Statement by Willy Kiekens, Executive Director for Turkey and Ozgur Demirkol, Senior Advisor to Executive Director

This paper discusses key findings of the Seventh Review and Inflation Consultation Under the Stand-By Arrangement for Turkey. Macroeconomic developments have become less favorable since the last review in May 2007. Political developments have distracted attention from an ambitious economic agenda. As a result, performance under the IMF-supported program suffered, with fiscal policy imparting an unplanned stimulus in 2007 and structural reforms meeting with delays. IMF staff welcomes the adoption of a medium-term fiscal framework to guide future policy, and encourages the authorities to strengthen its institutional underpinnings.


This paper discusses key findings of the Seventh Review and Inflation Consultation Under the Stand-By Arrangement for Turkey. Macroeconomic developments have become less favorable since the last review in May 2007. Political developments have distracted attention from an ambitious economic agenda. As a result, performance under the IMF-supported program suffered, with fiscal policy imparting an unplanned stimulus in 2007 and structural reforms meeting with delays. IMF staff welcomes the adoption of a medium-term fiscal framework to guide future policy, and encourages the authorities to strengthen its institutional underpinnings.

The Turkish economy has made significant progress in strengthening its fundamentals over the last six years. Rapid transformation of the economy was accompanied by high growth. In turn, high growth has helped the authorities in implementing many challenging structural reforms necessary for sustaining economic performance. The EU accession negotiations and two consecutive Fund-supported programs have provided a roadmap for the reform agenda. The Turkish authorities greatly value the policy advice and support of the Executive Board, management and staff.

The staff confirms that Turkey over performed on many targets during the program period. Growth has been high, fiscal policy has remained strong, public debt came down rapidly and the foreign reserve position continues to strengthen. Turkey now meets the EU criteria on the budget deficit and public debt. Among other factors, the authorities’ ownership and decisive program implementation was critical for this outcome.

Despite the strong economic performance, Turkey faces important challenges. Inflation is above target and the current account deficit continues to be large. Moreover, the current global economic environment is posing additional stress as pointed out in Box 2 of the Staff Report. Indeed, there are signs of a slow down in growth of syndicated and securitized loans. Nonetheless, long-term borrowing by Turkish corporations remained solid in the first quarter of the year.

Furthermore, Turkey needs to increase investment and raise its employment rate and total factor productivity so as to facilitate a rapid convergence with the European Union. These policy targets call for prompt implementation of labor market reforms, upgrading transportation and energy infrastructure, fighting against the informal economy, strengthening the competition in products market, improving the business environment and investing more on human capital. The Turkish authorities believe that in order to meet these challenges, it is important to have a balanced and integrated policy package which keeps the public debt on a declining path while addressing the pressing needs of the economy.


Turkey has achieved an annual average growth of 6.8 percent over the last six years. Moreover, it is clear that this growth rate is entrenched as it was not only higher but also much less volatile. In 2007, the economy grew by 4.5 percent despite the rather difficult domestic and global conditions. Last year, Turkey held a general election, a presidential election and a referendum. A severe drought harmed agricultural production. Moreover, the monetary tightening undertaken in 2006, global supply shocks and a weaker global economic environment all contributed to a slower growth. In the period ahead, the authorities expect economic activity to remain resilient with growth reaching 4.5 percent thanks to the higher agricultural production and net exports.

Current Account

The current account deficit continues to be high. Although the deficit contracted to 5.7 percent of GDP in 2007, staff expects it to widen again to 6.4 per cent of GDP in 2008. This is because along with the other imports, the surge in energy and commodity prices plays an important role in the current account deficit. A one-dollar rise in oil price, together with the consequential rise in natural gas prices, adds USD 530 million to the total bill of imported energy.

According to the most recent data, the hike in exports continued to hold well in the first quarter of the year. The growth in export volume exceeded that of import volume in the first few months of the year. Some leading indicators signal continued strong export growth in the second quarter. There are no obvious signs of a slowdown of exports to the European Union and exports to non-US and non-EU destinations continue to rise. The volume growth of imports is expected to slow as demand weakens along with the depreciation of the lira.

The financing of the current account deficit has improved. In 2006–07, FDI flows covered more than 60 percent of the current account deficit. According to staff’s projection, FDI will cover more than one quarter of the deficit in 2008 and external financing conditions will remain adequate. However, the authorities are cognizant of the risks and closely monitoring the developments in the current account and its financing.

Monetary Policy

The tight monetary policy stance of the central bank (CBT) since mid-2006 resulted in a noticeable reduction in core inflation in 2007. However, like in the rest of the world, higher food, energy and other commodity prices have increased inflationary pressures, resulting in the case of Turkey, in a slowing the decline of headline inflation in 2007.

The CBT’s monetary policy strategy has been clearly communicated: monetary policy will tolerate the first round effects of external price shocks but it will promptly respond to any deterioration in the overall pricing behavior. In this context, the CBT suspended the easing cycle in March 2008 because of the medium term outlook for inflation.

The continued rise in food and energy prices and the ongoing uncertainties in the global economy have worsened inflation expectations and increased upside risks along with the recent moves in the exchange rate. As presented in the staff’ update, the CBT now forecasts annual inflation to be around 9.3 per cent at the end of 2008. According to the CBT’s medium term forecast, assuming a measured and gradual tightening towards mid-2008 and constant policy rates thereafter, inflation will be between 4.9 per cent and 8.5 per cent (mid-point 6.7 per cent) at the end of 2009. Assuming a gradual moderation in food prices, inflation is expected to decelerate to 4.9 per cent at the end of 2010 and come down to 4 percent by mid-2011.

