Turkey
Sixth and Seventh Review Under the Stand-By Arrangement; Staff Supplement; and Press Release on the Executive Board Discussion

Turkey showed good macroeconomic performance under the Stand-By Arrangement. Executive Directors stressed the need to maintain strong fiscal and monetary policies, and accelerate structural reforms. They appreciated the authority's efforts to reestablish the fiscal solvency and the adoption of the new central bank law. They agreed that the full implementation of the economic program would help restore macroeconomic stability and address the structural root causes of the country's problems, thereby laying the foundations for the resumption of growth.

Abstract

Turkey showed good macroeconomic performance under the Stand-By Arrangement. Executive Directors stressed the need to maintain strong fiscal and monetary policies, and accelerate structural reforms. They appreciated the authority's efforts to reestablish the fiscal solvency and the adoption of the new central bank law. They agreed that the full implementation of the economic program would help restore macroeconomic stability and address the structural root causes of the country's problems, thereby laying the foundations for the resumption of growth.

I. Introduction

1. On February 22, 2001 the Turkish government floated the lira, thus abandoning the nominal anchor of the disinflation program initiated at end-1999. This decision was forced by a major speculative attack that was initially resisted through a freeze in domestic liquidity. The virtual paralysis of the payment system that followed, the rise of money market interest rates to over 2, 000 percent (simple rate), and the markets’ perception that the Turkish lira was overvalued, made it impossible to defend the crawling peg for more than a few days. In the aftermath of the crisis, a new economic team has been appointed—with Mr. Dervi§ as State Minister for Economic Affairs, Mr. Serdengecti as new Governor of the Central Bank of Turkey (CBT), and Mr. Öztrak as head of Treasury—-and has prepared a strengthened economic program aimed at financial stabilization, disinflation, fiscal adjustment, and improved governance and transparency. In support of this program, the authorities have asked for an augmentation of the SBA by the equivalent of SDR 6.3624 billion (660 percent of quota). The Turkish authorities have also asked the World Bank to raise lending to Turkey this year by US$2 billion with respect to the total originally envisaged under the Country Assistance Strategy.

2. The authorities’ policies are presented in the attached Letter of Intent (LoI) and Memorandum on Economic Policies (MEP). These documents are prefaced by a letter of political support signed by the three leaders of the government’s coalition (also attached). The LoI requests waivers of the performance criteria that were not observed since the completion of the fifth review as a result of the crisis, as well as in relation to the approval of the electricity markets law and following a change in the privatization strategy for Turk Telekom (see below).

II. The Road to the Crisis and its Aftermath

3. The speculative attack on the Turkish lira took place against the background of increased political uncertainty, policy slippages, and a weakening of economicfundamentals. Following the November crisis, the strengthened policy package supported by additional Fund resources through the Supplementary Reserve Facility led to a reversal of capital outflows and a decline of money market interest rates to about 50 percent in mid-January (Figure 1). The situation, however, remained fragile, with the bulk of the external funds invested at extremely short maturity. The credibility of the program, including its nominal anchor, had been badly shaken by the November crisis, and only a virtually impeccable policy implementation could have restored it. Unfortunately, while many of the program actions (particularly on the fiscal side) were implemented, slippages in some key structural areas compounded with increased political uncertainty.

Figure 1.
Figure 1.

Turkey: Nominal Interest Rates 2000-20011/

Citation: IMF Staff Country Reports 2001, 089; 10.5089/9781451838022.002.A001

Source: Data provided by the Turkish authorities.1/ Data refer to a monthly weighted average stripped spread of major international bonds to U.S. Treasury bonds.2/ As of March 27, 2001, the overnight interbank rate has been consistently equal to the Central Bank of Turkey’s bid rate.
  • As to political risk, financial markets increasingly focused on the possibility that the Constitutional Court might ban the Fazilet party, leading to the resignation of some 80 MPs and to by-elections. While the risk of by-elections may have been low in practice, the failure to clarify this issue squarely and openly at the political level increased the perceived political risk.

  • Regarding policy implementation, the LoI for the fifth program review had rescheduled the implementation of some structural measures envisaged in the December 18, 2000 LoI. There were further difficulties in implementing these actions by the new deadline. The electricity market law, which was expected to be approved by mid-February, was approved only after the crisis (¶3 of the attached LoI). The tobacco market law, scheduled for approval by end-February, is now programmed to be approved in May. The new regulation on the application of limits on connected lending on a consolidated basis, scheduled for end-February, is now expected for early June (see below). There were also other slippages. In late January, the government approved measures to facilitate the payment of tax arrears outstanding at end-December 2000, a step that was perceived as signaling a lack of full commitment to enforce tax compliance. Finally, the government did not convincingly address some legal challenges to the sale of Turk Telecom, the key privatization operation envisaged by the 2001 government program.

  • News on economic fundamentals was also not good. Inflation in January remained twice as large as the rate of crawl (Figure 2), and the rise in interest rates following the November crisis was weakening domestic demand. While this weakening was strengthening the external current account (imports sharply decelerated after November; Figure 3), it further increased the risk that policies might be relaxed to try to support the economy.

  • All this was reflected in a new rise in interest rates, starting in late January, which cast a shadow on fiscal sustainability and further endangered the banks more exposed to interest rate risk. It was clear that unless interest rates declined rapidly to a level more consistent with the 12 percent inflation target for 2001 and the preannounced 11 percent exchange rate depreciation, the macroeconomic situation would become unsustainable. At mid-February 2001, interest rates had instead climbed to some 70 percent.

Figure 2.
Figure 2.

Turkey: Inflation, 1996-2001

Citation: IMF Staff Country Reports 2001, 089; 10.5089/9781451838022.002.A001

Source: Data provided by the Turkish authorities.
Figure 3.
Figure 3.

Turkey: Trade Developments, 1992-2001

(In millions of U.S. dollars; seasonally adjusted three-month moving averages)

Citation: IMF Staff Country Reports 2001, 089; 10.5089/9781451838022.002.A001

Sources: Argentine authorities; J.P. Morgan; and Fund staff estimates.1/ Data refer to a monthly weighted average stripped spread of major international bonds to U.S. Treasury bonds.

4. Against this background, a short-lived but heated dispute between the Prime Minister and the President sent financial markets into a frenzy on Monday February 19. Taking the opportunity of a bank holiday in the United States, which de facto postponed the settlement of purchases of foreign exchange by banks from the CBT to the following day, banks placed purchase orders amounting to over US$7 billion at the CBT. The following day the freeze in liquidity imposed by the CBT limited the actual loss of reserves to some US$1½ billion (with banks canceling the orders for the remaining US$5½ billion). The foreign exchange sales, however, continued on Wednesday, February 21, notwithstanding a rise of overnight interest rates to over 2,000 percent (simple rate), with peaks of 5,000 percent. At that point, the expectation that the peg would be abandoned had become overwhelming and impossible to resist through high interest rates. The government announced the float in the morning of Thursday, February 22.

