17). Investment outlays are expected to increase significantly with the share of investment in agriculture, mining, and manufacturing declining and those of energy, health, education, and infrastructure rising (Table A23).

Table A23.

Turkey: Public Sector Fixed Investment, 1991-96

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Source: State Planning Organization.

Includes central government operations not covered by the consolidated budget, for example. State Hydraulic Authority (DSI) and State Highways and Rural Affairs Authority.

Budgetary performance during the first five months of the year indicates that the original deficit target of some TL 898 trillion will be missed by a large margin. With interest rates on Treasury bills running at levels much higher than programmed, and with the primary surplus likely to below budget targets, the deficit of the consolidated budget, inclusive of off-budget transactions and quasi-fiscal outlays, could reach 10 percent of GNP, compared with 7.5 percent of GNP in 1994.

b. Extrabudgetary funds (EBFs)

There are currently 126 EBFs. 62 of these funds are subject to centralized budgetary control, and included as a line item in the consolidated budget. Of the remaining 64, 11 funds are considered to be sufficiently important to be monitored and included in the public sector accounts prepared by the State Planning Organization (SPO) ; partial data is available for a further 46 funds, all of which are considered to be of minor importance; and no data is available for the remaining 7 funds. 1/ While some funds depend almost entirely on earmarked taxes from the consolidated budget, most also have independent sources of revenues, including various fees, penalty payments, and operating income of various infrastructural facilities. Their earmarked taxes come mainly from petroleum consumption taxes and various trade related taxes. They also collect levies on financial transactions. Their nontax revenue includes proceeds of lotteries and gambling houses. There are also substantial transfers of resources among the various funds, which creates difficulties in interpreting the data. Most of these funds do not publish their accounts on a regular basis and the information used in consolidating the accounts of the 11 largest EBFs is compiled with a substantial lag by the State Planning Office (SPO).

Data on EBF finances in Table A24 relate only to the 11 EBFs monitored by the SPO. Expenditures of these funds have been cut back in recent years, declining from a peak of 5.1 percent of GNP in 1992 to 3.4 percent in 1994 and 3.2 percent in 1995. These declines were reflected in a sizable fall in the aggregate borrowing requirement, from 1.6 percent of GNP in 1992 to 0.4 percent in 1994. Revenues rose sharply in 1995, reflecting transfers from central government outside the budgetary framework to finance debt service payments falling due; 1/ as a result, the borrowing requirement became negative in 1995, with the transfers from the central government being used to retire debt. For 1996, the authorities project resumed borrowing equivalent to some 0.3 percent of GNP, reflecting a sharp fall in revenues (both from taxes and transfers from central government) and a more modest decline in outlays.

Table A24.

Turkey: Extrabudgetary Funds 1/

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Source: State Planning Organization.

Excludes SEEs transferred to EBFs pending privatization.

Interest payments have been adjusted to include payments of revenue sharing certificates of the PPF.

c. Local governments

Local governments rely heavily on tax revenues collected at the central government level and transferred to local governments under a revenue-sharing formula. The local government share of these revenues was set at 10.25 percent in the 1991-93 period, reduced to 9.25 percent in 1994, and then increased to 11.45 percent in 1995. Revenues have been quite stable in relation to GNP, fluctuating between 2.8 and 3.1 percent of GNP during 1991-95. Increased outlays on personnel and investment resulted in rising expenditures from 1991 through 1993, with a commensurate increase in the deficit from 0.3 percent of GNP to 1 percent. A reversal of these expenditure trends under the 1994 stabilization program saw the borrowing requirement decline to 0.5 percent of GNP in 1994 and 1995. No marked change is expected for 1996.

d. Social security system

As noted in Appendix II, the Turkish social security system has registered increasing deficits in recent years. This resulted largely from the decision taken in 1992 to remove the minimum retirement age, and to provide minimum social assistance payments without regard to any corresponding payment of premium. In 1993, some measures were taken to improve revenue collections: actual payments of social security premia were to be documented to be able to deduct them from income for the purpose of the income tax, and the number of social security inspectors was increased. Nevertheless, low compliance and weak administration have added to the financial difficulties of the system and the deficit rose from 0.6 percent of GNP in 1993 to 1.5 percent by 1995, covered mainly by transfers from the budget (Table A26). The deficit for 1996 is projected to increase further to at least 2.0 percent of GNP. The health and hospital expenditure component of the system has continued to grow relative to insurance and administrative expenditure. The SSK accounted for almost 70 percent of the deficit of the system in 1995. Discussions on a fundamental reform of the system have been underway for some time (see Appendix II).

Table A25.

Turkey: Local Governments, 1991-96

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Source: State Planning Organization.
Table A26.

Turkey: Social Security System, 1993–96

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Source: State Planning Organization.

4. State economic enterprises

The nonfinancial state economic enterprises (SEEs) collectively account for some 3 percent of aggregate employment and 7 percent of aggregate fixed investment in the Turkish economy. The main SEEs, accounting for five sixths of SEE employment, report to line ministries and the Undersecretariat of the Treasury; the remainder are under the control of the Privatization Administration (PA), which is charged with the task of privatizing them. Financial data for the SEEs as a group are compiled from individual firm balance sheets by the Treasury, typically once a year (Tables A27 and A28).

Table A27.

Turkey: Profit and Loss Accounts of State Economic Enterprises

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Source: Data provided by the Turkish authorities.
Table A28.

Turkey: Financing Requirement of State Economic Enterprises

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Source: Data provided by the Turkish authorities.

Includes transfers of government bonds outside the budgetary framework.

The financial performance of the SEEs deteriorated sharply from the mid-1980s through 1993, with the borrowing requirement increasing over time despite falling investment outlays and rising transfers from the central government. This deterioration was due entirely to a large fall in the operating surplus, reflecting both surging personnel outlays (which almost doubled as a share of GNP despite a modest decline in employment levels) and noneconomic pricing policies. Financing of the borrowing requirement in the early 1990s entailed a mix of deferred payments (primarily to the Treasury, social security system, and other governmental entities) and borrowing from the domestic banking system (including the central bank); external borrowing was modest on a net basis, in part reflecting sizable amortization payments falling due (Table A29).

Table A29.

Turkey: Summary of Financial Performance of State Economic Enterprises

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Source: Fund staff estimates, using data provided by the Turkish authorities.

Operating surplus before depreciation and provisions.

Transfer of government bonds to enterprises outside the budgetary framework.

Deferred payments less advance payments.

A significant amount of accrued expenses are liabilities to government entities.

Net payables to private entities and joint ventures.

The Borrowing Requirement of the SEEs

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Measures to strengthen the finances of the SEEs were an important element of the April 1994 stabilization program, and included wage restraint, increases in administered prices, and cutbacks in investment, including reduced purchases of stocks by agricultural sector SEEs, which act as agents of the government’s price support system for key crops. In the event, the aggregate borrowing requirement of the SEEs was halved to 1.5 percent, notwithstanding a large cutback in government transfers. A decline in wage outlays of some 1.1 percent of GNP and a marked cutback in fixed investment and inventory accumulation were key to the improvement in these financial results. The reduced financing need was reflected in even higher deferred payments (up from an average of 2.3 percent of GNP in 1991-93 to 3.0 percent in 1994) while the SEEs as a group ran an overall cash surplus, reflected in sizable net debt repayments to banks and significant increases in holdings of cash and financial instruments. 1/ This financing mix may have reflected a profit-seeking response to the prevailing high yields on financial instruments (notably Treasury bills).

The macroeconomic program for 1995 envisaged a modest increase in the SEE borrowing requirement from 1994 levels (from 1.5 percent of GNP to 2.1 percent), with further reductions in government transfers to SEEs. 2/ The operating surplus was expected to decline modestly (from 0.5 percent to 0.25 percent of GNP) despite declines in the wage and interest bill, while gross investment outlays would also fall slightly (by some 0.3 percent of GNP), because of further declines in stockbuilding.

Developments proved to be substantially more favorable than programmed, with the borrowing requirement estimated to have fallen to near zero for the year as a whole, as a result of further declines in investment outlays and personnel expenditures, each of which fell by some 1 percent of GNP, following on declines of similar magnitude in 1994. Declining investment outlays reflected continued tight controls on discretionary expenditures by enterprises and smaller-than-expected purchases of stocks by agricultural sector SEEs due to favorable market price trends and a poor wheat harvest. Falling personnel outlays were due to both the long delay in concluding public sector wage negotiations (finally completed in late October following a nationwide strike) and continued real wage restraint embodied in the final settlement.

The lower borrowing requirement during 1995 was reflected primarily in lower deferred payments, mostly to the Treasury and social security system. As in 1994, the SEEs ran an overall cash surplus, in an amount equivalent to 1.5 percent of GNP, with enterprises reporting net debt repayment to banks and foreign creditors over the course of the year. However, the reported net debt repayment to domestic banks is not consistent with published data on SEE debt stocks, which indicate a modest increase in nominal debt to banks during the year; these inconsistencies underscore the limitations of the aggregate data on SEE financial performance.

The 1994/95 stand-by arrangement included a performance criterion limiting selected forms of borrowing by seven major SEEs; the SEEs covered under this borrowing limit included the three major agricultural sector SEEs (TMO (cereals), TEKEL (tobacco), and TSFAS (sugar)), three large loss-making enterprises (TCDD (state railways), TCDI (steel), and TTK (hard coal)), and the state electricity company, later split into separate generating (TEAS) and distribution (TEDAS) companies. 1/ Review of the financial performance of these individual enterprises in 1995 shows outcomes in line with trends for the SEE sector as a whole: the borrowing requirement of the enterprises declined as a share of GNP because of reduced personnel outlays and lower investment levels. The quarterly limits on financing of these SEEs specified as performance criteria for the 1995 program were met.

Looking ahead, the marked improvement in SEE finances achieved during 1994-95 reflected a sharp cutback in personnel outlays from the inflated levels of 1991-93 and a large decline in investment outlays. Investment levels and stockbuilding are likely to recover significantly in 1996 and afterward, especially if agricultural support programs remain in place and are used aggressively to support farm income. The policy challenge for the authorities will be to limit quasi-fiscal intervention in agriculture and to promote enhanced efficiency in enterprises that would make room for increased fixed investment without requiring sharp increases in borrowing.

5. Recent changes in tax legislation 2/

In 1995, petroleum excise tax rates were modified twice. In February, a petroleum stabilization fund levy, eliminated in April 1994 to mitigate the impact of higher petroleum prices on the population, was restored to 15 percent for all petroleum products; also, the petroleum consumption tax, reduced by some 18 percent in 1994, was restored to its previous level, except on heavy fuel oil. In August, selected levies on petroleum products accruing to the Mass Housing Fund were reduced, and then eliminated on January 1, 1996 as part of the implementation of the customs union with the EU.

Also in 1995, a presumptive tax on casinos and betting houses was enacted, with tax liabilities based on the number of betting tables or slot machines, and construction companies operating abroad have been given temporary export status with the possibility to receive export incentives and exemptions on corporate income tax provided that income from this source has been repatriated.

In addition, the minimum and maximum allowances under the investment incentive scheme 1/ which had been reduced in 1993 from 30-100 percent to 20-70 percent were raised back to their former higher rates. Also investment allowances are no longer included in the base for the calculation of the minimum corporate tax base, thus reducing the effective corporate income tax rate.

On January 1, 1996, the customs union between the EU and Turkey came into effect, resulting in the elimination of all trade taxes on imports into Turkey from the EU and the adoption of the EU’s Common External Tariff on imports, from third countries. As part of this change in trade policies, both the fixed Mass Housing Fund levy imposed on a limited range of products and the percentage Mass Housing Fund levy on imports were eliminated.

III. Money and Banking

This chapter contains four sections, each examining a different feature of financial market developments in Turkey since the economic crisis in early 1994. Section 1 reviews monetary developments during the period of the stand-by arrangement (SBA)—effectively the period from May 1994 through September 199—and examines how the monetary policy framework agreed under the SBA operated in practice. Section 2 examines monetary developments during the period of political uncertainty ahead of and after the December 1995 general elections, when severe pressures in money and FX markets were reflected in a large, albeit transitory, decline in central bank reserves. Section 3 discusses the structure and current condition of the banking system, while section 4 contains a brief discussion of developments in Turkish capital markets.

1. Monetary developments under the stand-by arrangement

On April 5, 1994, the Turkish authorities announced a macroeconomic adjustment program, for which they requested support from the Fund. A 14-month stand-by arrangement was approved by the Executive Board on July 8, 1994, which was later extended by an additional 6 months at the time of the second program review in April 1995. A fourth program review was scheduled for November 1995 but, with policies deviating sharply from program understandings ahead of unexpected general elections, the review was never completed.

a. The 1994 program

Discussions on the monetary policy component of the adjustment program to be supported by the SBA took place in May 1994, against the background of financial crisis. The lira had depreciated by almost 60 percent during the first four months of the year; foreign exchange reserves had been halved (Table A30); and overnight interest rates had reached five-digit levels on a number of occasions, reflecting intense pressure on the lira (Table A31). A key factor contributing to monetary instability had been heavy direct Treasury borrowing from the central bank (CBT), equivalent to some 10 percent of GNP during the first quarter; the Treasury had effectively suspended its borrowing from domestic financial markets in late-1993, instead relying on CBT funding to finance a widening budget deficit.

Table A30.

Turkey: Foreign Reserves of the Banking System

(In millions of U.S. dollars: end of period)

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Source: Central Bank of Turkey.

Gold is valued throughout at US$369.1 per ounce.

Table A31.

Turkey: Selected Interest Rates

(Compounded, percent)

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Sources: Central Bank of Turkey and Fund staff estimates.

Gaps indicate that no auctions for Treasury bills were held in the month in question.

The monetary policy stance agreed under the SBA sought early stabilization of the lira that would set the stage for low inflation during the second half of the year. 1/ Once initial stabilization had been achieved, monetary policy was to prevent the lira from depreciating below an agreed nominal path, set in line with program inflation objectives on the assumption that the real exchange rate would remain substantially unchanged from April 1994 levels. A quantitative financial program set limits on the net domestic assets (NDA) of the CBT and floors on CBT net international reserves (NIR) that were to be performance criteria under the SBA: this program was predicated on the assumptions of (i) partial recovery in real money balances through end-year, (ii) a marginal reduction in the level of currency substitution as the year proceeded, and (iii) a partial rebuilding of the depleted stock of foreign reserves (Chart 5). To free up interest rate policy to pursue the exchange rate objective, the Treasury was to cut back sharply its direct borrowing from the CBT, and instead resume borrowing in domestic financial markets at market-determined interest rates.

CHART 5
CHART 5

TURKEY: MONETARY DEVELOPMENTS, 1993-96

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Sources: Data provided by the Turkish authorities and staff estimates.1/ Excluding deposits of the Turkish Defense Fund.Note: M2=Brood money excluding FX deposits. M2X=Broad money including FX deposits.

Announcement of the April 5 stabilization program did little initially to quell market uncertainties. Instead, concerns about the financial integrity of the banking system and the commitment of the authorities to maintaining the liberal policy regime governing residents’ FX deposits were reflected in heavy withdrawals of FX deposits, a process contributing to, and then enhanced by, the failure of three banks during the second half of April. 2/ Key policy actions were taken which brought the situation under control during May. These included the resumption of market-based borrowing by the Treasury, initially at interest rates of as much as 50 percent per quarter; the expansion of the pre-existing deposit insurance system to cover all household deposits with the banking system; and the early success of the fiscal adjustment component of the April 5 measures, as reflected in a second quarter budget surplus. The lira stabilized during May and then appreciated modestly in June and July, leaving it some 13 percent above the program floor (Chart 6). 1/ Further bank failures were avoided, and an emergency credit facility made available by the CBT to banks in need of liquidity soon became redundant.

CHART 6
CHART 6

TURKEY: EXCHANGE RATE DEVELOPMENTS, 1994-95

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Data provided by the Turkish authorities.1/ Basket of 1 US dollar and 1.5 deutsche marks.

Reviving public confidence in the lira and in the domestic banking system resulted in a strong recovery in money stocks, as the capital flight during the crisis period was reversed; in sizable reverse currency substitution, as deposit-holders responded to high interest rates on lira deposits; and in a rapid rebuilding of foreign reserves to near pre-crisis levels. As a result, the growth of broad money (M2X) during the summer months was more than twice the programmed level, while lira broad money (M2) increased at an even faster pace, notwithstanding some efforts at sterilization by the CBT and net repayment of CBT advances by the Treasury (Table A32). 2/ Foreign reserves were soon well above the agreed program floors, while NDA was significantly below program ceilings (Chart 7). 3/

Table A32.

