Turkey: Turkey: Staff Report for the 2018 Article IV Consultation

2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Turkey


2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Turkey


1. Turkey’s growth has been higher than that of nearly all its peers in the wake of the global crisis. The end-2016 revision of national accounts data underscored both the strength of the post-2008 recovery and its heavy reliance on investment financed by rapid credit growth (Annex I).

2. Both external and internal imbalances are widening, however. Rapid growth over the past year has been accompanied by a wider current account deficit, inflation well above target, and rising private domestic and external indebtedness.


Turkey: Growth and Investment Relative to Peers, 2010–16

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: TurkStat and WEO.

3. Meanwhile, economic and political uncertainty remain elevated. The state of emergency put in place after the 2016 failed coup attempt and associated measures affected the predictability of the regulatory environment. Geopolitical tensions in the region are high. Local, parliamentary and presidential elections are expected in 2019.


Turkey: Inflation and Current Account Relative to Peers, 2010–16


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: TurkStat and WEO.

Recent Economic Developments

4. Growth rebounded strongly in 2017. Real GDP growth averaged 7.4 percent (year-on-year) in the first three quarters (Figure 1). Fiscal stimulus and a large credit impulse—supported by state loan guarantees and relaxed macroprudential measures—boosted domestic demand. Exports also contributed strongly to headline growth, spurred by stronger external demand and sizeable Lira depreciation. Imports increased rapidly in the second half of 2017, however, tempering the growth contribution of net exports. High-frequency data suggest slower, albeit still-robust, growth in the final quarter of 2017 (Figure 2). While unemployment has fallen in 2017, it remains high, suggesting ongoing labor market rigidities (Figure 1).

Figure 1.
Figure 1.

Turkey: Real Sector Developments

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: TurkStat, CBRT, European Commission, Bloomberg Financial Markets L.P., and IMF staff calculations.1/ Average of 12-month ahead and 24-month ahead, end-period inflation expectations.2/ Difference between the yield on a nominal fixed-rate bond and the real yield on an inflation-linked bond.
Figure 2.
Figure 2.

Turkey: Coincident and Leading Indicators

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Haver Analytics and IMF staff calculations, and TurkStat.1/ Balance of opinion.

Turkey: Quarterly GDP Growth and Output Gap

(Percentage points)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: TurkStat and staff estimates.

5. Inflation is at its highest since 2003, despite the benign global inflation environment, and expectations are well above target. Initially sparked by the large Lira depreciation, inflation has received further impetus from higher demand, rising cost pressures, and rising inflation expectations. Accelerating core inflation replaced food and energy prices as the main inflation driver in 2017 (Figure 1).


Turkey: Monetary Policy Rates


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: CBRT and Fund staff estimates.

6. Monetary policy tightening was insufficient to contain inflation. In response to the 20 percent Lira depreciation in late-2016/early-2017 and rising inflationary pressures, the central bank (CBRT) increased the effective cost of funding to banks by almost 500 basis points since November 2016. This was achieved by shifting liquidity provision from the policy rate facility to the more expensive late liquidity window. The ex-post, real effective rate has, however, remained low relative to that in some peer EMs. Moreover, the transmission of monetary policy was blunted by the easing of financial conditions (see paragraph 7), brought about by the Lira weakening and policy-induced credit growth. As a result, inflation remained in double digits and expectations moved further away from target.


Turkey: Real Policy Rate and Inflation Relative to Peers


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: Haver Analytics and Fund staff estimates.Note: Nominal policy rates are deflated by 12-month inflation outcomes.