5. In the immediate aftermath of the crisis, the authorities faced difficult choices. On the one hand, there was the need to avoid a complete loss of monetary control, which would result into a spiraling exchange rate devaluation. On the other hand, there was the need to avoid a breakdown of the payment system and to honor the guarantee on domestic and external banks’ liabilities issued by the government in early December. After a brief attempt to freeze domestic liquidity, the CBT announced in late February that it would provide liquidity at a maximum rate of 150 percent (simple rate); this move proved quite effective in jump-starting the payment system. Second, the authorities attempted to revive the foreign exchange market and avoid an overshooting of the exchange rate by selling foreign exchange. While this policy allowed Turkish banks and other residents to honor their external liabilities, it led to a further loss of foreign exchange reserves, which fell by US$4 billion between the date of the float and the beginning of April (Figure 4). (A more flexible approach was introduced at end-March, when the CBT started selling foreign exchange by auction. As the amounts sold were quite small, the move succeeded both in reducing the loss of reserves and in increasing exchange rate flexibility. Thus, the exchange rate which, from a level of TL 0.68 million per U.S. dollar had moved to some TL 0.9-1 million per U.S. dollar in the immediate aftermath of the crisis, weakened by an additional 25 percent during the first half of April (Figure 5). This further devaluation took some pressure off interest rates, which declined somewhat during April. The government’s shift to weekly (rather than monthly) government paper auctions helped the easing. In contrast to the failure of the February 21 treasury bill auctions, and the dramatic maturity shortening in March (to one month), the Treasury was able to sell securities of longer maturity (up to eight months) at a lower rate (some 120 percent) in April.

Figure 4.
Figure 4.

Turkey: Central Bank Gross International Reserves and Net Domestic Assets, 2000-2001

(In billions of U.S. dollars, at program cross exchange rates)

Citation: IMF Staff Country Reports 2001, 089; 10.5089/9781451838022.002.A001

Sources: Central Bank of Turkey.
Figure 5.
Figure 5.

Turkey: Lira Exchange Rate vis-à-vis the U.S. Dollar, 2001

Citation: IMF Staff Country Reports 2001, 089; 10.5089/9781451838022.002.A001

Source: Data provided by the Turkish authorities.1/ Since February 21, 2001

6. The crisis put the banks for which the state is financially responsible (that is, the state banks, as well as the banks taken over by the Saving Deposit Insurance Fund (SDIF)), under severe pressure, with major implications for monetary and fiscal policies.

  • The large overnight exposure of state and SDIF banks implied that any attempt to tighten monetary conditions (to defend the peg before the float) or to limit the exchange rate fall (after the float) was bound to cause severe losses to these banks. This problem was further exacerbated by the poor liquidity management and weak governance in the state banks.

  • With the state banks and SDIF banks being affected severely by the interest shocks, the fiscal costs of the interest rate hike before and after the crisis skyrocketed even if the Treasury’s borrowing schedule in the first four months of 2001 was not prohibitive. In the week of the float the losses of the two main state banks alone amounted to some 2 percent of GNP. In addition, some private banks more exposed to interest rate risk had to be taken over by the SDIF, raising the fiscal costs further. A detailed analysis of the increase in public debt arising from the increase in interest rates and the takeover of banks is included in Box 1.

  • These fiscal costs are partly mirrored by the increase in interest receipts of the private banks that are net lenders in the interbank market, including the major private banks, the core of the private banking sector in Turkey. While these banks had to face an increase in their borrowing costs from domestic and external customers, their financial position was strengthened by the interest payments received from state and SDIF banks. At the same time, some small- and medium-sized banks were instead more severely hit by the crisis (Box 2)

Increase in Public Sector Debt from Bank Recapitalization

Total public debt arising from state-owned banks and the takeover of private banks amounted to TL 44 quadrillion (24 percent of GNP) at end-April 2001 (Table 5 of the MEP). As about half of this debt was already included in the estimate of public debt at end-2000, the total increase during the first four months of 2001 amounts to TL 22 quadrillion.

Private banks taken over by the SDIF

In December 2000 some TL 3.8 quadrillion in treasury securities were issued to recapitalize private banks taken over by the SDIF. Even at the time, these bonds were less than needed given already incurred losses from increases in interest rates, additional losses in market value of the banks’ securities portfolios, and additional bank takeovers. High real interest rates and the impact of the devaluation on these banks’ open foreign position have added to these losses in 2001. By end-April 2001, the total public sector debt required to cover these losses and provision for additional nonperforming loans amounts to an estimated TL 13.7 quadrillion. This amount does not include the loss in market value of treasury bills currently held by SDIF banks, which is expected to be eliminated either through early redemptions by the treasury or through swapping these bills at face value for new treasury notes.1 In addition, the projection of the stock of public sector debt at end-2001 includes a sizeable contingency for possible further costs of bank restructuring that may arise.

To prevent additional losses in the banks taken over so far, debt to recapitalize these banks takes the form of a combination of floating rate notes with quarterly coupons linked to borrowing costs (with part linked to the CBT repo rate and part to the average treasury bill rate), and foreign exchange-linked bonds sufficient to close these banks’ open positions.

State-owned banks

At end-2000, the stock of government liabilities on account of the losses of state-owned banks exceeded TL 18 quadrillion. Although only TL 2.9 quadrillion had been securitized, the total including unsecuritized duty losses are included in the public debt at end-2000 (the program’s figures have always included these duty losses as part of public debt). With these banks borrowing heavily in the overnight market, very high interest rates associated with the February crisis have led to a large increase in accumulated losses. By end-April 2001, the total public sector debt required to cover these losses and provision for additional nonperforming loans amounts to an estimated TL 30.1 quadrillion, including recapitalization costs for Emlak and allowing for some TL 700 trillion in securities required to bring the risk-weighted capital adequacy ratio of the state banks to 8 percent.

As with the SDIF-owned banks, additional losses in state banks are to be eliminated by recapitalizing them with floating rate notes bearing quarterly coupons linked to market interest rates. Also, most of the securities previously issued to these banks to cover past duty losses pay interest rates below current market rates, and will be replaced by floating rate notes.

Interest costs in 2001

Total interest on debt for bank recapitalization in 2001 is projected to amount to TL 14½ quadrillion (8 percent of GNP). This amount is to be paid in cash by the treasury.

1At end-March the total loss in market value of treasury bills held by SDIF banks, including the subsequent loss on recapitalization notes in December 2000 is estimated at TL 2.5 quadrillion.