Turkey: Monetary Growth and Price Developments, 1992–96

(Quarterly percentage increase)

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Sources: Central Bank of Turkey and Fund staff estimates.

Currency basket containing US$1 and DM 1.5.

M2X equals M2 plus residents’ FX deposits.

As defined in the monetary survey: see Table A30.

Measured in U.S. dollars.

CHART 7
CHART 7

TURKEY: PRICES AND FOREIGN RESERVES, 1993-95

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Sources: Data provided by the Turkish authorities; and staff estimates.1/ WPI-based definition.2/ Program definition; constant cross ratios.

A significant break in these trends was recorded from late-July onward as eroding public confidence in the Government’s commitment to the adjustment effort was reflected in resumed currency substitution (Chart 8). The Government’s high profile privatization program was derailed by a Constitutional Court decision in early July; implementation of enterprise closures and other politically difficult reform measures promised in the April 5 program also failed to materialize. In late August, renewed speculative pressures on the lira, in part reflecting concerns about how the Treasury would handle large debt repayments falling due, contributed to an 8 percent drop in the value of the lira over a four-week period, at a time when inflation was programmed to be less than 2 percent per month. The CBT’s unwillingness to defend the lira through interest rate tightening reflected a reluctance to interrupt the ongoing decline in nominal interest rates at a time when the lira was well above the agreed program floor. However, the unexpected drop in the value of the lira, while not in conflict with the quantitative limits agreed under the program, provided a sizable inflationary stimulus and reinforced the incentive for depositors to shift back to FX-denominated assets. In ensuing months, currency substitution continued, while M2 and reserve money growth slowed to a near standstill until the final weeks of the year. Broad money (M2X) growth also slowed during the final quarter, in part reflecting the weakness of economic activity, but remained significantly higher than programmed through end-year.

CHART 8
CHART 8

TURKEY: SELECTED MONETARY INDICATORS, 1993-1996

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Sources: IMF. International Financial Statistics; Turkish authorities and staff estimates.1/ Excludes deposits of Turkish Defense Fund.

Inflation performance under the program was disappointing, notwithstanding early success in the June-August period when inflation was less than 2 percent per month–normally months of low price increases. By contrast, prices rose sharply from September onward, with inflation averaging some 7 percent during the last four months of the year. Factors suggested as having contributed significantly to the resurgence of inflation include delayed adjustment of domestic prices of tradables to the large currency depreciation of the first four months, lagged adjustment of prices to the rapid monetary growth during the summer, the accelerated depreciation of the lira in August-September, and inflation inertia, linked in part to the erosion of program credibility as reform commitments remained unimplemented.

In hindsight, the path adopted for the nominal exchange rate floor proved to be overly depreciated given program inflation objectives. This failing would have been of lesser import if the CBT had sought to maintain a pace of lira depreciation in line with program inflation targets once the lira had stabilized in June-July; instead, the preoccupation with lowering interest rates contributed to an ill-timed de facto devaluation in late August that changed expectations and facilitated the resurgence in inflation. In addition, the quantitative financial program, predicated on conservative assumptions about money demand, was overtaken by the reversal of earlier capital flight and currency substitution, resulting in rapid monetary growth fuelled by a reserve buildup.

b. The 1995 program

The macroeconomic program for 1995 aimed at achieving sharp disinflation over the course of the year. Key elements of the disinflation strategy were to include (i) tight limits on the pace of exchange rate depreciation, which would provide a form of nominal anchor for the program, and (ii) a reinvigorated structural reform drive that would underpin the sustainability of the fiscal adjustment effort over the medium term and enhance program credibility. The monetary policy framework adopted was similar to that of the previous year, but with an additional constraint: monetary policy was to be managed so as to prevent exchange rate depreciation at a pace significantly in excess of the targeted monthly rate of inflation, regardless of the position of the exchange rate vis-à-vis the program floor.1/

The quantitative financial program was similar in outline to that of 1994, specifying limits on central bank NDA and a floor on foreign reserves. The program was predicated on the assumptions of (i) no change in real money balances (M2X) over the course of the year, 1/ (ii) modest and gradual reverse currency substitution as the year proceeded, and (iii) a small increase in foreign reserves of some US$0.6 billion over the year. Interest rates were expected to decline gradually as program credibility improved. Program expectations for the balance of payments envisaged a small net short-term capital inflow, following the large net outflows recorded during 1994. Given the uncertainties on the external front, a revision of the financial program was called for if foreign reserve accumulation proved to be markedly in excess of program targets.

In the event, continued high, albeit declining, interest rates (Table A35 and Chart 9), under conditions where the pace of exchange rate depreciation was to fall sharply, resulted in large short-term capital inflows and an associated buildup of foreign reserves. 2/ There was significant reverse currency substitution, as depositors shifted back into lira-denominated deposits, while private sector credit demand increased sharply from the second quarter onward, both reflecting and contributing to the rapid growth in economic activity. Under these circumstances, the CBT sought to limit upward pressure on the lira by heavy buying of foreign exchange while acting to modify the accompanying monetary expansion through open market operations (mainly reverse repos); 3/ by end-June, the CBT had purchased some US$3.5 billion worth of foreign exchange while accumulating TL 113 trillion (US$2.6 billion, some 40 percent of reserve money) in outstanding repurchase commitments (Table A36). Despite these sterilization efforts, money stocks rose sharply, with M2X and M2 increasing by some 37 percent and 52 percent, respectively, during the first six months, compared with programmed rates of 22 percent and 20 percent. The lira continued to depreciate during this period, but at a pace below target inflation and the value of the lira was some 3 percent above the program floor by June. Surging money growth had little immediate effect on inflation, which declined sharply during the second quarter, aided by the relative stability of the lira and favorable seasonal effects; nevertheless, cumulative inflation for the first six months was some 32 percent, 7 percentage points above the program target.

Table A33.

Turkey: Monetary Survey 1990–95

(In trillions of Turkish liras: end of period)

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Source: Central Bank of Turkey.
Table A34.

Turkey: The Growth of Reserve Money, 1994–96

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Sources: Central Bank of Turkey; and Fund staff estimates.

Estimates adjusted for the effects of securitizations and debt consolidations.

Estimates adjusted for valuation effects and securitizations of the devaluation account.

Percent of the increase in reserve money.

Obligations to repurchase securities less obligations to resell securities and foreign exchange, expressed as a percentage of the current stock of reserve money.

Table A35.

Turkey: Pre-and Post-Tax Interest Rates on Deposits at Commercial Banks 1/

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

Weighted average interest rate quoted by 53 banks.

Deposit rates quoted by Turkish banks are annualized through simple multiplication.

Annualized rate of return, adjusted for compounding and withholding tax.

Period average.

CHART 9
CHART 9

TURKEY: SELECTED INTEREST RATES, JULY 1994-MAY 1996

(Percent; Annualized)

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.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+l.2/ Estimates given for February 1995, September 1995, and April 1996 are for 6-month paper.
Table A36.

Turkey: Balance Sheet of the Central Bank of Turkey, 1991–96

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Source: Central Bank of Turkey.

Given the strength of money growth during the first half of the year, the authorities agreed on a recalibration of the monetary policy stance during the discussions for the third program review, held in June-July 1995. 1/ Monetary policy was to be tightened, with the monthly limits on the pace of exchange rate depreciation to be augmented with limits on reserve money growth. 2/ Any further pressure from capital flows (which were viewed as transitory and likely to reverse themselves) would be reflected either in further appreciation vis-à-vis the program floors or intensified sterilization efforts.

Policy implementation deviated sharply from these understandings during July and August. Unsterilized reserve purchases were deployed to ease liquidity conditions and accelerate the pace of exchange rate depreciation, which averaged 3,1 percent a month in these two months against a program limit of 1.6 percent. With further reserve accumulation and a significant unwinding of the CBT’s reverse repo position, the stock of reserve money increased by almost 10 percent during the two months, against an indicative limit of 2 percent growth.

The policy stance was tightened again in late August, as the CBT sought to bring reserve money growth more closely into line with program targets. Heavy sales of government paper by the CBT (amounting to some US$1.4 billion between August 28 and September 8) were followed by temporary suspension of the surrender requirements applied on export proceeds. 3/ The liquidity tightening was immediately reflected in higher overnight interest rates and some nominal exchange rate appreciation. However, the unexpected fall of the Government on September 20 triggered another policy switch: liquidity conditions were eased, foreign exchange purchases by the CBT resumed, and the lira depreciated by some 4.5 percent through end-month. In the ensuing weeks, the pace of exchange rate depreciation was sharply increased, money and credit growth accelerated, and economic agents sought to move out of lira assets, eventually triggering a new run on the lira (see below).

Monetary growth (M2X) for the third quarter as a whole was 16.8 percent, compared with a program target of 6 percent, with reserve money increasing by 12.8 percent. Inflation performance continued to be disappointing, with the WPI increasing by some 10.4 percent, double the program objective of 5 percent; by September, cumulative wholesale price inflation for the year was 45 percent, 14 percentage points higher than programmed. 1/

Failure to achieve program inflation objectives can be attributed to a number of factors. The government’s inability to implement key structural reforms again, in 1994, undermined the credibility of the disinflation program. Shifts in monetary policy implementation, which deviated significantly from program understandings from July onward, produced ill-timed exchange rate depreciation during the summer months and signaled the Central Bank’s willingness to revert to its traditional accommodative policy stance. But the central role of capital inflows in fueling rapid monetary expansion and facilitating a broad-based surge in domestic demand also highlights key problems in program design. The unanticipated resurgence of capital inflows had yielded an increase in central bank NIR of some US$6.7 billion in the first three quarters of 1996. In these circumstances, attainment of program objectives required a fiscal stance significantly tighter than programmed if demand pressures were to be adequately restrained.

2. Monetary developments during the interregnum

The fall of the coalition government in late September 1995 initiated a period of political uncertainty, but efforts to form a new coalition continued through October. Initial market reaction was relatively muted: interest rates, already perturbed by the unexpected monetary tightening in September, rose by some 10-15 percentage points, in part reflecting the accelerated pace of exchange rate depreciation, while new issues of government paper were confined to maturities of not more than six months.2/ But capital inflows continued, albeit at a more moderate rate, and the CBT continued to add to its reserves through early November (Chart 10).

CHART 10
CHART 10

TURKEY: EXCHANGE MARKET DEVELOPMENTS OCTOBER 1995 - AUGUST 1996

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Data provided by the Turkish authorities.1/ Basket of 1 US dollar and 1.5 Deutsche Marks.

When the efforts to form a new government proved unsuccessful, it was announced in late October that elections would take place on December 24, 1996. Also, sizable unscheduled pay increases were awarded to civil servants and pensioners in mid-November, weakening the budgetary stance. Against this background, investor concerns about the immediate outlook were reflected in large capital outflows and a sizable drop in central bank reserves through end-year as the CBT sought to maintain a steady pace of depreciation of the lira in the currency market (at a monthly rate of some 6 percent) without raising short-term interest rates. In the six-week period from mid-November through end-December, CBT NIR declined by some US$4 billion, while its net domestic asset position increased commensurately (Chart 11).

CHART 11
CHART 11

TURKEY: CENTRAL BANK BALANCE SHEET OCTOBER 1995 - MARCH 1996

(TL trillion)

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Data provided by the Turkish authorities.1/ Five-day moving average.

On November 27, 1995, the CBT announced the introduction of a new forward exchange market to provide an additional tool through which to manage the exchange rate under unusually turbulent conditions.1/ The CBT indicated its willingness to sell FX forward at six different maturities, varying from 6-50 days, and quoted prices for these transactions consistent with its policy of gradual daily depreciation of the lira vis-à-vis the currency basket. At the same time, the CBT attempted to curb interest rates by maintaining an offer rate of 100 percent (170 percent compounded) in the overnight interbank market; banks borrowed heavily under this facility and the stock of CBT lending in the interbank market rose rapidly, exceeding 10 percent of reserve money by the election date. Despite this policy, the Treasury encountered increasing difficulties in selling new government paper: interest rates rose from 140 percent on November 24 to 185 percent immediately prior to the election, maturities shortened to three months or less, and sale volumes declined, forcing the Treasury to rely heavily on CBT advances to meet its financing needs.

As the central bank focused on managing the exchange rate during the final months of the year, the monetary aggregates expanded at an exceptionally rapid pace: M2X rose by some 27 percent during the final quarter, while the stock of domestic credit to the private sector rose by some 40 percent. Unsurprisingly, currency substitution increased significantly: the share of FX deposits in M2X rose from 40 percent to 46 percent, reversing the decline recorded during the first three quarters of the year.

The election results were generally interpreted to imply an extended period of political uncertainty while negotiations on the formation of a coalition government proceeded. Market unease was heightened by concerns that the Treasury would rapidly increase its borrowing from the CBT once the legal limit on advances was increased with the advent of a new fiscal year on January 1, derailing CBT efforts to defend the exchange rate in a repeat of the first quarter 1994 experience. 1/ Against this background, pressures on the lira intensified, triggering a drop of some 6.5 percent during December 25-27 and pushing the lira well off the trajectory to which the CBT was committed, despite further CBT sales in the spot and forward markets.

On December 28, the CBT suspended its overnight lending to banks, triggering a jump in overnight rates to some 500 percent (Chart 12). With the overnight window shut off, banks were forced to sell foreign exchange, yielding an immediate 2 percent appreciation of the lira on December 28-29. In the ensuing days, the Treasury offered 100-day paper direct to the public at a compounded rate of some 240 percent and the CBT held auctions of government securities in its own portfolio to tighten liquidity; by mid-month, the Treasury had raised a further US$2 billion in auctions of 3-and 4-month paper by paying interest rates of some 225 percent. This coordinated intervention by the CBT and the Treasury facilitated early recovery of the value of the lira to levels in line with the pre-election trajectory for the currency, while establishing the intention of the authorities to maintain unchanged the policies of gradual lira depreciation and market-based financing of the Treasury’s cash needs. With short-term capital inflows reviving in response to the high yield on government securities, CBT reserves began to recover from their end-year trough: NIR rose by some US$1 billion during the first five weeks of the year, even as the CBT sold reserves to unwind its forward commitments.

CHART 12
CHART 12

TURKEY: INTEREST RATE DEVELOPMENTS OCTOBER 1995 - MARCH 1996

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Data provided by the Turkish authorities.1/ Five-day moving average; compounded.2/ Includes irregular maturities of length close to 3 months; compounded.

From mid-January onward, interest rates on government paper began to decline and the Treasury had increasing success at lengthening maturities on new sales to five months and six months. By early March 1996, with the formation of a new government, interest rates on 3-month T-bills had declined to around 130 percent, and were to fall further in April and May until new political shocks reversed this favorable trajectory. Foreign reserves continued to increase, reflecting continued short-term capital inflows attracted by interest rates that, though falling, remained strongly positive in real terms; by end-June, CBT NIR had increased by some US$3.9 billion from end-1995 levels. However, the fiscal cost of the high interest rates added substantially to an interest burden that already accounted for more than half of budgetary revenues.

The pace of growth of the monetary aggregates eased substantially during the first quarter of 1996, in part reflecting seasonal trends. Broad money (M2X) and lira broad money (M2) expanded by some 12-13 percent, compared with a contemporaneous increase of some 24 percent in wholesale prices; reserve money increased by some 11 percent, with purchases of FX by the CBT more than accounting for the increase in reserve money. The scale of currency substitution showed little movement over the course of the quarter, suggesting that the shift back into lira-denominated assets during the first months of the year was more narrowly based than in previous periods.

3. Structure and conditions of commercial banks

a. Structure

Turkey’s commercial banking system consists of 68 banks–55 deposit money banks (5 state-owned, 19 foreign-owned and the remainder privately owned) and 13 investment and development banks (3 state-owned and 3 foreign-owned) (Table A37).1/ Banks operating in Turkey are universal banks, authorized to engage in virtually all types of financial activities, including underwriting and trading of securities, and managing mutual funds. Investment and development banks do not take deposits, rely heavily on borrowed funds (71 percent of total liabilities in 1995), and manage a small share of total bank assets (less than 8 percent).

Table A37.

Turkey: General Information on Banks

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Sources: Data provided by Turkish authorities.

State banks (SBs) continue to play a central role, accounting for 44 percent of total bank assets at end-1995, down from 47 percent a year before (Table A38). SBs are typically much larger in size than private banks as regards capital, branch network and employment. They undertake sizable preferential lending, acting as agents of government policy in selected sectors of the economy: agriculture (Ziraat Bank), housing and property development (Emlak Bank), and small business activities (Halk Bank). At end-1995, preferential lending (i.e., at below-market interest rates) represented 56 percent of total SBs’ loans, against ¼ of 1 percent for private banks. For Ziraat Bank, the largest bank in Turkey, preferential lending represented 81 percent of its total loan portfolio in 1994, according to its latest annual report. In May 1996, Ziraat’s preferential lending rates ranged from 43-55 percent per annum, depending on the type and maturity of loans, while the typical nonsubsidized interest rate (on 3-month Treasury paper, as bank lending rates are not available) was 115 percent on an annual basis.

