Recent Economic Developments and Selected Issues

This paper describes economic developments in Turkey during the 1990s. Economic activity continued to increase rapidly in 1996, with gross national product growing by 8 percent in real terms, for the second year in a row. Although the pace of activity seemed to ease a little during the first three quarters of the year, production gained momentum in the last quarter, especially in agriculture. The industrial sector continued to expand fastest (7.1 percent), but the service (6.6 percent) and the agricultural sectors (5.2 percent) also performed strongly.


This paper describes economic developments in Turkey during the 1990s. Economic activity continued to increase rapidly in 1996, with gross national product growing by 8 percent in real terms, for the second year in a row. Although the pace of activity seemed to ease a little during the first three quarters of the year, production gained momentum in the last quarter, especially in agriculture. The industrial sector continued to expand fastest (7.1 percent), but the service (6.6 percent) and the agricultural sectors (5.2 percent) also performed strongly.

Selected Economic Indicators, 1993-97

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

Includes TL 145 trillion in personnel expenditure in excess of the 1997 budgetary appropriations following the April wage increase.

Adjusted for extrabudgetary and quasi-fiscal operations.

M2 plus resident foreign exchange deposits.

Three-month treasury bill rate, annual average.

Adjusted for shuttle trade.

Gross official reserves at end-of-period; excluded balances of the Turkish Defense Fund; includes gold.

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

Period average.

I. The Real Economy

A. Output and Demand


1. Economic activity continued to increase rapidly in 1996, with GNP growing by 8 percent in real terms, for the second year in a row (Table A1 and Figure 1).1 2 While the pace of activity seemed to ease a little during the first three quarters of the year, production gained momentum in the last quarter, especially in agriculture. The industrial sector continued to expand fastest (7.1 percent), but the service (6.6 percent) and the agricultural sectors (5.2 percent) also performed strongly. Thus, the composition of output remained broadly unchanged with services accounting for roughly 60 percent of domestic production, industry for just over a quarter, and agriculture for the remainder.

Figure 1.
Figure 1.

Turkey: Output Developments, 1989-96

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

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

2. In industry, the energy and the private manufacturing sectors were the most dynamic in 1996. Energy production rose markedly (10.7 percent) in response to the rapidly increasing energy demand. Private manufacturing production was brisk (9 percent), especially machinery and equipment (17.2 percent), as companies undertook large investments to gear up for the increased competition brought about by the customs union with the European Union (EU) (Tables A2 and A3). With large investments maturing, the rate of capacity utilization in manufacturing industry slackened slightly in 1996 (to 78.1 percent from 78.6 percent in 1995) despite rapid output growth (Table A4. In Services, wholesale and retail trade expanded rapidly, together with transportation and communication. In agriculture, the production of sugar beet, tobacco, and groundnuts grew strongly (Tables A5 and A6).

3. Available data for 1997 suggest that the pace of growth may have eased somewhat. First quarter industrial production rose 5.4 percent compared to the first quarter of 1996, and imports slowed considerably. On the other hand, capacity utilization in manufacturing in the period January-April 1997 was slightly higher than in the same period of 1996.


4. In 1995 and in 1996, domestic demand increased by an average 10 percent a year (Tables A7 and A8, and Figure 2) with private investment and consumption growing strongly throughout the period. An expansionary fiscal policy fueled domestic demand in 1966, as public consumption and public investment increased by 10.5 percent and 19.8 percent, respectively, in contrast to 1995. In 1995, stockbuilding made a large positive contribution to growth, but was negligible in 1996.

Figure 2.
Figure 2.

Turkey: Demand and Savings Trends, 1991-96

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

Sources: Data provided by the Turkish authorities; and staff estimates.1/ Contribution to growth.

5. Strong domestic demand, coupled with tariff reductions in the wake of the customs union with the EU, continued to boost imports in 1996, overshadowing a solid export Performance. The negative contribution of net exports to growth was 2.2 percent in 1996. Imports of goods and nonfactor services rose by 22.8 percent in real terms in 1996, while exports of goods and services rose by 17.7 percent despite slow growth in the main partner countries, suggesting a significant increase in Turkey’s market share and continued buoyancy of unrecorded exports (shuttle trade) mostly to Eastern European countries, which are partly reflected in exports of services (see paragraph 7 and Chapter IV). Competitiveness appears to have remained broadly unchanged: the CPI-based real effective exchange rate appreciated by 2 percent, but a WPI-based real exchange rate index (which takes into account only the two main trading partners) showed a depreciation of 0.3 percent. In the first quarter of 1997, merchandise exports increased by 6.5 percent (in dollar terms) compared with a year earlier, while imports rose only by 6.2 percent (in dollar terms).

6. The analysis of savings-investment balance is hampered by the weakness of the national accounts (see below). On the basis of the official national accounts, the increase in total investment to some 25.3 percent of GNP in 1996 (from 24.8 percent in 1995) was reflected in a widening of the foreign balance deficit to 4.2 percent of GNP (from 3.3 percent) while national savings declined to 21 percent of GNP (from 21.5 percent). The higher share of investment in GNP in 1996 mainly reflected higher public investment. The decline in savings reflected a sharp deterioration in public sector savings (of some 4 percentage points), only partly offset by higher private savings as private disposable income was boosted by generous social security transfers and a large increase in government domestic interest payments.

7. The Turkish authorities recently undertook two surveys to capture unrecorded exports mainly to Eastern European countries (the so-called shuttle trade) (see Chapter IV), which suggests a need to substantially revise the balance of payments data. The authorities intend to revise the national accounts to reflect the upward revision in exports of goods and nonfactor services, currently estimated by the Central Bank of Turkey to amount to about US$3 billion for 1996. This will imply higher net exports, but at this stage, it is unclear what other changes need to be made to the national accounts. As a result, the interpretation of current macroeconomic trends is subject to more than usual uncertainty.