III. The Challenges Ahead and the Authorities’ Options

7. The main challenge for the government is to restore confidence and, in this way, bring down interest rates rapidly and in a sustainable way. At the mid-April level of interest rates, public debt would enter into an unsustainable spiral. The problem, however, goes beyond the public sector. The high level of nominal interest rates, coupled with extreme uncertainty about exchange rates and inflation, is paralyzing the economy, exacerbating the recession and increasing the likelihood of a surge in nonperforming loans and bank losses.

8. What has kept interest rates high? The most obvious reason is the weakness of public finances, the high level of indebtedness as a result of the crisis, and therefore the risk of monetization (or failure to roll over debt). The stock of public debt has increased rapidly in the last few months and the amount of securities to be rolled over every month has increased even more, on account of the maturity shortening. However, taking into account the measures implemented or soon to be implemented, the primary surplus is at a level that would be consistent with the sustainability of public debt, at low inflation (even were real interest rates remain quite high; more on this below). If financial markets can credibly be convinced that nominal and real interest rates will decline to more normal (even if still high) levels, fiscal sustainability will be guaranteed and interest rates will decline, as the risk of monetization would subside. But this is by no means a trivial task in an environment in which inflation and devaluation has been high and volatile for decades and confidence has just been shaken by two financial crises.1

9. Faced with this situation, the authorities could have fulfilled markets’ expectations and monetized the debt. This is what Turkey had done in the past in similar circumstances. This way out is, however, made more difficult now by the increased level of the debt and by its shorter duration (taking into account the share of floating rate notes in total debt). But, over and beyond this difficulty, the authorities believe that it is in Turkey’s best interest to avoid a return to high inflation rates, which would ultimately undermine Turkey’s long-term growth prospects.

Private Banks

Sixty-three private banks, accounting for roughly 56 percent of total banking system assets, remain in Turkey.1 Nearly 90 percent of those assets are held by 26 commercial banks, and more than half of that by 4 large banks (representing nearly 30 percent of total system assets). None of the largest banks have assets exceeding US$10 billion and 17 banks have assets below US$1 billion. Most banks in Turkey are owned by or closely associated with large industrial groups; the larger banks are listed on the stock exchange while most of the smaller banks are privately held. In addition, there are 18 branches or subsidiaries of foreign banks and 19 investment banks; all of them are small and, with a combined market share of about 7 percent of assets (1 percent of deposits), have no systemic importance.

Turkish banks have relatively small loan portfolios (averaging 35 percent of total assets) and relatively large holdings of securities (25 percent of assets). Total loans outstanding in private banks at end-year 2000 amounted to TL 19.2 quadrillion (US$28.6 billion) of which slightly less than one half was denominated in FX. At end-March 2001 exchange rate, the dollar value of these loans would be US$26 billion. Loan concentration is very high with only some 5,000 borrowers (0.1 percent of all borrowers) counting for nearly 40 percent of total loan value. This is a reflection of a traditional heavy concentration of lending to related group companies, a practice that the authorities are seeking to correct through legal and regulatory means, which will bring such exposures fully in line with EU standards by 2006. While this adjustment period is fairly long, it does not compare unfavorably with the experience of other countries that introduced similar regulations.

At year-end 2000, the four large banks had an average risk-weighted capital adequacy ratio (CAR) of 23 percent, while the remaining 23 commercial banks had a CAR of 13 percent. Since then, the financial condition of most of the largest and some small commercial banks, altogether representing nearly half of the commercial banking system, has been strengthened as a result of exceptionally high earnings during the recent crises episodes. At the same time, the remaining commercial banks have experienced substantial losses from high interest rates and the depreciation of the lira. In recent weeks banks have almost closed their net foreign liability positions, including off-balance sheet forward covers (see also supplement to the staff report of the foreign exchange position of Turkish banks) While nonperforming loans (NPLs) so far have remained low (below 4 percent of total loans) on average, the strict application of the loan classification and loan loss provisioning rules introduced in early 2000 are expected to reveal sharply increasing NPL numbers in the coming months.

Recognizing that the above CAR numbers have been seriously eroded and that the majority of banks have become undercapitalized and that the situation is bound to deteriorate further, the Banking Regulation and Supervisory Agency (BRSA) has held consultative meetings with all banks and has required all undercapitalized banks to present detailed and time-bound plans by end-April for raising additional capital. These plans are expressed in commitment letters, and the implementation of the banks’ plans will be closely monitored by the BRSA. To support banks’ strengthening of their capital base, dividend distributions have been suspended by the BRSA. In addition, bank mergers are being encouraged by making tax rules nonpunitive; this is initially expected to encourage mergers among banks with common owners.

BRSA has made it clear to the banks that their plans for raising new capital as expressed in their commitment letters will be followed very closely, and that banks will be taken over if the commitments are not honored. Early responses indicate that bank owners take the need to raise capital seriously and are prepared to sell assets and raise funds to provide the required additional capital. Information provided by the BRSA indicates that all undercapitalized banks have plans under way for strengthening their capital positions. The relatively small size of most banks, relative to the industrial groups that own them, makes the raising of the new capital feasible. In addition, the fact that many bank owners have unlimited liability for losses in their banks due to connected lending operations makes it more unlikely that they will walk away from their banks even if they were to become insolvent. The authorities’ strategy is thus to apply strict rules on the banks to recognize their capital deficiencies and maximum pressure on bank owners to recapitalize them—together with a clear message that banks will be taken over by the SDIF and the owners lose their stakes, if it becomes obvious that their planned recapitalization will not take place or a bank becomes insolvent or illiquid.

1Since the late 1990s, 13 commercial banks representing some 10 percent of total system assets have been taken over by the SDIF, and 3 investment banks have been liquidated.

10. The authorities’ strategy is strongly based on market-orientation and openness to the world economy; it aims to strengthen domestic policies and resume the adjustment process with support from the international community and private sector involvement sufficient to ensure that the program is financed, and thereby restore confidence. The strengthening of domestic policies aims at putting on stronger grounds the progress made since 1999 in the fiscal accounts and in key structural areas, while at the same time assigning to monetary policy the task of driving down inflation. It consists of:

  • A renewed effort to eliminate structural weaknesses that had not been fully tackled by the 2000 program, particularly by strengthening governance and good economic management through a number of steps: (i) in banking, a deep financial restructuring of state and SDIF banks, measures to facilitate the participation of private capital in the strengthening of the private banking system, and a further improvement of supervision; (ii) in fiscal transparency, the enhancement of which is a key condition to strengthen the medium-term evolution of public finances; and (iii) in increasing the role of the private sector in the Turkish economy, including foreign capital.

  • Additional fiscal measures to strengthen the primary fiscal position of the public sector in spite of the cyclical decline in revenues, reduce the immediate borrowing requirement of the government, and ensure the long-term sustainability of public debt even under more unfavorable real interest rate assumptions.