Table A38.

Turkey: Distribution of Bank Assets

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Source: Data provided by the Turkish authorities.

Reflecting the practice of capitalizing interest and periodically writing off outstanding loans, in early 1996 most outstanding credits to agricultural sale cooperatives were replaced in the balance sheet of Ziraat Bank with Treasury bonds (TL 138 trillion). Also in early 1996, losses associated with subsidized lending at Halk Bank involved also the placement of Treasury securities in the balance sheet (TL 20 trillion). Similar operations took place in May 1996, bringing the total placement of Treasury securities in state bank portfolios to TL 178 trillion (2.3 percent of 1995 GNP) in 1996 (see also Chapter II).

Private banks’ market share is about half of total bank assets (51 percent at end-1995). Most private national banks (29 out of 31 commercial banks) are owned by families and/or industrial groups, as the legal framework in Turkey does not call for a separation of banking and nonbanking enterprises. The widespread cross-ownership of private banks with industrial conglomerates complicates the task of prudential supervision, because of the additional risk of pressures on bank management to allocate credit to related parties regardless of creditworthiness considerations.

Foreign banks manage about 4 percent of bank assets and deposits at end-1995. Their relatively modest role in retail banking has remained virtually unchanged since the mid-1980s. Foreign banks do not compete with domestic banks in the full range of banking activities, but instead specialize in foreign-trade related operations.

Despite the still dominant presence of large state banks and the modest role of foreign banks, the decline in concentration ratios during the last ten years (Table A39) indicates increasing competition as a result of new private bank entry following the financial sector reforms introduced in the 1980s. The decline in concentration ratios was temporarily interrupted in 1994, as a run on bank deposits culminated in April 1994 with the closure of three small/mid-size banks. The run on deposits halted with the government decision to provide 100 percent guarantee to all household deposits with domestic banks. The full backing of deposits remains in place, despite widespread recognition of the associated moral hazard problems and distortionary effects on bank competition.

Table A39.

Turkey: Concentration Ratios for Deposit Money Banks

(Shares in percent)

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Source: The Banks Association of Turkey.

At end-1995, three of the largest five banks (Ziraat Bank, Halk Bank, and Emlak Bank), and four of the largest ten banks (the previous three and Vakiflar Bank) were state-owned.

b. Financial conditions of commercial banks

Private banks as a whole are typically better capitalized, more profitable and with a lower incidence of reported nonperforming assets than state banks. In 1995, the rebound of economic activity and high returns on holdings of government securities helped to strengthen bank balance sheets. However, their net open position in foreign currency, which had been drastically reduced in 1994, increased again. A definitive assessment on the quality of bank assets is not possible because the information made available by the Turkish authorities is based on unaudited bank reports, which may under-report nonperforming assets (see below).1/ Some small and medium-size private banks (accounting for about 12 percent of total commercial bank assets) are undercapitalized, suffer from poor asset quality and excessive lending to related parties, and are currently subject to enhanced monitoring by the supervisory authorities.

Standard indicators of capital adequacy on a risk-weighted basis point to a significant improvement in 1995. The aggregate ratio for all commercial banks increased to 12.6 percent, from 1994 average levels below the minimum 8 percent threshold recommended by the Basel agreement, and required by prudential regulations introduced in Turkey in February 1995 (Table A40). In gauging the improvement, it should be kept in mind that volatile macroeconomic and financial conditions, such as those prevailing in Turkey, argue for holding capital substantially in excess of the 8 percent minimum threshold, to reduce the risk of undercapitalization in the event of destabilizing shocks.

Table A40.

Turkey: Commercial Banking System Capital/Asset Ratios 1/

(In percent)

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Source: Data provided by the Turkish authorities.

The capital asset ratio is measured at end-of-period, and defined as the ratio of the capital base over risk-weighted assets, non-cash credits and obligations, in conformity with the Banking Law No. 3182 (Decree No. 12, February 9, 1995).

There are wide disparities in capital adequacy across different groups of banks. State investment banks remain below minimum capitalization, while state deposit money banks, although marginally above the 8 percent minimum, have not improved their levels of capitalization because of lower-than-average profitability (Table A38). Although individual banks’ capital-asset ratios are not available, several private and foreign banks in 1995 had nominal capital equivalent to only a fraction of the minimum level (TL 1 trillion) required to open a new bank by reforms introduced in June 1994.

Measured profitability improved in 1995 (Table A41), after a sizable deterioration in 1994 due to the effects of exchange rate depreciation on a large net open position in foreign currency. Within the aggregate, state banks recorded the lowest profitability ratios, and only a modest improvement on 1994 levels. The main factors behind improved profitability in 1995 were the impact of the rebound in activity in reducing loan servicing problems; high interest spreads; low remuneration of sight deposits (typically, 5 percent per annum on TL-denominated deposits, and zero for foreign currency deposits) ; and high yields on holdings of government securities.

Table A41.

Turkey: Bank Profitability Indicators

(In percent) 1/

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Source: Data provided by the Turkish authorities.

After tax profits and losses in percent of average stocks of equity or assets at beginning-and end-year. Branches abroad are excluded.

Includes both investment/development banks and deposit money banks.

Asset quality is difficult to assess on the basis of information made available to the mission. Reported nonperforming loans at end-1995 were relatively low–TL 47.2 trillion on a gross basis (equivalent to 1.2 percent of bank assets and 2.9 percent of total loans), and TL 21.4 trillion net of loan-loss provisions (0.5 percent of bank assets). Nonperforming loans were unevenly distributed, concentrated mainly in state banks and investment banks (Table A42). In mid-1994, about two thirds of past-due loans were concentrated in the agricultural sector, and in food, beverages and tobacco activities.

Table A42.

Turkey: Nonperforming Loans and Selected Assets in Bank Portfolios

(In percent of total assets) 1/

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Source: Data provided by the Turkish authorities.

Branches abroad are excluded.

Banking regulations in Turkey require banks to provision for past-due loans for the equivalent of 25 percent of the outstanding past-due amount every 6 months (i.e., 100 percent in two years). In principle, whenever a loan service delay occurs, regulations require a 30-day period to initiate administrative procedures, and another 30-day period to initiate legal procedures. After 60 days, the loan is considered nonperforming. These regulations conform to international standards, which normally require monitoring of past-due loans from 30 days onward.

Several commentators have noted a lack of transparency and frequent under-reporting of nonperforming loans by banks. 1/ The OECD (1996) attributes under-reporting of nonperforming assets to lack of deductibility of loan losses for tax purposes unless the loan is already at the stage of legal follow-up. The issue is complicated by accounting practices in state banks, for instance the capitalization of deist service on technically past-due loans, and by “captive lending” practices in private banks as a result of cross-ownership links with industrial conglomerates. Limits on credits extended to related parties, which were tightened in June 1994, remain well in excess of international standards. Credits to shareholders since 1994 cannot exceed 50 percent of a bank’s net worth (down from 100 percent), and credit to related parties cannot exceed 200 percent of a bank’s net worth (down from 300 percent). By comparison, EU prudential practices allow less than 20 percent lending to related enterprises, and U.S. practices involve lending of less than 15 percent of total capital to each and 100 percent to all related parties.

The net liability position in foreign currency widened in 1995 after a sharp reduction in 1994 (Table A43). This renewed widening took place despite sizable losses recorded in 1994 as a result of the impact of a large exchange rate depreciation early in the year on a net open position that at the end of 1993 was close to 180 percent of paid-in capital. The aggregate net open position in foreign currency of commercial banks was reduced to US$1 billion at end-1994 (55 percent of paid-in capital) but rose again to US$1.5 billion at end-1995 (68 percent of paid-in capital). For two of the largest state banks, the net open position at end-1995 was the equivalent of 51 and 44 percent of equity (including paid-in capital, reserves and revaluation funds). New prudential regulations were introduced in February 1995 to limit banks’ exposure to foreign exchange risk in terms of the capital base, with a transition period to last until March 1996. Despite the change in regulations, according to central bank estimates the net open position of commercial banks rose by a further US$1 billion from end-December 1995 to mid-May 1996.

Table A43.

Turkey: Net Open Position of Commercial Banks 1/

(In million U.S. dollars)

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Source: Data provided by the Turkish authorities.

The net open position is defined as (total asset + forward purchases) - (total liabilities + forward sales) in foreign currency valued at end-period central bank buying exchange rates. Exchange indexed transactions are not included. FX exposure risk ratio related to the capital base started as of April 1995.

c. Recent changes in regulation and prudential supervision

Following the mini-crisis in early 1994, legislative reforms were introduced in June 1994, which involved: (1) an increase in the minimum paid-up capital required to open a bank (to TL 1 trillion); (2) a tightening of limits on credits extended to related parties, equity participation in nonfinancial institutions and real estate investments; (3) stronger public disclosure requirements and; (4) tighter control procedures for credits in excess of TL 10 billion. No changes have been made to the banking law since end-1994.

Additional regulations were introduced in February 1995, that changed the definition of capital/asset ratios in terms of risk-weighted assets, in conformity with international standards, and limited the net open position in foreign currency a bank may hold to no more than 50 percent of its capital base. Banks not in compliance were allowed a transition period through end-March 1996 to restructure their balance sheet. The new limits exceed EU standards, which range from 20-40 percent. The OECD reports that for the purpose of this limit, exchange rate-indexed assets and liabilities carry a 50 percent weight and that five investment banks–three of which state-owned–are exempted from this regulation.

d. Reserve and liquidity requirements

Banks in Turkey are subject to both reserve and liquidity requirements on their deposit and nondeposit liabilities. Following a major reform in April 1994, these requirements have been modified only marginally since then, and remained as described in SM/95/69, Appendix IV.1/ By requiring banks to hold unremunerated reserves at the CBT, and to hold a set fraction of their liabilities in indexed government securities, these regulations impose costs on the banks that act as a tax on financial intermediation, reflected in a wider spread between borrowing and lending rates. CBT estimates indicate that these requirements added, on average, some 11 percentage points to the overall cost of deposits to the banks during January-May 1996: adjusted for these costs, the average cost of deposits was increased from 94.8 percent (the rate paid to depositors) to 106 percent. Explicit taxes on borrowing (revenues from which are used to finance interest subsidies through an extrabudgetary fund) and transactions taxes are estimated by the CBT to have added a further 13 percentage points to the cost to borrowers. Implicit and explicit taxes jointly account for almost two-thirds of the estimated 39 percentage point spread between deposit and commercial borrowing rates. 2/

4. Recent developments in Turkish capital markets

The legal framework for capital markets in Turkey was laid out in the 1981 Capital Market Law, most recently amended in 1992. The Capital Market Board (CMB) was established in 1982, and given authority to regulate primary and secondary markets in securities, supervise securities intermediaries and mutual funds, and approve all public offerings of securities (other than government paper). Regulations governing the operation of the Istanbul Stock Exchange (ISE) were approved by the CMB in December 1985, and the ISE, in its current form, commenced operations in 1986. Measures to strengthen the powers of the CMB and bring regulatory structures more closely into line with EU practice were incorporated in a Decree Law issued in June 1995, but this law was annulled on procedural grounds by the Constitutional Court in November.

Effective liberalization of capital account transactions in 1989, opening securities markets to foreign investors, provided a major boost to the development of the capital markets. New securities issues registered with the CMB more than doubled (in U.S. dollar terms) in 1990, as did trading volumes in secondary markets, setting the stage for rapid, if unsteady, growth in ensuing years (Chart 13). The number of companies whose shares are actively traded in the ISE has doubled since 1989, reaching 198 at end-1995, while total market capitalization (in U.S. dollar terms) has trebled over the same period, reaching US$21.2 billion at end-1995. Stock price indices (in U.S. dollar terms) have shown large year-to-year fluctuations, generating correspondingly large changes in market capitalization measures.

CHART 13
CHART 13

TURKEY: SECURITIES MARKETS: SELECTED INDICATORS, 1987-95

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Capitol Market Board.1/ End-year index converted into US dollars.2/ End-year stocks converted into US dollars.

The development of markets in private securities, especially debt instruments, has been impeded by the heavy financing need of the public sector in recent years. Government paper (mainly T-bills) accounted for nine-tenths of new issues of securities during 1994-95; for seven-eights of all trading in secondary markets during this period; and for some 95 percent of the outstanding stock of debt instruments at end-1995 (Table A44). The stock of government securities was equivalent to 48 percent of broad money (M2X) at end-1995, up from 26 percent at end-1991, and had reached some 60 percent of broad money as of end-June 1996. Given the dominant role of government paper in the financial markets, markets for corporate debt instruments remain underdeveloped, forcing companies to rely heavily on bank finance for their funding needs.

Table A44.

Turkey: Capital Markets: Selected Indicators, 1989–1995

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Source: Capital Markets Board and Fund staff estimates.

New private securities registered with the CMB amounted to some US$3.8 billion in 1995, up by one-third from the depressed levels of 1994, but still well below the estimated US$6.6 billion recorded in 1993. A feature of new issues in recent years has been the rapid growth of asset-backed securities (ABS), explained in part by banks’ efforts to avoid the costs of reserve requirements on deposits by exploiting new funding sources. The expansion of reserve requirements to include nondeposit liabilities in April 1994, coupled with the impact of economic contraction, resulted in a sharp decline in ABS issues during 1994, but economic recovery in 1995 saw a significant rebound in new issues. New equity issues held up quite well through the 1994 recession, but new issues of private debt instruments (other than ABS) fell sharply in 1994 and remained at depressed levels during 1995.

Issues of government securities, mainly T-bills, have increased rapidly in recent years, reaching a new peak (in U.S. dollar terms) of some US$37 billion during 1995. Given the heavy net borrowing levels required to finance fiscal deficits (see Chapter II), the outstanding stock of government securities more than doubled during 1992-93 and, following a decline during 1994, resumed its growth during 1995, reaching some US$20.2 billion at end-1995. With heavy domestic borrowing by the Treasury in the first half of 1996, the stock increased further to some US$25.6 billion at end-June 1996.

Stock prices (measured by the ISE composite index converted into dollars) declined sharply during the financial crisis in 1994, with the index falling by some 50 percent over the course of the year (Chart 14). Much of this decline represented a correction of the rapid growth recorded in 1993, during which the index had more than trebled. During 1995, stock prices showed little movement in January-February, then surged in March and April and reaching a peak at end-July with the index up some 64 percent from end-1994 levels. Changing market sentiment, adversely impacted by monetary shocks in August-September and increased political uncertainty, saw a partial reversal of these gains through end-October, followed by a drop of one-third during the financial turmoil in November-December. At end-year, the index was some 5 percent below its level at end-1994. Reviving confidence in the stance of financial policies (discussed above) was reflected in a rebound of the index during the first quarter of 1996, fully reversing the decline recorded during November-December. However, prices eased again with the advent of renewed political uncertainty during the second quarter.

CHART 14
CHART 14

TURKEY: EQUITY PRICE MOVEMENTS, 1992-96

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Capital Markets Board, Monthly Bulletin.1/ ISE composite index converted into US Dollars.

IV. External Sector Developments

Developments in Turkey’s balance of payments during 1995 were dominated by two main interrelated factors: the much stronger-than-expected rebound of economic activity; and the much stronger-than-expected inflow of capital from abroad (US$4.7 billion as against program projections of US$0.2 billion). The latter reflected the rebound of activity, regained access to the international capital market (after mid-1995), and a surge of short-term inflows, taking advantage of interest differentials resulting from the pre-announced exchange rate policy combined with high domestic interest rates that reflected continued heavy borrowing of the public sector in the narrow domestic market. The capital inflow was particularly heavy in the first three quarters, and was followed by a reversal of short-term flows prior to the December 1994 elections.

The combination of these elements resulted in trade and current account deficits that were well in excess of the 1995 program projections–respectively, 7.9 percent and 1.4 percent of GNP, against expectations of 4.1 percent of GNP for the trade deficit and 1 percent of GNP current account surplus. Even so, the surge in net capital inflows contributed to finance a much larger than expected accumulation of foreign exchange reserves, which rose by over US$5 billion, to the equivalent of US$12.4 billion (3.4 months of imports of goods and services) at end-December 1995.

