TURKEY: STAFF REPORT FOR THE 2011 ARTICLE IV CONSULTATION

International Monetary Fund

doi:10.5089/9781463934484.002.A002

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TURKEY: STAFF REPORT FOR THE 2011 ARTICLE IV CONSULTATION

Author: International Monetary Fund

Publication Date:: 27 Jan 2012

eISBN:: 9781463934484

ISBN:: 9781463934484

Language:: English

Keywords:: ISCR; CR; IMF staff estimate; estimate; exchange rate; debt ratio; potential GDP; market share; Current account deficits; Inflation; Loans; Fiscal stance; Global

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This 2011 Article IV Consultation highlights that the Turkish economy continued to grow strongly through the first half of 2011, reaping the benefits of institutional reforms and revamped policy frameworks implemented in the previous decade. However, growth became increasingly fueled by domestic demand and imports. Policy responses were insufficient to prevent the development of a large current account deficit and high inflation. Executive Directors have commended the Turkish authorities for their agile economic management during the global crisis, which, together with structural reforms undertaken earlier, contributed to a rapid recovery.

Abstract

BACKGROUND

1. In the decade since the tumultuous 1990s, Turkey achieved a remarkable economic revival, which brought new strengths but also challenges. Fiscal indiscipline and weakly-regulated banks combined during the 1990s to produce chronic inflation, high real interest rates, and fiscal unsustainability. In the wake of a severe crisis in 2000–01, a new economic framework was established, focusing on unprecedented fiscal consolidation, inflation targeting under a newly-independent central bank, and overhaul of banking system regulation. This framework delivered rapid growth with single-digit inflation, large fiscal primary surpluses, and strong reserve buildup, but also attracted large capital inflows that widened the current account deficit. Nonetheless, Turkey entered the global crisis in a stronger position than many other countries in the region.

A. Recent Developments

2. The Turkish economy experienced a dynamic rebound from the 2008–09 global crisis. Growth recovered strongly, and by mid-2011, real output was 25 percent above its crisis trough and 9 percent higher than its pre-crisis peak. As a result, the unemployment rate fell below 10 percent—a floor not breached before the crisis—notwithstanding an increase in labor force participation. This impressive performance was underpinned by ample capital inflows, reflecting Turkey’s generally strong balance sheets, favorable medium-term growth prospects, as well as abundant global liquidity (see Analytical Annex I).

3. However, in line with prior episodes of rapid growth, economic activity became increasingly skewed toward domestic demand and imports. GDP grew 9 percent in 2010 and 10 percent in H1 2011, led by private consumption and investment. The external sector’s contribution was negative and large. On the production side, activity during H1 2011 was especially strong in the non-tradable sectors of construction, trade, and transport and communication, but slowed to a still-robust 10¾ percent in manufacturing.

4. Historically-low real interest rates and a considerable competitiveness gap contributed to a sharp widening of the non-energy current account deficit (CAD). The net import intensity of GDP rose to an all-time high as nominal import growth accelerated to around 40 percent—about twice the rate of exports. As a result, the current account deficit expanded from over 6½ percent of GDP in 2010 to 9¼ percent of GDP in H1 2011. Although energy accounts for the largest part of the trade deficit (around 4¾ percent of GDP on average in recent years), the non-energy balance contributed three-quarters of the deterioration. These developments reflect a large decline in the private sector saving-investment balance that more than offset the improved public sector balance, in addition to continued substitution toward imports reflecting the—until recently—considerably overvalued real exchange rate (see Box 1 and Analytical Annex I).

5. Capital inflows have been dominated by potentially-volatile short-term debt—largely channeled through banks—and unidentified financing. Alongside sharply higher financing needs, funding sources have become less reliable, with much greater dependence on interest-sensitive portfolio flows and short-term borrowing, as well as errors and omissions.¹ This contrasts with predominantly FDI and medium- and long-term debt flows prior to the global crisis. Hence, while the CBT’s reserves grew by US$17¼ billion since end-2009, reserve cover of short-term debt (projected at US$130 billion—around 15 percent of GDP—in 2012) declined to 70 percent as of end October 2011, very low in comparison with international peers. Banks absorbed the largest share of external funding—much of it short term—and the sector’s net external liability position rose to 8½ percent of GDP.

6. Credit growth has been strong, supported until recently by ample, low-cost external financing. Loans to the private sector grew by around 40 percent y-on-y during Q4 2010 to Q2 2011, to reach 48 percent of GDP. This reflected the historically-low interest rate environment and banks’ intense competition for market share (Box 3). Lending was especially rapid to households (for general purpose and housing loans)² and to small- and medium-sized firms due to strong demand and higher profit margins on these loans. With the increase in resident’s deposits—previously banks’ main funding source—falling far short of the increase in lending, banks’ average loan-to-deposit ratio jumped from 76 percent at end 2009 to near 95 percent in mid 2011. To expand loans, during the first nine months of 2011, banks relied on financing sourced from abroad to the same extent as residents’ deposit growth.

7. While headline inflation has been volatile, core inflation is steadily trending up. This primarily reflects pass-through of the cumulative 30 percent nominal depreciation (against an equally-weighted euro-dollar basket) since November 2010 (see below). In addition, tighter domestic supply conditions—with declining unemployment,³ strong labor cost growth, and rising capacity utilization—also contributed. Producer price inflation has increased rapidly on rising world commodity prices and the weakening lira, and temporarily decoupled from consumer price inflation, which has weaker and more-delayed exchange rate pass through, and because administered retail prices for electricity and natural gas were held constant during October 2009 and September 2011.

8. Data suggest a modest pause in real activity in recent months. Loan growth eased from around 50 percent year-on-year in early June to around 10 percent in October. However, other indicators of activity—imports, capacity utilization, confidence, and unemployment—have held up, despite previous monetary and prudential tightening measures (see below), and some US$4½ billion in portfolio debt outflows associated with recent strains in global funding markets. The absence of a decisive slowdown may reflect the cushioning provided by the CBT’s large reserve drawdown, which entirely financed the August current account deficit.

Political Setting

9. The Justice and Development (AK) Party won a third consecutive term in the June 2011 general elections. As stated in the government’s program, a key political priority is the adoption of a new constitution aimed at strengthening democracy; a new constitution is on the parliamentary agenda. The economic program aims to maintain macroeconomic stability, boost competitiveness and productivity, enhance regional development, and bolster institutions.

B. Authorities’ Policy Response

10. Through an unorthodox approach to monetary policy, the CBT took the lead in responding to growing imbalances, with other policy interventions being less timely or more limited.

Monetary Policy

11. Surging inflows and a sharp appreciation were met with an unorthodox monetary policy mix. The CBT initially responded by hiking daily fx purchases from US$40 million to US$140 million. However, this failed to staunch the nominal appreciation and also created difficulties sterilizing the large liquidity injections (equivalent to an annualized 5 percent of GDP). Since mid-November 2010, the CBT has actively pursued financial stability alongside price stability. This entailed: (i) widening the CBT’s interest rate corridor to facilitate greater volatility of short-term money market rates; (ii) halting remuneration of reserve requirements (URR), and applying progressively higher rates on shorter maturity liabilities; (iii) lowering the policy interest rate; and, (iv) using moral suasion to target a maximum 25 percent increase on banks’ annual loan growth, adjusted for exchange rate movements. The CBT also sharply scaled back its fx purchases to US$40–50 million per day. These measures were intended to discourage very short-term carry-trade inflows, lengthen the maturity of bank funding, and contain domestic credit growth.

12. The most discernable effect was a decoupling of the lira from other emerging market currencies. The lira weakened immediately relative to peer countries, as inflows—while remaining strong—were insufficient to cover the burgeoning current account deficit. This is consistent with anecdotal evidence that investors were wary of the new framework. On the other hand, loan growth slowed decisively only with a considerable lag as banks continued to actively tap short-term foreign funding.

13. The CBT’s policy stance shifted in early August to reflect evolving domestic and external risks. This was prompted by concerns about global financial markets, a sharp depreciation of the currency, and evidence of a domestic slowdown (see Box 4). The policy rate was lowered by a further ½ percentage point. The O/N borrowing rate was raised significantly to narrow the interest rate corridor and reduce interest rate volatility. Cuts in URR on fx liabilities, together with large, sustained fx sales, released some US$10 billion of reserves, partially offset by allowing banks to hold part of their URR on lira liabilities in fx.⁴ In addition, in contrast to prior practice, the Governor commented on the level of the lira, noting the currency had overshot its equilibrium. Reflecting the substantial release of reserves in recent months, the lira depreciated by less than many other EM currencies. A further significant policy realignment was introduced in late October (see ¶31).

Fiscal Policy

14. The headline fiscal balance continued to improve and public debt further declined, but masked a relaxed fiscal stance. The 4¾ percentage points of GDP improvement in the nonfinancial public sector (NFPS) overall balance during 2009–11 reflects efforts at fiscal restraint, but also a smaller interest bill, higher indirect tax rates, and transient revenue from the sizable competitiveness gap, boom in output and imports, and a comprehensive tax restructuring program (see Analytical Annex II).⁵ However, primary spending remains 3 percentage points of GDP above pre-crisis levels, primarily due to higher appropriations for capital, wages and pensions. Moreover, holding constant energy tariffs deteriorated the balance of the energy SEEs. Thus, while the end-year outturn is expected to over-perform the original target in the 2011–13 Medium-Term Program (MTP) by more than 1 percentage point of GDP, in structural terms, the primary balance continued to deteriorate in 2011, with a structural primary deficit of around 1¼ percent of GDP

Fiscal Indicators, 2007–11

(Percent of GDP)

Sources: Ministry of Development; and IMF staff estimates.

^¹/MTP for 2012-14. Contribution of unsustainable macroeconomic conditions to fiscal revenue calculated under staff’s macroeconomic scenario and methodology

Fiscal Indicators, 2007–11

(Percent of GDP)

				2007	2008	2009	2010	2011
				Actual				MTP ¹/	Proj.
Nonfinancial public sector primary balance (a)				3.2	1.6	-1.0	0.8	1.2	1.3
Transient revenue (b+c)				1.7	1.3	-0.9	0.9	2.8	2.9
	Contribution of unsustainable macroeconomic conditions to fiscal revenue (b)			1.5	0.6	-1.0	0.9	1.9	1.9
			Imports	0.4	0.2	-0.3	0.7	1.0	1.1
			Banking / financial	0.2	0.1	0.2	0.2	0.1	0.1
			Other income	0.9	0.3	-1.0	0.1	0.8	0.8
	Revenue from receivables restructuring (c)			0.2	0.7	0.2	0.0	0.9	0.9
Structural primary balance (a-b-c)				1.5	0.3	-0.1	-0.1	-1.6	-1.1
		Cumulative fiscal effort since 2007		…	-1.2	-1.6	-1.6	-3.1	-2.6
Nonfinancial public sector overall balance				-1.8	-2.8	-5.5	-2.9	-1.4	-0.8
Import gap (percent of potential GDP)				3.5	3.1	-1.0	4.2	7.9	7.9
Output gap (percent of potential GDP)				3.5	1.3	-3.6	0.2	2.9	2.9

Sources: Ministry of Development; and IMF staff estimates.