  • A monetary policy centered, in the short run, on the pursuit of monetary aggregates, but shifting to a full-fledged inflation-targeting regime managed by an independent central bank.

  • An effort to involve the social partners in the support of the program, including through incomes policies aimed at supporting disinflation and removing some of the existing distortions in the wage structure in the public sector.

11. The above policies aim at making sure that economic fundamentals are fully consistent with a decline in interest rates and inflation. However, in the short run, a key catalytic role to facilitate this decline is expected to be played by the voluntary rollover agreement with banks in place since last December and other forms of private sector involvement (PSI), as discussed below, as well as by the availability of official foreign financing. All this is expected to ensure that sufficient financing resources are available in the short run in the economy.

IV. The Authorities’ Policy Program

12. The authorities’ policies are presented in the attached MEP. Section B relates to structural policies to enhance the strength of the economy and provide a better environment for macroeconomic policies to play their role. Section C presents the program’s fiscal and monetary policies. Section D focuses on social dialogue and incomes policies. More emphasis, which is reflected in the whole MEP, is put on providing clearer information on the program to the public. More specifically, the authorities are committed to a “new communication and openness policy” and they have already started recruiting communication experts for this purpose (¶5 of the MEP).

Structural policies for a stronger economy

13. The structural policy agenda focuses on three key areas: banking, fiscal transparency, and policies to enhance the role of the private sector in the economy. The common thread of these policies is an effort to enhance the efficiency of the economy through greater transparency, better governance, and a stronger regulatory environment. These actions are to be seen as part of more long-term reform programs, which the authorities will be preparing with the assistance of the World Bank.

14. The highlights of the structural section of the MEP relate to the banking sector, which has been at the center of the recent crisis. There are four main areas related to: (i) the restructuring of state and SDIF banks; (ii) the resolution of SDIF banks; (iii) the strengthening of private banking; and (iv) the legislative and regulatory environment. The overall goal is to remove the structural weaknesses that have been highlighted during the recent crisis.

  • The restructuring of state and SDIF banks is urgently needed for several reasons. First, the presence on the market of banks with a negative net worth casts doubts on the whole banking system. Second, the overnight exposure of these banks had surged to unprecedented proportions (almost 8 percent of GNP in mid-March). Third, governance in these banks has been weak. To address these problems, a number of radical steps are being taken. First, the state and SDIF banks will be fully recapitalized with the provision of government securities (mostly floating rate notes in Turkish lira but also securities in fx so as to close their open fx position) bearing quarterly coupons, so as to meet their liquidity needs (¶10). In practice, this means that the government will stop financing its deficit through the state (and SDIF) banks.2 Second, part of the securities received by state and SDIF banks from Treasury will be sold to the CBT and the proceeds will be used to repay the overnight debt of these banks towards the private sector (¶8). Two-thirds of the overnight exposure of state and SDIF banks will be eliminated before the completion of the current review, with the balance following within the next month.3 In essence, this operation shifts from the state and SDIF banks to the CBT the management of this very short-term borrowing (as the CBT will mop up through reverse repos the liquidity injection related to the purchase of securities from state and SDIF banks). The CBT is in a better position to manage this borrowing at lower rates and longer maturities (the CBT has been mopping up the liquidity with reverse repos of up to two weeks maturity). One key challenge for the CBT in the months ahead will be to roll over the short-term debt, not an ideal situation for a central bank. However, with all interest payment on the government securities received from state and SDIF banks paid in cash by the Treasury, and taking into account the strong CBT profits expected this year, the stock of short-term borrowing by the CBT should shrink rapidly (Table 1).4 Third, in preparation for their eventual privatization, the larger state banks (Ziraat and Halk) will be managed by professional managers, and will no longer be controlled by line ministers.5 The managers will have to follow strict guidelines issued by their governing board, in consultation with the CBT, regarding the maturity at which they borrow (so as to avoid a return to excessive overnight borrowing) and their deposit rates, which will be kept below the rate on the treasury securities (their main source of income), so as to guarantee their profitability (which will be monitored under the program (¶10)). It is hard to assess the extent to which this new deposit rate policy will lead to a loss of deposits. The financial flows behind the program assume that the balance sheet of these banks will remain constant in nominal terms, so that their size in real terms will shrink. If these banks lost deposit in nominal terms, these would be met by sales of their government securities, but, in the program baseline, this is not expected to happen, once their overnight position—the most interest-sensitive component of their liabilities—has been shifted to the CBT.

  • The resolution of the SDIF banks will proceed rapidly, in spite of the difficult conditions of the banking market. Of the thirteen banks taken over by the SDIF since 1997, four have already been closed (and are being downsized as part of Sumerbank, a first transition bank; ¶12), and four more are expected to be closed by mid-May (including through a second transition bank; ¶13). Three more banks are in the process of being sold (¶3). The two transition banks are expected to be sold, put into liquidation, or otherwise resolved by end-2001. Arrangements to facilitate the collection of nonperforming loans of these banks—which are critical to minimize the cost to taxpayers of the restructuring of the banking system—are described in ¶14.

  • Private banks are also expected to strengthen their capitalization, while the government guarantee on their liabilities, which has now been put on firmer legal grounds (¶5), is in place. Cash dividend distribution has been suspended and banks are agreeing with the BRSA on recapitalization plans. The tax deductibility of loan loss provisions will facilitate a proper provisioning by banks. Finally, tax laws are being modified to facilitate the restructuring of private banks through mergers.

  • The banking law and bank supervision regulations will be further amended in a number of aspects (¶16-17), the most important of which are the gradual application of connected lending limits on a consolidated basis, the strengthening the debt recovery powers of the SDIF, and the introduction, as of 2002, of international accounting standards. The legal system is also being reviewed in order to identify improvements in foreclosure and bankruptcy laws (¶18)

Table 1.

Turkey: Central Bank Balance Sheet, 1999-2003

(End-of-period stocks, in trillions of Turkish liras) 1/

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

All foreign currency aggregates are valued at current exchange rates.

Adjusted for the Bayram effect at end-2000 and the lowering of the reserve requirements in 2001.

15. A second critical area is fiscal transparency. The program included from its inception measures in this area and a fiscal ROSC was completed in the summer of 2000. Some of the commitments in the attached MEP simply reaffirm the commitments undertaken in the December LoI (such as the closure of budgetary and extrabudgetary funds). But there are also new commitments, including: the drastic reduction in the number of the so-called revolving funds (see definition in ¶19), a further improvement in the information made public on the fiscal accounts in their broader sense (so as to allow a better scrutiny by Parliament and the public opinion), a new procurement law, and steps to enhance governance and fight corruption.