B. Income Distribution

8. The last (1994) Household Income and Consumption Expenditure Survey revealed that income distribution in Turkey has become more skewed in recent years. In the period from 1987-1994, average real per capita income increased by a cumulative 5 percent, but real per capita income of the poorest 20 percent of the population declined by 1 percent, while real per capita income of the richest 20 percent of the population increased by 15 percent.3 Thus, the national income share of the poorest quintile declined to 4.9 percent in 1994 from 5.2 percent in 1987, while the national income share of the richest quintile increased to 54.9 percent from 49.9 percent.4 Also, the distribution of income between regions has become more skewed: while in 1987, rural (urban) income represented 40.8 (59.2) percent of total income, in 1994 the share of rural (urban) income had dropped (risen) to 31.1 (68.9) percent.5

9. The 1994 household survey also showed that interest and dividend income rose sharply as a share of household disposable income (from 1.8 percent in 1987 to 7.7 percent in 1994) mirroring the sharp increase in government interest payments, while agricultural income declined markedly (from 22.8 percent to 16.7 percent). The latter decline, which was reflected in lower entrepreneurial income, was matched by an increase in wages and salaries (to 28.3 percent from 24 percent in 1987).

C. Prices

10. Inflation remained at about 80 percent in 1996 for the second year in succession because of the expansionary fiscal stance, the accommodating monetary policy, which was mainly devoted to maintaining a stable real exchange rate, and increasing wage pressure. Year-on-year (December-December) consumer price inflation was 82.3 (79.8) percent in 1996; year-on-year (December-December) wholesale price inflation was 77.9 (84.9) percent (Tables A9 and A10, and Figure 3). Energy prices reported the largest increases in 1996 (129.9 percent), while manufacturing had the smallest increase (80.6 percent). Energy prices and other public sector prices rose markedly to catch up after the relatively small increases in 1995.

Figure 3.

Turkey: Price Developments, 1989-97

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

Sources: Data provided by the Turkish authorities; and staff estimates.1/ 3-months moving average.

11. Wholesale (consumer) price inflation during the first five months of 1997 was 32.1 (31.6) percent, bringing the year-on-year changes to 74.6 (77.5) percent. However, while trend inflation declined during the second half of 1996, it has picked up again in 1997 to about 87 percent (annual rate).

D. The Labor Market

12. Available indicators suggest a tightening of the labor market in 1996 with employment increasing, unemployment declining, and real wages rising. Employment expanded by 2.5 percent in 1996 (despite a continued drop in the number of state enterprise workers) absorbing the increase in the labor force and affording a moderate decline in the number of unemployed. By October 1996, the official unemployment rate had dropped to 5.8 percent from 6.9 percent in 1995, a low for the past decade, while the official underemployment rate eased to 6.3 percent from 6.7 percent a year earlier (Table A11). In rural areas there is very sizable disguised unemployment, which is not captured by the official employment figures.

13. Industrial sector employment expanded fastest (6.9 percent), bringing about an increase in the share of industrial employment to total employment to some 16 percent from 15 percent a year earlier. Similarly, the share of the service sector rose to about 39 percent from 38 percent, while the share of agriculture declined to some 45 percent from 47 percent. The still high level of employment in agriculture highlights the low productivity of the sector (less than one quarter that of the manufacturing and services sectors) and the consequent large potential for internal migration and urbanization in Turkey.

14. After two consecutive years of declining real wages, in 1996 real wages increased, except for public sector workers whose contracts had been concluded in 1995 with a modest nominal increase (38 percent) for 1996 (Table A12).6 The minimum wage was increased by 115 percent (19 percent in real terms) in 1996, after having declined by a cumulative 36 percent in the previous two years in real terms; private sector real wages rose by 3.1 percent in 1996, after having dropped by a cumulative 32 percent in the previous two years, according to official data.

15. The appearance of indexation clauses in some public sector wage contracts in 1997 represents an important institutional development which is expected to reduce the degree of flexibility of real wages, thus reducing the economy’s ability to withstand shocks. While most private sector wages apparently are already implicitly indexed, e.g., by being fixed in dollar terms or set in two-year collective contracts, which typically include an above-inflation initial adjustment and full indexation for the second year, it is likely that indexation clauses will become even more widespread in the private sector.7

II. Public Finances

A. The Structure of the Nonfinancial Public Sector8

16. The nonfinancial public sector in Turkey consists of five main subsectors: the consolidated budget which includes the central government, the budgetary funds, and the annex budget (covering some autonomous organizations such as universities); extrabudgetary funds (EBFs); local governments; the social security institutions and revolving funds; and nonfinancial state economic enterprises (SEEs). The first four entities constitute the general government. In addition, the central government issues debt to cover debt service payments by EBFs and SEEs, losses of SEEs, and subsidies to exporters and the agricultural sector (extrabudgetary operations), as well as debt to cover losses of state banks, mainly in the context of agricultural subsidy schemes, and central bank losses from open market operations (quasi-fiscal operations). There are also extrabudgetary funds on which no information is available.

B. Overall Trends

17. Following the implementation of the stabilization program in April 1994, the public sector borrowing requirement (PSBR) was reduced from 15.2 percent in 1993 to 9.3 percent of GNP in 1994, and 6.8 percent in 1995 (Table A13).9 This was mainly achieved by reductions in the wage bill and noninterest transfers. In 1996, this trend was reversed, and the PSBR rose by 4.5 percentage points to 11.3 percent of GNP, mainly due to a worsening of the balance of the consolidated budget, and increased recourse to extrabudgetary and quasifiscal operations.

18. The PSBR was financed by large domestic borrowing which reached 12 percent of GNP in 1996 against 7.1 percent in 1995. As in previous years, repayments on foreign borrowing were larger than drawings on external credits. Privatization revenues covered only a very small share of the public sector financing needs.

C. The General Government

19. After two years of fiscal consolidation, the financial position of the general government worsened markedly in 1996. The overall deficit, including extrabudgetary and quasi-fiscal operations, rose from 7.5 percent of GNP in 1995 to 11.1 percent in 1996 (Tables A14 and A15, and Figure 4). The general government primary balance worsened by 1.4 percentage points of GNP to a deficit of 0.6 percent and increased interest outlays represented more than half of the increase in the general government borrowing requirement.

Figure 4.
Figure 4.