^¹/MTP for 2012-14. Contribution of unsustainable macroeconomic conditions to fiscal revenue calculated under staff’s macroeconomic scenario and methodology

Fiscal Indicators, 2007–11

(Percent of GDP)

				2007	2008	2009	2010	2011
				Actual				MTP ¹/	Proj.
Nonfinancial public sector primary balance (a)				3.2	1.6	-1.0	0.8	1.2	1.3
Transient revenue (b+c)				1.7	1.3	-0.9	0.9	2.8	2.9
	Contribution of unsustainable macroeconomic conditions to fiscal revenue (b)			1.5	0.6	-1.0	0.9	1.9	1.9
			Imports	0.4	0.2	-0.3	0.7	1.0	1.1
			Banking / financial	0.2	0.1	0.2	0.2	0.1	0.1
			Other income	0.9	0.3	-1.0	0.1	0.8	0.8
	Revenue from receivables restructuring (c)			0.2	0.7	0.2	0.0	0.9	0.9
Structural primary balance (a-b-c)				1.5	0.3	-0.1	-0.1	-1.6	-1.1
		Cumulative fiscal effort since 2007		…	-1.2	-1.6	-1.6	-3.1	-2.6
Nonfinancial public sector overall balance				-1.8	-2.8	-5.5	-2.9	-1.4	-0.8
Import gap (percent of potential GDP)				3.5	3.1	-1.0	4.2	7.9	7.9
Output gap (percent of potential GDP)				3.5	1.3	-3.6	0.2	2.9	2.9

Sources: Ministry of Development; and IMF staff estimates.

^¹/MTP for 2012-14. Contribution of unsustainable macroeconomic conditions to fiscal revenue calculated under staff’s macroeconomic scenario and methodology

Financial Policies⁶

15. Financial policy responses were appropriately targeted but, from a macroprudential perspective, in some cases were delayed. The Banking Regulation and Supervision Agency (BRSA) imposed loan-to-value ceilings on housing and commercial real estate loans in early 2011. However, crisis-era relaxation of prudential norms on loan restructuring and general provisioning were rescinded only in March 2011, following a one-year extension. Despite extremely rapid loan growth during H1 2011, provisioning requirements and risk weights on general purpose loans (GPLs)—the fastest growing category—were raised only in mid June. With banks’ profits having moderated due to competition for loan-market share (Box 3), they immediately passed these higher intermediation costs through to lending rates. However, delayed adoption caused the measure to coincide with the deteriorating international conditions. In addition, since June, individual credit card limits may not be increased if three or more monthly payments within a calendar year are less than half the outstanding debt on the card (including any new payables incurred in the latest transaction period), and no cash advance is permitted if the card has an outstanding balance. Several measures that had been under consideration, including URR on banks’ on-balance sheet short fx positions or significantly higher marginal URR on new funding were not introduced.

16. Financial conditions tightened on monetary and prudential policy actions and more restrictive external financing conditions. Interest rates on lira-denominated bank loans—which provide the best gauge of the net impact of the numerous policy changes—have risen substantially, especially for households. As a result, real rates for households are now back to pre-crisis levels, but are considerably lower—but still strongly positive—for corporates. On the other hand, real rates on lira-denominated deposits remain low, and a meaningful yield curve for deposits has been slow to emerge.

C. Strengths and Challenges

17. The previous externally-financed demand boom has weakened Turkey’s resilience in some areas. Since 2008, private short-term foreign debt climbed sharply. With banks absorbing most of these liabilities, they face intensified rollover risk, notwithstanding that aggregate capital adequacy ratios (CARs) remain well-above the allowable 12 percent floor (but have slipped more than 4 percentage points to 16½ percent) and open fx positions are small. Nonfinancial corporates’ net fx liabilities have risen to US$120 billion, exposing them to currency depreciation, although short-term fx obligations are a more manageable US$15 billion. Households retain long fx positions,⁷ and are net savers. But deposits are extremely concentrated (the largest 0.1 percent of accounts hold more than 46 percent of system-wide deposits), while the number of retail borrowers increased sharply, presumably expanding beyond very wealthy households. Moreover, while the headline fiscal balance continues to improve—returning the public debt to GDP ratio to a downward path—this strong performance is contingent on favorable macroeconomic conditions at home and abroad.

Selected Macroeconomic Indicators, 2008–11

Sources: Central Bank of Turkey, BRSA, and IMF staff estimates.

^¹/EU definition.

^²/Data for 2011 as of Q2.

^³/Data for 2011 as of Q3.

Selected Macroeconomic Indicators, 2008–11

	2008	2011
		Proj.
Current account balance (percent of GDP)	-5.7	-10.2
External debt (percent of GDP)	38.4	42.9
Short-term debt (billions of U.S. dollars)	53.1	94.1
Nonfinancial public sector overall balance (percent of GDP)	-2.8	-0.8
Nonfinancial public sector structural primary balance (percent of GDP)	0.1	-1.3
General government gross debt (percent of GDP) ¹/	39.5	39.1
Net financial assets of corporates (percent of GDP) ²/	-16.8	-19.4
Net financial assets of households (percent of GDP) ²/	22.0	21.2
FX position of corporates (billions of U.S. dollars) ²/	-80.4	-119.3
FX position of households (billions of U.S. dollars) ³/	58.2	56.4

Sources: Central Bank of Turkey, BRSA, and IMF staff estimates.

^¹/EU definition.

^²/Data for 2011 as of Q2.

^³/Data for 2011 as of Q3.

Selected Macroeconomic Indicators, 2008–11

	2008	2011
		Proj.
Current account balance (percent of GDP)	-5.7	-10.2
External debt (percent of GDP)	38.4	42.9
Short-term debt (billions of U.S. dollars)	53.1	94.1
Nonfinancial public sector overall balance (percent of GDP)	-2.8	-0.8
Nonfinancial public sector structural primary balance (percent of GDP)	0.1	-1.3
General government gross debt (percent of GDP) ¹/	39.5	39.1
Net financial assets of corporates (percent of GDP) ²/	-16.8	-19.4
Net financial assets of households (percent of GDP) ²/	22.0	21.2
FX position of corporates (billions of U.S. dollars) ²/	-80.4	-119.3
FX position of households (billions of U.S. dollars) ³/	58.2	56.4

Sources: Central Bank of Turkey, BRSA, and IMF staff estimates.

^¹/EU definition.

^²/Data for 2011 as of Q2.

^³/Data for 2011 as of Q3.

REPORT ON THE DISCUSSIONS¹⁰

A. Outlook, Competitiveness and Risks

18. The authorities expected a healthy soft landing to continue in the medium term. Policy actions implemented since late 2010 were credited with slowing domestic demand and imports, and buoying exports. As outlined in the 2012–14 MTP, GDP growth is forecast to temporarily slow to 4 percent next year, before recovering to 5 percent thereafter, and with the CAD gradually moderating to 7 percent of GDP in 2014. Inflation is expected to drop to close to the 5 percent target by end-2012 and remain there through the medium term. Domestic and external demand would underpin growth, while imports relative to GDP stabilize, reflecting a series of policy measures, including recent hikes in indirect taxes.⁹ Sustained growth and labor market reforms were expected to continue to boost employment.

19. While the mission’s baseline envisages a broadly similar path for the CAD ratio as in the MTP, they expect a steeper slowdown in growth. A reduction in external financing (from US$75 billion in 2011 to US$60 billion in 2012—around 8 percent of GDP) is expected to compress imports, measured in dollar terms.¹⁰ Because imports are mostly raw materials and manufactured intermediates—key inputs into domestic value added—GDP growth is likely to moderate sharply from 7½ percent this year to 2 percent in 2012. This is consistent with previous capital flow-driven corrections.¹¹ Thereafter, some limited expenditure switching and expanded domestic production of import substitutes is projected in response to the previous real depreciation, raising GDP growth and further moderating the CAD (see Analytical Annex III). However, persistent positive inflation differentials—with inflation surging to 9½ percent this year and to 6½ percent in 2012—are forecast to gradually erode initial competitiveness gains. Thus, the RER would remain noticeably overvalued relative to equilibrium. Still-large current account deficits in the medium term are forecast to raise external debt to 50 percent of GDP by 2016, with additional risk from slower growth and more depreciation (Analytical Annex III).

20. The authorities and staff considered risks skewed to the downside. A weaker outlook for global activity and more severe international funding strains have the potential to spill over to Turkey. Notwithstanding, the authorities expected that with its relatively healthier balance sheets, Turkey could receive safe-haven inflows. The mission agreed the near-term outlook was contingent on capital inflows, and cautioned a more coherent set of policies was needed to avoid an abrupt adjustment. Moreover, the mission was concerned that heightened risk aversion or deleveraging by European banks could sharply limit external financing, causing further depreciation, fx funding strains for banks and corporates amid low reserve buffers, and compressing imports and credit. As in 2008–09, the effect on growth could be harsh.

Comparison of MTP and Staff Projections

Sources: Ministry of Development; and IMF staff estimates.

^¹/According to the CBT’s latest Inflation Report (October 26, 2011), inflation in 2011 is forecast at 8.2 percent, with the 2012 forecast remaining as in the MTP.

Comparison of MTP and Staff Projections

	2011		2012
	Staff	MTP	Staff	MTP
Real GDP growth (percent)	7.5	7.5	2.0	4.0
Current account deficit (billions of U.S. dollars)	-78.8	-71.7	-62.9	-65.4
Current account deficit (percent of GDP)	-10.2	-9.4	-7.8	-8.0
Exports (fob, billions of U.S. dollars)	134.2	134.8	143.6	148.5
Imports (cif, billions of U.S. dollars)	241.6	236.9	243.5	248.7
CPI inflation (eop, percent) ¹/	9.5	7.8	6.4	5.2

Sources: Ministry of Development; and IMF staff estimates.

^¹/According to the CBT’s latest Inflation Report (October 26, 2011), inflation in 2011 is forecast at 8.2 percent, with the 2012 forecast remaining as in the MTP.

Comparison of MTP and Staff Projections

	2011		2012
	Staff	MTP	Staff	MTP
Real GDP growth (percent)	7.5	7.5	2.0	4.0
Current account deficit (billions of U.S. dollars)	-78.8	-71.7	-62.9	-65.4
Current account deficit (percent of GDP)	-10.2	-9.4	-7.8	-8.0
Exports (fob, billions of U.S. dollars)	134.2	134.8	143.6	148.5
Imports (cif, billions of U.S. dollars)	241.6	236.9	243.5	248.7
CPI inflation (eop, percent) ¹/	9.5	7.8	6.4	5.2

Sources: Ministry of Development; and IMF staff estimates.