Because of a temporary disruption to the data reporting system associated with the implementation of the Custom Union agreement with the EU, no official data are available on trade and current account developments in 1996. Preliminary import projections based on VAT collection suggest a continuation of the 1995 trends, with first quarter year-on-year import growth estimated at some 38 percent (to about US$9 billion). Provisional trade records from Turkey’s leading Western trade partners also indicate continued buoyancy of imports in the first few months of 1996, which, if confirmed, would be consistent with a further deterioration in the trade balance. Year-on-year first quarter export growth is estimated at 14 percent (to US$5.4 billion), and, according to the Union of Exporters, at 8 percent for the January-May period, with some difficulties for textile products. The continued widening of the trade deficit was helped by access to international capital markets. By end-June 1996, gross international reserves had further increased by over US$3.5 billion, to US$16 billion (about 4 months of imports of goods and services), exceeding the official target for reserve accumulation for the whole year.

1. External current account

Reflecting the fluctuations in domestic activity, the current account balance in Turkey has varied widely in recent years. In 1993, the current account recorded a sizable deficit (US$6.4 billion, or 3.5 percent of GNP (Table A45) due to surging domestic demand, a real effective exchange rate appreciation, and weakness in export markets. This deterioration helped to trigger a foreign exchange crisis in early 1994, and a sharp exchange rate depreciation. A tightening of domestic demand policies, combined with a pickup in external demand, resulted in a major turnaround in the current account to a surplus of US$2.6 billion (2 percent of GNP) in 1994. With the recovery of domestic activity and larger access to external financing the current account swung back into deficit in 1995 (US$2.3 billion or 1.4 percent of GNP), despite increasing inflows from net services and transfers. The deficit is expected to widen further in 1996 on current trends.

Table A45.

Turkey: Balance of Payments

(In millions of U.S. dollars)

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Source: Data provided by the Turkish authorities.

Provisional.

Including US$1, 136 million allocated to the Turkish Defense Fund in 1995.

a. Trade

The Turkish economy became further integrated with the rest of the world in the 1990s, with trade flows (imports plus exports) increasing by over 10 percentage points of GNP (from 22-23 percent in 1990-91 to 34 percent in 1995). The higher degree of openness reflected both enhanced export orientation and greater import intensity. Because of large swings in domestic demand, the trade deficit fluctuated around an average of 5-6 percent of GNP, reaching peaks of some 8 percent of GNP in two years (1993 and 1995) of surging economic activity.

Exports have performed strongly in recent years, rising by almost 10 percent a year in volume terms during 1991-95 with a particularly sharp rise in 1994, in the wake of the depreciation of the Turkish lira and the severe domestic recession. In value terms, however, the performance over the past five years has been less impressive, as unit prices declined by a cumulative 6 percent in 1991-94 before rebounding strongly in 1995 (Table A46). Nevertheless, the combination of rapid volume growth in 1994 and less buoyant volume with a sharp recovery in unit prices in 1995 meant that export earnings rose by close to 20 percent a year during 1994-95.

Table A46.

Turkey: Foreign Trade, Value and Volume

(In millions of U.S. dollars)

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Source: State Planning Organization and State Institute of Statistics.

Excluding transit trade.

Excluding transit trade and nonmonetary gold.

Price indices are estimated by the State Institute of Statistics.

The strong performance of exports in recent years was sustained in part by improved international competitiveness following the sharp depreciation of the Turkish lira in early 1994. In real terms, the depreciation in 1994 amounted to about 20 percent based on WPI-based real exchange rate indices, while unit labor (wage) costs in manufacturing in US dollars declined by some 33 percent (Table A47). The gain in competitiveness was subsequently in part reversed, with a real appreciation ranging from 14-17 percent during 1995 and the first four months of 1996 depending on the real exchange rate index considered. However, as of early-1996 the real exchange rate remained well below the 1992-93 levels, irrespective of the weighting systems and the index, while manufacturing unit wage costs remained virtually constant in 1995 at sharply depreciated levels. The robust recovery of export prices (in U.S. dollar terms) during 1995 (Table A46) combined with flat unit wage costs in the same currency point to increasing margins of export profitability.

Table A47.

Turkey: Real Exchange Rate Indices

(Base 1992=100)

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Source: Data provided by the Turkish authorities.

Based on a basket of nominal exchange rates weighted by 0.75 US$ and 0.25 DM and wholesale price indices.

Based on a basket of nominal exchange rates weighted by 1 US$ and 1.5 DM and wholesale price indices.

Based on nominal exchange rates and wholesale price indices weighted by the shares of U.S., Germany, Belgium, the Netherlands, Switzerland, Italy, the U.K., and Japan in Turkey’s exports.

Based on nominal exchange rates and wholesale price indices weighted by the shares of U.S., Germany, Belgium, the Netherlands, Switzerland, Italy, the U.K., and Japan in Turkey’s imports.

Industrial products increased from 83 percent of total exports in 1992 to 87 percent in 1995, matched by a corresponding reduction in the share of agricultural exports, from 15 to 11 percent. Two thirds of industrial exports consist of processed agricultural products, textiles, and iron and steel. Exports of unprocessed agricultural products and iron and steel products declined in 1995, while most other traditional export categories, notably textiles, petrochemicals, electrical appliances and motor vehicles, all posted large gains (Table A48).

Table A48.

Turkey: Commodity Composition of Exports 1/

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Source: Data provided by the Turkish authorities.

Exports f.o.b., excluding transit trade.

As to the geographical distribution of exports. OECD countries continued to represent the main market for Turkish exports (61 percent of total in 1995), with EU countries representing 51 percent of total. The Commonwealth of Independent States was confirmed as the new emerging market, accounting for 10 percent of total exports in 1995 (Table A49). In contrast, the weight of Middle Eastern and North African countries declined, from about 18 percent in 1992 to 15 percent in 1995, reflecting lower exports to Iran, Iraq, and, more recently, to Saudi Arabia.

Table A49.

Turkey: Geographical Distribution of Exports

(In millions of U.S. dollars)

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Source: Data provided by the Turkish authorities.

Imports have fluctuated widely in recent years, following closely the wide fluctuations in domestic demand and activity (Table A46). Import unit prices declined by a cumulative 11 percent in 1991-93 before rebounding strongly thereafter. After a sharp contraction in 1994, due to the steep decline in activity and a substantial run down of stocks, imports surged by some 53 percent in nominal terms in 1995, reflecting strong volume growth (31 percent) and a sharp recovery in unit prices (17 percent). The main factors underlying the sharp import growth in 1995 were the surge in domestic demand, particularly the recovery in fixed investment and stocks; the reduction in protection rates in preparation of the Customs Union agreement with the EU; and unusually high agricultural imports due to the impact of unfavorable weather conditions on harvests. The import rise in 1995 was broad-based, and the relative shares of investment goods, consumption goods and raw materials remained virtually unchanged at 29 percent, 12 percent and 58 percent, respectively. The share of industrial products in total imports continued to increase, reaching over 83 percent in 1995, up from 81 percent in 1992 (Table A50).

Table A50.

Turkey: Commodity Composition of Imports 1/

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Source: Data provided by the Turkish authorities.

Imports c.i.f., excluding nonmonetary gold and transit trade.

OECD countries remained the main suppliers of import commodities (two thirds of total imports in 1995, Table A51). About 47 percent of Turkey’s imports come from EU countries, fostered by reductions in tariffs vis-à-vis the EU and export credit facilities provided by many EU countries. No significant changes were recorded in the geographical distribution of imports, except for a sizable increase in the share of the Commonwealth of Independent States. Middle Eastern and North African countries were also significant suppliers (12 percent of total imports), primarily of petroleum and petroleum products, and a similar share of imports continued to come from countries adhering to the North America Free Trade Agreement (NAFTA).

Table A51.

Turkey: Geographical Distribution of Imports

(In millions of U.S. dollars)

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Source: Data provided by the Turkish authorities.

b. Services and transfers

In 1995 the services and income surplus rose to US$6.4 billion, up from US$3.7 billion in 1994 (Table A45). The improvement (by about 1 percentage point of GNP) reflected a sizable gain in net tourism receipts and other unspecified services; and a modest reduction in net interest payments. The transfers balance increased by US$1.4 billion (0.3 percentage points of GNP), fully on account of official transfers. Private transfers (mainly workers remittances) remained unchanged at about 2 percent of GNP.

Net tourism receipts recorded a 1995 surplus of about US$4 billion, up from US$3.5 billion in 1994. Tourism receipts rose by 15 percent, mostly on account of the increase in tourist arrivals. In 1991-95, tourist arrivals increased at an average annual rate of 8.8 percent, compared with 10.6 percent for Greece (in 1991-94) and 4.3 percent for Spain, albeit from a much larger base. In 1995, arrivals reached a new record level (7.7 million) and increased by 16 percent, after a sharp decline in 1993 due to civil disturbances early in the tourism season. Tourist arrivals continued to increase at a rate of 16 percent also in January-May 1996 over the corresponding period of 1995, with a further rise in the share (about half) of relatively high spending visitors from OECD countries. The accelerating growth of arrivals since 1994 suggests that competitiveness conditions in the tourism sector are healthy.

Net interest payments declined from US$3 billion in 1994 to US$2.8 billion in 1995, as larger interest receipts on international reserves were partially offset by higher interest payments on medium-and long-term debt. Net other services improved by about US$1.8 billion, mainly reflecting the increasingly positive performance of net "other services" (from 2.2 percent of GNP in 1992-93 to 5.8 percent in 1995). The Statistical Institute attributes the rapid growth of "other services-credits" in recent years to a possible misclassification of unilateral transfer transactions, while the central bank considers that a large share of such increase may reflect unrecorded exports to neighboring countries and other transactions taking place out of foreign currency denominated accounts. Given the high degree of currency substitution in Turkey, there is a also the risk that resident-to-resident transactions in foreign currency are being improperly recorded as transactions between residents and nonresidents. This is because the estimates used by the authorities in excluding resident-to-resident foreign currency transactions is based on a 1989 survey estimate of foreign currency denominated accounts, and the share of resident-to-resident transactions in foreign currency operations of the banks has probably risen substantially since that time. The Turkish authorities are considering undertaking a new survey of foreign currency accounts to clarify the nature of the transactions.

CHART 15
CHART 15

TURKEY: REAL EXCHANGE RATE DEVELOPMENTS

(1990=100)

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Data provided by Turkish authorities.

2. Capital account

Turkey’s capital account has fluctuated sharply in recent years, with large net inflows in the early 1990s, followed by a net outflow (excluding net errors and omissions) of 3.2 percent of GNP in 1994, and shifting back to a large net inflow of 2.8 percent of GNP in 1995. The main determinants of the outflows in 1994 were: (1) the loss of government access to international capital markets in the wake of the exchange market crisis in early 1994 and the downgrading of Turkey’s credit rating1/; (2) substantial repayments of short-term foreign loans by commercial banks; and (3) the reduction in trade credits, relative to the decline in imports, and outflows of short-term capital. Turkey had no issues of sovereign bonds for almost one year starting from the second quarter of 1994, while continuing to service sizable scheduled repayments of medium-and long-term debt (some US$6 billion).

The surge in inflows in 1995 reflected a turnaround of commercial bank borrowing and short-term nonbank borrowing, a sharp increase in import financing, and a gradual regaining of public and private sector access to international markets for sovereign bonds and medium-and long-term syndicated loans. Equity placements as a result of privatization were lower than envisaged in the 1995 program. 2/ Overall, the inflow exceeded by about US$4.5 billion the external financing envisaged in the 1995 program. The inflows were particularly strong during the first three quarters of 1995, as risk perceptions associated with political uncertainty led to short-term outflows in the run up to the December political elections.

Direct foreign investment and portfolio investment in equity securities remained virtually unchanged, respectively at ½ and ¾ of 1 percent of GNP. The two components combined increased from US$1.6 billion in 1994 to US$2.1 billion in 1995, but were still below program expectations. About one third of the 1995 net flow of direct investment reflected the acquisition of a cement company in the last quarter of 1995. Direct foreign investment in Turkey remains relatively small, considering the large domestic market, the strategic location vis-à-vis the markets in Europe, the Middle East and transition economies, and Turkey’s access to the EU. Direct foreign investment flows in recent years were in the range of US$0.6-0.8 billion a year (Tables 8 and 9). Although broadly comparable with the flows recorded in Egypt (US$0.5 billion in 1994/95) and Poland (US$0.9 billion in 1995), they were substantially lower than those recorded in Hungary (fluctuating in the range of US$l-2 billion a year, peaking at US$4 billion in 1995 due to large privatizations), Chile (US$3.2 billion in 1994), and Mexico (US$8 billion in 1994, and US$5.5 billion in 1995).

The sharp reversal of short-term capital–from an outflow of about US$5.1 billion in 1994 (US$3.4 including errors and omissions) to an inflow of over US$2.3 billion in 1995 (US$4.6 including errors and omissions)–took place on account of borrowing by commercial banks and the private sector to take advantage of exceptionally high yields in foreign currency terms because of high interest rates on government paper in conditions of modest near-term expected exchange rate changes. The upsurge of trade and foreign exchange borrowing by the nonbank sector (Table A54) also was associated with the output recovery, as creditworthy domestic firms met their credit needs through foreign borrowing. In September 1995, the government attempted to moderate short-term inflows by imposing a 6 percent tax on foreign borrowing by commercial banks. The effectiveness of this tax is difficult to gauge, since it came into effect at a time in which expectations were also being affected by perceptions of increasing risk due to the forthcoming elections.

Table A52.

Turkey: Long-Term Capital Flows

(In millions of U.S. dollars)

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Source: Data provided by the Turkish authorities.
Table A53.

Turkey: Foreign Direct Investment

(In millions of U.S. dollars)

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Source: Data provided by the Turkish authorities.
Table A54.

Turkey: Short-Term Capital Flows

(In millions of U.S. dollars)

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Source: Data provided by the Turkish authorities.

After one year of absence, sovereign bond issues resumed in the second quarter of 1995, and accelerated during the rest of the year to a gross cumulative amount of US$2.3 billion, about four times the program projection (US$650 million). Maturities gradually lengthened: Turkey was able to tap the market for up to three-year maturities until September 1995, when it succeeded in issuing 9 ½-year maturity bonds (US$264 million). In January-May 1996, the Treasury continued to access the Eurobond market (with 10-year and 6-year maturity Yen-denominated paper, 5-year DM-denominated paper and 3-year US$-denominated paper) and the Samurai Japanese domestic market (with 5-year Yen-denominated paper), for a total gross borrowing equivalent to US$1.9 billion. Yield spreads on these issues remained relatively high, albeit declining relative to mid-1994 post-crisis levels. For instance, the spread in Yen-denominated securities (56 percent of total international bond issues in 1996) ranged from 407 basis points for 10-year Eurobond paper to 344 basis point for 5-year Samurai paper. This compares to about 200 basis points paid by Hungary for a 10-year Yen-denominated issue. The higher risk premium reflects Turkey’s lower credit rating, B+ as against BB+ for Hungary, according to S&P. The S&P credit rating for Turkey is in the bottom range for developing country borrowers, as for Jordan, Pakistan and Brazil, albeit above Venezuela (downgraded from B+ to B in February 1996). S&P placed Turkey’s credit rating on review for a possible downgrade in July 1996.

Medium-and long-term syndicated loan commitments, after a six-month hiatus, accelerated sharply after the second quarter of 1995, and in November-December 1995, Turkey was the largest borrower among developing countries in Europe, with US$2 billion commitments for two large utility projects. Long-term credit disbursements greatly exceeded programmed values for state enterprises, private sector and the commercial banks (by about US$2.3 billion), but fell short of program expectations for government loans (by about US$1.3 billion). In addition, the central bank was able to attract considerably larger than projected medium-term funds through the Dresdner facility (US$1,5 billion, almost double the amount expected in the 1995 program, Table A52).1/

Reflecting the sharp turnaround of net capital flows, the overall balance of payments recorded a large surplus in 1995 (US$4.7 billion), and a corresponding accumulation of gross international reserves. During the first nine months, the cumulative surplus reached US$8.3 billion, followed by an overall deficit in the last quarter of about US$3.7 billion in the run up to the December elections.

At end-December 1995, gross official reserves, excluding Turkish Defense Fund (TDF) balances, stood at US$12.7 billion, or the equivalent of 3.4 months of imports of goods and services (Table A55). Excluding outstanding liabilities to the Fund and other short-term liabilities, net international reserves rose from US$7.4 billion in 1994 to US$11 billion in 1995. Taking into account the large stock (US$10.4 billion) of outstanding medium-and long-term liabilities of the CBT (mainly Dresdner facility deposits of Turkish citizens resident abroad), the CBT net foreign assets position shifted from a negative balance (US$1.2 billion) in 1994 to a small positive balance (US$0.5 billion) in 1995.

Table A55.