Turkey: Fiscal Indicators, 1992-97

(In percent of GNP)

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

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

Central government budget Operations

20. The deficit of the central government, including extrabudgetary and quasi-fiscal operations, deteriorated from 6.9 percent of GNP in 1995 to 11.6 percent in 1996, thereby substantially exceeding budget estimates (Tables A16 and A17). This is reflected in a large increase in adjusted domestic borrowing, from 7.9 percent of GNP in 1995 to 12.5 percent in 1996.


21. Revenues of the consolidated central government remained unchanged in 1996 from 1995 at 17.7 percent of GNP, after temporarily peaking in 1994 due to the implementation of a package of once-off revenue measures. However, tax revenues rose by 1.1 percentage points to 14.9 percent of GNP in 1996, while other revenues fell by the equivalent amount.10 This largely reflected the change in tax regime for imported oil products from the EU as of January 1, 1996, when the customs union with the EU was completed. As a result, revenues from the oil product import levy of the Mass Housing Fund fell markedly, while collections of the domestic Petroleum Consumption Tax increased. To compensate for the loss of customs duties and import levies due to the creation of the customs union, the rates of the Petroleum Consumption Tax were raised by about 15 percent in early 1996.

22. Revenues from direct taxes decreased slightly in proportion to GNP in 1996 to 5.8 percent of GNP (Table A18 and Appendix II). As in the preceding two years, income tax brackets were adjusted by more than inflation in 1996, thus reducing the buoyancy of the income tax (Table A19). Indirect tax revenues increased from 7.9 percent of GNP in 1995 to 9 percent in 1996, mainly reflecting the above mentioned shift from fund revenues to taxes. In addition, indirect taxes were boosted by the rapid growth in imports.

23. Other revenues declined from 3.9 percent of GNP in 1995 to 2.9 percent of GNP in 1996 as the revenues from the import levy on petroleum products and other levies on imports earmarked for the budgetary funds fell markedly. Nontax revenues also declined, reflecting low profit transfers from public entities.

Expenditures and net lending

24. The downward movement of expenditures and net lending during 1994 and 1995 was reversed in 1996, as expenditures and net lending of the consolidated budget rose from 21.8 percent of GNP in 1995 to 25.9 percent in 1996. This large increase was mainly on account of increased interest payments and transfers to the social security system.

25. Noninterest expenditures increased by 1.6 percentage points to 16 percent of GNP in 1996. Despite pressures to increase wages to compensate for the large real wage declines during 1994-95, personnel expenditures remained constant at 6.4 percent of GNP in 1996. Noninterest transfers rose from 5.1 percent of GNP to 6 percent, on account of higher transfers to the social security institutions. The government that took office in July 1996 increased transfers to budgetary and extrabudgetary funds in an effort to raise spending on certain social and cultural items. Investment outlays increased to 1.8 percent of GNP in 1996, from 1.6 percent in 1995.

26. Interest payments were markedly higher in 1996 than in 1995: 9.9 percent of GNP against 7.3 percent a year earlier. This partly reflected a lengthening of maturities during the period March-September 1995, that had the effect of pushing sizable interest payments into 1996, compounded by a sharp worsening of borrowing conditions toward the end of 1995. In addition, interest outlays reflected the hike in interest rates in late 1995 and early 1996 associated with elections and continued political uncertainty. In the second half of 1996, however, borrowing conditions improved markedly as confidence in the stability and policies of the new government increased; average maturities reached 13½ months in November 1996 against just over four months in May, and average interest rates on domestic borrowing dropped from 208 percent in January 1996 to 104 percent in December.

27. Defense and security related expenditures reported in the budget were 3.3 percent of GNP in 1996, and have remained roughly unchanged since 1993 (Table A20). However, an unknown part of defense spending is not included under these items, but is carried out through off-budget items, such as the Defense Industry Support Fund.

28. Extrabudgetary and quasi-fiscal operations increased from 3.1 percent of GNP in 1995 to 3.3 percent in 1996 (Table A21). This increase reflected a large issue to the central bank to cover accrued losses. The debt issued in 1996 in the context of extrabudgetary and quasifiscal operations carried on average higher interest rates than in previous years; typically the annual interest rate on these debt issues was indexed to wholesale prices plus 6 percent.


29. Since 1994, net foreign borrowing of the consolidated budget has been negative, requiring the central government to rely even more heavily on domestic financing to cover the fiscal deficit. In the absence of significant privatization revenue and with limited financing from the central bank,11 the central government increased securities issuance from 3.6 percent of GNP in 1995 to 7 percent in 1996. Reflecting these trends, the share of foreign debt in total central government debt declined from 51.8 percent in 1995 to 44.1 percent 1996, (Table A22), the share of nonsecuritized debt to the central bank fell from 7.7 percent in 1995 to 6.6 percent in 1996, while t-bills and bonds rose from 40.5 percent to 49.3 percent.

30. In an effort to increase the maturity structure and lower the cost of domestic borrowing, the government introduced a number of new debt instruments in the second half of 1996. In September and November 1996, the government issued foreign-currency dominated bonds, at spreads of up to 260 basis points over LIBOR.12 In addition, some US$1 billion was raised by attracting one-year deposits of DM 50,000 at an interest rate of 10 percent; depositors also received the right to import used cars and machinery at a preferential tariff. Finally, the government set up the Unified Public Account (UPA), a central account where public entities pool their cash resources, and used the resources at an interest rate of 60 percent (the return for depositing agencies is 50 percent).13 In early 1997 for the first time two-year bonds indexed to the consumer price index were issued. To compensate for the lower liquidity, longer maturity, and more complicated pricing of these bonds relative to treasury bills, investors demanded relatively high real yields of up to 32 percent.

The 1997 consolidated budget

31. The 1997 budget was presented by the government as a balanced budget (in the sense of no recourse to domestic market borrowing), based on an ambitious resource mobilization program.14 Revenues are budgeted to increase by 2.9 percentage points from 1996 to 20.6 percent of GNP. The introduction of a withholding tax on income from treasury bills, government bonds, and other types of securities was expected to generate an increase in tax revenues by 0.6 percentage point of GNP. Further substantial revenue increases were expected from administrative measures, such as the introduction of a prepaid stamp system (banderole) to improve collection of excises on alcohol and tobacco, widening the tax net by registering shuttle traders, and a general improvement of the tax performance that would result from increased use of Taxpayer Identification Numbers and an increase in collection efforts and audit procedures.