^¹/According to the CBT’s latest Inflation Report (October 26, 2011), inflation in 2011 is forecast at 8.2 percent, with the 2012 forecast remaining as in the MTP.

B. Policy Framework

21. The authorities were committed to gradually reducing the current account deficit while bolstering macroeconomic stability. They intend to maintain their unconventional monetary policy framework, supplemented by the more ambitious fiscal adjustment path in the 2012–14 MTP and structural reforms. However, fiscal consolidation was seen as having limited effect at moderating the CAD due to accelerating private sector credit. Thus, when faced with potential large inflows, they would keep interest differentials low to discourage carry trades, and use macroprudential tools to moderate credit growth.

22. In the mission’s view, monetary policy is overburdened while fiscal, prudential, and structural policies remain underutilized. The recent increase in public saving was primarily attributable to tax revenue derived from higher private sector dissaving and hence, at a structural level, fiscal policy has not leaned against the wind. With other policies largely on the sidelines, monetary policy attempted to deliver multiple objectives, through an increasingly activist approach.

23. To reduce the propensity for volatile capital flow-driven cycles, the mission advised rebalancing the policy mix within a standard inflation-targeting framework. With a tighter structural fiscal position to support disinflation, and financial policies geared to reducing macroprudential risks, monetary policy would then be better placed to maintain inflation and policy rates at levels prevailing in other countries within a conventional inflation-targeting framework. This would reduce attractiveness to short-term inflows and limit erosion of competitiveness through inflation differentials. Structural reforms would also help reduce reliance on imports and support price flexibility.

24. The mission observed that if staff’s recommended policy mix had been adopted 18 months earlier, a more moderate capital flow-driven boom would have ensued. Consistent with staff’s advice at the time, implementing a much tighter structural fiscal position—with all transient revenue being saved—and preemptively strengthening macroprudential policies would have reduced absorption of “hot money” inflows that fuelled credit, domestic demand and imports. As a result, the current account deficit and domestic and external vulnerabilities would have been smaller, obviating the need for the CBT’s unconventional policy mix, which pushed up inflation. Despite the changed macroeconomic conditions, the recommended mix still remains valid, but now must be implemented more cautiously.

Fiscal Policy

25. To differentiate Turkey’s healthy budget balance and debt trends from those elsewhere in the region, the authorities intend to keep lowering the fiscal deficit. Turkey will likely out-perform the 2011 fiscal targets set in the previous MTP. Going forward, a back-loaded improvement in the NFPS primary balance of 0.3 percentage point by 2014 is targeted—with a slight deterioration next year—despite the loss of 1 percentage point of one-off revenue from the receivables restructuring program. This would reduce the debt ratio by 8 percentage points to 32 percent of GDP. The improvement relies on restraining primary spending, the recently-increased indirect tax rates, and rapid growth of the tax base. Spending restraint would focus on wages and capital—categories that grew rapidly in recent years.

26. The mission commended the 3-year planning horizon for fiscal policy in the MTP, but observed that fiscal targets tend to be outdated early in the first year. The current MTP assumes a 2011 NFPS primary outturn of 1.2 percent of GDP, against the mission’s projection of 1.8 percent of GDP, based on performance through September and announced spending plans for the rest of the year. This implies either a large late-year jump in spending in excess of approved limits,¹² which is permissible under the public financial management framework, or a much smaller fiscal adjustment in 2012. This unpredictability of policy severely limits the relevance of the budget and the MTP as indicators of the fiscal stance, and complicates macroeconomic policy coordination.

27. Instead, the mission recommended targeting a strong structural primary surplus—excluding transient revenue—to support disinflation and protect against large negative revenue shocks.

The focus of fiscal policy should go beyond public debt sustainability to reducing absorption of short-term inflows that contribute to boom-bust cycles. Thus, the structural primary surplus target should be set sufficiently high to ensure inflation and nominal policy rates are broadly comparable to those of EM peers. While this target should be reviewed periodically to ensure these macroeconomic goals are being met, and with a view to gradually relaxing the target once lower inflation has become entrenched, a structural primary surplus of around 1 percent of GDP is an appropriate target. This would imply a return to the level prevailing in 2007, thereby reversing the fiscal stimulus injected in response and subsequent to the crisis (see text table below). With the net interest bill around 2–3 percent of GDP, this would be consistent with a small overall structural deficit. The already high tax rates and large share of predetermined spending constrain Turkey’s ability to adjust public finances, and thus the 1 percent structural primary surplus target would safeguard sustainability in the event of an abrupt capital reversal, where the short-run revenue loss could considerably exceed current transient revenue and borrowing costs could increase sharply.
How quickly this target should be reached depends on the pace of economic activity. While deferring adjustment would leave the economy vulnerable to capital flows, the pace should balance the drag on growth with the need to reverse the structural loosening of recent years. For 2012, targeting a NFPS headline primary surplus near 2 percent of GDP—against the MTP target of just over 1 percent—would be appropriate under the baseline macroeconomic scenario where the current account deficit remains high and the output gap is still positive. As shown in the text table, staff projects that fiscal policy in 2012 will be stronger than in the MTP, and thus achieving a 2 percent target would require ½ percentage point in new measures relative to those already planned for 2012, and would be best achieved by slowing the growth of current spending. With this structural improvement of 1½ percentage points in 2012, a further ½ percentage point would be needed over the next few years to reach the 1 percent of GDP structural primary surplus target. However, slower structural adjustment is appropriate if growth considerably underperforms the baseline forecast.

Fiscal Indicators, 2007–12

(Percent of GDP)

Sources: Ministry of Development; and IMF staff estimates.

^¹/MTP for 2012-14. Contribution of unsustainable macroeconomic conditions to fiscal revenue calculated under staff’s macroeconomic scenario and methodology.

Fiscal Indicators, 2007–12

(Percent of GDP)

				2007	2008	2009	2010	2011		2012
				Actual				MTP ¹/	Proj.	MTP ¹/	Proj.	Staff Recomm.
Nonfinancial public sector primary balance (a)				3.2	1.6	-1.0	0.8	1.2	1.8	1.1	1.5	1.9
Transient revenue (b+c)				1.7	1.3	-0.9	0.9	2.8	2.9	1.6	1.6	1.8
	Contribution of unsustainable macroeconomic conditions to fiscal revenue (b)			1.5	0.6	-1.0	0.9	1.9	1.9	1.2	1.2	1.4
			Imports	0.4	0.2	-0.3	0.7	1.0	1.1	0.9	0.9	1.1
			Banking / financial	0.2	0.1	0.2	0.2	0.1	0.1	0.0	0.0	0.0
			Other income	0.9	0.3	-1.0	0.1	0.8	0.8	0.2	0.2	0.2
	Revenue from receivables restructuring (c)			0.2	0.7	0.2	0.0	0.9	0.9	0.4	0.4	0.4
Structural primary balance (a-b-c)				1.5	0.3	-0.1	-0.1	-1.6	-1.1	-0.5	-0.1	0.1
		Cumulative fiscal effort since 2007		…	-1.2	-1.6	-1.6	-3.1	-2.6	-2.0	-1.6	-1.4
Required additional adjustment with respect to projections												0.4
Nonfinancial public sector overall balance				-1.8	-2.8	-5.6	-2.9	-1.4	-0.8	-1.5	-1.1	-0.7
Import gap (percent of potential GDP)				3.5	3.1	-1.0	4.2	7.9	7.9	5.3	5.3	5.0
Output gap (percent of potential GDP)				3.5	1.3	-3.6	0.2	2.9	2.9	0.9	0.9	0.9

Sources: Ministry of Development; and IMF staff estimates.

^¹/MTP for 2012-14. Contribution of unsustainable macroeconomic conditions to fiscal revenue calculated under staff’s macroeconomic scenario and methodology.

Fiscal Indicators, 2007–12

(Percent of GDP)

				2007	2008	2009	2010	2011		2012
				Actual				MTP ¹/	Proj.	MTP ¹/	Proj.	Staff Recomm.
Nonfinancial public sector primary balance (a)				3.2	1.6	-1.0	0.8	1.2	1.8	1.1	1.5	1.9
Transient revenue (b+c)				1.7	1.3	-0.9	0.9	2.8	2.9	1.6	1.6	1.8
	Contribution of unsustainable macroeconomic conditions to fiscal revenue (b)			1.5	0.6	-1.0	0.9	1.9	1.9	1.2	1.2	1.4
			Imports	0.4	0.2	-0.3	0.7	1.0	1.1	0.9	0.9	1.1
			Banking / financial	0.2	0.1	0.2	0.2	0.1	0.1	0.0	0.0	0.0
			Other income	0.9	0.3	-1.0	0.1	0.8	0.8	0.2	0.2	0.2
	Revenue from receivables restructuring (c)			0.2	0.7	0.2	0.0	0.9	0.9	0.4	0.4	0.4
Structural primary balance (a-b-c)				1.5	0.3	-0.1	-0.1	-1.6	-1.1	-0.5	-0.1	0.1
		Cumulative fiscal effort since 2007		…	-1.2	-1.6	-1.6	-3.1	-2.6	-2.0	-1.6	-1.4
Required additional adjustment with respect to projections												0.4
Nonfinancial public sector overall balance				-1.8	-2.8	-5.6	-2.9	-1.4	-0.8	-1.5	-1.1	-0.7
Import gap (percent of potential GDP)				3.5	3.1	-1.0	4.2	7.9	7.9	5.3	5.3	5.0
Output gap (percent of potential GDP)				3.5	1.3	-3.6	0.2	2.9	2.9	0.9	0.9	0.9

Sources: Ministry of Development; and IMF staff estimates.

^¹/MTP for 2012-14. Contribution of unsustainable macroeconomic conditions to fiscal revenue calculated under staff’s macroeconomic scenario and methodology.

28. Expanding recourse to public-private partnerships (PPPs) should be accompanied by strengthened, centralized oversight. Some US$16 billion (1¼ percent of GDP) of PPP-financed infrastructure projects have been approved or are in the pipeline. To limit associated risks: (i) an updated legal framework integrating the various laws covering PPPs is needed; (ii) PPP projects should be subject to the same cost-benefit criteria as other government investments; (iii) decision-making should be centralized, with approval of Treasury and the relevant line ministry being needed before projects can proceed; (iv) the Credit Risk Management Department of the Treasury should compile a comprehensive PPP database and regularly report on associated fiscal risks; and (v) the fiscal impact of PPPs, including contingent liabilities, should be transparently discussed in budget documents and integrated into debt sustainability analysis.