Turkey: International Reserves

(In millions of U.S. dollars)

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Source: Data provided by the national authorities and IMF, International Financial Statistics.

As reported in IMF, International Financial Statistics.

As reported by the Central Bank of Turkey.

Gold national valuation is valued at the price of U.S. dollar 369.1 per fine ounce.

Excluding letters of credits and other liabilities (US$347 million at end-1994 and US$394 million at end- 1995).

3. External debt

Turkey’s stock of private and public external debt increased from about US$50 billion in 1990-91 to US$73.3 billion in 1995, including cross-currency valuation effects (Table A56). In relation to GNP, total external debt increased from 32-33 percent in 1990-91 to 44 percent in 1995. At end-1995, about 34 percent of total external debt was denominated in U.S. dollars, 35 percent in deutsche marks, 19 percent in Japanese yen and 12 percent in other currencies (Table 13). As regard to the maturity profile, medium-and long-term obligations (13 years on average) accounted for about 80 percent of total external debt (35 percent of GNP), two thirds of which at fixed interest rates. In the last two years, the maturity structure lengthened somewhat, the weight of short-term debt in total debt declining from 27 percent in 1993 to 21 percent in 1995. The ratio of liquid reserves of the central bank to short-term liabilities increased from 34 percent at end-1993 to 79 percent at end-1995.

Table A56.

Turkey: External Debt

(In millions of U.S. dollars: end of period)

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Source: Data provided by the Turkish authorities.

Latest data available.

Including bond issues.

A large proportion of medium-and long-term external debt (87 percent of the total at end-1995) represented public sector obligations, down from 95 percent in 1990. Including short-term obligations of the central bank, largely on account of deposit liabilities under the Dresdner scheme, total public external debt increased from US$39 billion (25 percent of GNP) in 1990 to US$51 billion (31 percent of GNP) in 1995. Private medium-term external debt rose from US$1.8 billion (1.2 percent of GNP) in 1990 to US$7.6 billion (4.6 percent of GNP) in 1995. Short-term debt net of central bank obligations increased in the same period from US$9 billion to US$15 billion, largely on account of nonbank borrowing in form of acceptance credits and export financing.

The external debt service ratio remained in 1995 at the relatively high level of about 29 percent of current account receipts (net of official transfers), slightly down from the average of the previous three years (Table A58). In 1995 there was a sizable increase in medium-and long-term debt repayments (US$7.6 billion, up from US$4.7 billion in 1993), and even higher principal repayments, in the range of US$8-9 billion a year, are officially projected for 1996-98.

Table A57.

Turkey: Term Structure and Currency Composition of External Debt

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Source: Data provided by the Turkish authorities.

Provisional—second quarter.

Table A58.

Turkey: External Debt Service

(In millions of U.S. dollars)

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Source: Data provided by the Turkish authorities.

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

4. Other developments

Turkey completed the 22-year transition to full customs union (CU) with the European Union (EU) on January 1, 1996. The CU covers only industrial and processed agricultural products, but not traditional agricultural products.

In preparation for the CU, Turkey has adapted its commercial and competition policy, including patent rules, copyrights, state aid to exports, standardization of foreign trade, surveillance and safeguard procedures on imports, management of quotas and consumer protection, with a view to harmonize its rules and regulations with those of the European Community.

With the entry into effect of the CU, the gradual elimination of customs duties and charges on industrial products imported from the EU was completed with the adoption of the 1996 Import Regime (Official Gazette no. bis 22510, December 31, 1995). In addition, Turkey adopted the EU’s Common Customs Tariff (CCT) rates for imports from third countries, although a joint decision between Turkey and the EU allowed Turkey to apply rates of protection exceeding those specified in the CCT for selected products and to gradually adopt the CCT rates for such products within a period of 5 years. Turkey also eliminated the Mass Housing Fund charges levied on imports of industrial products.

In order to avoid trade diversion, Turkey has also undertaken to gradually align itself with the preferential trade agreements between the EU and third countries within a period of five years. 1/ Regarding processed agricultural products, Turkey and the EU have agreed on the adoption of a system whereby Turkey would differentiate between agricultural and industrial components of the duties applied to these products, in line with EU practices.

With the 1996 Import Regime, Turkey’s weighted rate of protection for imports of industrial products was reduced from 5.9 percent to zero for products originating in the EU and in EFTA countries, and from 10.8 percent to 6 percent for products originating in other countries. Official estimates set the expected revenue loss for the budget at US$1.4 billion (or 0.8 percent of GNP).

The expected short-and long-term impact of the customs union on the Turkish economy will depend on complementary policies adopted to keep the fiscal deficit from rising as a result of the loss of tariff revenues. Beneficial effects are expected on prices of imported products in industries relying on imported raw materials and investment goods; from efficiency improvements associated with the stimulus to investment and rationalization of production brought about by increasing competition with EU producers; from the elimination of quotas applied by the EU on Turkish textile products; from the impact on Turkish exports of improved reciprocal access to third countries to whom the EU grants preferential access; and from the impact of the technology transfer expected to come from an increased flow of foreign direct investment in Turkey.

The process of implementation of the CU agreement was partially reversed in July 1996, when the Turkish authorities re imposed a 6 percent import charge that had been abolished at the beginning of the year on all import commodities except investment goods, re-export goods, oil and oil products, grain, sugar, and fertilizers, in the attempt to rein in a widening trade deficit. At the time of writing, details on this measure were not available.

APPENDIX I: Privatization 1/

1. Overview

Turkey’s privatization program was initiated in the mid-1980s. The state-owned enterprise sector at the time consisted of some 35 enterprises which served as parent holdings for over 120 wholly owned companies; the state also held majority shares in numerous affiliated partnerships, and minority shares in more than 100 joint-stock companies. 2/

State enterprises (SEEs) in Turkey are divided into those which are considered primarily commercial in nature, and those which are not necessarily expected to operate at a profit. The latter, called public economic institutions, include providers of infrastructure-related goods and services, such as TEA$ and TEDA$ (electricity), TCDD (railways), and TTA$ (telecommunications), as well as agricultural producers such as TEKEL (alcohol and tobacco), and çaykur (tea). The SEEs and their affiliates are active in almost all sectors of the economy, playing a dominant role in services (e.g., railways, telecommunications and electricity), commodity trading, banking, mining, the production of basic metals and chemicals, and defense.

The overall progress of the privatization program has been very slow. Divestment has proceeded on a piecemeal basis, reflecting inadequacies in the legal and institutional framework for privatization, shifting objectives for the sales drive, and effective political opposition to reform. Early on, the government stressed the need to improve economic efficiency as the motivation for its privatization efforts, but in the late 1980s, the focus shifted to domestic capital market deepening through the promotion of wider share ownership; more recently, the emphasis has moved to raising revenue and limiting the financial burden of SEEs on the budget. The process has also been hampered by thin capital markets and by the absence of post-privatization competition legislation in sectors covered by state monopolies.

2. Legal and institutional framework

The legal and institutional framework for privatization has developed over the last decade in a somewhat ad hoc fashion, with elements of the legislation being repeatedly subject to successful constitutional challenges.

Law 2983, passed in 1984, established the Housing Development and Public Participation Administration (HDPPA) to implement privatization and finance mass housing and major infrastructure projects such as highways and dams. The HDPPA was subsequently split into two separate bodies: the Mass Housing Administration and the Public Participation Administration (PPA). The latter was given the responsibility for implementing privatization, i.e., determining the strategy and method of sale, conducting valuations, managing the legal and administrative process, hiring consultants, initiating the tender process, handling promotional activities, and conducting the final sale operations.

Law 3291 in 1986 outlined the decision-making process and procedures for the incorporation and privatization of SEEs. The Council of Ministers was given the authority to decide which SEEs (wholly state-owned companies) were to be transferred to the Public Participation Administration (PPA) for privatization. A High Planning Council (HPC), chaired by the Prime Minister, was given the corresponding authority for partially state-owned companies and subsidiaries, and for the sale of minority shareholdings. Once a decision to privatize was made by the Council of Ministers or the HPC, the SEE was transferred from the Treasury and relevant line ministries to the ownership of the PPA, which had the authority to convert it into a joint stock company and then sell it. The PPA operated under the supervision of the Public Participation High Council (PPHC), also chaired by the Prime Minister, which was established by a decree law in 1991.

In 1993, the government attempted to accelerate the privatization program by pushing through Parliament enabling legislation to allow it to enact reforms by decree. However, the privatization decree was subsequently annulled by the Constitutional Court. A similar enabling act passed in mid-1994 was also blocked by the Constitutional Court, following cross-party opposition to the act on the grounds that it was unconstitutional and would result in arbitrary and hasty divestment.

In November 1994, the government enacted a new privatization law- -Law 4046- -with a view to speeding up the pace of privatization by overcoming the legal obstacles that had been raised in Parliament. Law 4046 replaced the PPA with the Privatization Administration (PA), and established the Privatization High Council (PHC) as the ultimate decision making body for privatization, taking over the duties previously held by the Council of Ministers and the PPHC The PHC, comprising the Prime Minister and four other Ministers, decides on such matters as the SEEs to be privatized, the privatization method to be used, and the preparatory restructuring (including closure) to be undertaken, and sets the privatization targets and the budget for the PA. Unanimous PHC approval is required for the sale of any SEE. The PA’s responsibilities are to coordinate and supervise the valuation and tender process, to deal with legal and administrative issues regarding the company under privatization, and to handle all promotional activities associated with the sale. The 1994 privatization law also stipulates that privatization proceeds cannot be used to finance the budget, but instead should be devoted to paying for the privatization process, to finance selected infrastructure projects, or to retire existing public debt. Law No. 4046 does not cover the privatization of public economic institutions; separate laws are still required for such enterprises. 1/

3. Progress to date

Since 1985, over 160 companies have been taken into the privatization portfolio. Nine companies were later withdrawn for various reasons, including two state banks, Türkiye Öğretmenler Bank, which was merged with Halk Bank in May 1992, and Denizcilik Bank, which was merged with Emlak Bank in November 1992. Privatization implementation began with the transfer of a few incomplete plants to the private sector to be finished or reconstructed, and continued at a relatively slow pace, with block sales of a few small agro-industrial companies and five cement companies. As the main objective of the privatization drive shifted toward promoting wider share ownership among the Turkish public, public offerings of minority shareholdings became more common. Indeed, the earlier cement plant sales (which had been made to foreign investors) were overturned by court rulings for failing to meet the privatization objective. However, the foreign owners continued to operate the firms and were subsequently supported by an ex post decree.

From 1986 to 1993, the privatization process generated less than US$2 billion in gross revenues, most of which was used to subsidize loss-making enterprises in the PPA portfolio (Annex Table 1). The most significant sales in the initial years of the privatization program were the public offering of 8 percent of PETKİM (petrochemicals) shares, which raised US$150 million, and the public offering of 3 percent of ERDEMİR (iron and steel) shares, for US$53 million; together, these accounted for over 40 percent of total privatization revenues between 1986 and 1991.

Table 1.

Turkey: Privatization gross revenues, cash proceeds and expenditures

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Source: Data provided by the Turkish authorities.

Payments received, including previous years’ installment collections.

Capital injections, transfers, and other credits to companies under privatization.

Social assistance supplements and retirement bonuses.

In 1992, changes in the management and structure of the PPA lent a new impetus to the privatization program, and accelerated the pace of divestment. Block sales of state shares in 18 companies were completed, the most important ones being IPRAGAZ (a liquid petroleum gas distributor) for US$64 million, and six cement companies for a total of US$281 million. These were followed in 1993 by block sales of four more cement companies for US$166 million, and the sale of minority shareholdings in some electricity producers and telecommunications equipment companies.

In early 1994, an international offering of the state’s 16.67 percent holding in the automobile manufacturer, T0FA$, raised US$300 million, but the privatization program stalled in the middle of the year after the Constitutional Court blocked the Government’s plans to privatize by decree. When the new privatization law was finally passed in November 1994, the privatization program was expected to pick up momentum. The government announced an ambitious target for 1995, projecting US$5 billion in revenues from the sale of some 20 enterprises. However, the program was held up by the uncertain political environment during the year: there were three different heads of the PA, and a large number of tenders and final sales were held up by the inability of the PHC to meet and reach a unanimous decision. Also, several sales were canceled or reversed by the PHC. As a result, the target was revised downward over the course of the year, to US$2.7 billion in June, and US$1 billion in October. Actual revenues for 1995 amounted to only US$515 million from 13 block sales, some asset sales and a few share participations. The major sales were that of KÜMAŞ (mining) for US$108 million and Sümerbank—the first state bank to be sold—for US$103 million.

To date, some 108 companies have been privatized—89 of them fully—either through the sale of shares or asset sales, and the privatization program has generated gross revenues of around US$2.8 billion, of which some US$2.6 billion has been realized 1/ (Annex Table 1). Together with US$0.9 billion of dividend and other income of privatized companies, total cash proceeds as of end-1995 amounted to slightly over US$3.5 billion. As noted, a substantial portion (about 65 percent) of these proceeds went toward financing companies in the privatization portfolio, through equity participation and loans; only about 15 percent of the cash proceeds were transferred to the Treasury.

The labor market impact of the divestment program has so far been minimal: the privatized companies have all been relatively small and very few workers have been laid off. However, the privatization program remains unpopular with trade unions, particularly in those sectors with substantial overstaffing, such as steel, textiles and electricity.

4. The 1996 program

There are currently some 59 companies in the privatization portfolio, two thirds of which are majority owned by the state. The PA has set an ambitious program of almost US$2.5 billion in gross receipts for 1996. In March, ÇİNKUR, a zinc and lead mining and production company, was sold for US$14 million and in May 1996, 5 cement factories previously owned by ÇİTOSAN were sold piecemeal for about US$200 million.

Included in the 1996 program are several large firms that have been in the privatization portfolio for several years. The most significant are: PETKlM, the state-run petrochemicals producer; POAŞ, the main distributing and marketing company for petroleum products; and ERDEMṞR, the sole integrated flat steel producer in Turkey. The PA plans to partially privatize these companies, by selling 60-70 percent of its shares in PETKİM, 1/ up to 40 percent of its shares in POAŞ, and 30 percent of its shares ERDEMIR. 2/ Also slated for full privatization are several large firms such as Etibank and the loss-making TEA$ (four electric power plants). Smaller enterprises expected to be sold in 1996 include the remaining ORÜS forestry products plants, KBİ (copper), and several Sümer Holding textile plants.

Beyond 1996, the PA expects to dispose of three of the four petroleum refineries of TÜPRA$; to complete the privatization of Turk Telekom (see below); and to include in its privatization portfolio power generation companies belonging to TEDA$, sugar producing companies belonging to $EKER, and tobacco factories belonging to TEKEL. The establishment of post-privatization regulatory mechanisms will be crucial for sales to proceed, particularly in the cases of TÜPRA$, Turk Telekom, and utilities sales.

5. Privatization of Turk Telekomünikasyon A.S. (Turk Telekom)

The sale of the large state-owned telecommunications company, Turk Telekom, has long been a key objective of the privatization drive, but the proposed privatization has been beset by legal and political obstacles, and interrupted by no fewer than three court annulments in almost as many years.

Turk Telekom was separated from the state-run Turkish Post Office (PTT) in 1993 by a decree law which provided for the future sale of up to 49 percent of the shares in Turk Telekom and the full privatization of services such as mobile telephones, paging, and data transmission. However, the privatization process was halted when the decree was declared unconstitutional by the Constitutional Court later in 1993. A second attempt met with a similar fate when Law No. 4000, passed in 1994, was annulled on the grounds that it granted too much power to the Communications and Transport Ministry: the legislation had authorized the PHC to draw up guidelines for the sale, and charged the Communications and Transport Ministry with the responsibility for issuing operational licenses to private companies for telecommunications operations.

A third attempt was made in 1995 when Law No. 4107 was passed, making the PHC responsible for setting out the principles and procedures for the transfer and sale of Turk Telekom shares as well as approving the final sales, and assigning the PA the task of determining the value of the shares and administering the privatization procedure. In accordance with this law, 10 percent of the shares was to be transferred free of charge to the Turkish Postal Services, 5 percent was to be set aside for employees of Turkish Postal Services and Turk Telekom, and the remaining 34 percent was to be offered to international and domestic investors. By December 1995, the PA had received several bids for privatization consultancy services, and was in the process of evaluating final bids from a short-list of six international consultants.

However, in February 1996, the Constitutional Court again struck down certain articles of Law No. 4107 as unconstitutional, and suspended all executive action based on this law. Three articles of Law 4107 were annulled: the article granting the PHC final authority over the sale and transfer of Turk Telekom shares; the article giving the PA responsibility for pricing the shares and running the privatization process; and the article authorizing the PA to price and tender licenses for value-added services such as paging and GSM (Group Special Mobile) licenses. As a result of the ruling, the tender process for privatization consultancy services was canceled and further work on the sale has been shelved, pending the adoption of new legislation.