32. Expenditures were budgeted to decline from 25.9 percent of GNP in 1996 to 25.2 percent in 1997. This reflects a marked drop in interest expenditures (by 2.2 percentage points of GNP), and an increase in noninterest expenditures. Interest expenditures were budgeted to decline due to the introduction of the new debt instruments discussed earlier, and the expectation of continued favorable conditions in the market for treasury bills and government bonds which, by extending maturities, would push interest payments into 1998 and beyond. Noninterest expenditures would rise from 16.0 percent of GNP in 1996 to 17.9 percent in 1997, partly due to the increases in government wages given during the first four months of the year, increased purchases of goods and services and higher investment outlays (Table A23).

33. No official data have been published on fiscal developments in the first five months of 1997, in contrast to previous practice. From the partial information that has become available on performance during the first five months of the year, it appears that resources available to the consolidated budget will be lower than was expected, and that the recourse to domestic financing will be considerably higher than budgeted, as privatization revenues are likely to fall well short of the ambitious target of the Government. Although tax collections appear to be coming in about as budgeted in nominal terms, they are not increasing significantly as a share of GNP.

Extrabudgetary funds (EBFs)

34. Since 1992, deficits of the EBFs have come down steadily, to reach 0.4 percent of GNP in 1996 (Table A24).15 Revenues of the EBFs fell from 2.7 percent of GNP in 1995 to 2.0 percent in 1996, reflecting the reduction of import levies earmarked as fund revenues after Turkey joined the customs union, and a fall in transfers from the central government outside the budgetary framework that cover debt service payments of the Public Participation Fund.16 Expenditures declined by 1.3 percentage points to 2.3 percent of GNP, reflecting a marked reduction in transfer payments.

Local governments

35. The aggregate deficit of local governments declined slightly, from 0.4 percent of GNP in 1995 to 0.2 percent in 1996 (Table A25). This was mainly due to an increase in revenues, while expenditures remained virtually unchanged. Local governments derive most of their revenues from tax-sharing arrangements with the central government. The increase in revenues reflects an increase in the share of local taxes in total taxes, from 11.8 percent in 1995 to 12 percent in 1996. The local tax-share in direct taxes is somewhat higher (13.3 percent) than the share in indirect taxes (11.2 percent).

Social security system

36. The deficit of the three social security institutions (SSK, Bag-Kur, and Emekli Sandigi) widened from 1.1 percent of GNP in 1995 to 2 percent in 1996. This worsening in part reflected reduced collections of social security contributions, from 3.3 percent of GNP in 1995 to 3 percent in 1996. The government has recognized that the administration of social security contributions needs strengthening, and is planning to improve administrative procedures, for example by introducing an identification number system. In addition, the authorities have drafted measures to increase penalties for non-payment of contributions and improve auditing procedures. Expenditures of the social security system have come down from 5.6 percent of GNP in 1994 to 5.2 percent of GNP in 1995 and 1996. In 1996, expenditures for retirement insurance went up slightly, while health care expenditures declined.

D. State Economic Enterprises (SEEs)

37. SEEs operating balances improved slightly in 1996; the after-tax operating surplus adjusted for depreciation and provisions increased from 2.1 percent of GNP in 1995 to 2.3 percent (Table A27). This was achieved despite a drop in current revenue from 20.2 percent of GNP to 18.9 percent, reflecting lower revenues from interest as SEEs were required to hold their balances in the Unified Pool Account. The decline in revenues was counterbalanced by a drop in current outlays from 18.1 percent of GNP in 1995 to 16.6 percent of GNP in 1996, due to continued constrained wage policies, a reduction in the number of employees, and lower interest charges following the net repayments on domestic and foreign credits in 1994 and 1995, and lower purchases of agricultural commodities.

38. Despite the improvement in their operating surplus, the SEEs had a small borrowing requirement (0.1 percent of GNP) in 1996 compared to a surplus in 1995 due to lower government transfers and increased investment outlays (Tables A28 and A29). The SEEs borrowing requirement was entirely financed by deferred payments, while net foreign borrowing was negative.

E. Recent Changes in Tax Legislation17

39. On January 1 1996, Turkey entered into a customs union with the EU completing a 30-year process of tariff reductions; import tariffs were lowered on average by about 5 percentage points, and as a result, the trade between Turkey and the EU became subject to the domestic tax regime. To compensate for the loss in customs duties and import levies on petroleum and other products, the rates for the Petroleum Consumption Tax were increased by about 15 percent.

40. In November 1996, a withholding tax of 12 percent was introduced for interest income on government debt, Certificates of Deposit, foreign exchange deposits, and private bonds. At the same time, capital income from securities was subjected to a 10 percent withholding tax, which was increased to 12 percent on January 1, 1997, while the withholding tax on interest income was increased from 5 percent to 12 percent. The withholding tax on interest income is subject to a surcharge of 10 percent of the tax, with the proceeds distributed among funds and the Treasury. Payments for the withholding tax can be deducted from income tax payments.

III. Monetary and Financial Market Developments

A. Introduction

41. Monetary policy in 1996 and so far in 1997 has sought to ensure financial market stability, rather than restraining inflation. In particular, the central bank pursued a real exchange rate rule aimed at maintaining competitiveness and increasing the predictability of the exchange rate through backward indexation. Reflecting this practice, the real effective exchange rate varied little in 1996. Money growth has been managed with the view to dampening the volatility of overnight interest rates and preventing them from much exceeding 75 percent (about 112 percent compounded). This monetary stance, along with an expansionary fiscal policy and a strong upswing in private demand contributed to an increase in the WPI of about 80 percent in 1996 (Figure 5). As noted, in the 12 months through May 1997, prices at the wholesale level rose by 74.5 percent.

Figure 5.

Turkey: Price and Exchange Rate Developments, 1994-97

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

Sources: Data provided by the Turkish authorities; and staff estimates.1/ Seasonolly adjusted smoothed indices.2/ Basket of 1 US dollar and 1.5 deutsche mark.

