February 4, 2002

1. This statement provides an update on economic and policy developments since the staff report (EBS/02/8, 1/18/02) was issued. The new information does not warrant changes in the thrust of the staff appraisal.

2. Financial indicators have continued to reflect a positive market sentiment. In January, the Turkish lira appreciated by 11 percent relative to the U.S. dollar, bringing the cumulative appreciation since mid-October 2001 to 22 percent. The interest rate on the benchmark bond (maturing in July 2002) declined by a further 1 percentage point during the month, to 69 percent. Stock prices remain more than 80 percent above the post-September 11 low, despite a modest decline of 4 percent in January.

3. The prior actions for approval of the SBA have been completed. As already mentioned in the staff report, three prior actions were met before the Letter of Intent was signed. Parliament passed the Tobacco Law on January 3, 2002 and the Procurement Law on January 4, 2002 (both have since been signed into law by the President), and all banks taken over by the SDIF by November 2001, with the exception of two whose resolution has been halted by courts, were resolved by end-2001. The other prior actions have been implemented as follows:

• Fiscal policy. The Council of Ministers’ decree implementing the reduction in the share of central government tax revenues accruing to metropolitan municipalities was issued on January 29. The circular to implement attrition rules was issued on January 28. The Minister of Finance signed the letter approving the reallocation of spending to ensure adequate funding for direct income support for small-scale farmers on January 11.

• Banking reform. Many of the banking reform prior actions were linked to passage of the amended Banking Law. Although the Law originally approved by parliament on January 10, the President vetoed three articles in it on January 25. They related to the auditing and reporting of independent supervisory and regulatory boards (not directly relevant for banking reform), changing the status of state bank employees, and providing legal protection for state bank management (the latter two articles were aimed at facilitating the restructuring of state banks and state banks’ participation in corporate debt restructuring under the Istanbul approach). On January 30, parliament passed the Law for a second time, without amendment, after which the President was required to sign the Law, which he did on January 31. The Law took effect on February 1, when it was published in the official gazette. Although the disputed articles can be challenged in the Constitutional Court, this does not affect the remainder of the Law. Moreover, the authorities have indicated that until the Constitutional Court makes its ruling, the disputed articles remain in effect, and any actions taken on the basis of these articles will stand even if they are ruled unconstitutional. With the amended Banking Law passed and signed into law, the following prior actions were met: (i) the legal framework for the public support for private banks became effective, (ii) the legal amendment to eliminate the existing four-year transition rule for loan-loss provisioning was passed, and (iii) the necessary legal amendments for staff reductions in state banks were put in place. The remaining prior actions in banking were completed through a Council of Ministers’ decree on staff reductions in state banks signed on January 29; through the circulation on January 30 by the BRSA to the Turkish banking community of rules (effective July 1, 2002) to begin the trial implementation of accounting standards in line with the IAS; and through approval by the BRSA on January 31 of regulations related to the private bank recapitalization scheme and of guidelines for the targeted evaluation of banks’ loan portfolios.

• Public sector reform. (i) On January 29, the Council of Ministers approved a plan to reform the tax system. A matrix that spells out the reform in further detail was approved by the Ministers of Finance and Economy on January 31. (ii) Between December 3 (the issuance of the Prime Minister’s circular) and mid-January, 12,657 public sector workers were retired or notified of retirement. In addition, in the context of the merger of the state-owned steel company Isdemir with Erdemir on January 31, 2,606 workers at Isdemir were laid off on that day, bringing the reduction in the number of public sector workers above the targeted 15,000. Erdemir is a steel company classified as private under the commercial code, with the state’s present share at 50.4 percent. The authorities have agreed to reduce the state’s share in Erdemir to below 50 percent by mid-February. While the inclusion of the laid-off workers in meeting the targeted reduction does not meet the letter of the envisaged action (retirement), the staff considers that satisfactory progress has been made toward completing this prior action.

• Enhancing the role of the private sector. The Council of Ministers approved an action plan to foster domestic and foreign investment on January 28.

4. Although not prior actions for the approval of the SBA, progress has also been made with two program actions envisaged for completion by end-January. First, the review of redundancies in state economic enterprises has been initiated (with World Bank assistance) and the Treasury has issued an instruction to eliminate 90 percent of existing open positions in state economic enterprises, paving the way for completing the related prior action for the first program review in due course. Second, the strategy for increasing transparency and combating rent-seeking activities has been opened for signature by the Council of Ministers (adoption of this strategy is a structural benchmark).