16. The third area relates to privatization and, more generally, an increased involvement of the private sector in the Turkish economy. This is another area that had featured in the 2000 program, but slippages had emerged, partly because of poor market conditions, partly because of delays and less than full commitment to privatize. These delays had also reflected excessive political control of the enterprises to be privatized. A number of steps to remove obstacles to privatization are being taken. However, there is a change in emphasis. The new strategy envisages a stronger effort on the side of the authorities to put Turkey in the best position to privatize its public enterprises. However, acknowledging that market conditions may not be in the immediate future favorable to fast privatization, the expected privatization receipts for this year have been lowered from US$6 billion in the December 2000 program to US$3 billion (of which, US$2 billion have already been cashed, as they refer to 2000 privatization deals). Key steps in this area relate to:

  • Turk Telekom, Turkey’s headline privatization operation (¶21). The authorities have now decided on a series of legal and administrative steps to improve the management of Turk Telekom, including legally allowing the full privatization of the company,6 and changing the composition of the privatization committee (which had not worked effectively). Moreover, the company will be corporatized ahead of its privatization, and competition in the telecommunication sector will be increased.

  • Three laws to reform the sugar, tobacco, and natural gas markets and sell the state enterprises that now operate as monopolies.

  • The electricity market, where the generation and electricity distribution companies that will not be handled through transfer of operating rights by end-June will be privatized.

  • A number of steps, to be taken over the next few months, to facilitate FDI (¶22). While these are important—particularly the approval of the law fully implementing the constitutional amendment on international arbitration enacted in 1999—a recent study prepared by the Foreign Investment Advisory Service of the IFC/World Bank shows that there are no major legal or administrative impediments to FDI, and that the main obstacle is macroeconomic and political instability. Even assuming that the program is fully successful it may take some time before FDI responds to the improved macroeconomic environment, and conservative assumptions have been made in projecting FDI over 2001-02.

Macroeconomic policies

17. Fiscal policy will be further tightened to help face the increased interest burden of the government and facilitate a decline in interest rates. The extent of the fiscal adjustment is highlighted by the table below (see also Table 3 of the MEP).

Primary Surplus of the Public Sector

(In percent of GNP)

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The revised baseline is based on the revised macroeconomic framework after the February 2001 crisis. It assumes that revenues and expenditures are adjusted in line with the revision in inflation. The new fiscal measures introduced as part of the strengthened program are not included.

The original 2001 program envisaged an increase in the primary surplus of the public sector from 2¾ percent of GNP to 5 percentage points of GNP, thus requiring the introduction of additional fiscal measures amounting to over 2 percentage points of GNP. Because of the weakening of economic activity (some 7 percentage points below the original baseline), the primary surplus would be projected to fall to 2½ percentage points of GNP. The new target for 2001 is 5½ percentage points of GNP, requiring the introduction of additional measures amounting to 3 percentage points of GNP. This is a massive fiscal effort. Altogether, between 2000 and 2001, the government will have introduced measures amounting to 5 percentage points of GNP (in addition to the almost 5 percentage points of GNP adjustment implemented between 1999 and 2000).

18. Most of the increase in the primary surplus of the public sector targeted for 2001 (2¾ percentage points) is due to expenditure cuts. While some revenue measures were implemented in December and are to be implemented ahead of the Board meeting ¶30), the revenue ratio for the central government is declining somewhat, reflecting inter alia the severe effect of the crisis on the profit taxes. However, this is more than offset by major cuts in primary expenditure, with the primary spending of the central government targeted to decline by 1 percentage point of GNP, or 8 percent in real terms (after adjusting for the expenditure of one extrabudgetary fund included in the 2001 budget). These cuts reflect prudent wage and employment policies, and reductions in investment spending and in other current spending (including security outlays; ¶31 and Table 2).7 Moreover, the primary deficit of the state enterprises is targeted to fall by 1½ percentage points of GNP, owing to draconian cuts in real wages of the workers in this sector (see below), and increases in public sector prices (including electricity) which had not covered production costs in 2000 (¶32).

Table 2.

Turkey: Central Government Budget, 1997-2001

(In percent of GNP)

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Source: Data provided by Turkish authorities, and Fund staff estimates.

Excluding privatization proceeds, interest receipts, and CBT profits.

Excluding interest receipts and CBT profits.

In percent of the original program’s GNP.

19. Finally, the fight against tax evasion will be strengthened. While the program’s projections do not include any revenue from increased collection efficiency, the rolling out of tax identification numbers (the base for any modern tax enforcement system) will be accelerated (¶34), together with the collection of tax arrears.

20. The MEP also includes detailed discussions of debt management in 2001-02 (¶37-¶39). The forms through which public debt, in its broader definition, is managed in Turkey will undergo a dramatic change in this period. As noted, the management of public debt will be centralized, with the Treasury servicing the net debt of the state and SDIF banks to the private sector (consequently, the amount of securities that will have to be issued will increase significantly). The availability of external financing will reduce, ceteris paribus, the amount of government securities in circulation, so that the auctioned debt-to-GNP ratio is not expected to increase in 2001 (Table 3). However, it will rise significantly in 2002 and 2003, but this will be more than offset by the decline in percent of GNP of the value of the securities transferred to state and SDIF banks.8 The immediate task of the Treasury will be to lengthen the maturities, including through possible voluntary debt swap operations. Additional possible steps in this area are discussed in ¶39.

Table 3.

Turkey: Selected Indicators, 1999-2003

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Source: Data provided by Turkish authorities, and Fund staff estimates.

Average of monthly nominal T-bill interest rate divided by 12-month past CPI inflation.

Average of monthly nominal T-bill interest rate divided by 12-mouth ahead CPI inflation.

Excluding profit transfers from the CBT, interest receipts, and privatization proceeds.

Interest payments minus interest receipts plus profit transfers from the central bank.

Overall balance netted out of the difference between nominal interest payments and real interest payments.

Interest payments minus interest receipts plus CBT profits before transfers to the government.

Gross public debt net of the net assets of the CBT.

Defined as the sum of quarterly GNP in the last two quarters of the year and in the first two quarters of the following year.

Change in reserve money (currency issued plus reserve requirements) in percent of GNP.

21. Monetary policy is to continue the task of reducing the rate of inflation within a flexible exchange rate framework. The authorities intend to introduce, as early as possible, a formal inflation-targeting framework (¶42). As a first step, key amendments to the CBT law have been introduced to give independence to the CBT in pursuing its primary goal of maintaining price stability.

22. The shift to inflation targeting, however, cannot be immediate. While the preparatory work has been ongoing for a while, it will take some time for the CBT to improve its inflation forecasting techniques and set up the procedures for the implementation, transparency, and accountability of monetary policy that are a key component of this framework. Public opinion also needs to be prepared to understand the meaning of central bank independence and inflation targeting. Moreover, the CBT is understandably hesitant, in this phase of great uncertainty on short-term inflation movements and still unsettled financial market conditions, to take up the formal responsibility for achieving a specific inflation target.