B. Monetary Developments

42. Reserve money grew by 81 percent in 1996, broadly in line with the increase in wholesale prices, and by a faster 29 percent in the first five months of 1997. The increase in the net foreign exchange position of the central bank was the main impetus behind reserve money growth in 1996, followed closely by growing central bank claims on the treasury.

43. Capital inflows attracted by high interest rates contributed to a sharp increase in the foreign assets of the central bank (130 percent). The net foreign exchange position of the central bank improved from a short position of US$1.6 billion at end-1995 to a long position of US$1.3 billion at end-1996.

44. Central bank lending in 1996 consisted almost entirely of short-term advances to the Treasury, which increased 93.2 percent in 1996 to reach TL 370.9 trillion,18 or about 40 percent of central bank assets. The increase in short-term advances in 1996 represented 15.2 percent of the increase in M2.

45. Partially offsetting this effect, central bank operations on the interbank market reduced liquidity equivalent to about 7 percent of the increase in reserve money.

46. All of the monetary aggregates grew faster than nominal GNP (92 Vi percent) in 1996, with both narrow money and M2X19 increasing by about 110 percent (Figure 6). The increase in narrow money, which had been considerably slower in the first ten months of 1996 (up 57.8 percent from end-1995) surged thereafter as a result of the adoption of a unified pool account for state economic enterprises (SEEs) which had the effect of shifting SEE cash balances from the repo market to sight deposits (see Box). The share of foreign currency deposits in M2X remained around 50 percent throughout 1996, placing Turkey among the most dollarized countries in the world.

Figure 6.
Figure 6.

Turkey: Monetary Developments, 1995-97

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

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

Unified Pool Account

The authorities’ funding strategy since the second half of 1996 has been oriented toward relieving pressure on the treasury bill market through privatization, the introduction the indexed bonds, and a number of “resource packages” aimed at raising funds from unconventional sources, including the working capital of SEEs. In November 1996, the treasury instituted a unified pool account for state economic enterprises (SEEs) under which SEEs were compelled to place their working capital and other cash balances in Turkish lira and foreign currency sight deposits with one of four state banks. These deposits were then used by the treasury to manage its cash position. Although this arrangement did nothing to alter the PSBR, the liquidity in the accounts permitted the treasury to ease pressure on the treasury bill market, whose interest rate is a closely watched indicator. It also had the effect of boosting sight deposits and the growth of narrow money.

47. In the first five months of 1997, reserve money grew by about 29 percent, as net domestic assets increased by one third. Capital inflows remained strong as reflected in an increase in central bank net international reserves of US$0.7 billion to US$16.3 billion at end-May 1997 (Figure 7). In the first five months of 1997, narrow money, M2 and M2X increased by 25 percent, 26 percent, and 27 percent, respectively, compared with an increase in the WPI of 32 percent. Over the same period in 1996, Ml, M2 and M2X increased by 18.5 percent, 32.8 percent and 27.6 percent, respectively.

Figure 7.
Figure 7.

Turkey: Recent Exchange Market Developments, 1995-97

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

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

48. Real interest rates remained high throughout 1996 and early 1997 (Figures 8 and 9). These high real interest rate levels reflect the risk premium demanded by creditors and the pressure of government borrowing on shallow financial markets. T-bill rates, which rose strongly in the fourth quarter of 1995 in the run-up to national elections, peaked in January 1996 at 208 percent, and declined through the remainder of the year. Yields on t-bills fell from 146 percent in the first half of 1996 to 120 percent in the second half, and were 130 percent (or 26 percent in real terms) for the year as a whole. In the first quarter of 1997, average t-bill yields were 94 percent, but rose again to about 100 percent by mid-June.

49. Like t-bill yields, interest rates on one- and three-month time deposits peaked in January 1996 and declined thereafter; the real rates on time deposits remained well below t-bill rates, however. Daily interest rates in the interbank market also fell in the course of 1996 (from a peak of 95.2 percent in January) and averaged 77.4 percent in 1996 (116 percent annualized, or about 20 percent annualized in real terms) and about 65 percent (91.4 percent annualized) in the first quarter of 1997.

50. While the average real interest rate on t-bills in 1996 was about 26 percent, new issues of indexed bonds, auctioned during March-June 1997, bore real interest rates ranging from 22 percent to 32 percent. The magnitude of the risk premium on indexed bonds is in part attributable to the novelty of the instrument and lack of familiarity with its pricing and the illiquidity of the secondary market for indexed bonds.

C. Banking Sector Developments

51. The total assets of the banking sector expanded by 16½ percent in real terms in the year through November 1996 (116.3 percent in nominal terms), boosting banking sector’s assets from about 50 percent of GNP to 56 percent of GNP. The loan portfolio of banks over the same period grew by almost 24 percent in real terms: private bank lending grew by about 32 percent in real terms, more than twice the pace of state bank lending (15 percent in real terms). The share of loans in total bank assets increased from 39.4 percent in November 1995 to 41.8 percent in 1996, but as a ratio of deposits, loans declined slightly from 62 percent to 61.5 percent.

52. The structure of bank lending in 1996 changed little from the previous year. Bank lending in 1996 remained oriented toward financing exports (31 percent of all lending) and business (31 percent). The share of loans denominated in foreign currencies continued to represent about half of the total (increasing from 50.2 percent in 1995 to 52.1 percent in 1996), as foreign currency-denominated loans grew by 138.3 percent in nominal terms. Most lending (about 83 percent) continued to take the form of short-term credits, with long-term lending typically denominated in foreign currencies.

Figure 8.

Turkey: Interest Rates, 1995-97

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

Sources: Data provided by Turkish authorities; and staff estimates.1/ Include Treasury bills of irregular maturities.2/ Annualized inflation in month t is derlved from the change in the wholesale price index between t-2 and t+1. Monthly in flation in June 1997 is ossumed to be unchanged from May in seosonally odjustsd terms.3/ Annualized increase in price of currency basket. For month †, annualized rate is derived from the change in the price of the currency baskst between †-2 †-1 and The increase In the price of the currency basket for June 1997 is assumed to be 5 percent, unchanged from May.
Figure 9.
Figure 9.