APPENDIX II: Social Security Reform 1/

The financial position of Turkey’s state social security system has deteriorated markedly in recent years, with rising deficits imposing an increasing burden on the budget. The financial imbalances are occurring despite a relatively young population, and reflect deep-rooted structural problems that were exacerbated by the abolition of the minimum retirement age in 1992. Also, the interaction between pension and health insurance and other social security schemes (e.g., severance pay and social assistance) is having adverse effects on employment creation, the level and intermediation of savings, and social equity, with inadequate targeting of social assistance to the poor and elderly. Further deterioration in financial performance is expected in the coming years unless major reforms are implemented.

Proposals to reform the pension system and other elements of the government’s social welfare system have been under consideration for some time. In 1994, the government, with financial assistance from the IBRD, 2/ commissioned a study to clarify the reform options available in regard to pension insurance; a related study was also initiated on reform options in health care provision. The study on pension system reform, undertaken by the ILO, was completed in 1995 and, at the government’s initiative, has been widely disseminated in Turkey as a means for promoting public debate on social security reform. The results of a related study on health insurance, prepared by the Australian Health Insurance Commission, have also recently been released.

1. Current social security system

There are three public pension institutions in Turkey: Sosyal Sigortalar Kurumu (SSK), Emekli Sandigi (ES), and Bag-Kur (BK). SSK is the largest of the three organizations, providing coverage to almost one third of the population, including all workers in the (formal) private sector and the public sector, except for civil servants. SSK also extends voluntary coverage to seasonal workers in the agricultural sector. ES covers civil servants, while BK provides coverage to the self-employed as well as housewives, elected village and municipal officials and agricultural workers. Together, these pension schemes cover about 70 percent of the population. However, this figure includes direct and indirect beneficiaries, i.e., contributors, pensioners, and their dependents. The number of active members is much smaller: out of the 40 million or so who are “covered”, only around 7 million are active members of the social security institutions.

The three social security institutions also provide health, disability, and death benefits. SSK and BK provide health insurance coverage for ail members and their families, while ES provides health insurance coverage only for retired civil servants (leaving the employing ministries to cover health insurance for working civil servants). SSK is a major health care provider; ES and BK do not directly provide health care. Health coverage for the remainder of the population not covered by these institutions is provided by the Ministry of Health, university hospitals, other sectoral ministries, and the private sector.

The social security institutions essentially operate on a pay-as-you-go (PAYG) basis. The contribution rate for SSK is 33.5 percent (21.5 percent for pensions and 12 percent for health insurance); 19.5 percent of the contribution is paid by the employer and 14 percent by the employee. Voluntary and agricultural contributors to SSK pay a contribution rate of 20 percent (which does not include health insurance). The contribution rate for BK members is 32 percent (20 percent for pensions and 12 percent for health insurance). The contribution rate for civil servants in ES is 35 percent (inclusive of health insurance).

Despite these contribution rates, the actual contribution revenue is low, mainly due to the fact that the base wage on which the contributions are calculated is subject to a low ceiling (of 1.4 times the minimum wage in the case of the SSK, for example). Furthermore, there is a widespread tendency to under-report income, and to make contributions on an irregular basis, especially in the informal sector where enforcement is problematic. The compliance rate is particularly low for BK—which is estimated to collect only about 10 percent of contributions due—partly reflecting its deliberate policy of not collecting from its poorest members. The compliance rate for the other two institutions is higher: ES collects 100 percent of contributions due from civil servants, 1/ and SSK has, reportedly improved its collection from 70 percent to 85-90 percent of contributions it reports as being due. 2/

Retirement benefits 3/ provided by the three major social security organizations are proportional to contributions, but only weakly related to earnings. This is because benefit payments are subject to the same ceiling as the base wage on which the contributions are calculated. All public sector retirees also receive a flat rate social support supplement (SYZ). This supplement, which is an unfunded payment in the sense that it was introduced without a corresponding increase in contribution rates, represents a large proportion of the benefits paid from SSK. The ratio of the average pension to average insured earnings in 1995 was 95 percent for SSK, 67 percent for ES, and 78 percent for BK.

Under the current system, there is no minimum qualifying age for a pension: members may receive retirement benefits once they have accumulated 5,000 premium-paid days, regardless of age. There is no standard retirement age either: men may retire after working for 25 years and women after working for 20 years, implying that the pensionable age could be as low as 43 years for men and 38 for women. The average age of new retirees has been declining in recent years, and now stands at around 49 for men and 46 for women. This trend toward early retirement has contributed to an increasing ratio of pensioners to contributors, currently at 55 percent for SSK (meaning that each pensioner is being supported by approximately 2 active contributors to the scheme), 63 percent for ES and 34 percent for BK.

Returns on pension fund assets are small as a share of expenditures—about 4 percent in ES, 2 percent in SSK, and close to zero in BK.

The high and increasing incidence of early retirement, large unfunded social assistance payments to retirees, low compliance ratios in the informal sector, and poor returns on pension fund assets have been reflected in continued deterioration of the financial position of social security system. In 1995, the combined deficit of the major social security institutions amounted to TL 142 trillion (about 1.8 percent of GNP). This represents a growing drain on the budget: budgetary transfers to the pension institutions amounted to 1.4 percent of GNP in 1995, and the figure is expected to rise to 2.1 percent of projected GNP in 1996. ILO projections suggest that, in the absence of policy changes, the combined deficit of the three pension schemes will increase from 1.8 percent of GNP to almost 3.5 percent of GNP by 2005. Looking to the longer term, this deficit is projected to rise to 10 percent of GNP by 2050,

2. ILO proposals for social security reform

The ILO report considered four options for social security reform: (1) a restructured version of the existing PAYG scheme; (2) a mandatory, fully funded retirement savings scheme; (3) a mixed system combining a restructured PAYG system with a compulsory private pension scheme; and (4) a mixed system combining a restructured PAYG system with a voluntary private pension scheme. Under all four options, it proposes that the standard pensionable age be set initially at 55 years for men and 53 for women, but raised over a ten-year period to 60 years for men and 58 for women.

Under Option 1, the contribution rate of the current PAYG system would be set at 21.5 percent, subject to a ceiling of five times the minimum wage; the scheme would provide a pension amounting to 1.5 percent of average annual lifetime earnings (adjusted in line with movements in gross national average earnings) 1/, likewise subject to a ceiling of five times the minimum wage. This restructured PAYG scheme would cover civil servants and all other employees; the self employed would be covered by a separate restructured version of BK. 2/

Option 2 represents the most drastic change, replacing the PAYG system with a system of individual savings accounts. Mandatory contributions at a rate of 17 percent of all earnings, would be shared equally between the employer and employee. The amount of the pension would depend on the contributions paid and on the rate of return achieved by the private pension fund chosen by the individual to manage his or her pension savings. This system would cover civil servants, all other employees, and the self employed.

Option 3 is a combination of the PAYG system of Option 1 (the first tier) with the mandatory retirement savings component of Option 2 (the second tier). The contribution rate would be 16.5 percent for the first tier and 5 percent (split equally between employer and employee) for the second tier, both subject to a ceiling of 5 times the minimum wage. Two versions of Option 3 were considered: under Option 3a, the first tier pension would comprise a flat-rate element of 20 percent of national average earnings and an earnings-related element equal to 0.75 percent of average lifetime earnings; under Option 3b, the first tier pension would be simply 1.33 percent of average lifetime earnings. Option 3 would cover civil servants and all employees; the self employed would be insured for the flat rate component of Option 3a in return for flat rate contributions, and would be covered on the earnings-related component (of both Options 3a and 3b) and on the mandatory savings scheme component by a restructured BK scheme.

Option 4 is similar to Option 3 except that the second tier is voluntary instead of mandatory. As in Option 1, the first tier contribution rate would be set at 21.5 percent, and the PAYG scheme would provide for a pension of 1.5 times average lifetime earnings. Both contributions and benefits for the first tier would be subject to a ceiling of three times the minimum wage, lower than that for the first three options. This scheme would cover civil servants and all other employees; the self-employed would be covered by a restructured BK, as in Option 1.

A summary of the main reform options is presented in Annex Table 1. According to the ILO’s calculations, of the four options, Options 1 and 4 would achieve the greatest long term reduction in social security pension scheme deficits and hence, lead to the most substantial improvement in the balance of the consolidated government budget. (Annex Table 2). Both options would also lead to reductions in social protection expenditure and subsidies in the medium term. Option 2 would also reduce subsidies to the pension system, but only in the very long term. The savings scheme components in Options 2, 3 and 4 would have the additional benefit of promoting the development of the capital market.

Table 1.

Turkey: Summary of ILO proposals for reform of social security

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Source: International Labour Office, Republic of Turkey Social Security and Health Insurance Reform Project, Social Security Final Report, Geneva, 1996.
Table 2.

Turkey: Economic Impact of the ILO’s Reform Options

(in percent of GDP)

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Source: International Labour Office, Republic of Turkey Social Security and Health Insurance Reform Project, Social Security Final Report, Geneva, 1996.

3. Progress to date

Initial efforts to implement social security reform have encountered strong public opposition. A draft law for the reform of SSK, mandating a minimum retirement age and longer minimum enrolment periods for pension eligibility, was submitted to Parliament in April 1995, but was eventually shelved in the face of vigorous public criticism.

The government is promoting renewed public debate of social security reform, using the ILO report as a basis for informing and focusing the debate. In early May 1996, the government organized a two-day conference on social security reform to discuss the proposals put forward by the ILO study. Participants at the conference included several ministers as well as representatives from the major political parties, labor and employers unions, private insurance companies and international institutions, academics, and foreign experts. The Turkish authorities report that conference participants generally favored reform along the lines of the ILO’s Option 4—a reformed PAYG system, supplemented with some form of voluntary retirement savings scheme.

APPENDIX III

Turkey: Tax Summary

(as of May 1996)

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Law No. 1615 will be abolished and the Customs Law of the European Communities will be applied.

This tax will be abolished, once the Special Consumption Tax comes into effect.

APPENDIX IV: An Econometric Analysis of the Determinants of Inflation in Turkey 1/

1. Introduction

Turkey has experienced high and variable inflation since the 1970s. Various stabilization programs implemented over the years have brought only temporary relief, and inflation remains a central feature of the Turkish economy. A sizable literature has emerged examining elements of the inflationary process in Turkey, typically focusing on a single determinant of inflation. 2/ This study seeks to throw additional light on the determinants of inflation in Turkey by analyzing price determination within the framework of a simplified multi-sector macroeconomic model, along the lines proposed by Bruno and Melnick (1994).

Inflation in Turkey was in line with that of industrial countries through 1970, but accelerated throughout the 1970s to a high of some 100 percent in 1980 (Chart 1). Implementation of a major stabilization program saw a sharp drop in inflation to some 30 percent a year during the early 1980s, but this was soon reversed as inflation trended upwards from the mid-1980s, reaching a peak of 120 percent in 1994 (following an exchange market crisis) before dropping back to 88 percent in 1995. During the 1980s, wide-ranging structural reforms were introduced, notably in the financial and external sectors, that transformed a heavily regulated inward-looking financially repressed economy into one in which market forces and external competition play a central role in resource allocation. Inflation during the late. 1980s and early 1990s therefore took place in the context of an economic structure very different from that of the 1970s, but with one constant theme–a large, albeit fluctuating, public sector borrowing requirement (Chart 2).

Chart 1
Chart 1

TURKEY: INFLATION DEVELOPMENTS 1/

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Sources: Turkish authorities; and IMF, International Financial Statistics.1/ Period average percentage changes.
Chart 2
Chart 2

TURKEY: PUBLIC SECTOR DEVELOPMENTS

(In percent of GNP)

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: Turkish authorities.

II. A Model of the Inflation Dynamics

The model offers a simple representation of an economy in which there are four sectors—goods, money, labor, and external sectors. The goods market provides the equilibrium condition for the long-run price level. The evolution of prices in the short run is dependent not merely on conditions in the goods market, but is also influenced by conditions in the money, external, and labor markets. These influences are captured by including estimates of market disequilibria in these markets in the inflation equation, along with the standard error correction term and other short-run explanatory factors.

1. A long-run mode 1

Standard aggregate demand and supply functions are assumed that determine the long-run equilibrium level for domestic prices. 1/ Aggregate demand increases if real money balances rise and/or competitiveness improves (i.e., if domestic prices in foreign currency terms decline relative to foreign prices of competing exports). Aggregate supply declines if real wages and/or imported input prices increase. Hence, the balance of aggregate demand, yd, and supply, ys, can be written as:

y d ( M P , P x * P E ; ε d ) = y s ( W P , P r * P E ; ε s )

where P denotes the domestic price level, W nominal wages, E the exchange rate (defined as the price of domestic currency in foreign currency), 2/ M money, P*x the exogenous price of exports, P*r exogenous imported input prices, and ∊d and ∊s are random demand and supply shocks, respectively. Solving for the price level yields the following long-run price equation:

P = θ 0 ⁢   ⁢   ⁢   E + θ 1 ⁢   M ⁢   + θ 2 ⁢   W +   θ 3 ⁢     P X ⁢ * ⁢   + θ 4 ⁢   P r * ⁢ + ε ( 1 )

The expected signs of money, wages, export and import prices are positive, while the expected sign for the exchange rate is negative.

To identify pressures on prices deriving from external sector disequilibrium, the observed level of the real exchange rate is compared with a measure of the “equilibrium” real exchange rate (RER), defined to be the real exchange rate that, given estimated export and import relationships, is compatible with a financeable deficit on the goods and services account. The financeable deficit (K) is estimated by average levels of medium and long-term capital flows, current transfers, and net factor income. 3/ Given standard export and import functions, with export (import) volumes depending on the real exchange rate and foreign (domestic) income, the RER can be derived as follows:

R E R = P E P * ⁢   = K + β y f P x * − δ y P r * ⁢ +   ξ P x * − μ P r * α P x ⁢   * + γ P r * ( 2 )

where P* is a weighted average of foreign export and import prices, δ is the estimated coefficient of domestic income (y) in the import function, β is the estimated coefficient of foreign income (yf) in the export function, ξ and μ are the estimated constants in the export and import function, respectively, and α and γ are the estimated coefficients of the real exchange rate in the export and import function, respectively. The difference between the actual and equilibrium real exchange rates provides a measure of disequilibrium in the external sector that impacts on price developments.

Equilibrium in the money market is obtained when the public sector deficit, as a ratio to GNP, is fully financed by long-run seigniorage–money creation–and a sustainable level of borrowing. The long-run seigniorage level is assumed to change in proportion to expected inflation and real income growth; for simplicity, a unit elasticity of real money balances demanded with respect to income is assumed. Sustainable borrowing, both domestically and externally, is defined by reference to a debt-to-output ratio that is constant or not rising. The financeable deficit, G*, can then be written as the maximum deficit consistent with the projected demand for real money balances and a constant debt to output ratio:

G * ⁢   = ( y . * ⁢   + π * )     H Y t − 1 ⁢ + D . * Y ( 3 )

where is the projected growth in real output, Y is nominal output, π* is the targeted inflation rate, H base money and D˙* are changes in total debt such that the debt-output ratio is constant. The difference between the actual public sector deficit and the financeable deficit, as measured in equation (3), yields the disequilibrium in the money market. If a large positive disequilibrium is obtained then upward pressures on inflation will emerge. This is referred to as the required deficit reduction consistent with the stipulated macroeconomic targets. 1/

The long-run real wage is determined as a weighted average of the real wage offered by firms (i.e., the real wage on the labor demand function) and the real wage demanded by workers (i.e., the real wage on the labor supply function), with weights determined by the relative bargaining power of firms and workers. Hence, the long-run real wage is given by:

W P ⁢   ⁢ = ω 0 ⁢ y L ⁢   + ω 1 ⁢ u (4)

where L is employment so that y/L measures productivity, and u unemployment. The disequilibrium in the labor market is then estimated by the residuals of equation (4).

2. A short-run model for inflation

The short-run inflation equation is an error correction representation of equation (2) expanded to include the disequilibrium term from the other three sectors:

π ⁢ =   β 0 ⁢   + Σ i = 1 n ⁢   ( β 1 i π t − i ) ⁢   + Σ i = 0 n ( β 2 i Δ E t − i ⁢     + β 3 i ⁢   Δ M t − i ⁢   + β 4 i ⁢   Δ W t − i ⁢     + β 5 i ⁢   Δ P e t − i * ⁢   + β 6 i Δ P r t − i * ⁢   + β 7 i ⁢ Δ Z t − i )   + β 8 ⁢ E C M t − 1 ⁢   + β 9 D e t − 1 ⁢     + β 10 ⁢   D m t − 1 ⁢   + β 11 D w t − 1 ⁢   + v t ( 5 )

where π is the inflation rate, ECM, the error correction term, Di, i=e, m, w, represent the respective deviation of the actual real exchange rate, public sector deficit and real wage from their long run equilibrium, Zt is a vector of other exogenous variables such as changes in real government expenditure, and vt is the residual.

