Abstract
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.
Despite increased uncertainties in the global economy, the Turkish economy has maintained strong growth during 2011. Its resilience is grounded in a strong fiscal position, political stability, a well capitalized banking sector and skilful monetary policy. Political stability has facilitated agile economic policies in response to global developments. The hard-won credibility has been crucial in preserving confidence. A prudent fiscal stance has been one of the key pillars of previous economic programs, and remains so in the new Medium-Term Program. The strength of the banking sector allowed a sound credit expansion, thereby supporting growth. Sound credit is closely monitored by the prudential supervision and financial stability authorities. Monetary policy targets inflation while preserving financial stability. Despite the strength of the economy, the authorities remain vigilant about the risks and are ready to take necessary measures.
Growth
The Turkish economy grew strongly in 2010 and 2011, driven by strong private investment and consumption. By contrast, because of prudent fiscal policies, the contribution of public investment and consumption to growth was rather limited. With strong private-led growth, the economy has created around 3.4 million jobs since April 2009, allowing the unemployment rate to drop below 10 percent.
Strong private investment and consumption was fuelled by large foreign capital inflows and significantly contributed to a widening current account deficit. The authorities, each within their institutional mandate, and in light of global developments, have taken monetary, fiscal and financial policy measures to rebalance growth. As a result, the latest data show signs both of a slowdown in the economy and a moderation of the current account deficit.
The authorities target a 4 percent growth in 2012. The authorities are closely monitoring the regional and global developments and acknowledge that the risks are downside.
Fiscal Policy
The fiscal balance has continued to improve and has exceeded the targets in the Medium-Term Program. The budget deficit in terms of GDP is expected to improve from 3.6 percent in 2010 to 1.7 percent in 2011. Under the government’s most recent Medium-Term Program the fiscal deficit should be further reduced to 1.5, 1.4, and 1 percent of GDP during the next three years.
On the fiscal stance, the views of the authorities and of the staff differ to some degree. The authorities appreciate the efforts of the staff in assessing Turkey’s structural fiscal position and the extent to which fiscal revenues are transient. However there is no agreement in the literature on how to calculate the structural fiscal balance and transient revenues. The comments on the fiscal stance can be misleading without a consensus on the methodologies applied.
The authorities consider the fiscal balance to be prudent. The public sector primary surplus is expected to be 1.2 percent of GDP in 2011 of which 0.8 percentage points result from the restructuring of public receivables. The remaining 0.4 percent of primary surplus exceeds the target in the previous Medium-Term Program. For 2012, the public sector primary surplus target is 1.1 percent, of which 0.3 percentage points are revenues from public receivables. The remaining 0.8 percentage points of the primary surplus would be again higher than the target in the previous Medium-Term Program.
The prudent fiscal stance and high growth have improved public debt sustainability. The EU-defined General Government debt-to-GDP ratio drops from 42.2 percent in 2010 to an expected 39.8 percent in 2011.
The authorities are determined to take the necessary measures to strengthen the fiscal stance and reduce imbalances in the economy. To moderate import demand while increasing fiscal buffers, the government has recently raised indirect taxes on several categories of mainly imported consumer durables. Domestic energy tariffs have been adjusted to avoid losses in public energy companies.
Monetary Policy—External Balance
The Central Bank of the Republic of Turkey (CBRT) has pursued a non-conventional policy shaped by domestic and external developments. The appreciation of the Turkish Lira (TL) has been moderated by a series of policy measures which decoupled the behavior of the TL exchange rate from other emerging market currencies. However, after the recent signs of a further deterioration in the global markets, the authorities reversed their policies in line with development in the financial markets.
The Consumer Price Index (CPI) is expected to significantly overshoot its target by the end of the year. The exchange rate pass-through and the recent adjustments in indirect taxes and administrative prices help explain the surge in inflation. The monetary authorities have tightened monetary policy to contain the second round effects of these temporary price increases. In sum, the CBRT’s policy should help inflation converge to its end-2012 target.
The authorities share the concern of the staff that a heightened risk aversion and deleveraging by European Banks could limit external financing for Turkey. The authorities are closely monitoring the external conditions and are ready to take coordinated monetary, fiscal and financial measures. The authorities took note of the staff’s recommendation to increase the monetary policy rates. However, in a highly uncertain period and because of an expected decline in growth next year, the authorities are cautious to tighten monetary policy under the present circumstances.
Despite the rise in external debt, the banking sector, corporate sector and the households have strong balance sheets and buffers. The external debt of the banking sector is only 13 percent of total liabilities. This is low in comparison with other emerging market countries. Additionally, banks have started to diversify their funding by issuing Eurobonds and TL denominated securities. The nonfinancial corporate net FX liabilities have increased, however short-term FX obligations are limited (i.e. around USD 15 billion). By contrast, the households have a strong long FX position and almost no FX liabilities.
The newly established “Financial Stability Committee” will assume an important role in coordinating the policies to address countercyclical adjustments and macro-financial stability risks. This Committee is chaired by the Deputy Prime Minister for Economic and Financial Affairs. The Committee consists of the Undersecretariat of Treasury, the Central Bank, the Banking Regulation and Supervision Authority, the Deposit Insurance Fund, and the Capital Markets Board. The Committee meetings will facilitate prompt coordinated action and better integrate micro- and macro-prudential perspectives among the institutions.
Financial Sector
The banking sector remains adequately capitalized. Last September, the aggregate Capital Adequacy Ratio (CAR) was 16.42 percent. The non-performing loan ratio has declined to historical lows. The private sector credit now reaches 48 percent of GDP, which is still comparably low. Funding is covered, in part by domestic bond issuances and external financing. The latest Eurobond issuances of the banking sector have been positive in terms of diversifying the investor base and lengthening the maturity.
The Financial Sector Assessment Program (FSAP) Update has been completed. There has been significant improvement since the latest FSAP. The stress test results confirm the strength of the financial sector but call for more attention to the risks stemming from global uncertainties. The banking sector’s capital buffers protect banks even when hit by large shocks. The authorities welcome the FSAP’s policy recommendations. New AML/CFT legislation to ensure compliance with international standards is on the agenda of the Parliament.
The authorities are closely monitoring bank capital adequacy and credit growth. They will take additional measures as needed. The risk weights for general purpose (consumer) loans and general provisioning requirements for banks with high levels of consumer loans or non-performing consumer loans have been increased. The Banking Regulation and Supervision Agency (BRSA) has restricted the dividend payouts by banks with low CAR. The criteria for assessing the minimum required CARs for foreign-owned banks have been modified to minimize contagious external effects. New capital charges on large maturity mismatches to discourage the duration gaps will come into force on July 1, 2012. Reserve requirements that vary with the maturity of liabilities have increased the term structure of deposits thereby reducing the maturity mismatch in the banks’ balance sheets. The authorities are also preparing new regulation on credit risk management.
Structural Reforms
The authorities agree with the staff’s assessment that the current account deficit has deep structural roots. They are determined to implement the reforms in the current Medium-Term Program to improve the business climate and combating informality. Public investment will focus on improving infrastructure and human capital. The country’s export capacity will be strengthened. Energy efficiency will be enhanced and renewable and domestic energy resources promoted. The flexibility and the quality of the labor force will be enhanced.