The CBT has emphasized that its updated inflation forecasts will serve as an anchor in the short run while the 4 percent inflation target continues to be the medium-term anchor. The CBT also stressed that extending the horizon of convergence to the inflation target does not imply a loose monetary policy in the period ahead. Monetary policy already assumed a more cautious stance in order to avoid second round effects. Ensuring a steady decline in inflation will likely require tight monetary policy to be maintained for an extended period. The CBT has also announced that monetary policy will be more responsive to bad news than good news in the period ahead.

Fiscal Policy and Medium Term Fiscal Framework

Turkey has sustained large primary surpluses over the past few years. During 2003–06, the average primary surplus was 5 percent of GDP. The policy of targeting large primary surpluses served well and helped in reducing the net debt of the public sector from 61.5 percent of GDP in 2001 to 29.1 percent in 2007. Last year, gross public sector debt was 38.8 percent of GDP, significantly below the EU-27 average. The maturity and composition of the public debt improved considerably, making it less vulnerable to external shocks. The public sector net debt in foreign currency, or linked to foreign currency was 3.2 percent of GDP in 2007, down from its high level of 35.4 percent in 2002.

The improved fiscal position and the declining path of public debt justify a new fiscal framework centered around the target for gross debt (according to the EU definition) of no more than 30 percent of GDP by 2012. This target will be reached by observing primary surpluses of at least 3.5 percent of GDP in 2008, 3 percent in 2009 and gradually declining to 2.4 percent in 2012.

The new primary surplus path will allow the authorities to address some acute investment needs and finance the cost of the long overdue labor market reform. Turkey has the highest taxation on labor income in the OECD, which is a significant deterrent for creating formal employment in the country. Tax rates on labor income will need to be reduced. The new fiscal framework will also allow higher infrastructure investments in the Southeastern Anatolian Project which is expected to increase agricultural production, create employment and address income inequalities in the area. The authorities are also considering to use a limited part of the fiscal space for reforming the local administrations so as to increase the efficiency of public services. The Turkish authorities are committed to continue with prudent fiscal management and will comply in the near term with the announced primary surplus targets, even if the debt ratio falls below the projected level. The authorities are examining various options to institutionalize this framework before the 2009 budget.

As underscored by staff, the 2008 primary surplus target of 3.5 percent of GDP represents a slight tightening of the structural balance. In order to secure the 2008 budget target, the authorities have taken several important measures, including the upfront increase of electricity tariffs, automatic price adjustment mechanism in electricity, adjustment of certain excise taxes, hiring caps in public sector and enhancing the efficiency of healthcare spending.

Structural Fiscal Reforms

A landmark social security reform was adopted in the Parliament last month, after the previous reform of 2006 was struck down by a Constitutional Court. The new law addresses the concerns raised by the Constitutional Court while preserving the overall budget savings targeted in the original 2006 law. The law establishes a universal health insurance, but also creates incentives and authority to manage health expenditures better.

Strengthening of the tax administration is a top reform agenda item. The authorities are determined to increase tax compliance and collection in the country. The authorities have taken many important steps, including the introduction of a risk based audit system for VAT refunds, requiring employers to pay salaries through bank accounts and unified forms for social security and tax declarations.

The authorities are grateful for the generous technical support given by the Fund to enhance the capacity of tax administration. They are giving serious consideration to staff advice with regard to the merger of all audit functions and will soon make a decision on this matter.

Financial Sector

The impact of global developments on the banking sector has so far been limited. The authorities remain vigilant about the developments in this sector and continue to upgrade the regulatory and supervisory practices as advised by the 2006 FSAP study. While Turkish banks enjoy high capital adequacy, strong profitability and sound liquidity, the Banking Regulatory and Supervisory Agency (BRSA) recently tightened provisioning and liquidity requirements as a part of preemptive policy action. The authorities are also vigilant about developments in the banking and corporate sectors and are taking further steps to better monitor the foreign exchange risk. The adoption of a new commercial code will reinforce these efforts in the period ahead.

Privatization and Investment Environment

In the past few years, Turkey has undertaken unprecedented privatization, reaching USD 30 billion in the period 2003-07. The authorities are committed to pushing ahead with the privatization agenda in 2008, including electricity distribution and generation, the national lottery, Turk Telekom (an IPO of 17.5 per cent of the remaining 45 percent state share), the sugar factories, the tobacco company and an additional share offering of Halkbank. The tender process has already begun for the four electricity distribution companies and IPO of Turk Telekom has been launched. Preparations for 24 percent of Halkbank’s second offering is also underway. The authorities’ efforts to improve the investment climate have elevated Turkey’s ranking in the World Bank’s Doing Business Report from 93 in 2006 to 57 in 2008.


This is the last Review under the current Stand-by Arrangement. The increased resilience of the Turkish economy, continuously tested by many external and internal shocks, stands as the best testimony to the success of the program. Rapid convergence with the EU, consolidation of macroeconomic stability, high and uninterrupted growth with relatively low inflation and deep-rooted structural reforms in many areas ranging from social security to privatization are among the main achievements under the program that deserve mention.

The Turkish authorities appreciate the strong support provided by the Fund to Turkey during the program period and would like to thank the Executive Board, Management and staff for their helpful policy advice. The constructive and open dialogue and cooperation between Turkey and the Fund has been and will remain important to overcome many challenges facing the economy.