Monetary Policy

29. The CBT saw little alternative to its unconventional framework, and was generally satisfied with the results. With an already-large current account deficit, Turkey could ill afford further real appreciation and the inevitable boom-bust cycle that large interest-sensitive short-term flows would bring. In addition, there was room in late 2010-early 2011 to cut the policy rate because headline inflation was below target and any inflationary pressure was expected to be temporary. Narrower interest differentials and greater downside volatility of money market rates were seen as immediately effective at alleviating appreciation pressure—even to the point where the lira depreciated, which was a welcome side benefit. However, the CBT saw URR increases as only partially effective at slowing credit, in part because they are a blunt instrument, unlike the BRSA’s more targeted tools (see Analytical Annex IV).

30. The mission recognized the appeal of the new framework given the constrained environment monetary policy was operating in, but was uncertain of its effectiveness and consistency. The CBT’s innovative strategy for regaining monetary policy independence in the context of abundant international liquidity relies on segmenting the domestic financial market to allow the co-existence of widely-dispersed interest rates. This helped engineer a large nominal depreciation that would begin to narrow the current account deficit. However, raising RR contributed to dampening deposit rates and slowing deposit growth—banks’ main funding source—that, contrary to intentions, increased reliance on foreign financing and discouraged domestic saving. In addition, capital inflows remained predominantly short term, and credit growth did not slow markedly until strains appeared in international financial markets, the annual credit growth cap began to bind, and the BRSA measure on GPLs was introduced. Moreover, tension with the inflation target is severe. Relying on multiple goals and policy instruments can lead to inconsistencies and unintended outcomes.

31. Responding to recent intensified depreciation pressure, in late October the CBT realigned its unconventional framework to tighten monetary conditions. Whereas previously downside interest rate volatility had been used to weaken the lira, the CBT is now generating greater upside variability in interbank rates to strengthen the lira and defend the inflation target. In practical terms, the CBT considers it has two policy rates—the 7-day repo rate (the official policy rate) at 5.75 percent and the new higher O/N lending rate at 12.5 percent. The CBT will push banks to the upper-rate window on days when it sees the lira depreciating sharply; otherwise it will inject funds at the lower rate. The CBT viewed this shifting-rate mechanism as providing needed flexibility, and was not inclined to tighten through the policy rate ahead of major central banks. Other policy tools would be used as needed, and URR on shorter-duration lira liabilities were cut while fx sales were temporarily suspended and resumed in November on a smaller scale.

32. While the mission welcomed the suspension of fx sales, it was concerned about the side effects of the new approach to tightening. The mission noted that the previous rapid depletion of reserves may itself have encouraged speculative demand because sales needed to be halted at some point to preserve limited reserve cover.¹³ The volatility inherent in the new dual-rate system may discourage speculative activity by making it more costly to short the lira, but will be burdensome for banks already facing a difficult external funding environment, requiring them to hold larger liquidity buffers and risking an excessively abrupt deleveraging. It also creates the impression the exchange rate is the overriding policy goal. In addition, the dual-rate system is discriminatory toward banks that are more dependent on CBT funding, and scope for arbitrariness may raise concerns about CBT objectivity. Hence, while flexibility to quickly reorient policy at a time of heightened international uncertainty may be beneficial, selective tightening in response to only a single source of inflation—the exchange rate—is unlikely to restore price stability.

33. Against the risk of a sustained rise in inflation, and with weaker global risk appetite, the mission urged raising the policy rate within a transparent and consistent framework. In contrast to the dual-rate approach, raising the single policy rate within a narrow interest rate corridor would send a clear signal on the future direction of policy that is essential for shaping inflation expectations. Staff forecasts inflation at 6½ percent at end-2012, broadly in line with expectations, but well above the 5 percent target.¹⁴ While the real policy rate is currently very negative, conditions warrant a firmly positive real rate, and a decisive first step in this direction is urgently needed. If, however, domestic and external demands quickly turn down, and the lira is not under disproportionate selling pressure, some reduction in the policy rate may be appropriate amid lower inflation and global monetary policy easing.

34. The authorities considered their current inflation targets appropriate, while the mission recommended lowering them over the medium term to preserve competitiveness. High targets and wide bands push up “acceptable” inflation outcomes. Moreover, the top of the band has often been overshot. The CBT viewed its existing targets as warranted to avoid unduly constraining growth, with the wider band needed to accommodate high food price volatility. The mission observed a tendency to downplay the adverse consequences of inflation for competitiveness. It also noted that volatility was not noticeably higher than in other EMs (see Box 5). Narrowing the tolerance band and introducing a continuous target would help reinvigorate the commitment to price stability. Subsequently, supported by a tighter structural fiscal stance, a lower inflation outcome would be feasible with more moderate real and nominal policy rates.

Financial Sector

35. The banking sector’s dependence on short-term funding heightens procyclicality and exposes it to global funding shocks. Current pressures in international financial markets were seen as further reducing access to longer-term external funding.

Greater recourse to long-term funding would reduce rollover risk and permit a corresponding lengthening of loan maturities, enabling banks to straddle temporary liquidity shocks without having to recall loans. Some modest progress has been made by differentiating URR according to the maturity of liabilities since late 2010 and allowing banks to issue lira-denominated bonds since October 2010. However, with banks having built up large short-term external debt, they will be impacted by ongoing funding strains in international markets. While the CBT can mitigate lira and—to some extent—fx funding shocks, any residual shortfall would—as in 2008–09—be propagated to the real economy. Behind-the-curve timing of some otherwise well-designed macroprudential measures may also have contributed to procyclicality of the banking sector. In addition, given the advantages of retaining government securities in the face of a funding shock—zero risk weight in the calculation of capital adequacy and collateral for CBT funding—banks may prefer to de-lever loans while retaining their securities portfolio.
Incentives for reducing maturity mismatch should therefore be designed to promote longer-duration funding. Otherwise, banks may narrow duration gaps by shortening loan terms. Thus the BRSA’s new measure imposing capital charges on banks’ interest rate risk (see text table) should be complemented with the introduction of minimum lira and fx liquidity ratios at the 3-month and longer horizons (the current outer limit is one month) to extend funding duration. To reflect the greater fx funding risk from the rising loan-to-deposit ratio, which exposes banks to volatile international wholesale funding markets, higher capital charges could be imposed on shorter-term fx funding. Such a measure would need to be phased in very gradually, and with a lag, to avoid deleveraging. Early enforcement of the recent increase in required capital for some banks with strategic foreign shareholders could force them to cut risk-weighted assets. Further deepening local capital markets and developing new private savings vehicles are ultimately needed to promote domestic savings and enhance Turkey’s resilience to swings in global financial conditions. However, limiting the upside flexibility of the policy rate, and providing undue assurances that the policy rate will remain low, may preclude the development on an upward-sloping deposit yield curve, thwarting other attempts to lengthen deposits and increase savings.

Recent Macroprudential Measures

Measure	Details
Interest Rate Risk	Announced by BRSA in August 2011. Interest rate risk is to be contained through capital charges on large maturity mismatches, discouraging duration gaps.
Changes to Deposit Insurance	Announced by the Savings Deposit Insurance Fund (SDIF) in September 2011. Introduced a premium surcharge for large financial institutions, amendments in the profitability and the insured deposit ratio thresholds, and a new factor to calculate the bank’s score for the deposit premium determination.
Changes to Capital Adequacy Requirements	Introduced by the ERSA in September 2011 but to apply to banks with foreign strategic shareholders as of January 2012. The new minimum capital requirement depends on various factors, such as the CDS spread of the parent bank and its sovereign, EBA stress test results, and the public debt ratio in the country of origin.
Credit Risk Management	The BRSA has currently a draft regulation on banks’ credit risk management that should help to limit the unhedged borrowing by corporates.

Recent Macroprudential Measures

Measure	Details
Interest Rate Risk	Announced by BRSA in August 2011. Interest rate risk is to be contained through capital charges on large maturity mismatches, discouraging duration gaps.
Changes to Deposit Insurance	Announced by the Savings Deposit Insurance Fund (SDIF) in September 2011. Introduced a premium surcharge for large financial institutions, amendments in the profitability and the insured deposit ratio thresholds, and a new factor to calculate the bank’s score for the deposit premium determination.
Changes to Capital Adequacy Requirements	Introduced by the ERSA in September 2011 but to apply to banks with foreign strategic shareholders as of January 2012. The new minimum capital requirement depends on various factors, such as the CDS spread of the parent bank and its sovereign, EBA stress test results, and the public debt ratio in the country of origin.
Credit Risk Management	The BRSA has currently a draft regulation on banks’ credit risk management that should help to limit the unhedged borrowing by corporates.

36. The new Financial Stability Committee (FSC) provides the basis for a systemic approach to financial supervision that may be better suited to preemptively containing aggregate risk. Officials noted that mandates of individual institutions may not always be fully aligned with the policy tools at their disposal. The FSC—established in June 2011 and comprising the Treasury, CBT, BRSA, Deposit Insurance Fund, and Capital Markets Board, chaired by the Deputy Prime Minister in charge of Economic and Financial Affairs—is intended to improve detection and mitigation of emerging systemic risk. The authorities reported the FSC meets frequently, and discussions have included the policy response to recent international financial events. The mission observed that balancing institutional coordination with preserving the independence of respective institutions may be a challenge. They called for preemptively developing measures for a coordinated response to future systemic risks—such as a renewed credit boom cycle—to support timely future implementation.

37. The Financial Sector Assessment Program (FSAP) Update called for further strengthening supervision and regulation. Banks’ sizable capital buffers were seen as capable of absorbing a short-lived macroeconomic shock, but strains would be much greater if the shock were protracted. In addition, a few banks would face significant funding pressure if Turkey was hit by a sudden stop. The existing crisis management framework and the CBT’s emergency liquidity assistance facilities were considered fully adequate. While the BRSA has issued the numerous supporting regulations to fully implement the Banking Law, to help address evolving risks, further strengthening the supervisory framework—especially more stringent oversight of liquidity and operational risks, banks’ risk management framework and models, and more comprehensive supervision of financial groups—is needed. Initiatives in all these areas are underway. The BRSA also needs to attract and retain specialist staff to effectively supervise an increasingly complex banking system.

38. Turkey has yet to bring its AML/CFT legislation into line with international standards to improve its status in the Financial Action Task Force (FATF) International Cooperation Review Group process. Since June 2011, Turkey has been listed by the FATF among the jurisdictions with strategic anti-money laundering/combating the financing of terrorism (AML/CFT) deficiencies that have not made sufficient progress in addressing them (see annex III, para. 10). If not improved, heightened due diligence may affect financial markets.

Structural Policies

39. The authorities and staff agreed that structural reforms are needed to deliver a permanent improvement in the current account deficit. To moderate import demand, the authorities raised indirect taxes on several categories of imported consumer durables (large engine-capacity cars, cell phones), and are considering measures to decrease dependence on the imports of intermediate goods, although this was seen as longer-term endeavor. The mission noted that attracting investment to facilitate domestic sourcing of manufactured inputs requires improving the business climate, including combating informality to support a revenue-neutral cut in the tax burden on formal-sector employment and activity. The decision to decouple all tax audit functions from tax collection was viewed as a set-back for encouraging voluntary compliance. Timely adjustment of regulated energy prices to changes in world prices and the exchange rate would encourage efficient usage and domestic production to cut down on imports, while avoiding loss buildup in public energy companies. The mission therefore welcomed the recent tariff increases as a step toward achieving cost-recovery pricing. They noted that passage of the updated Commercial Code and Code of Obligations—once fully effective in mid-2012—could significantly improve the business environment.