As pointed out earlier, the dynamic adjustment of the rate of inflation depends not only on the speed at which the disequilibrium within the goods market corrects itself, but also on the dynamic adjustment of the foreign exchange market, the money market and the labor market to their respective long-run equilibria. The expected sign of the exchange rate disequilibrium is negative because when the real exchange rate is more appreciated than its long-run level downward pressure on inflation is exerted. The disequilibrium effects originating from the money and labor markets are expected to be positively signed, as an excess supply of money and a higher-than-equilibrium real wage level raise inflation.

III. Empirical Analysis

1. Data

The model is estimated with quarterly time series data from 1970 to 1994; see Appendix I for a description of data sources. The choice of the sample period is dictated by the desire to take a long-term view while the rationale for quarterly as opposed to annual frequency, is to capture short- term inflation dynamics. For some series, quarterly data had to be interpolated from annual data.

Prices are measured by the wholesale price index for the private manufacturing sector, thereby excluding administratively influenced state enterprise prices and agricultural prices. However, because the private manufacturing index was not available prior to 1981, the total wholesale price index is used in the earlier period. Wages are estimated from the annual payments made to employees in the private manufacturing sector as well as from survey data of the Turkish Confederation of Employers’ Association. The monetary aggregate used is broad money inclusive of foreign exchange deposits, M2X, and the exchange rate variable is the nominal effective exchange rate as provided by the IMF Information Notice System.

2. Estimates for the long-run model
a. Prices

The long-run price equation is estimated over the period 1970 to 1994 (Table 1). Both likelihood ratio tests of the Johansen procedure point to multiple cointegrating relationships. The choice of the cointegrating vector to be included in the short-run inflation equation is determined by the vector that has the right signs as expected from economic theory and is shown below:

P = − 0.57 E + 0.22 M + 0.08 W + 0.52 P x ⁢ + 0.01 P r
Table 1

Long Run Price Equation 1/

Johansen Maximum Likelihood Procedure: lag in VAR = 6

94 Observations from 1971-Q3 to 1994-Q4

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Denotes the vector chosen to represent the long run relationship.

All variables are in logarithm.

r indicates the number of cointegrating vectors.

The residuals from this estimation are included as the error correction term ECM in equation (5). The expected sign is negative because when prices are above their equilibrium level, due for instance to a shock, downward pressure on prices is exerted, thus “correcting” the error and driving prices back toward equilibrium.

b. The real exchange rate

All variables in the export and import equations—with the exception of the sum of capital inflows, transfers and income–were transformed by an eight-quarter moving average, in an effort to capture long-term trends. The financeable deficit for the goods and services balance was calculated as a four-quarter moving average of the sum of medium-and long-term capital inflows, transfers, and net factor income. No cointegrating relationships were identified for both the export and import functions when estimated over the period 1970 to 1994, which is not surprising given the significant structural break that occurred in the trade regime with the shift from an inward-looking import substitution strategy in the 1970s to an export- oriented growth strategy in the 1980s. To account for this shift in the trade regime, the estimation period was divided into two subsample periods: (i) from 1970 to 1983 and (ii) from 1984 to 1994. 1/ A cointegrating relationship was obtained for both the export and import functions in each of the subsample periods (Tables 2a and 2b). The cointegrating vector for exports includes exports of goods and services (deflated by the export price index), the real effective exchange rate, and an index of world imports, which proxies the level of demand in partner countries. On imports, the cointegrating vector includes imports of goods and services (deflated by the import price index), the real effective exchange rate and real domestic income. All the variables have the expected sign in both periods.

Table 2a

Exports of Goods and Services 1/

Johansen Maximum Likelihood Procedure: lag in Var = 4

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Denotes vecotr chosen.

All variables are transformed by an eight-quarter moving average.

See footnote 2 in Table 1.

Table 2b

Imports of Goods and Services 1/

Johansen Maximum Likelihood Procedure: lag in Var = 4

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Denotes vector chosen.

All variables are transformed by an eight-quarter moving average.

See footnote 2 in Table 1.

Chart 3 plots the actual and estimated equilibrium real exchange rates; the difference between the actual and equilibrium exchange rates is included as De in the inflation equation (5) (Chart 4, top panel). It would appear that the real exchange rate was overvalued during most of the 1970s but this was reversed in the 1980s when the authorities actively pursued a real depreciation policy. The appreciation of the equilibrium exchange rate in the early 1990s reflects the improving terms of trade and the increased availability of external financing, a trend reversed in 1994 with the cutoff in access to capital markets.1/

Chart 3
Chart 3

TURKEY: REAL EFFECTIVE EXCHANGE RATE

(1990=100)

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: IMF, Information Notice System. Equilibrium real effective exchange rates are as calculated from equation (2).
Chart 4
Chart 4

TURKEY: MARKET DISEQUILIBRIA

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: As estimated from the model.1/ A positive value implies that the actual value is higher than its equilibrium value.
c. The financeable public sector deficit

The financeable deficit is computed according to equation (3), where π is taken to be zero to imply seignorage consistent with noninflationary financing, and D grows at the rate of nominal GNP to maintain a constant debt to GNP ratio. 2/ Real GNP growth is assumed to average 4 percent a year, representing the trend growth over the sample period. The difference between the actual PSBR and the financeable deficit measure constitutes the required deficit reduction, included in the inflation equation (5) as Dm(Chart 4, bottom panel). The required deficit reduction has been mostly positive over the entire sample period. In 1994, for instance, the required deficit reduction necessary to obtain noninflationary financing and sustainable debt growth amounts to over 6 percent of GNP.

d. The real wage

Although a cointegrating vector was obtained for the wage equation, it was not satisfactory in that the coefficient for the unemployment rate was incorrectly signed (Table 3). Failure to obtain a satisfactory result may partly reflect data deficiencies, but may also be due to heavy regulation of labor markets, notably during the 1980s. The residuals from the cointegrating vector, Dw, were included in the inflation equation (5) in an attempt to capture the inflationary impact of the disequilibrium in the labor market, but did not prove to be significant.

Table 3.

Long Run Real Wage Equation 1/

Johansen Maximum Likelihood Procedure: lag in VAR = 8

92 Observations from 1972-Q1 to 1994-Q4

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All variables are in logarithm except for the unemployment rate, UNR, and the dummy variable, DUM1 (1970-1987-0; 1988-1994-1)

See footnote 2 in Table 1.

3. The inflation equation

A general specification of the short-run inflation equation (5) is estimated using ordinary least squares (OLS) and instrumental variables (IV) for the sample period 1972 to 1994. 3/ Table 4 reports the estimated equation obtained after eliminating variables with t-ratios less than one. The inflation equation includes (i) the first and third lags of inflation; (ii) the contemporaneous and one-period lagged change in the nominal effective exchange rate; (iii) the second lag of the change in money; (iv) the first lag of wage inflation; (v) the fourth lag of the change in export prices; and (vi) all the market disequilibrium terms, except that for the labor market. 1/ The estimated equation explains 77 percent of the variation in inflation and tracks the actual inflation developments quite well (Chart 5, top panel). The results obtained using IV estimation do not differ significantly from those obtained using OLS, and all diagnostic tests from both estimation procedures are generally satisfactory. However, Chow tests indicate significant structural breaks in the inflation equation between 1980 and 1983, in line with the substantial structural changes that the Turkish economy underwent in that period.

Table 4.

Inflation Equation

Dependent variable is ΔP

89 observations used for estimation from 1973-Q1 to 1995-Q1

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t–ratios in parenthesis.
Chart 5
Chart 5

TURKEY: INFLATION

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: As estimated from equation (5).

To allow for these structural shifts, the inflation equation was re-estimated for the period 1970-1980 and 1981-1994. 2/ The final results obtained are reported in Table 5 and described below; the estimated inflation equations account for up to 74 percent of the variation in inflation in the 1970s, and as much as 86 percent during the 1980s and 1990s (Chart 5, middle and bottom panels). All diagnostic tests are satisfactory. Chart 6 plots the actual and dynamic forecasts of inflation for both periods.

Table 5.

Inflation Equation

Dependent variable is ΔP

37 observations used for estimation from 1971-Q4 to 1980-Q4

57 observations used for estimation from 1981-Q4 to 1995-Q1

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t-ration in parenthesis
Chart 6
Chart 6

TURKEY: ACTUAL INFLATION AND DYNAMIC FORECASTS

Citation: IMF Staff Country Reports 1996, 122; 10.5089/9781451837988.002.A001

Source: As estimated from equation (5).

For the 1970s, the results indicate strong influences on prices from wages, money, and the exchange rate. The independent role for wage growth presumably reflects the sizable influence of trade union activity on wage growth during this period; real wages are estimated to have increased by some 100 percent between 1970 and 1979. Both the third lag of inflation and the error correction term are also significant and correctly signed, suggesting that inflation inertia was already of significance during the 1970s; the estimated coefficient on the error correction term implies an adjustment period to equilibrium of four quarters. The terms representing real exchange rate disequilibrium and the public sector deficit are not statistically significant, implying that these variables did not have an influence on inflation separate from variables that were statistically significant (i.e., money, wages, and the nominal exchange rate).

For the post-1980 period, the results indicate strong influences on price growth from the exchange rate and lagged inflation. Interestingly, the independent role for wage and money growth observed during the 1970s disappears. This likely reflects the more restrictive environment for trade unions (at least through the late 1980s) and the liberalization of external trade and financial relationships, which would have expanded both the direct role of the exchange rate in price determination and the importance of the exchange rate as a channel through which monetary policy influences prices.

Up to three lags of inflation are positively signed with both the first and third lag statistically significant at the 5 percent level. Moreover, the estimated coefficent of the error correction term implies an even longer return to equilibrium–almost seven quarters–for the price level compared to the 1970s. In other words, the inflationary process exhibited greater inertia during this later period as inflationary expectations became more entrenched. 1/

The terms representing the exchange rate disequilibrium and the pressure of the public sector deficit are both significant for this period. The significance of the former likely captures the effects of the policy of real exchange rate depreciation pursued by the authorities during much of the 1980s as an export promotion tool, and supports the view that at times the exchange rate has been a key factor in generating, as distinct from merely accomodating, inflation. 2/ The significance of the deficit measure supports the public finance view of the inflationary process in Turkey, although the conjunction of this result with the conclusion that money growth does not have a significant separate influence on inflation is surprising.

IV. Concluding Remarks

The econometric analysis developed here supports an interpretation of Turkish inflation in which monetary variables (initially money, more recently the exchange rate) play a central role in the inflationary process; inertial factors are quantitatively important; and public sector financing needs play a role additional to any direct role in contributing to monetary growth. Policymakers’ commitment to active exchange rate depreciation on several occasions in the past 15 years have also contributed to the inflationary process. These conclusions are broadly in line with the results from other developing countries, 3/ albeit perhaps with the exchange rate having a stronger role in the inflationary process than is the case in several other countries.

Further refinement of the analysis developed here, notably by sharpening the measures of the equilibrium exchange rate and the financeable public sector deficit, could yield stronger empirical results. Additional analysis is also needed to clarify the robustness of the results to changes in model specification, and to establish whether the results obtained are heavily influenced by the experience in crisis periods (e.g., the 1994 crisis). Perhaps the most important area for further work is in reviewing why the monetary authorities opted for accomodative monetary and exchange rate policies at various key points during the last decade–an issue which will likely focus further attention on the problems of excessive fiscal deficits and, perhaps, an excessive bias among policymakers in favor of real exchange rate depreciation.

Data Issues

  • Wholesale price index, quarterly, 1990-100. Between 1970 and 1981, the index is based on prices of all items. From 1982, the index is based on prices in the private manufacturing industry. Source: State Institute of Statistics (SIS).

  • Broad money (M2X), quarterly, in billions of Turkish liras. From 1987, the series includes foreign exchange deposits. Source: IMF, International Financial Statistics (IFS).

  • Reserve money, quarterly, in billions of Turkish liras. Source: IMF, IFS.

  • Nominal and real effective exchange rate indices, quarterly, 1990-100. Real effective exchange rates are based on consumer prices. Source: IMF, Information Notice System (INS).

  • Wages, annual, in millions of Turkish liras. Estimated as annual payments per employee in the private manufacturing industry. From 1983, the series was updated with survey data from the Turkish Confederation of Employers’ Association. Quarterly series are obtained from linear interpolation. Source: SIS and staff estimates.

  • Public sector borrowing requirement, annual, in billions of Turkish liras. Quarterly series are obtained from linear interpolation. Source: State Planning Organization.

  • Export price index, quarterly, 1990-100. Source: SIS

  • Import price index, quarterly, 1990-100. Source: SIS.

  • Consumer price index, quarterly, 1990-100. Source: IMF, IFS.

  • Average productivity, annual, in Turkish liras. Estimated as the value added per worker in the private manufacturing industry. Quarterly series obtained from linear interpolation. Source: SIS.

  • Unemployment rate, quarterly. Data for 1993 and 1994 are derived from annual averages. Source: OECD Analytical Base (1970-1992) and SIS (1993 and 1994).

  • Index of world imports, annual, 1990-100. Based on the volume of world imports of goods and services. Quarterly series are obtained from linear interpolation. Source: IMF, World Economic Outlook Database.

  • Imports of goods, quarterly, in millions of U.S. dollars. Services debit are interpolated from annual data. Imports are FOB. Source: IMF, IFS.

  • Current transfers and income, annual, millions of U.S. dollars. Source: IMF, IFS.

  • Medium and long-term capital, annual, millions of U.S. dollars. Source: IMF, IFS and Recent Economic Developments (various issues).

References

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  • Anand, R. and S. van-Wijnbergen, “Inflation, External Debt and Financial Sector Reform: A Quantitative Approach to Consistent Fiscal Policy with an Application to Turkey”, NBER Research Working Paper, No. 2731, October 1988.

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  • Basci, E and S. Togan, “Is the Public More Informed than the Economist? An Empirical Comparison of Rational Expectations Models in the Context of Turkish Inflation”, mimeo (Ankara, Turkey: Bilkent University, June 1995).

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  • Batavia, B. and N.A. Lash, “Self-perpetuating Inflation: The Case of Turkey”, Journal of Economic Development, 8 (2), December 1983, pp. 149–66.

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  • Bilginsoy, C., “Inflation, Growth, and Import Bottlenecks in the Turkish Manufacturing Industry”, Journal of Development Economics, 42 (1), October 1993, pp. 111–31.

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  • Bruno, M. and R. Melnick, “High Inflation Dynamics: Integrating Short-Run Accommodation and Long-Run Steady-States, mimeo, 1994.

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  • Da Cunha, V., S.B. Webb and L. Isaac, “The Dynamics of Inflation in Turkey” (Washington, DC: The World Bank, April 1990).

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  • Dornbusch, R. and S. Fischer, “Moderate Inflation”, The World Bank Economic Review, Vol. 7, No. 1, pp. 1–44.

  • Engle, R.F. and C.W.J. Granger, “Cointegration and Error Correction: Representation, Estimation and Testing, Econometrica, 1987, Vol. 55, No. 2, pp. 251–276.

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  • Fischer, S., “The Economics of the Government Budget Constraint”, Policy, Planning and Research Working Papers, The World Bank, May 1989.

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  • Hsiao, C., “Autoregressive Modelling of Canadian Money and Income Data”, Journal of the American Statistical Association, Vol. 74, No. 367, Sept 1979, pp. 553–60.

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  • Johansen, S., “Statistical Analysis of Cointegrating Vectors”, Journal of Economic Dynamics and Control, Vol. 12. No. 2/3, pp. 231–254.

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  • Kunst, R.M. and D. Marin, “On Exports and Productivity: A Causal Analysis”, Review of Economics and Statistics, Vol. 51, No. 4, November 1989, pp. 699–703.

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  • Metin, K., “The Analysis of Inflation: The Case of Turkey (1948-1988)”, Capital Markets Board, Publication number 20, Turkey, 1995.

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  • Organization for Economic Cooperation and Development, OECD Economic Surveys, Turkey 1995 (Paris: OECD, 1995).

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  • Ozatay, F., “The Role of Public Sector Prices in Price Dynamics in Turkey”, in Price Dynamics, ed. by H. Ersel (Ankara: Central Bank of the Republic of Turkey, December 1992, pp. 33–69).