7. Financial conditions were expansionary in 2017. The increase in state loan guarantees through the Credit Guarantee Fund (CGF) was the main driver behind the surge in Lira loans that has led to a doubling of the growth rate of commercial credits since the start of the year (Figure 3). At the same time, the growth of FX loans has been weak, reflecting in part elevated FX debt burdens. The share of state-owned banks in total loans increased by 2 percentage points in 2017, increasing their share to 44 percent of loans. The relaxation of macroprudential policies from September 2016—including the lowering of provisioning requirements for commercial, consumer and restructured loans; the reduction of risk weights of consumer loans; and the increase in the LTV limit for housing loans and the maximum maturity of general purpose and credit card loans—have also added to the credit momentum. Following a significant increase in supply, the residential and commercial real estate market is starting to cool, with pockets of oversupply in some regions and market segments. Growth of commercial loans has tapered off, as the impulse from state loan guarantees decreased towards the end of the year.

Figure 3
Figure 3

Turkey: Financial Sector Developments

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: BRSA, Haver Analytics, and IMF staff calculations.

Turkey: Real Bank Credit Growth


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: BRSA and staff estimates.Notes: Deflated by CPI. FX-denominated and indexed loans adjusted for valuation effects.

8. Bank capital levels remained high, although some buffers are decreasing. Since end-2016, the system-wide Tier 1 CAR has increased by one percentage point to 14.1 percent (Figure 3). The negative effect from the large Lira depreciation was offset by robust retained earnings, the lower risk weights on CGF-backed loans, and the relaxation of macroprudential measures. Capital adequacy levels were further strengthened with Tier 2 bond issuance. The headline non-performing loans (NPL) ratio remains low at 3 percent. However, a broader definition of impaired loans—including restructured credits, “watch list” loans, and NPLs sold to third parties—amounts to around 8 percent of all loans, signaling emerging loan quality weakness. This is especially a concern in consumer credit and small- and medium-size enterprise (SME) loans, while signs of distress have also emerged in some larger corporate groups. CGF-backed loans could have temporarily helped contain NPLs, to the extent they have been used for working capital and helped alleviate corporate payment delays. The banking system’s negative, on-balance sheet, net FX position, which is almost completely hedged by its off-balance sheet position, more than doubled to minus 50 percent of regulatory capital in 2017, mainly on account of the increase in resident FX deposits and banks borrowing from abroad to fund CGF-backed loans in domestic currency.


Growth of Real House Prices


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: CBRT and IMF staff estimates.

9. Fiscal and quasi-fiscal policies have become more expansionary. The on-budget fiscal deficit expanded in 2016–17, due to temporary tax reductions, continued minimum wage subsidies, and an employment incentive scheme launched in 2017 (Figure 4). The 2017 general government primary deficit exceeded the target set in the 2017–19 Medium-Term Program (MTP), but was below the upward revision made in the 2018–20 MTP. In cyclically-adjusted terms, the resultant fiscal impulse is estimated at close to one percentage point of GDP in 2017. Public debt increased slightly to a still-low 28½ percent of GDP, with financing rollover ratios exceeding 100 percent. Contingent liabilities have, however, increased rapidly, due to still-high public-private partnership (PPP) activity and the expansion of state loan guarantees.

Figure 4.
Figure 4.

Turkey: Fiscal Stance

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Ministry of Finance, Treasury, Haver Analytics, and IMF staff calculations.

Turkey: General Government Primary Balance 1/

(Percent of GDP)

article image
Sources: Turkish Authorities; and IMF staff calculations.

All numbers presented are in the IMF-program definition.

Actual executions for the CG and UIF, and IMF staff projections for others GG institutions.

The MTP 2017–19 numbers are re-based, using the new GDP series.


Turkey: Current Account

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: TurkStat and staff estimates.Note: The nominator and denominator of the ratios are 4-quarter rolling sums.

10. The current account deficit widened to more than 5 percent of GDP. Exports increased on the back of strong global and EU growth, the significant Lira depreciation, and the rebound in tourism arrivals (Figure 5). This was more than offset by higher energy prices, strong gold imports—that play a role in hedging against inflation and uncertainty—and demand-driven import increases. Turkey’s external position remains weaker than the level consistent with medium-term fundamentals and desirable policy settings (Box I, Annex II). The widening of the current account deficit took place against the backdrop of a real depreciation of around 10 percent (Box 2). At around 50 percent of GDP, Turkey’s external debt is sustainable, but has increased rapidly, and is sensitive to exchange rate valuation risks, as well as liquidity risks stemming from the large annual rollover needs of around 20 percent of GDP (Annex V).