40. Greater flexibility of the formal labor market would raise employment, lower inflation persistence, and distribute the gains from growth more evenly. Preparation of a National Employment Strategy remains ongoing, with a focus on microeconomic labor market measures. The authorities attributed the strong employment gains since the crisis to the rapid pace of growth and the 5 percentage point cut in the employers’ social security contribution introduced in 2008. To encourage new employment and job mobility within the formal sector, the mission urged lowering restrictions on temporary and part-time work, and replacing the current ex post severance pay with a pre-funded, lower-cost insurance scheme. Keeping the growth rate of the minimum wage and civil servant salaries strictly in line with the inflation point target—and with no ex post adjustment for inflation overshoots—would improve external competitiveness and reduce inflation inertia. Raising the educational attainment at the lower end of the skill distribution (the median for employed workers is 5 years of schooling) and better tailoring education to employers’ needs (including through vocational training) would improve labor productivity, reduce skill mismatch, and boost employment and income growth over the medium term.

STAFF APPRAISAL

41. Previous policy actions laid the foundation for Turkey’s enviable growth performance over the past two and a half years. Turkey entered the 2008–09 global crisis with stronger private and public sector balance sheets than many other countries in the region, reflecting deep-seated institutional reforms and revamped policy frameworks adopted earlier in the decade. Moreover, the deft macroeconomic and financial policy response during the crisis enhanced policy credibility and helped position Turkey as a safe-haven destination for capital. These factors paved the way for the subsequent robust recovery.

42. Nonetheless, a sizable competitiveness gap had emerged. Much-needed reforms to enhance flexibility of labor and product markets were delayed. With inflation regularly exceeding rates in other emerging markets, and official and implicit indexation of wages to inflation, the Turkish economy gradually lost competitiveness. As a result, import dependence grew, and the current account deficit was already elevated in 2008. With external financing shrinking during the crisis, these problems lay dormant.

43. An inadequate policy response to renewed capital flows caused growth to revert to its previous unbalanced path. Fiscal policy failed to rein back crisis-era stimulus and the structural balance further weakened. Financial policies were too timid or implemented with a long delay, reducing effectiveness. Monetary policy was forced to assume responsibility for a wide range of goals for which it was not well-equipped, particularly in a setting of abundant global liquidity. With an overvalued real exchange rate and abundant external financing, demand became skewed toward imports and the current account deficit widened precipitously.

44. Vulnerabilities have quickly risen. Potentially-volatile short-term debt—much of it absorbed by banks—and unidentified inflows became the primary form of external funding. Household indebtedness increased, firms accumulated additional foreign currency debt, and reserve cover of short-term debt and banks’ capital ratios declined. While headline fiscal balances and public debt relative to GDP continued to improve, this strong performance benefited from transient revenue brought by unsustainable macroeconomic conditions and one-offs.

45. Reconfiguring the policy framework could reduce Turkey’s propensity for capital flow-driven cycles. Without adequate support from fiscal, financial, and structural policies, monetary policy has tended to shoulder the burden of countercyclical adjustment. But there are limits to what monetary policy can achieve in a setting of abundant global capital flows. A much tighter structural fiscal position and financial policies geared to moderating systemic risk would allow monetary policy to maintain inflation and policy rates at levels similar to other emerging markets within a conventional inflation-targeting framework. This revamping of policies would deliver more balanced, less volatile output by reducing attractiveness to short-term inflows and limiting erosion of competitiveness through inflation. Targeted structural reforms would reinforce the framework.

46. A much-strengthened structural fiscal position is a key element of the policy-mix rebalancing. Restoring a structural primary surplus for the nonfinancial public sector to a level similar to the one in 2007 would moderate domestic demand to promote disinflation and also provide a buffer in the event capital flows reverse. A more comprehensive estimate of transient revenue would prevent an unintended structural tightening during a downturn that could result from an excessively-narrow concept of cyclical revenue, and—symmetrically—a procyclical loosening during an expansion. Further delaying structural adjustment leaves Turkey vulnerable to the next inflow cycle. Adjustment should be front loaded, unless growth is very weak.

47. Reinforcing the framework for public financial management would enhance fiscal policy’s demand-management role. Current practice places undue attention on delivering the fiscal balance target as a share of GDP, resulting in procyclical policy. Fiscal targets should be set in structural terms, with realistic estimates of base-year revenue and spending underpinning budget forecasts. Spending appropriations without explicit ex ante parliamentary authorization should not be permitted. Project financing through public-private partnerships should be better regulated to limit fiscal risk, and ensure such financing arrangements are not used to create budget space.

48. A decisive increase in the single policy rate is essential to re-anchor inflation expectations and regain policy credibility. The unorthodox framework has not demonstrated it can deliver either price stability or financial stability. In the current subdued risk appetite setting, raising the single policy rate would also relieve selling pressure on the lira, allowing conservation of scarce reserves by keeping fx sales on hold. To reduce the scale and adverse impact of future capital cycles, and in tandem with a tightened structural fiscal stance, the inflation tolerance band should be narrowed and inflation targets gradually lowered.

49. With the financial cycle having begun to turn down, Turkey faces new challenges. Scope to mitigate an external funding shock is limited. More restricted external financing is therefore expected to slow loan supply, although demand is also likely to soften. However, care is needed to avoid exacerbating the effect on the real economy by introducing measures intended to bolster banks’ resilience, but which would have been more appropriately implemented when systemic risks were building. More-timely detection and response to emerging macroprudential risk will hopefully be achieved with the new Financial Stability Committee in place

50. Further delaying labor and product market reforms is detrimental to competitiveness, social equity, and the ability to cope with volatile capital flows. Structural reforms are needed to prevent the emergence of a negative output gap as the current account is corrected. Hence, nominal depreciation provides only a temporary and partial fix. Preserving benefits of labor-market insiders disadvantages workers in the shadow economy and the disenfranchised, and also reduces efficiency. Minimum wages in the formal sector should be brought into line with peer countries, restrictions on flexible work arrangements should be relaxed, and a benefit scheme cushioning unemployment spells—rather than discouraging job mobility—should be introduced. With civil servant and public sector wage increases sending an important signal for the rest of the economy, breaking inflation inertia requires indexing public sector wages only to the point inflation target and halting asymmetric catch-up indexation for inflation overshoots. Timely adjustment of energy prices to movements in the domestic cost of imports would incentivize suppliers and users, and help lower Turkey’s energy trade deficit.

51. It is recommended that the next Article IV Consultation with Turkey be held on the standard 12-month cycle.

Box 1.

Turkey’s External Competitiveness

Relative to late 2010, Turkey’s external competitiveness has improved considerably on the back of a large nominal depreciation, but sustainability could be jeopardized by persistent differentials in the growth rates of prices and wages relative to trading partners.

Real effective exchange rates based on consumer and producer prices fell by close to 20 percent from their October 2010 historical peaks, reflecting recent depreciation of the nominal effective exchange rate. As a result, price-based REER indicators are now below levels prevailing during the crisis, but remain some 5 percent above levels of 2003. Coming from a much higher peak in late 2010, the ULC-based REER fell sharply in Q1 2011, as unit labor cost growth slowed on moderating nominal wage increases and improved labor productivity. But this was partially reversed in Q2 2011 on account of weakening labor productivity, keeping the ULC-based REER elevated.

The US dollar-euro exchange rate is also an important determinant of the competitiveness of Turkey’s exports, especially in view of the high import content—and hence relatively low domestic valued added—of Turkish production. Many raw materials and intermediate inputs are priced in US dollars or currencies that move closely with the US dollar, while about half of exports are sold in Europe, priced in euros. Thus a strengthening of the euro relative to the US dollar increases export profit margins, on average. This is supported by the observation that growth of imports (around 70 percent of which are intermediate goods) tends to outpace that of exports when the US dollar weakens against the euro. Since mid-2010, the more appreciated euro relative to the US dollar has therefore supported exporters.

Fairly rapid export growth in recent years has kept Turkey’s share of major advanced country import markets (Germany and the EU as a whole) fairly stable. However, penetration of emerging-market has declined considerably since the global financial crisis, reversing in part the significant gains of earlier years. The disruption in MENA external trade due to unrest in some countries is expected to have only a modest adverse on Turkey’s exports, and may even present an opportunity in view of disruptions to production in affected countries.

CGER-type assessments of the equilibrium value of the real exchange rate in Fall 2011 continue to point to a considerable competitiveness gap. Although the extent of misalignment has narrowed significantly since the previous vintage in view of the substantial real depreciation since end-2010, still-large current account deficits and a deteriorating net foreign asset position projected for the medium term suggest a persistent competitiveness gap. The recent nominal depreciation since the CGER reference period of July-August would tend to further reduce the misalignment, but the magnitude in nominal effective terms is likely moderate (given that many currencies simultaneously depreciated) and may not be persistent. Moreover, the near-term improvement is projected to unwind gradually due to persistent inflation differentials.

In the context of large capital inflows, however, standard CGER assessments may overstate the extent of overvaluation. The recent surge of capital inflows to Turkey has not only financed the current account deficit in an accounting sense but may have also caused it in a behavioral sense: by relaxing consumers’ budget constraints to facilitate import demand. When the inflows abate, as they have now begun to do, both the near- and medium-term current account projections would improve which, in turn, would imply smaller misalignment. This is consistent with the notion of “capital account dominance” in Emerging Markets. Alternatively, if the flows—though mostly of a short-term duration—turn out to be more persistent, then the equilibrium exchange rate itself would appreciate, reflecting better fundamentals, and hence leading to a smaller estimated misalignment, other things being equal.¹

¹ It is difficult to predict if a surge in inflows is temporary or portends a persistent trend. A rule of thumb, offered by Ostry et al. (2010), is that flows that push the REER toward equilibrium are more likely to be persistent than flows that lead to overshooting since these would presumably be subject to future reversal as overshooting eventually unwinds. This suggests current inflows into Turkey are most likely temporary.

Box 2.

Implications of Misclassifying Securities Repos

In recent years, many emerging markets have seen capital inflows tilt heavily toward portfolio debt securities. This reflects deep and liquid government debt markets, and sizable interest differentials. Portfolio debt flows also reversed rapidly in recent months on renewed concerns about euro-area sustainability, accompanied by strong depreciation pressures. Relative to GDP, Turkey received considerable such flows during 2010 and Q1 2011, and saw some of the largest reversals in September 2011.