23. In the interim, the CBT will focus on the control of monetary aggregates. The indicative target set for base money (47 percent December 2001/December 2000) reflects some expected increase in the velocity of cash in circulation. There is a large margin of uncertainty around these projections, though, as money demand in Turkey has been difficult to predict. On this account, the indicative base money ceilings are expected to be closely scrutinized during the program reviews. Moreover, the CBT is also committed to follow other inflation indicators (one key feature of the forthcoming inflation targeting framework). In particular, it will stand ready to raise interest rates—even if base money is close to its target—in response to developments that jeopardize the disinflation process (¶43).

24. The sources of base money creation will depend, at least in part, on how rapidly confidence is restored. While an accumulation of some US$2½ billion during the balance of 2001 is projected, the program’s NDA ceilings and the NIR floors give the CBT the possibility of using a large component of the foreign exchange resources available under the program to provide liquidity to the economy and support the government paper market (for example, by purchasing government paper from the secondary market and mopping up the Turkish lira liquidity through sales of foreign exchange) in case confidence is not immediately restored (¶43). A balance of payments scenario consistent with the use of external financing for this purpose is presented in Tables 45 (see also Section VII).9 The MEP, however, contains a clear commitment to use the external financing for reserve accumulation, if confidence is rapidly restored and interest rates fall more rapidly than projected in the program. In this case, NDA would remain well below the program’s ceilings.

Table 4.

Turkey: Balance of Payments, 1998-2003

(In billions of U.S. dollars)

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

The decline in other receipts between 1998 and 2000 partly reflects a methodological change in the compilation of this item.

Including privatization receipts.

Nonbank external debt less the NFA of the banking system.

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

Table 5.

Turkey: External Financing Requirements and Sources, 1997-2003

(In billions of U.S. dollars)

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General government and Central Bank of Turkey.

Errors and omissions.

25. The foreign exchange resources will in no case be used to support any specific exchange rate target or target range (last bullet of ¶43). The sale of foreign exchange to the market will occur primarily through auctions.10 It is, however, likely that sales of foreign exchange under the program will, ceteris paribus, strengthen the Turkish lira, leading to a faster stabilization of inflation, and a decline in interest rates.

Incomes policies

26. Incomes policies are also being strengthened.

  • The 2000 program used the wages of civil servants (the some two million “white collars” in the public sector) as one of the program’s nominal anchors. Wages were set at the beginning of each semester in line with targeted inflation. However, a catch-up clause allowed an adjustment in wages, should inflation exceed the target. This policy—while breaking with the past practice of backward indexation11—provided only a short-term anchor. It would have been, however, difficult to follow a different approach as the level of civil servants’ wages was very low, by historical standards, at end-1999, and it has remained low (currently below the 1990 level in real terms). The policy of ex ante increases in line with targeted inflation, coupled with ex post adjustments if the target is overshoot will continue in 2001 (¶31).

  • There will be instead a major change for the wages of the so-called “public sector workers” (some one-half million blue collars in the state enterprises, but also in other components of the public sector). Reflecting generous contracts signed in the spring of 1999, their real wage has increased by a cumulative 40 percent in 1999-2000. Consequently, their relative wage with respect to that of civil servants has increased rapidly over the last two years (to 2.6 in 2000). The authorities intend to reduce this ratio to some 2.1 in 2001 and to 2.0 percent in 2002 (¶45). This will involve cuts in real terms by some 20 percent in the first year, with some further cuts in 2002. The indexation mechanism will also be innovative. No indexation, nor ex post catch-up, is expected for the first six months, while in the remaining 18 months of the contract, there will be an ex post catch-up, but only partial (¶45).

  • The program also envisages a more active role of the government in incomes policy discussions with the private sector. This was a major implementation failure during 2000, and the authorities intend to be more active in this area. The new Minister of the Economy has already started more intense consultations with the social partners. Moreover, a law approved in April has given an institutional backing to the previously informal (and rarely convened) Economic and Social Council, which will become the main forum for incomes policy discussions ¶46).

  • The authorities are also considering how the social safety net can be enhanced, in cooperation with the World Bank (¶47).

V. The Role of PSI

27. The private sector is involved in many aspects of the resolution of Turkey’s crisis. In order to maintain their ownership and control of their banks, shareholders are being forced to raise additional capital. The recapitalization of the intervened banks, while intended to allow the banks to continue operations and to protect depositors, in no way sheltered the original shareholders from shouldering the losses. The sovereign guarantee on the on- and off-balance sheet liabilities of the banking system limited the risks borne by depositors and foreign commercial bank creditors. The rationale for the guarantee, however, was to stabilize confidence in the financial system at a moment of severe crisis, and thereby contain the risk of wholesale capital flight.

28. More broadly, private investors have generally not been protected from the impact of the crisis. The government has allowed the corporate sector to independently carry the burden of a depreciated exchange rate and high interest rates on their balance sheets.12

29. It is also important that the macroeconomic vulnerabilities associated with private sector financing of government debt be managed carefully. As interest rates decline and market conditions improve, the government should seek to lengthen the maturity of its debt both in terms of new debt issues in the auction market and through liability management. This will help to provide assurances that any temporary interruption in debt sales does not become a full-blown crisis.

30. The involvement of foreign creditors has also generally been maintained. Eurobond redemptions have not been excessive. On the contrary, the government was able to place a Є0.7 billion bond with European retail investors in January. There has been a reduction in commercial interbank lines, as described in Box 3, mostly resulting from the unwinding of positions based on carry trade. The authorities have recently consulted with the foreign commercial bank creditors, seeking a renewed commitment both to reconstitute exposure to the level of December 11, 2001 (the date of the earlier agreement with the banks) and to maintain that level.

PSI—Maintenance of Interbank Exposures

A particular vulnerability of the Turkish banking system is its reliance on very short-term funding, including from foreign banks. During the November 2000 crisis the withdrawal of short-term interbank loans by foreign banks was a major contributor to the pressure on the exchange rate and the loss of foreign exchange reserves by the central bank, thus emphasizing the important role of a stable external funding base for Turkish banks in any future set of policies.

Accordingly, on December 11, 2000, following meetings in Frankfurt and New York between the Turkish authorities and major foreign bank creditors, foreign banks made a voluntary commitment to maintain aggregate exposure to the Turkish banking system in the form of interbank and trade related credit lines in existence at December 11. This commitment was intended to complement the catalytic effect of the revised Fund arrangement approved earlier that month, and the agreement of foreign banks was facilitated by the government’s sovereign guarantee of the liabilities of Turkish banks. In order to monitor adherence to the agreement, the CBT has been collecting daily data from Turkish banks on changes in their liabilities to foreign banks, and this data is reported to the Fund and, via Executive Directors, to the central banks and supervisors of the foreign banks concerned. At the Frankfurt and New York meetings, foreign banks were also asked to maintain exposure on trade lines provided directly to the nonfinancial corporate sector (although this aspect has not been monitored.)