Turkey: Selected Interest Rates, July 1994-May 1997

(Percent; Annualized)

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

Sources: Data provided by Turkish authorities; and staff estimates1/ Aunnalizad inflotion month † is derived from the wholesale prise the Index between †-2 and †+1

53. On the liability side, banking sector deposits, excluding interbank deposits, increased by 30.7 percent in real terms (138 percent nominal) in the year through November 1996. Foreign exchange deposits represented 50.2 percent of the total at end-November 1996, compared with 49.2 percent at end-November 1995. Depositors strongly preferred short maturities: three quarters of all deposits had maturities of three months or less.20

D. Institutional Developments

54. The main institutional developments included the reduction of liquidity and reserve requirements for bank deposits in July 1996 and the ceiling on central bank short-term advances to the treasury. Steps were also taken to improve reporting and accounting standards and tighten supervision, with the view to enhancing transparency and improving the coordination between the two supervisory agencies—the treasury and the central bank.

55. Reserve and liquidity requirements were reduced in 1996. Required reserves were lowered from 9 percent to 8 percent on Turkish lira deposits and from 13 percent to 11 percent for foreign currency deposits. There is no reserve requirement for gold stock accounts. Domestic interbank deposits and certain treasury deposits are exempt from the reserve requirement. Liquidity requirements on nondeposit liabilities were also lowered. Banks may satisfy the 6 percent liquidity requirement on Turkish lira nondeposit liabilities entirely through bonds. In the case of nondeposit foreign exchange liabilities, the liquidity ratio was set at 14 percent (down from 15 percent), of which only 3 percent may be satisfied through foreign securities.

56. The statutory limit on central bank short-term advances to the treasury was reduced from 10 percent of the increase in budgetary appropriations from the previous year in 1996 to 6 percent in 1997; it is to be further reduced (to 3 percent) in 1998.21 This is a significant development since the ability of the central bank to manage the money markets is clearly affected by large and unpredictable flows in and out of the short-term advance account. Short-term advances in 1996 represented ½ percent of GNP.

E. Capital Market Developments

57. Public sector securities, mainly bills and bonds, continue to dominate Turkish financial markets, representing about 97 percent of all new issues in 1996, and 94 percent of the trading volume on the secondary markets.

58. The market capitalization of the Istanbul stock exchange increased from US$20.8 billion in 1995 to US$30.8 billion, or 16.6 percent of GNP in 1996, reflecting strong market performance (39 percent increase in U.S. dollar terms) and the introduction of new companies to the exchange (Figure 10). Banks and other financial institutions strongly outperformed the broader market in 1996. The price earnings ratio (in U.S. dollar terms) rose from 9.2 in 1995 to 10.7 in 1996, while the dividend yield rose a bit to 3.9 percent. Trading volume, in U.S. dollar terms, declined.

Figure 10.
Figure 10.

Turkey: SecurJtles Markets: Selected Indicators, 1987-96

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

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

IV. External Sector Developments

59. Analysis of external sector developments in Turkey in recent years is complicated by the rise of a large unrecorded “shuttle” (or “suitcase”) trade with the countries of the former Soviet Union (FSU) and Eastern Europe. This trade now accounts for somewhere between one-quarter and one-half of Turkey’s total goods exports, but lack of reliable statistics make it difficult to quantify and chart trends. Linked to this has been a methodological problem in recording services exports, causing them to be overstated. These ongoing problems were exacerbated in 1996 and early 1997, when entrance into customs union with the EU and the related adoption of new customs procedures caused delays of up to 6-8 months in the release of trade and balance of payments data. These factors should be kept in mind in the discussion of official statistics (reported below).

A. The Shuttle Trade

60. The shuttle trade consists of the large-scale export of textiles, leather goods, and household products—generally Turkish made—to the FSU and Eastern European countries, ostensibly as accompanied baggage (hence the term “suitcase trade”). What began as a small operation among tourists from these transition economies has since evolved into a large and sophisticated (but as yet unrecorded) industry. Visitors use cargo planes, buses equipped with cargo trailers, and refitted cruise ships in a trade worth billions of dollars annually.

Size of the trade

61. While all observers agree that this shuttle trade has become very large, there is little firm data on its exact size. Anecdotal evidence suggests exports as high as US$10-15 billion (43-65 percent of total recorded goods exports in 1996). Two preliminary studies have also recently attempted to capture the size of the trade. One effort, by the State Institute of Statistics (SIS) used a survey of 3,000 foreign visitors to measure shuttle trade in the first half of 1996 and produced an estimate of US$1.6 billion (which would result in a full-year total of roughly US$4 billion). In early 1997, the Central Bank of Turkey (CBT) conducted the first round of a survey (covering 1,000 people) which directly measured trade per person. This survey produced a figure of US$8,700 in shuttle trade per FSU visitor. Aggregating from this number based on the assumption of roughly 1 million traders, the CBT estimated total shuttle exports in 1996 at US$8.8 billion. Two additional rounds of the CBT survey will be conducted later in 1997, and a more reliable estimate is expected to emerge as the methodology is refined and the sample size is enlarged. Evidence from Russia supports the idea that shuttle trade is indeed very large, and that the central bank figures could be underestimated.

Implications of the shuttle trade for the balance of payments

62. Given the uncertain size of the shuttle trade, it is difficult to derive conclusions about the true level of the trade and current account balances. The analysis is further complicated by mismeasurement of services exports. Data for a large proportion of services credits (in the category denominated “other other services”) are derived from data on foreign exchange transactions in the banking system. While some of these transactions undoubtedly reflect foreign exchange earnings derived from the shuttle trade (and other unrecorded goods and services exports), the liberalization of foreign exchange accounts in Turkey in recent years and the increasing dollarization of the economy means that much of this activity reflects resident-to-resident transactions. So, while goods exports are clearly underreported, services exports are also overrecorded; a correction of the current account would thus involve at least a partial offsetting of these two factors. The CBT adjustment produces an overall improvement of the current account on the order of US$3 billion, with a corresponding adjustment in the capital account. The CBT proposes two changes for 1996—short-term net capital inflows are adjusted downward by US$1 billion (reflecting higher holdings of U.S. dollars outside the Turkish banking system) and errors and omissions decline by US$1.9 billion. Table A37 presents CBT estimates of the balance of payments statistics for 1996 with and without the shuttle trade to illustrate the possible effects on the current and capital accounts.