However, some of Turkey’s portfolio debt flows are not in fact outright sales to nonresidents, but the first leg of sale-and-repurchase agreements (securities repos). These agreements involve the sale of a security by a domestic bank to a foreigner, with a commitment to repurchase the security at an agreed future date and price. Functionally, a repo is equivalent to collateralized borrowing by the spot seller of the security. While the security may be denominated in local currency, in most emerging-market cases, the cash exchanged is typically in fx. Importantly, the duration of the repo is not linked to the maturity of the security, and repos are typically short term. As of June 2011, Turkish banks had US$15.6 billion of external repos, of which US$11.2 billion had maturities of less than one year.

Statistical Treatment of Repos¹

Securities repos involve dual concepts of ownership. Legal ownership (“full, unfettered title”) of the security moves from the domestic bank to the foreigner at the start of the contract, and back again at termination. However, beneficial ownership remains throughout with the domestic-bank seller because—given the commitment to repurchase at a fixed price—the seller bears all valuation risk.

The statistical treatment of securities repos follows the economic character of the instrument, rather than its legal format. The BRSA follows this convention, consistent with International Accounting Standards and the revised System of National Accounts.² Accordingly, since the domestic bank retains the risks and benefits of ownership, the security remains on the domestic bank’s balance sheet throughout the repo contract. The loan—and the corresponding receipt of cash—is recorded separately, expanding its balance sheet. The corresponding entries in the financial account of the BoP are an “other investment” inflow when the repo is initiated, and an outflow through the same category when the contract is unwound.

Recording repo transactions using the legal-ownership concept—as done by the CBT—gives a quite different impression. If the repo is treated as a separate spot sale and future purchase, the size of the domestic bank’s balance sheet would remain fixed, but with a decline in securities and an increase in cash on the asset side. These entries would be reversed when the contract expires. Under this treatment, the financial account of the BoP would report a nonresident inflow into portfolio securities, with a similar outflow when the contract matures.

Implications

Recording securities repos using the legal-ownership convention makes it more difficult to gauge the extent and location of market risk. This has several implications: First, while Turkey’s official BoP and external debt statistics suggest foreigners bear the risk of interest rate fluctuations, that risk in fact resides with the domestic bank. Second, the maturity of the underlying security conveys no information about the duration of the loan. Third, domestic banks’ short-term external debt is understated. Fourth, the conventional wisdom that sudden reversals of portfolio flows create only modest exchange rate pressure—because falling local-currency asset values erode the amount of fx reserves needed to repatriate the investment—does not apply. Instead, if the foreign lender is unwilling to renew the securities repo, the domestic bank will need to secure sufficient fx to repay the loan in full, exerting downward pressure on the currency. And fifth, margin calls on the domestic bank to top-up collateral in response to a rise in domestic interest rates (and hence a lower value of the security) effectively shrink the net size of the loan.

¹ See S. Gray (2009), “Repos and Central Banks,” unpublished IMF manuscript.² See mdgs.un.org/unsd/nationalaccount/AEG/papers/m4Liabilities.pdf

Box 3.

Banks’ Competition for Market Share and Implications for Policy Transmission

Turkish banks’ drive for market share is widely seen as taking precedence over near-term profit maximization. Relative to other EMs, the market share of the five largest banks—accounting for around 70 percent of system assets—has remained remarkably stable, and the rank-ordering of their individual market shares has barely changed in recent years. This suggests preserving market share has been an important objective for large Turkish banks, including during the recent period of rapid credit growth.

There are several reasons why Turkish banks may place market share ahead of near-term profit maximization. First, a large market share supports fee income—a growing contributor to bank profits. Second, larger banks may be perceived as less exposed to deposit runs, thereby lowering the risk premium they pay to attract depositors. Third, larger banks may be less vulnerable to takeovers from rivals. Fourth, larger banks may benefit from economies of scale. Fifth, with the growing importance of foreign funding, size may improve access to, and lower the cost of, credit in the international wholesale market. And finally, in recent years, the BRSA has limited dividend payouts, thus encouraging growing market share (and hence future profits) over current profits.

With state banks having certain inherent advantages over their peers, aiming to preserve market share may have negatively impacted profits of other banks. Relative to other banks, state banks (including the largest bank in the system) have access to cheaper and more stable deposit funding because they are perceived as less risky in view of an implicit government guarantee. Moreover, they generally offer lower lending rates because their retail borrowers (including civil servants) are seen as good credit risks. These benefits give state banks an edge over their competitors in terms of funding costs and lending rates. Moreover, state banks have lower loan-to-deposit ratios (LTDs) than other banks, and hence do not need to rely on less stable, more expensive wholesale funding to finance loan expansion compared with other banks with much higher LTDs. This allowed state banks to be market leaders during the recent credit boom, growing their loan books earlier and faster than other banks, and encouraging other banks to catch up.

The strong drive for market share may have generated a “collective action” problem that weakens or delays the effectiveness of policies intended to slow credit growth. Following the increase in URR, being the first to pass on these higher intermediation costs to lending rates would have risked losing market share. Instead, banks tended to absorb the cost into lower profits and accelerate lending to compensate lower profit margin with higher volume. Hence, the higher URR were not initially successful at moderating loan growth. This was compounded by the rapid loan expansion of state banks, pressuring other banks to follow. These considerations—drive for market share and the privileged funding position of state banks—would likely have led to a similarly weak or delayed credit response by banks if instead of raising URR, the CBT had raised the policy rate. On the other hand, raising risk weights and provisioning in June 2011 directly impacted, among others, the large state banks that had previously lent most aggressively, encouraging immediate system-wide repricing of loans.

Box 4.

The CBT’s Recent Policy Actions

Since early August 2011, the CBT has made numerous changes to its policy instruments. Two separate periods can be identified: (i) August-mid October, in response to concerns about sovereign debt problems in Europe and uncertainties regarding the global economy; and (ii) since mid October, responding mainly to a sharp increase in inflation.

August -mid October

To support the lira and shore up fx reserves: (a) The CBT raised its O/N borrowing rate from 1.5 percent to 5 percent, considerably narrowing the interest rate corridor to limit potential volatility of money market rates that had previously discouraged very short-term inflows;
(b) URR on banks’ fx liabilities were reduced three times (in July, August, and October) and mostly on longer duration liabilities by an effective 1.5 percentage points, releasing about US$2.8 billion to banks;
(c) Part of RR obligations on TL liabilities (up to 10 percent from September and 20 percent from October) was allowed to be held in fx. This was intended to encourage banks to repatriate their fx liquid assets back to Turkey, and could potentially boost the CBT’s reserves by up to US$7.6 billion. Moreover, because the cost of borrowing fx is lower than lira, banks’ opportunity cost of holding URR was reduced—equivalent to a reduction in the RR ratio on lira liabilities;
(d) the CBT scaled back its daily fx purchases (from US$50 billion to US$40 billion in May and to US$30 billion in June), halted fx activity at end July, and switched to fx sales in early August. Total sales reached US$4.9 billion through mid October, with varying daily amounts;
(e) URR were imposed on banks’ gold deposit accounts.
To support real activity, the main policy interest rate—the 7-day repo rate—was further lowered by 50 bp in August to 5.75 percent.
To reduce the cost of financial intermediation transacted in lira, and to promote longer non-deposit bank funding, RRs on TL liabilities were reduced in early October by effective 0.6 percentage points, with the largest reductions on longer-duration non-deposit liabilities, releasing TL3.2 billion to banks.

Since mid October

To contain the deterioration in inflation expectations, especially resulting from TL depreciation:
(a) The CBT engaged in large-scale fx selling auctions and direct intervention. Total sales through auctions reached US$3.3 billion.
(b) The O/N lending rate was raised from 9 percent to 12.5 percent (and from 8 percent to 12 percent for primary dealers). This facilitates greater upside volatility of money market rates;
(c) On RR obligations relating to TL liabilities, a maximum of 40 percent (raised from the previous 20 percent) may be held in fx, and up to 10 percent may be held in gold. If fully utilized, this would add a combined US$7.7 billion to CBT reserves. In addition, URR on lira-denominated short-term liabilities were lowered, resulting in a 2 percentage point effective reduction.
(d) The CBT re-opened its “blind broker” fx borrowing and lending facility to facilitate greater mobility of fx between banks in response to heightened uncertainties in international markets.

Box 5.

Inflation Targets in Turkey

Among the group of inflation targeters, Turkey stands out as having one of the highest targets. Targets are generally set higher in EMs than in advanced economies to minimize the output cost from low inflation as EMs face more structural problems including higher price rigidity, lower monetary and fiscal credibility, and larger exchange rate volatility. However, Turkey’s 5 percent target for 2012 is several percentage points higher than for most other major EMs.¹ Indeed, in mid-2008, Turkey revised up its end-of-period inflation targets from a constant 4 percent to 7.5, 6.5 and 5.5 percent, respectively, for 2009–11 in response to the upside risks posed by food and energy prices to the medium-term inflation outlook and the possibility of further supply side shocks.

Turkey also has the widest tolerance band, intended to accommodate its higher food inflation volatility than other EMs. The high volatility of Turkey’s unprocessed food prices together with its high share in the consumption basket (around 15 percent) is the main reason given for setting the inflation tolerance band at ±2 percentage points.² Several factors contribute to the volatility of Turkey’s food prices. In addition to measurement issues,³ while Turkey exports unprocessed food, such imports are very restricted, thereby precluding international trade as a means to smooth domestic prices.

Turkey has maintained high import tariffs and tight quotas to support farmers, which account for around a quarter of the workforce. This has contributed to a considerable increase of food price volatility since 2007, and the level of food inflation is among the highest within the EM group. Other structural factors also compound the effect of import controls, notably uncertain agriculture subsidies, geographical concentration of production, volatile export prices and external demand, and long supply chains with a prevalence of small farmers which immediately price in weather effects.⁴ Nonetheless, looking at sample period of 2004-2011, the volatility of headline inflation and of food inflation weighted by its share in the basket is not among the highest within the group of EMs. However, Turkey’s inflation was on average the highest among the group during 2004–11.

Despite the combination of a high point target and a wide tolerance band, Turkey has frequently overshot the top of the band. The exceptions were the recession year of 2009, and in 2010 when inflation came in just below the revised target due to a large downward shock to food prices. Thus, the flexibility afforded by the wide band has tended to be used asymmetrically.

¹ Thailand targets core inflation while the rest target headline inflation.² Atuk, O. and O. Sevinç. (2010), “Fixed and Variable Weight Approach for the Treatment of Seasonal Products in the Consumer Price Index: A Study on Turkey’s Fresh Fruit and Vegetable Prices”, CBT Economic Notes No. 10/15.³ The consumption basket for fresh food used to calculate food inflation is seasonal and the weights depend on the previous year’s consumption basket. Öğünç, F. (2010), “Volatility of Unprocessed Food Inflation in Turkey: A Review of the Current Situation”, CBT Economic Notes No. 10/05.⁴ Orman, C., Öğünç, F., Saygili, Ş. and G. Yilmaz (2010), “Structural Factors Causing Volatility in Unprocessed Food Prices”, CBT Economic Notes No. 10/16.