Figure 5.
Figure 5.

Turkey: External Sector Developments

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: CBRT, Haver Analytics, and IMF staff calculations.

11. Turkish financial markets are sensitive to changes in international investor sentiment. Turkey was among the countries most affected by the November 2016 emerging market asset selloff (Figure 6). Domestic and external government bond yields fell following the April 2017 referendum, against the backdrop of the global asset rotation back to emerging markets. However, gains were partly reversed in the last quarter of 2017, as the Lira came under renewed pressure.

Figure 6.
Figure 6.

Turkey: Financial Markets Developments

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Bloomberg, Haver, and IMF staff estimates.Notes: Average of data for other G-20 emerging markets covers Brazil, Mexico, India, Indonesia, and South Africa. Event lines indicate the timing of Turkish PM Davutoğlu resignation (May 5, 2016), the failed coup attempt (Jul 15, 2016), Moody’s downgrade to below investment grade (Sep 23, 2016), US presidential elections (Nov 8, 2016), and the Constitutional Referendum (April 16, 2017).

Outlook and Risks

12. Over the medium term, growth is expected to fall to its potential of about 3½-4 percent annually, with inflation remaining above target. The moderation of growth in 2018 is expected to be driven by the weaker policy stimulus. Inflation is forecast to remain in double digits this year, driven by expected Lira depreciation and higher energy prices. It is expected to moderate, as energy prices and exchange rate effects fade (assuming expectations remain contained), and the CBRT’s current interest rate should be enough to stabilize it, albeit at a level well above target. The current account deficit and external financing needs are expected to remain elevated over the medium term. Looking further ahead, and absent deep structural reforms, weak productivity growth is projected to remain a drag on potential growth (Annex I).

13. Risks to the medium-term baseline are tilted to the downside (Annex III):

  • Reflecting policy imbalances, downside risks are increasing, including from Turkey’s large gross external financing needs, low reserves and dependence on short-term capital inflows (Box 1), the widening negative NIIP, high corporate exposure to FX risk, and higher reliance on market funding (with bank loan-to-deposit ratios of 123 percent). These weaknesses could exacerbate the negative effects of any increase in the cost of external financing caused by a normalization of monetary policies in advanced economies or increasing emerging market risk premia.

  • Inadequate policy adjustment could lead to accelerating inflation. Although inflation is expected to remain well above its 5 percent target over the medium term under the baseline, risks of materially higher-than-projected inflation and weaker CBRT credibility remain.

  • A possible further deterioration in geopolitical tensions in the region, as well as domestic political risk factors ahead of the election cycle, could also undermine investor and consumer confidence. The guilty verdict in an US court against a senior official of a state-owned bank on money laundering and evasion of US sanctions on Iran poses reputational and financial risks.

  • On the upside, US dollar weakness and Euro strength could reduce the external debt servicing burden and help narrow external imbalances.

Policy Discussions

14. Expansionary economic policies are contributing to the build-up of internal and external imbalances, against the backdrop of falling buffers. Robust investment activity is driven by strong PPP activity, government guarantees and investment incentives, and an earlier relaxation of the macroprudential regime. Estimates of the private credit gap, which attempt to measure the deviation of private debt from what fundamentals would support, put the credit oversupply in the range of 10 to over 20 percent of GDP (Annex I). The macroprudential regime may not adequately internalize the increase in corporate leverage and the risks stemming from the large negative FX position of the economy. Procyclical fiscal and quasi-fiscal policies have boosted domestic demand and credit growth, putting further pressure on the current account deficit. Against the backdrop of the slowdown of potential growth, the expansionary policy stance has led to internal and external imbalances, and the cost of bringing inflation down to target is estimated between 4 and 11 percentage points of potential GDP. In addition, the external position remains weaker than implied by fundamentals, despite the real effective exchange rate being broadly consistent with such fundamentals (Box 1). Turkey’s low international reserves do not appear to provide an adequate buffer for sizeable external shocks, especially against the backdrop of Turkey’s large external financing needs.