63. The inclusion of the large shuttle trade has implications both for the analysis of trends in the balance of payments and for the analysis of other macroeconomic variables. While it would be extremely difficult to retroactively adjust the current account for the shuttle trade prior to 1996 due to lack of data, the available figures on visitor arrivals from the FSU and Eastern Europe would suggest that the trade has been of considerable magnitude for several years (Table 1). If this is the case, the current account may well have been in surplus in 1995, and the deficit in 1993 (year of the last foreign exchange crisis) was possibly well below the 3.5 percent of GDP reported in the official external accounts. Furthermore, it is not clear that the current account deteriorated significantly during 1996, nor could one draw the conclusion that the present external sector position is unsustainable. As a counterpart to the improved current account, errors and omissions would be much less positive than reported in 1994 and 1995, and there would have been a substantial unrecorded accumulation of foreign exchange holdings outside the banking system (either in holdings of foreign exchange cash or in capital flight).

Table 1.

Turkey: Selected Indicators on Shuttle Trade

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Sources: State Institute of Statistics; and Central Bank of Turkey.

B. External Current Account

64. According to preliminary official statistics (excluding shuttle trade), during 1996 a large increase in imports overwhelmed solid export performance to produce a sharp deterioration in the current account (Table A38 and Figure 11). The recorded trade deficit climbed from US$13.2 billion (7.7 percent of GNP) in 1995 to US$18.5 billion (9.9 percent of GNP) in 1996, while the services balance improved from US$6.3 billion to US$9.3 billion, producing an increase in the current account deficit from US$2.3 billion (1.4 percent of GNP) to US$4.4 billion (2.4 percent of GNP). Adjusted for the shuttle trade, the current deficit in 1996 was US$1.4 billion (0.8 percent of GNP) according to central bank figures. On the export side, foreign market growth—particularly in Germany—was weak, resulting in slower export growth (6.8 percent in 1996 versus 19.5 percent in 1995). On the import side, the entrance into full customs union with the EU together with strong domestic demand stimulated import growth of 19 percent. Domestic demand rose by 8.9 percent in 1996, and while entrance into the Customs Union produced a reduction in average rates of protection on imports (detailed below).

Figure 11.
Figure 11.

Turkey: Current Account Developments, 1989-97

(In billions of US$)

Citation: IMF Staff Country Reports 1997, 110; 10.5089/9781451837995.002.A001

Source: Data provided by the Turkish authorities; and staff estimates.1/ 3-months moving average.

65. Despite the deceleration in non-shuttle goods exports in 1996, the 6.8 percent growth rate achieved in dollar terms still slightly exceeded that of non-oil goods imports in partner countries (5.3 percent), producing a slight increase in market share (Table A39). Exports grew by 10.8 percent in volume terms while prices declined by 3.2 percent for the year. Export growth was led by agricultural products, which rose by 17 percent. Industrial products exports were less robust (up 5.7 percent), with a sharp increase in electrical goods offsetting weak performance in other areas (Table A41). Mining and mineral exports grew moderately (rising by 6.2 percent). Exports to EU countries were weak, with slow economic growth and anti-dumping restrictions imposed on certain products limiting growth to under 4 percent (Table A42). Exports to transition economies were mixed, with trade to Eastern European countries falling, while exports to the FSU were up sharply led by non-shuttle exports to Russia, Ukraine, Uzbekistan, and Azerbaijan.22

66. Imports of goods grew at a blistering pace early in 1996, rising by 30 percent in the first half of the year. Import growth moderated to 11 percent in the second half, however, which produced a rise of 19.2 percent for the year as a whole. Consumption goods imports led the way (up 53 percent), with imports of automobiles and electrical appliances growing particularly strongly. Investment goods imports also showed robust growth (up 41 percent), driven by strong investment in both the public and private sectors. Higher machinery and equipment growth accounted for the bulk of the increase. Raw materials imports grew somewhat less strongly; petroleum products imports climbed by 17 percent, but chemicals imports actually fell (Table A43). The effects of the customs union with the EU manifested themselves in the geographical distribution of imports (Table A44). Imports from EU countries jumped to 53 percent of total imports from 47 percent in 1995. This gain seems to have come mainly at the expense of the United States and Japan, whose market shares fell by 2.9 percentage points and 0.8 percentage points, respectively. The sharp increase in exports to the FSU countries was not accompanied by a corresponding rise in imports; FSU share of total imports fell sharply, with Russian and Ukrainian imports particularly weak.

67. The services surplus rose in 1996 due to a sharp 38 percent increase in credits, while debits rose by 22 percent. In the category of travel and tourism, receipts rose by 14 percent while expenditures rose much more sharply (39 percent), causing net receipts to rise only slightly. Growth in tourist arrivals slowed to 4 percent (to 7.9 million), after a very strong increase in 1995, while expenditure per person rose by 10 percent. Visits from OECD countries increased by 12 percent, while entrants from Eastern Europe and the Former Soviet Union (mainly thought to be shuttle traders) fell by 5 percent. Interest payments abroad declined by 2 percent due to lower interest rates despite a 9 percent increase in foreign debt stock. Effective interest rates on short-term loans rose, but interest paid on medium- and long-term borrowing fell by nearly 1 percentage point.

68. The bulk of the improvement in the services account (not adjusted for shuttle trade) was generated by “other services,” which include transportation, freight, insurance, and direct investment income. While data are not yet available on the breakdown of this category for 1996, the probable source of this sharp increase came from the subcategory of unspecified other services (the so-called “other other Services”)—credits generated by foreign exchange receipts entering the Turkish banking system from sources unattributed to other categories. As suggested above, these credits to a large extent reflect the unrecorded “Shuttle” trade exports of Turkish goods to FSU and Eastern European countries.