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  • Rittenberg, L., “Exchange Rate Policy and Price Level Changes: Causality Tests for Turkey in the Post-liberalization Period”, Journal of Development Studies, 29 (2), January 1993, pp. 245–59.

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  • Rodrik, D., “Premature Liberalization, Incomplete Stabilization: The Ozal Decade in Turkey”, in Lessons of Economic Stabilization and its Aftermath, ed. by M. Bruno, S. Fischer, E. Helpman and N. Liviatan with L. Meridor (Cambridge, Mass. and London: MIT Press, 1991).

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  • Togan,S., “The Influence of Money and the Rate of Interest on the Rate of Inflation in a Financially Repressed Economy: The Case of Turkey”, Applied Economics, 19 (12), December 1987, pp. 1585–1601.

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  • Uygur, E., “Price, Output and Investment Decisions of Firms: An Explanation of Inflation and Growth in Turkish Industry”, in Price Dynamics, ed. by H. Ersel (Ankara: Central Bank of the Republic of Turkey, December 1992, pp. 1–31).

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1/

Messrs. Bass, Mecagni, and Nolan, and Ms. Tan.

1/

The industrial production and capacity utilization indices are collected monthly as well as quarterly, based on the results of separate surveys. The monthly industrial production index covers some 2,500 firms, including all public sector firms and most private sector firms; the coverage of the monthly capacity utilization index is slightly wider. The sample sizes for the monthly and quarterly data are different (in the case of both measures): for the industrial production index, for example, public sector firms–which tend to be larger firms where information is more readily accessible–are relatively more heavily represented in the monthly index compared with the quarterly index, which includes many more smaller firms found in the food and beverage and textile and apparel industries.

1/

The Turkish Agricultural Bank (Ziraat Bank) extends loans to farmers on concessionary terms. Although these loans are not legally guaranteed by Treasury, the Government from time to time has required the Treasury to offset nonperforming loans.

2/

These are funded by the Turkish Agricultural Bank, which is later reimbursed from the Support and Price Stabilization Fund (an extrabudgetary fund). The fertilizer subsidy program is the most important one; others, such as livestock incentives, are relatively small.

1/

See Appendix II in SM/95/69 (4/11/95) for a brief description of the operations of these SEEs.

2/

The compensation often falls short of the duty loss claimed.

1/

Investment allowances, which were reduced in mid-1994 to 70 percent for undeveloped regions and 20 percent for developed regions, were returned to their original levels of 100 percent and 30 percent, respectively, in mid-1995 to encourage investments in the newly established industrial zones. Unlike in the past, the allowances were also made available to small firms.

2/

Other measures, such as land allocation, energy support, and subsidized credit have been approved but not yet implemented.

1/

The Undersecretariat for the Treasury and Foreign Trade does not keep track of developments after issuing the certificates.

1/

Trend inflation is measured as the annualized rate of increase of an index constructed from the seasonally adjusted WPI and CPI.

2/

The compulsory minimum level of schooling is 5 years, but this is expected to be raised to 8 years very soon.

1/

The HLFS is the best available source of labor market statistics in Turkey. It tracks unemployment reasonably well, but not with precision due to its small sample size (approximately 40,000 individuals aged 12 and above are surveyed out of a labor force of over 20 million) and the weakness in the calculation of the “blow up” factor. The blow up factor was recently updated using the results of the 1990 census–data from 1988 have been revised using the new “blow up” factor; the population projections used in the post-1990 data have also been adjusted.

2/

Urban unemployment was 12.8 percent in April 1994 and 11.1 percent in October 1994.

1/

Between 1989 and 1991, gross wages of private sector workers increased by 355 percent, gross wages of public sector workers increased by 386 percent, and net salaries of civil servants increased by 228 percent, in nominal terms. In real terms, the increases were: 71 percent for private sector workers, 83 percent for public sector workers, and 23 percent for civil servants.

1/

Fund staff have undertaken substantial revisions to the public accounts to allow for sizeable fiscal and quasi-fiscal outlays not captured in the authorities’ measurement system. Details of the revisions are described in footnotes to the relevant tables.

2/

The addition of the general government borrowing requirement (a cash-based concept) and the SEE borrowing requirement (an accrual-based concept) to obtain a PSBR has important shortcomings. Much of the SEE borrowing requirement represents the accrual of liabilities to the general government, rather than increased liabilities to the non-governmental sector.

1/

These are the following: Capital Market Fund (SPK), Savings and Deposits Insurance Fund (TMS), Foreign Exchange Risk Guarantee Scheme (FERIS), Insurance Inspection (SMK), Student Election Fund (OSYM), Publicity and Promotion Fund (TF), and Social Solidarity Fund (SYDFF).

1/

In the staff presentation, these transfers are classified as an outlay of the budget and a revenue for the EBFs, netting out in the finances of the general government.

1/

This figure of net debt repayment to banks does not square with the sizable increase in banks’ claims on nonfinancial public enterprises reported in the monetary survey (Table A33). Treasury staff argue that the data reported by banks to the CBT overstate banks’ claims on SEEs by misclassifying claims on extrabudgetary governmental entities.

2/

Government transfers to SEEs take one of two forms: direct transfers from the budget and, since 1992, the provision of marketable government paper to selected enterprises by the Treasury. The second form of assistance is not treated as a budgetary transaction, although legal authorization for such transactions is provided through special articles of the budget law. In this chapter, such operations are included in extra-budgetary transfers.

1/

See SM/95/69, Appendix II (4/11/95) for further details on these enterprises.

2/

See Appendix III for a summary of the main features of the tax system.

1/

Under this scheme, a certain percentage of the cost of the investment may be deducted from the taxable income. This percentage varies according to regions and sectors.

1/

See paragraphs 8 and 12 of the authorities’ letter of intent (EBS/94/114, 5/27/94), and pp. 8-9 of the accompanying staff report (EBS/94/114, Supplement 1, 6/17/94).

2/

The stock of resident FX deposits fell by 20 percent during April.

1/

The charts portray the price of foreign currency, the inverse of the exchange rate; consequently, the floor on the exchange rate is a ceiling on the price of foreign currency.

2/

Broad money (M2X) includes resident foreign currency deposits; lira broad money (M2) does not include such deposits (Table A33).

3/

Growth in reserve money during the second and third quarters was more than fully accounted for CBT purchases of foreign exchange (Table A34).

1/

See paragraphs 13 and 14 of the authorities’ letter of intent (EBS/95/28, 3/9/95).

1/

With output expected to grow by 3 percent on the 1994 level, the constant real balances assumption implied a modest increase in the velocity of M2X.

2/

These inflows initially took the form of domestic banks selling foreign assets to buy government paper (reflected in a large jump in their net open FX position (Chart 4)), but expanded to include portfolio inflows and asset repatriation by non-bank residents as the year proceeded.

3/

See SM/95/69, Appendix V (4/11/95) for discussion of the instruments of liquidity management employed by the CBT.

1/

See EBS/95/142, (8/18/95) pp. 5-6, and attached letter of intent, and EBS/95/142, Supplement 1 (9/15/95) for fuller discussions of the policy understandings reached, and the considerations influencing the policy stance chosen.

2/

A monthly Indicative path for reserve money for the second half of the year envisaged growth at a pace in line with the monthly inflation target of some 1 ½ percent.

3/

Banks are required to sell a set fraction of the proceeds of exports of goods and services deposited with them to the CBT. This fraction has been reduced, in a series of steps, from 20 percent in April 1994 to 10 percent in June 1996.

1/

Program targets focused on the wholesale price index, which the authorities view as the best indicator of broader price trends. Consumer prices rose more rapidly than wholesale prices during most of 1995, having increased at a slower pace during much of 1994; divergences in the price indices are usually interpreted as an indicator of the strength of domestic demand pressures, to which the CPI is deemed to be more sensitive.

2/

Through early September, the Treasury had succeeded in selling nine-month and one-year paper; during October, the longest maturity sold was 153 days, which was to shorten to 145 days on November and 91 days in December.

1/

Forward transactions were already allowed, but did not take place within the framework of a exchange market.

1/

The central bank law imposes a limit on new CBT advances to the government in each fiscal year, set as a fraction of the nominal increase in budgetary outlays approved for the year; there is no restriction on the intra-year disbursements of these advances.

1/

A small deposit money bank, SumerBank, was privatized in 1995.

1/

Credit ratings by international agencies are available for a handful of individual banks operating in Turkey. Standard and Poor’s gave in May 1996 a rating of B+ on senior debt of one of the largest private banks in Turkey. In July 1996, Moody’s rated with D two banks, D+ the second largest bank in Turkey, and E+ another bank, on a scale ranging from A to E. Moody’s commented that the impact of the operating environment on a bank’s fundamentals meant that it would be unusual for a bank in Turkey to receive a rating above the C level.

1/

See for instance, IBRD, "Performance Audit Report: Turkey: Financial Sector Adjustment Loans I and II", June 1994, prepared by the Operations Evaluation Department; OECD, "Turkey–Economic Survey, 1996", forthcoming.

1/

Changes to the reserve and liquidity requirements were announced on July 22, 1996; details were not immediately available.

2/

Estimates derived from data provided by the Banking Department of the CBT.

1/

S&P and Moody’s downgraded their rating to noninvestment grades B+ and Ba3 in April 1994 and June 1994, respectively.

2/

The official estimate of net portfolio investment in equity securities in1995 is about US$1.3 billion, in part reflecting repatriation of assets by residents. This amount fell short of the program projection premised on accelerated privatization (US$2.2 billion).

1/

The Dresdner facility is a special arrangement between the Central Bank of Turkey (CBT) and the Dresdner Bank of Germany under which the Dresdner Bank acts as an agent of the CBT in mobilizing savings of Turkish citizens residing in Europe (mainly Germany). Under the scheme, Turkish citizens may open foreign currency accounts with the CBT, with maturity typically of 1-2 years, and interest rates on deposits and penalties for early withdrawal set by the CBT.

1/

In June 1996, the Turkish Government notified the WTO that it intends to eliminate the trade restrictions justified under the WTO balance of payments clause as of January 1, 1997. These restrictions concern tariffs in excess of bound rates on 36 items, mainly transport vehicles, accounting for some 0.2 percent of 1995 imports.

1/

Prepared by Ms. L. H. Tan.

2/

SEEs, their subsidiary companies, and affiliated partnerships are governed by a decree law; joint-stock companies are governed entirely by commercial law.

1/

The new law identifies certain “strategic enterprises” in which the state will retain “golden shares” in the event that over 49 percent is privatized. These enterprises include Turkish Airlines, Ziraat Bank and Halk Bank, TMO, and the Turkish Petroleum Company.

1/

Some of the asset and share sales were made on installment payments or in terms of a foreign currency. The discrepancy between gross revenues and cash proceeds derives from interest on instalment payments and exchange rate variations.

1/

Five percent of the shares in this company are already publicly owned.

2/

Forty-nine percent of the shares in this company are already publicly owned and traded on the Istanbul Stock Exchange.

1/

Prepared by Ms. L. H. Tan.

2/

The IBRD has had a close dialogue with the government on social security reform since 1992-93; see the recent IBRD report, Turkey: Challenges for Adjustment (Report #150760TU, April 1, 1996), Chapter 3, for further analysis of the policy issues confronting the Turkish authorities.

1/

ES contributions are deducted directly from civil servants’ salaries.

2/

SSK’s low collection rate stemmed mainly from the failure of several SEEs to keep up with their premium payments. In 1995, the government took steps to remedy this problem, including: imposing stiffer penalties on overdue payments; appointing additional collectors and inspectors; and involving private banks in the collection process.

3/

Upon retirement, SSK and ES members receive a lump sum payment (equivalent to approximately one month’s wages for each year worked) in addition to the monthly pension; BK members receive only their monthly pension. Benefits continue to accrue to the member’s spouse and dependent children upon his or her death.

1/

This means that pensioners are assumed to share in the general increase (decrease) of prosperity if real earnings rise (fall) in the economy.

2/

Contributions by self-employed persons would be subject to a floor of 50 percent of the minimum wage in the first year of membership, 60 percent of the minimum wage in the second year and so on, up to 100 percent of the minimum wage by the sixth year. Farmers and agricultural laborers would be entitled to a matching government contribution of 50 percent of the minimum contribution.

1

This appendix was prepared by Ms. C.H. Lim and L. Papi.

2

See EBS/95/142, Appendix II for a review of this literature

1/

As in Bruno and Melnick, the aggregate demand schedule is derived from the standard open economy IS-LM framework where interest rates have been substituted from the model. The aggregate supply schedule is obtained from a three-factor production function.

2/

Hence, an increase in E means appreciation.

3/

Note that the RER, as defined here, is not an equilibrium exchange rate in the broader sense of being sustainable over the medium term

1/

See World Bank (1995) for a more detailed exposition of the concept of financeable deficit and the required deficit reduction.

1/

Most of the trade liberalization measures became effective from 1984 onward.

1/

It should be recalled that the concept of “equilibrium” exchange rate used is not defined in RMS terms of a sustainable balance of payments over the medium term, but more narrowly to refer to the rate that yields a financeable deficit on goods and services given current patterns of capital inflows.

2/

For simplicity, we assume a constant level based on the debt to GNP ratio in 1970 (25 percent).

3/

The contemporaneous exchange rate is instrumented with past values of the exchange rate itself and other exogenous variables of the model. This was done to take account of the possible endogeneity of the nominal exchange rate variable given past policy of depreciating the nominal exchange rate in order to offset the impact of inflation on external competitiveness

1/

Other exogenous variables, such as real government expenditures, were not signficant when included in the inflation equation.

2/

1980 was chosen as the point of structural break on the basis that both the Turkish economy and the political system underwent significant changes. Furthermore, the F-test rejects the null that the coefficients are stable at more than 1 percent significance level.

1/

It would be important to examine the role of expectations in inflation formation more thoroughly and incorporate it explicitly into the model.

2/

Calvo, Reinhart and Vegh (1994) also find that policies of targeting the real exchange rate to enhance external competitiveness in developing countries have typically led to an undervalued real exchange rate. Their results show that depreciating the real exchange rate beyond its equilibrium level is likely to result in higher inflation as evidenced in Brazil and Columbia between 1979 and 1992.

3/

See Chapter VI of the forthcoming World Economic Outlook. “The Rise and Fall of Inflation—Lessons from the Post-War Experience”.

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Cover IMF Staff Country Reports
Turkey: Recent Economic Developments
Author:
International Monetary Fund
Volume/Issue:
Volume 1996: Issue 122
Publisher:
International Monetary Fund
ISBN:
9781451837988
ISSN:
1934-7685
Pages:
179
DOI:
https://doi.org/10.5089/9781451837988.002
CHART 1

TURKEY: MAIN DEVELOPMENTS, 1989-1995
CHART 2

TURKEY: OUTPUT TRENDS, 1994-95
Chart 3

Turkey: General Government and Public Sector Borrowing Requirement
Chart 4

Turkey: Borrowing Cost and Principal Payments
CHART 5

TURKEY: MONETARY DEVELOPMENTS, 1993-96
CHART 6

TURKEY: EXCHANGE RATE DEVELOPMENTS, 1994-95
CHART 7

TURKEY: PRICES AND FOREIGN RESERVES, 1993-95
CHART 8

TURKEY: SELECTED MONETARY INDICATORS, 1993-1996
CHART 9

TURKEY: SELECTED INTEREST RATES, JULY 1994-MAY 1996

(Percent; Annualized)
CHART 10

TURKEY: EXCHANGE MARKET DEVELOPMENTS OCTOBER 1995 - AUGUST 1996
CHART 11

TURKEY: CENTRAL BANK BALANCE SHEET OCTOBER 1995 - MARCH 1996

(TL trillion)
CHART 12

TURKEY: INTEREST RATE DEVELOPMENTS OCTOBER 1995 - MARCH 1996
CHART 13

TURKEY: SECURITIES MARKETS: SELECTED INDICATORS, 1987-95
CHART 14

TURKEY: EQUITY PRICE MOVEMENTS, 1992-96
CHART 15

TURKEY: REAL EXCHANGE RATE DEVELOPMENTS

(1990=100)
Chart 1

TURKEY: INFLATION DEVELOPMENTS 1/
Chart 2

TURKEY: PUBLIC SECTOR DEVELOPMENTS

(In percent of GNP)
Chart 3

TURKEY: REAL EFFECTIVE EXCHANGE RATE

(1990=100)
Chart 4

TURKEY: MARKET DISEQUILIBRIA
Chart 5

TURKEY: INFLATION
Chart 6

TURKEY: ACTUAL INFLATION AND DYNAMIC FORECASTS