Box 6.

Other Key Takeaways on the Banking Sector

Profitability: Banks’ return on assets and equity have significantly declined since 2009 and currently stand at 1.6 and 13.6 percent, respectively, in August 2011. This decline has been mainly driven by declining net interest rate margins amid banks’ strong competition for market share for loans and the waning effect from the one-off repricing of assets in response to the CBT’s more than 10 percentage point cut in the policy rate during late 2008-2009.

NPLs: Despite very rapid credit growth, NPLs relative to total loans have declined to historical lows (under 3 percent). This was aided by: (i) banks selling off NPLs; (ii) following the crisis, some restructuring of loans in distress; and (iii) more recently, the increase in the denominator, with nominal NPLs remaining stable. Looking ahead, loan quality is likely to be cyclical, especially as much of recent lending is concentrated in profitable, but potentially-risky, uncollateralized consumer lending. A protracted economic slowdown could lead to a steady rise in NPLs, especially on credit card and general purpose loans, lowering banks’ profitability and capital buffers.

Capital Adequacy Ratios: Based on Basel I regulatory standards, banks are adequately capitalized with an aggregate CAR of 16½ percent in October, comfortably above the BRSA’s floor of 12 percent. This is down from 19 percent at end-2010 (and 21 percent at end 2009), mainly because of the shift from zero risk-weighted government securities to positive risk-weighted loans during the recent credit boom. The introduction of Basel II in 2012, as well as the recent currency depreciation that expanded the lira-equivalent—and hence risk-weight—of fx loans, will further reduce CARs. In recent years, the BRSA has restricted dividend payouts by banks with low CARs. Going forward, CARs may be a constraint on future loan growth. The criteria for assessing minimum required CARs for foreign-owned banks was recently modified, requiring several banks to increase capital.

External Funding: Nearly one third of Turkey’s banking system (measured by assets) has links to parents in peripheral Europe and, despite limited direct funding from their foreign parents, availability and cost of funding is likely to reflect to some extent the parents’ financial condition. While the Turkish banking sector have continued to tap syndicated loans at low spreads, external funding conditions have undoubtedly been affected by funding strains in international markets. Possible de-leveraging by European banks as they rebuild their capital ratios may further affect Turkish banks’ access to wholesale funding. Turkish branches abroad play a smaller role in providing loans to resident firms than in the past, but have become more active in securing external funding (accompanied by an increase in their holdings of government securities). Overall, at 13 percent of total liabilities, banks’ external funding is not high relative to other countries in the region.

Open Foreign Currency Positions: Banks’ on-balance sheet short fx positions, which tend to be closed off-balance sheet through the use of cross currency swaps (CCS), recently widened close to its historical peak, reflecting banks’ growing recourse to external funding. The recent sharp increase in average CBT and market interest rates has fed into higher costs for short-term CCS, which banks use to repeatedly roll over sizable short-duration swaps, exposing them to interest rate risk.

Table 1.

Selected Economic Indicators, 2006–12

Sources: Turkish authorities; and IMF staff estimates and projections.

^¹/The external debt ratio is calculated by dividing external debt numbers in U.S. dollars based on official Treasury figures by GDP in U.S. dollars calculated by staff using the average exchange rate (consolidated from daily data published by the CBT).

^²/GDP in U.S. dollars is derived using the average exchange rate (consolidated from daily data published by the CBT).

Table 1.

Selected Economic Indicators, 2006–12

			2006	2007	2008	2009	2010	2011	2012
								Proj.
			(Percent)
Real sector
	Real GDP growth rate		6.9	4.7	0.7	-4.8	9.0	7.5	2.0
		Private consumption growth rate	4.6	5.5	-0.3	-2.3	6.7	6.8	0.5
		Private gross fixed investment growth rate	15.0	2.6	-9.0	-22.5	33.5	25.2	0.6
	Contributions to GDP growth
		Private domestic demand	6.3	5.0	-1.8	-8.3	12.6	9.4	0.6
		Public spending	0.9	0.8	0.6	0.8	0.8	0.7	0.4
		Net exports	-0.3	-1.2	1.9	2.7	-4.4	-2.6	1.0
	GDP deflator growth rate		9.3	6.2	12.0	5.3	6.3	8.6	8.6
	Nominal GDP growth rate		16.9	11.2	12.7	0.2	15.9	16.7	10.8
	CPI inflation (12-month; end-of period)		9.7	8.4	10.1	6.5	6.4	9.5	6.4
	PPI inflation (12-month; end-of-period)		11.6	5.9	8.1	5.9	8.9	11.3	6.6
	Unemployment rate		10.2	10.3	11.0	14.0	11.9	…	…
Average nominal treasury bill interest rate			18.4	18.1	19.2	11.4	8.1	…	…
Average ex-ante real interest rate			8.6	6.9	12.2	2.6	1.9	…	…
			(Percent of GDP)
Nonfinancial public sector
	Primary balance		4.5	3.2	1.6	-1.0	0.8	1.8	1.5
	Net interest payments		5.1	4.9	4.4	4.6	3.7	2.6	2.6
	Overall balance		-0.6	-1.8	-2.8	-5.6	-2.9	-0.8	-1.1
	Structural balance		3.0	1.5	0.3	-0.1	-0.1	-1.1	-0.1
Debt of the public sector
	General government gross debt (EU definition)		46.5	39.9	40.0	46.1	42.2	39.1	36.2
	Nonfinancial public sector net debt		40.1	34.4	34.5	39.5	36.6	33.5	30.8
External sector
	Current account balance		-6.1	-5.9	-5.7	-2.3	-6.5	-10.2	-7.8
	Nonfuel current account balance		-1.3	-1.5	-0.2	2.0	-1.9	-4.1	-1.8
	Gross financing requirement		21.1	18.7	18.9	17.4	18.9	22.2	23.1
	Foreign direct investment (net)		3.6	3.1	2.3	1.1	1.1	1.6	2.0
	Gross external debt ¹/		39.3	38.4	38.4	43.7	39.5	42.9	44.7
	Net external debt		21.0	21.0	21.5	24.7	24.0	27.8	30.9
	Short-term external debt (by remaining maturity)		15.0	11.7	16.0	15.2	16.1	17.9	17.2
Monetary aggregates
	Nominal growth of M2 broad money (percent)		22.2	15.2	24.8	12.7	18.3	…	…
GDP (billions of U.S. dollars) ²/			529.2	649.1	730.3	614.4	734.6	…	…
GDP (billions of Turkish lira)			758.4	843.2	950.5	952.6	1,103.7	1,288.3	1,427.4
Per capita GDP (2010): $10,297 (WEO)
Quota (As of October 31, 2011): SDR 1,455.8 million.

Sources: Turkish authorities; and IMF staff estimates and projections.

^²/GDP in U.S. dollars is derived using the average exchange rate (consolidated from daily data published by the CBT).

Table 1.

Selected Economic Indicators, 2006–12

			2006	2007	2008	2009	2010	2011	2012
								Proj.
			(Percent)
Real sector
	Real GDP growth rate		6.9	4.7	0.7	-4.8	9.0	7.5	2.0
		Private consumption growth rate	4.6	5.5	-0.3	-2.3	6.7	6.8	0.5
		Private gross fixed investment growth rate	15.0	2.6	-9.0	-22.5	33.5	25.2	0.6
	Contributions to GDP growth
		Private domestic demand	6.3	5.0	-1.8	-8.3	12.6	9.4	0.6
		Public spending	0.9	0.8	0.6	0.8	0.8	0.7	0.4
		Net exports	-0.3	-1.2	1.9	2.7	-4.4	-2.6	1.0
	GDP deflator growth rate		9.3	6.2	12.0	5.3	6.3	8.6	8.6
	Nominal GDP growth rate		16.9	11.2	12.7	0.2	15.9	16.7	10.8
	CPI inflation (12-month; end-of period)		9.7	8.4	10.1	6.5	6.4	9.5	6.4
	PPI inflation (12-month; end-of-period)		11.6	5.9	8.1	5.9	8.9	11.3	6.6
	Unemployment rate		10.2	10.3	11.0	14.0	11.9	…	…
Average nominal treasury bill interest rate			18.4	18.1	19.2	11.4	8.1	…	…
Average ex-ante real interest rate			8.6	6.9	12.2	2.6	1.9	…	…
			(Percent of GDP)
Nonfinancial public sector
	Primary balance		4.5	3.2	1.6	-1.0	0.8	1.8	1.5
	Net interest payments		5.1	4.9	4.4	4.6	3.7	2.6	2.6
	Overall balance		-0.6	-1.8	-2.8	-5.6	-2.9	-0.8	-1.1
	Structural balance		3.0	1.5	0.3	-0.1	-0.1	-1.1	-0.1
Debt of the public sector
	General government gross debt (EU definition)		46.5	39.9	40.0	46.1	42.2	39.1	36.2
	Nonfinancial public sector net debt		40.1	34.4	34.5	39.5	36.6	33.5	30.8
External sector
	Current account balance		-6.1	-5.9	-5.7	-2.3	-6.5	-10.2	-7.8
	Nonfuel current account balance		-1.3	-1.5	-0.2	2.0	-1.9	-4.1	-1.8
	Gross financing requirement		21.1	18.7	18.9	17.4	18.9	22.2	23.1
	Foreign direct investment (net)		3.6	3.1	2.3	1.1	1.1	1.6	2.0
	Gross external debt ¹/		39.3	38.4	38.4	43.7	39.5	42.9	44.7
	Net external debt		21.0	21.0	21.5	24.7	24.0	27.8	30.9
	Short-term external debt (by remaining maturity)		15.0	11.7	16.0	15.2	16.1	17.9	17.2
Monetary aggregates
	Nominal growth of M2 broad money (percent)		22.2	15.2	24.8	12.7	18.3	…	…
GDP (billions of U.S. dollars) ²/			529.2	649.1	730.3	614.4	734.6	…	…
GDP (billions of Turkish lira)			758.4	843.2	950.5	952.6	1,103.7	1,288.3	1,427.4
Per capita GDP (2010): $10,297 (WEO)
Quota (As of October 31, 2011): SDR 1,455.8 million.

Sources: Turkish authorities; and IMF staff estimates and projections.

^²/GDP in U.S. dollars is derived using the average exchange rate (consolidated from daily data published by the CBT).

Table 2.

Balance of Payments, 2007–16

(Billions of U.S. dollars)

Sources: Turkish authorities; and IMF staff estimates and projections.

^¹/Including privatization receipts.

^²/Volumes based on World Economic Outlook deflators.

^³/Changes in stocks may not equal balance of payments flows due to valuation effects of exchange rate changes.