69. The transfers balance remained constant in dollar terms in 1996. Workers’ remittances and other private transfer inflows grew by 14 percent, but this was counteracted by a sharp drop in official transfers. Lower official transfers were due in part to delays in payments from the EU to Turkey in compensation for adjustment costs to the Customs Union.

70. Preliminary data for the first quarter of 1997 showed a sharp increase in the current account deficit. The current account deficit (excluding shuttle trade) nearly doubled to US$1.3 billion. When shuttle trade is included, the current account deficit rose to US$713 million from US$167 million in 1996. There was a further deceleration in import growth from the rapid pace of early 1996, while non-shuttle export growth remained roughly constant. Imports grew by 6.2 percent and exports grew by 6.5 percent. Export growth was driven by manufacturing goods (up 8.0 percent), while agricultural exports declined. Shipments to European countries continued to be weak, with strong growth in trade with FSU countries, the United States, and the Middle East. Despite lower import growth, the trade deficit (unadjusted) in January-March climbed 5.7 percent to US$3.9 billion. At the same time, the non-shuttle services surplus declined by 11 percent in the first quarter and net transfer payments dropped by 21 percent, generating the deterioration in the current account.

C. Capital Account

71. During 1996 there was a sharp increase in net capital inflows into Turkey. The capital account (including errors and omissions) rose to US$8.9 billion from US$7 billion in 1995. This increase was produced primarily by an increase in short-term capital flows (including errors and omissions). Net long-term capital also increased, while net direct and portfolio investment declined (Table A45).

72. From a small base, net direct foreign investment fell by 21 percent in 1996 to US$772 million (Table A46). However, the decrease was due solely to a rise in Turkish investment abroad from US$163 million to US$325 million. Investment in Turkey remained virtually unchanged at US$935 million (½ percent of GNP), a very small level considering the large domestic market, strong growth rate, and advantageous trade position vis-à-vis the EU, Middle East, and FSU countries. Portfolio investment fell sharply, dropping from US$1.7 billion in 1995 to only US$570 million in 1996. Private portfolio flows declined by US$2.1 billion, while net issues of government securities rose by US$700 million. This increase came notwithstanding a deteriorating assessment of Turkish government debt by the major ratings organizations. Standard and Poor’s gave a negative outlook to Turkish debt in July 1996, followed by downgrading from B+ to B in December. Other ratings agencies followed suit, with IBCA also downgrading in December and Moody’s adjusting in March 1997. Even in the wake of the latest round of downgradings, however, the government has had little difficulty in placing bonds, albeit at very high spreads over LIBOR. During the first half of 1997, the government placed four bond issues totaling US$1.4 billion.

73. Net medium- and long-term lending rose sharply to US$1.6 billion in 1996, from near zero in 1995. The increase was due to large inflows to the banking sector and increase in private enterprise foreign borrowing. Official long-term capital flows were negative both years as growth in Dresdner deposits to the central bank moderated, while the general government had repayments of nearly US$3 billion. Turning to short-term capital, 1996 produced a US$4.4 billion increase (Table A47), Trade credits doubled, reaching US$3.4 billion, associated with the sharp rise in imports. Foreign exchange reserves of the banking system also climbed by US$1.5 billion. This rise was partially offset by the drop in errors and omissions, which moved from an inflow of US$2.3 billion to a net outflow of US$800 million. Together, short-term flows and errors and omissions yielded a net inflow of US$1.9 billion compared to 1996.23

74. The large capital account surplus permitted a second straight year of strong reserves accumulation in 1996. Central bank reserves rose by US$4.5 billion, reaching US$16.8 billion at year end. During the first four months of 1997, reserves (excluding the Turkish Defense Fund) fell by US$1 billion, primarily due to the downward revision of DM holdings with the decline in the mark since the beginning of the year. However, this trend reversed during May, with an accumulation of US$600 million, bringing reserves back to near their end-1996 level.

D. External Debt

75. Turkey’s stock of public and private external debt increased by US$6.5 billion during 1996, reaching a total of US$79.8 billion. Due to strong economic growth in 1996, debt outstanding as a share of GNP remained virtually unchanged at 42.9 percent (Tables A49-A51). The maturity of obligations shortened significantly, with short-term debt increasing from 21.4 percent to 25.7 percent of total debt. This shift resulted from modest growth in medium- and long-term borrowing, while short-term liabilities rose much more rapidly (by US$4.8 billion). Underlying the evolution of medium- and long-term liabilities was a decline of US$1.1 billion in borrowing by the public sector (mainly the result of a drop of US$900 million in debt to multilateral organizations), while private sector obligations rose by US$2.8 billion. The sharp increase in short-term obligations resulted from a rise in trade credits and higher short-term foreign lending to the banking system.

76. The debt Service ratio declined to an estimated 24 percent in 1996 from 29 percent in 1995. In dollar terms, debt Service dropped by US$650 million, while exports of goods and services rose by 21 percent. However, this decline is expected to be reversed in 1997, as principal repayments on medium- and long-term debt are expected to climb by over US$2 billion, while the interest burden will rise slightly due to the higher debt stock. Public sector amortization payments are scheduled to rise sharply in 1998.

E. Trade Policy Developments

77. Entrance in the Customs Union with the EU reduced the average protection rates substantially. Customs duties on industrial and processed agricultural EU products were eliminated, reducing protection rates vis-à-vis the EU from 4.9 percent to 1.9 percent,24 while the adoption of the EU’s common external tariff on third country imports reduced rates there from 18 percent to 5.6 percent. A further reduction to 3.5 percent is expected in 1999 as part of obligations undertaken by the EU under the Uruguay Round of trade negotiations. Turkey retains a number of exceptions to the common external tariff, with full harmonization slated to occur by 2001. In addition, free trade agreements have been signed with Israel, Hungary, Romania, Lithuania, and Estonia since March 1996. The 1997 import regime incorporates additional cuts in tariffs on agricultural goods (in line with WTO commitments) and the reduction of the import surcharge levied to support the government’s Mass Housing Fund.25 As of January 1, 1997, Turkey has reduced tariffs that exceeded WTO bound rates (after having raised them for balance of payments reasons in 1994).

Turkey: Recent Economic Developments and Selected Issues
Author: International Monetary Fund