Until late January there were encouraging signs that this combination of a catalytic approach and accompanying maintenance of bank lines was bearing fruit. The Turkish government was able to place a G0.7 billion bond with European retail investors, and aggregate foreign bank exposure to the Turkish banking system was maintained. However, the foreign banks’ commitment had been conditional on there not being a recurrence of macroeconomic and financial instability in Turkey and on continued maintenance of exposure by each other. When the February crisis developed, banks gradually withdrew $3 billion of exposure (which had amounted to around $18 billion at the time of the original commitment). Since early March the level of exposure has stabilized at around S15 billion, thus indicating that the continued loss of foreign exchange reserves during March was not caused by further withdrawals of interbank funding by foreign banks.

The authorities have initiated contact with the banks that are responsible for most of the outflows during the crisis. This information has also been provided to these banks’ central banks and supervisors. More generally, the authorities plan to meet with foreign banks to obtain agreement to restore exposures to the December 11, 2000 level and to reinstate the commitment in stronger form, in order to complement the provision of additional Fund resources.

31. Looking to the future, it is critical that the operation of domestic financial markets should be put on a footing that promotes sound financial practices, including proper assessment of risk, and provide mechanisms to resolve individual problems that may arise. To this end, the staff attaches great importance on measures to ensure the effective supervision of the Turkish financial system, as well as ensuring that difficulties that may arise in the corporate sector be resolved in an efficient and expeditious fashion (including through a possible revision of foreclosure and bankruptcy laws; ¶18).

VI. The Program’s Macroeconomic Baseline and Risks

32. The program baseline envisages a gradual but steady improvement in economic conditions as a result of the program’s policies and the availability of foreign financing.

  • Real interest rates, deflated by targeted CPI inflation, are expected to fall from some 65 percent in mid-April to some 25 percent in December, edging down further in 2002 (to some 20 percent on average). These real interest rates projections are based on the experience of other countries (e.g., Brazil) plus a sizable margin to reflect differences in the starting situation, notably as regards inflation and the strength of the banking system (8-10 percentage points; Figure 6).

  • GNP growth (-3 percent for 2001; ¶3 and Table 3) is expected to be negative in the first two quarters of 2001, but a turnaround is projected for the third quarter, reflecting the recovery of exports (as the effects of the devaluation take hold), in tourism (there are strong indications that the tourism season will be a record one), and the projected decline in interest rates. The recovery is expected to continue in 2002 and 2003 with annual growth rates of 5-6 percent. While estimates of potential growth and the output gap for Turkey are not very reliable, these growth rates seem to be consistent with a gradual absorption of the existing output gap, and are indeed lower than those experienced by Turkey following the 1994 crisis.

  • The program projects CPI inflation at 52½ percent in 2001 (December/December). While the inflation rate over the next few months is very uncertain, the authorities intend to bring inflation to 2 percent per month by the last quarter of this year, and to lower inflation to 20 percent in 2002 (¶3). This decline should reflect the combined effect of: (i) a monetary policy focused on limiting the growth of base money; (ii) some appreciation of the nominal exchange rate, following the initial overshooting, as confidence is restored and external support flows in; (iii) the overall effect on inflation expectations of the policy strengthening; and (iv) wage and price moderation as a result of more active consultations with the social partners.

  • The external current account balance is projected to improve markedly, as a result of the recession, and, to a lesser extent, of increased competitiveness and an acceleration of exports (it will take some time before the effect on the latter of the real devaluation if fully felt).13

Figure 6.
Figure 6.

Turkey; Real Interest Rates

(Deflated by 12-month ahead CPI inflation)1/

Citation: IMF Staff Country Reports 2001, 089; 10.5089/9781451838022.002.A001

Source: International Financial Statistics; and Fund staff projections.1/ Month 0 corresponds to March 2001 for Turkey, January 1999 for Brazil when the Real was floated, July 1997 for Thailand, and December 1997 for Korea.

33. The above developments crucially hinge on the return of confidence ensuring the sustainability of public debt dynamics, which developments in early 2001 have put in question. Even assuming a decline in interest rates over the balance of 2001, the public debt-to-GNP ratio is projected to rise by 20 percentage points of GNP in 2001 (17 percentage points using centered GNP14). However, this rise was due, to a considerable extent, to temporary factors. Indeed, looking ahead, fiscal sustainability would be ensured, even at relatively high interest rates.

  • The rise in the debt ratio in 2001 is in part due to temporary factors—the real devaluation (the effect of which is equal to some 3 percentage points of GNP), the inclusion in the public debt figures of debt components previously not included (amounting to some 6 percentage points of GNP),15 the decline in GNP (about 2 percentage points) and the exceptionally high level of real interest rates in the first quarter of 2001, which inflated the losses of state and SDIF banks.

  • Taking also into account privatization revenues, the public debt ratio (using centered GNP) is actually projected to decline by a cumulative 8 percent by end-2003 (see Box 4 for an analysis of the factors behind the decline in the debt ratio).

Why the Public Sector Debt Ratio Declines in 2002

The net public debt-to-GNP ratio is projected to drop by about 8 percentage points in 2002 (Table 3) in spite of very high real interest rates on treasury bills in 2001 (36 ½ percent) and 2002 (20 percent).1 Based on the debt sustainability analysis referred to in the text of the staff report, real interest rates at this level should involve an increase in the debt ratio, given the targeted primary surplus. Why does the public debt ratio fall instead of rising?

There are several reasons for this. First, half of the decline is accounted for by a well-known statistical bias that occurs in high inflation cases. Conventional debt-to-GNP ratios (based on end-year debt stock over annual GNP) tend to overstate the rise in debt when inflation accelerates following a devaluation (as in 2001), and thus overstate the fall when inflation decelerates. The reason is that the end-period debt stock fully reflects the jump in inflation and the exchange rate, while the annual GNP figures “lag behind.” One simple way to correct for this bias and provide a better indicator of the dynamics of public debt is to use a measure of GNP that is centered around the end of the year. According to this measure, the debt ratio drops by 4 ¼ percentage points, from 68 percent in 2001 to 63¾ percent in 2002 (Table 3). Second, part of the decline in the debt ratio is accounted for by privatization proceeds (some 1¾ percent of GNP). Third, seignorage projected for 2002 is high relative to that expected over the medium term. Fourth, the real effective interest rate on public sector debt in 2001-02 will be well below the real rate for treasury bills.