^⁴/The external debt ratio is calculated by dividing external debt numbers in U.S. dollars based on official Treasury figures by GDP in U.S. dollars calculated by staff using the average exchange rate (consolidated from daily data published by the CBT).

^⁵/Interest plus medium- and long-term debt repayments in percent of current account receipts (excluding official transfers).

Table 2.

Balance of Payments, 2007–16

(Billions of U.S. dollars)

						2007	2008	2009	2010	2011	2012	2013	2014	2015	2016
										Proj.
Current account balance						-38.4	-42.0	-14.0	-47.7	-78.8	-62.9	-53.0	-56.0	-65.0	-77.1
	Trade balance					-46.9	-53.0	-24.9	-56.4	-92.2	-82.7	-77.1	-82.3	-94.1	-108.2
		Exports (f.o.b.)				115.4	140.8	109.6	120.9	141.5	151.5	161.0	171.1	179.9	189.3
		Of which:
				Exports (f.o.b.) in trade returns		107.3	132.0	102.1	113.9	134.2	143.6	152.7	162.4	170.8	179.6
				Shuttle trade		6.0	6.2	4.8	5.0	4.5	4.7	4.9	5.2	5.4	5.7
		Imports (f.o.b.)				-162.2	-193.8	-134.5	-177.3	-233.7	-234.1	-238.0	-253.4	-274.1	-297.5
		Of which:
				Imports (c.i.f.), incl. non-monetary gold		-170.1	-202.0	-140.9	-185.5	-241.6	-243.5	-247.3	-263.2	-284.6	-308.8
					Fuel imports (c.i.f.)	-33.9	-48.3	-29.9	-38.5	-53.2	-54.6	-55.0	-54.9	-55.4	-55.9
	Services and Income (net)					6.2	8.9	8.6	7.3	11.6	17.6	21.2	23.0	25.3	26.8
		Services and Income (credit)				35.4	42.0	38.6	38.5	44.4	48.6	52.0	55.7	59.9	64.0
			Of which:
					Tourism receipts	18.5	22.0	21.3	20.8	24.5	27.5	29.5	31.8	34.3	37.0
		Services and Income (debit)				-29.2	-33.0	-30.1	-31.2	-32.8	-31.0	-30.8	-32.8	-34.6	-37.2
			Of which:
					Interest	-13.4	-15.1	-13.2	-11.6	-11.6	-9.7	-9.0	-9.9	-10.5	-11.7
	Private transfers (net)					1.4	1.4	1.1	0.9	1.1	1.5	2.0	2.4	2.9	3.2
	Official transfers (net)					0.8	0.7	1.2	0.6	0.7	0.7	0.8	0.9	1.0	1.0
Capital account balance (excluding IMF)						48.8	34.6	8.3	59.2	78.9	61.2	67.3	75.5	85.4	93.8
	Including errors and omissions					50.6	39.3	13.4	63.9	87.7	61.2	67.3	75.5	85.4	93.8
	Direct investment ¹/					19.9	17.0	6.9	7.8	12.6	16.2	17.5	19.4	21.4	23.2
	Portfolio investment in securities					-0.1	-5.6	-1.6	12.0	22.7	16.5	14.0	14.3	18.3	19.5
	Public sector (central and local governments and EBFs)					1.0	2.3	3.4	7.6	6.4	4.4	5.3	5.6	5.6	5.6
				Bonds (net)		0.9	0.6	1.8	4.1	4.3	3.1	4.0	4.3	4.3	4.3
					Eurobond drawings	4.6	4.0	3.8	6.7	6.0	5.5	5.5	5.5	5.5	5.5
					Eurobond repayments	-3.7	-3.4	-1.9	-2.6	-1.8	-2.4	-1.5	-1.2	-1.2	-1.2
				Loans (net)		0.1	1.7	1.6	3.6	2.1	1.3	1.3	1.3	1.3	1.3
					Loan disbursements	3.4	5.2	4.8	6.7	5.6	5.8	5.7	5.7	5.7	5.7
					Loan repayments	-3.3	-3.5	-3.2	-3.2	-3.4	-4.4	-4.4	-4.4	-4.4	-4.4
	Central Bank of Turkey (excl. reserve assets, liabilities)					-1.1	-1.4	-0.5	-0.1	-0.6	-0.5	-0.4	-0.4	-0.4	-0.4
	Deposit money banks (net)					0.3	-4.3	12.9	36.7	33.8	15.9	20.5	24.1	23.4	27.1
		FX deposits abroad (- denotes accumulation)				-3.5	-13.3	12.7	8.8	18.7	4.1	1.4	1.2	1.0	0.8
		Other (net)				3.9	9.0	0.2	27.9	15.1	11.7	19.1	23.0	22.4	26.4
				Medium and long-term (net)		7.3	0.9	-1.7	2.0	6.4	4.0	8.5	10.4	12.7	15.6
				Short-term (net)		-3.4	8.1	1.9	25.9	8.6	7.8	10.6	12.6	9.7	10.7
	Other private sector (net)					28.7	26.6	-12.9	-4.9	3.9	8.7	10.5	12.4	17.2	18.7
		Medium and long term (net)				25.8	22.9	-9.7	-7.1	7.1	5.9	4.9	5.0	8.2	8.9
		Short term (net)				2.9	3.6	-3.1	2.2	-3.2	2.7	5.6	7.4	8.9	9.8
	Errors and omissions					1.8	4.7	5.1	4.7	8.8	0.0	0.0	0.0	0.0	0.0
Overall balance						12.1	-2.7	-0.6	16.2	8.9	-1.7	14.2	19.5	20.4	16.7
Overall financing (NIR change, + denotes decline)						-12.0	2.8	0.7	-15.0	-6.4	1.7	-14.2	-19.5	-20.4	-16.7
		Change in gross official reserve assets (+ denotes decline)				-8.0	1.1	-0.1	-12.8	-3.6	3.8	-13.4	-19.5	-20.4	-16.7
		Change in reserve liabilities (IMF)				-4.0	1.7	-0.7	-2.2	-2.8	-2.1	-0.9	0.0	0.0	0.0
				Purchases		1.1	3.6	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
				Repurchases		-5.1	-1.9	-0.7	-2.2	-2.8	-2.1	-0.9	0.0	0.0	0.0
		SDR allocation				0.0	0.0	1.5	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Memorandum items:
Trade in goods and services
	Percent of GDP
		Current account balance (incl. shuttle trade)				-5.9	-5.7	-2.3	-6.5	-10.2	-7.8	-6.1	-5.9	-6.3	-6.8
		Nonfuel current account balance				-1.5	-0.2	2.0	-1.9	-4.1	-1.8	-0.6	-0.9	-1.7	-2.6
		Trade account balance (incl. shuttle trade)				-7.2	-7.3	-4.0	-7.7	-11.9	-10.2	-8.8	-8.7	-9.1	-9.6
		Exports of goods and nonfactor services				22.2	24.1	23.3	21.1	23.3	24.0	23.6	23.2	22.4	21.7
		Imports of goods and nonfactor services				27.4	29.0	24.6	26.8	32.8	31.5	29.6	29.0	28.8	28.5
	Percent change
		Value growth in exports of goods (incl. shuttle trade)				22.9	19.7	-23.5	13.0	18.2	7.0	6.3	6.3	5.1	5.2
		Value growth in exports of goods (excl. shuttle trade)				25.1	23.1	-22.1	10.6	18.2	7.1	6.3	6.4	5.2	5.2
		Value growth in imports of goods				20.5	19.5	-30.6	31.9	31.0	0.8	1.7	6.5	8.2	8.5
		Volume growth in exports of goods ²/				10.9	6.1	-8.1	6.3	8.3	5.8	6.3	6.2	5.0	5.0
		Volume growth in imports of goods ²/				11.1	-2.1	-13.2	21.4	17.9	-0.2	1.7	6.8	8.2	8.6
		Volume growth in imports of goods exluding fuel ²/				15.5	-2.6	-12.0	30.9	18.1	1.7	1.8	8.2	9.8	10.2
		Terms of trade				1.1	-4.0	7.9	-4.9	-1.3	1.4	1.0	0.8	0.6	0.6
Reserve and debt indicators
	Gross foreign reserves (Central Bank of Turkey) ³/
		Billions of U.S. dollars				76.2	74.0	73.8	86.6	90.1	86.3	99.7	119.2	139.6	156.3
		Months of goods and nonfactor service imports				4.9	4.0	5.6	5.1	4.1	4.0	4.6	5.1	5.6	5.7
		Net international reserves (Central Bank of Turkey)				56.1	57.1	56.3	63.9	67.5	63.7	77.1	96.7	117.2	133.9
		Net international reserves (net of IMF)				43.9	48.8	48.7	58.5	64.9	63.2	77.5	97.1	117.6	134.3
	External debt (end-of-period)
		Billions of U.S. dollars				249.4	280.4	268.8	290.4	332.7	362.4	398.8	442.2	488.5	542.4
		Percent of GDP ⁴/				38.4	38.4	43.7	39.5	42.9	44.7	45.5	46.5	47.2	47.9
		Percent of exports of goods and nonfactor services				174.7	163.6	195.0	191.0	186.0	188.6	195.3	203.6	213.2	224.3
	Short-term debt (end-of-period)
		Billions of U.S. dollars				43.1	53.1	49.7	78.6	94.1	101.7	114.2	130.4	144.9	161.2
		Reserves to short-term debt ratio				176.7	139.4	148.4	110.1	95.8	84.9	87.3	91.4	96.4	97.0
	Short-term debt plus amortization of medium- and long-term debt
		Billions of U.S. dollars				84.3	100.6	95.9	115.5	131.5	139.3	153.3	172.9	187.4	203.7
		Reserves to short-term debt ratio				90.5	73.6	76.9	75.0	68.5	62.0	65.0	68.9	74.5	76.7
	Debt service ratio ⁵/					31.9	32.1	37.8	28.3	23.8	21.7	20.6	21.0	19.9	19.1

Sources: Turkish authorities; and IMF staff estimates and projections.

^¹/Including privatization receipts.

^²/Volumes based on World Economic Outlook deflators.

^³/Changes in stocks may not equal balance of payments flows due to valuation effects of exchange rate changes.

^⁵/Interest plus medium- and long-term debt repayments in percent of current account receipts (excluding official transfers).

Topics

Countries

Series

About

Resources

Abstract

BACKGROUND

A. Recent Developments

Political Setting

B. Authorities’ Policy Response

Monetary Policy

Fiscal Policy

Financial Policies6

C. Strengths and Challenges

REPORT ON THE DISCUSSIONS10

A. Outlook, Competitiveness and Risks

B. Policy Framework

Fiscal Policy

Monetary Policy

Financial Sector

Structural Policies

STAFF APPRAISAL

Statistical Treatment of Repos1

Implications

August -mid October

Since mid October

Financial Policies⁶

REPORT ON THE DISCUSSIONS¹⁰

Statistical Treatment of Repos¹