There are three reasons why the real effective interest rate in 2001-2002 is lower than the treasury bill rate. First, a large portion of public debt is denominated in foreign exchange and thus has to be serviced at fx dollar interest rates, which are well below the domestic real interest rates in 2001-02. The share of net public sector debt linked to foreign exchange will be about 45 percent at end-2001. The average interest rate in U.S. dollar terms in 2002 on the total stock of external and fx-linked domestic debt is projected at about 8½ percent (taking into account official lending). Second, the share of floating rate notes in TL-denominated domestic debt of the central government will reach about 75 percent by end-2001. This component of debt reacts rapidly to the decline in interest rates projected under the program, thus reducing the expected effect on interest payments in 2002 of higher interest rates in 2001. Third, borrowing at fixed interest rates in 2001 year will be disproportionately concentrated in the post-crisis period when interest rates are expected to be below the annual average. Fourth, all borrowing during February-April, when crisis interest rates prevailed, took place at short maturities to be repaid before end-2001, which are expected to be rolled over into debt-paying lower interest rates.

1The level of interest rates in 2001 affects the deficit and debt figures in 2002 because of the lag between interest rates and interest payments for fixed coupon bonds.
  • Leaving aside the specific developments in 2002-03, with a primary surplus of some 6 percent of GNP the debt dynamics would be unstable only for extremely high levels of real interest rates. Standard debt sustainability formulae (focusing on the trend behavior of the debt-to-GNP ratio) show that the debt ratio would not increase even for real interest rates on domestic debt as high as 20½ percent.16

  • Maintaining a primary surplus at 6 percent over the medium term may be demanding. On the other hand, there is no reason why real interest rates on domestic debt should remain at 20 percent over the medium term once the economy has stabilized (high inflation and exchange rate volatility have been regarded as the main reasons for high real interest rates in Turkey). To illustrate this, Table 6 presents a long-term scenario in which a gradual decline in real domestic interest rates is accompanied by a gradual decline in the primary surplus, while at the same maintaining the public debt ratio on a slightly downward sloping path.

Table 6.

Turkey: Medium-Term Fiscal Projections For the Consolidated Public Sector, 2000-10

(In percent of GNP, unless otherwise specified)

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In percent of centered GNP.

In making the projection for 2003 and beyond, a dollar real interest rate of 10 percent was assumed.

34. While the program is strong, there are some risks:

  • There may be additional costs for bank restructuring: This is indeed possible, taking into account the recession corporate risks, and the likely rise of nonperforming loans. However, the fiscal projection includes a sizable contingency that can be used to cover these costs if necessary.

  • Implementation risks are significant: several critical actions have been or will be implemented before the completion of the current review—including the financial and operational restructuring of public banks, amendments in the banking law, a new CBT law, a new Turk Telekom law, and increases in tax rates and public sector prices. Nevertheless, the list of structural measures to be implemented during the rest of 2001 isnot a short one (Table 2 of the MEP). Moreover, the attainment of the ambitious fiscal targets for 2001 depends on strict program implementation. Two aspects are particularly important: first, the contract for public sector workers; second, the expenditure cuts envisaged in the post-crisis period. The new budget to be approved before the completion of the eighth review must be in line with the program’s expenditure ceilings. At a more general level, the coalition government stands behind the economic program, as highlighted by the letter addressed to the Managing Director from the three coalition leaders. Finally, the high frequency of the program reviews (four more before end-2001) will allow a close monitoring of developments.

  • Inflation may not decelerate: Inflation inertia has proved very strong in Turkey. Surveys of inflation expectations suggest that the government’s inflation target is not regarded as unrealistic. Nevertheless, the risk of an inflation overshooting is not trivial. A relatively small overshooting is unlikely to be problematic in the context of a floating exchange rate. Problems may arise if there were a major overshooting (say, an inflation rate of 80-100 percent) as this would likely be associated with increased exchange rate and price uncertainty and, thus, in increased risk premia and high real interest rates. Such a large inflation slippage could, however, happen only in case of major deviations from program policies.

  • Interest rates may not decline as expected: the decline in interest rates is critical to the success of the program. Problems in this area may arise not only as a result of domestic shocks but also of contagion from other emerging markets. There are some built-in safety margins, though. The interest rate path is cautious, based on the experience of other countries in successful post-crisis periods (see above). Moreover, the public debt ratio would continue declining in 2002 even if interest rates were some 15 percentage points higher (although this would largely reflect one-off privatization receipts).

  • Growth may fall short of expectations: this is not a trivial risk, particularly if interest rates do not decline rapidly. The Turkish economy has, however, shown much resiliency in the past and the removal of the exchange rate overvaluation which had accumulated before the crisis (perhaps some 15 percent) should help in this respect.

VII. Augmentation of Access Under the SBA, Financing Needs, and Monitoring Issues

35. Despite the sharp projected decline in its external current account deficit in 2001, the impact of the recent crises on Turkey’s access to international capital markets will lead to an overall balance of payments deficit and an external financing gap that warrants Fund support in the form of augmentation of access under the SBA (Table 7). Given Turkey’s recession and the improvement in its international competitiveness following the float, a sharp turnaround in the current account deficit is expected—to just US$ 1 billion in 2001 from almost US$10 billion in 2000. However, the projected current account improvement is dwarfed by the projected worsening of Turkey’s capital account given the negative impact of the recent crises on Turkey’s access to international capital markets. Portfolio flows and private sector bank and corporate sector financing from international sources are all expected to fall sharply this year. Also, private banks need to build up their foreign assets to close their open on balance sheet foreign exchange positions, which will further add to pressures on the capital account. With a projected capital account deficit of US$14.4 billion, the overall projected balance of payments for 2001 is expected to reach US$15.4 billion. Without strong international support, Turkey’s reserves would plummet to dangerously low levels—already Turkey’s reserves are just half of its short-term debt by remaining maturity. These payment difficulties generate an external financing gap estimated at $10 billion. The collapse of the Turkish lira unveiled severe structural weaknesses especially in the banking system. The ensuing balance of payments need is more of a medium-term nature and justifies Fund support on SBA terms. Moreover, Turkey is facing a demanding repayment schedule that would be exacerbated by providing resources of a much shorter-term nature. Relatedly, the ratio of reserves to short-term debt by remaining maturity is not set to begin increasing significantly until 2004—therefore favoring augmentation under the SBA rather than the SRF.

Table 7.

Turkey: Schedule of Purchases Under the SBA/SRF, 1999-2002

(SBA augmentation at 660 percent of quota)

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End-May performance criteria on NDA and NIR.

End-June performance criteria on NDA and NIR; and end-May performance criteria on consolidated government sector primary balance and central government primary expenditure.

End-August performance criteria on NDA and NIR; end-July performance criteria on consolidated government sector primary balance and central government primary expenditure; and end-June performance criteria on external debt.

End-October performance criteria on NDA and NIR; end-September for all other performance criteria.