15. The main policy challenge is to recalibrate macroeconomic policies in a measured yet credible manner that fosters sustainable growth, while reducing the vulnerability of the Turkish economy to downside risks. The recalibrated policy mix would entail further monetary, fiscal and quasi-fiscal tightening, and careful management of the associated build-up of direct and contingent liabilities. Macroprudential policies need to be squarely focused on maintaining financial stability and adequate buffers. Combined with structural reforms targeted to underpin medium- and longer-term growth, this would leave Turkey better placed to handle any possible weakening of global sentiment towards emerging markets.

Authorities’ Views

16. While the authorities agree that last year’s growth was above potential, they do not see a risk of overheating going forward. They estimate the economy’s growth potential to be about 5–5½ percent, and maintain that the output gap should, as a result, close this year and remain around zero going forward on current policies. In particular, the authorities view the current monetary stance as sufficiently tight. The authorities also re-affirmed their commitment to fiscal discipline and advancing the structural reform agenda.

17. The authorities saw the wider current account deficit as largely reflecting external factors, but agreed that reserves could be rebuilt as conditions allow. They expected the current account deficit to narrow, while growth returning to its potential would also help. They saw its financing as underpinned by the attractiveness of Turkish assets to foreign investors. The authorities considered the recent reliance on short-term inflows (Box 1) to be mainly driven by cost factors and did not expect it to continue as a longer-term trend.

A. Monetary Policy

18. The monetary tightening already undertaken is welcome, but further steps are needed to lower inflation meaningfully and re-anchor expectations. Although the effective CBRT rate has been increased by almost 500 bps since November 2016, this has not been sufficient to contain inflation and prevent inflation expectations from becoming unanchored. The real effective policy rate (Table 1) appears well below what a simple Taylor rule would imply (a 200–300 bps mark-up over the neutral rate, estimated by staff in the range of 1–3 percent) in the face of a positive output gap and inflation well above its target To address these concerns, the binding real policy rate—since March 2017, in effect, the late liquidity window (LLW) rate—should be increased by a further 100–300 bps, in addition what would be needed to keep pace with any US Fed Fund Rate hikes. This should preferably occur in a frontloaded manner, along with a clear commitment to additional measures as needed to restore credibility. Ideally, this would be accompanied by a change in the policy (one-week repo) rate to move it closer to the LLW rate, helping to improve the transparency of the policy framework. Over time, the aim should be to move to more conventional monetary policy instruments to help underpin credibility.

Table 1.

Turkey: Selected Economic Indicators, 2016–23

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

In percent of potential output.

The external debt ratio is calculated by dividing external debt in U.S. dollars by GDP in U.S. dollars estimated by staff.


Monetary Policy Response to Large Devaluations

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: CBRT and staff estimates.

19. A credible monetary tightening would help underpin the Lira and allow the CBRT to rebuild international reserve buffers. Gross international reserves (GIR) should be raised to cover at least 100 percent of the ARA metric over 2018–19 from the current 82 percent cover and move closer to the midpoint of the ARA range over the medium term. With still-favorable global liquidity conditions, the CBRT could gradually increase NIR through sterilized intervention—as market conditions permit—using preannounced regular auctions to help minimize market disruptions. Non-deliverable forwards—introduced by the CBRT to manage the demand for FX and support hedging by banks and corporates—have been useful in managing exchange rate volatility without depleting reserves, but their use should be limited to circumstances when the market for hedging instruments is illiquid. Following up on the 2017 FSAP recommendations, the improvement in systemic FX liquidity management should continue, notably through the ceasing of off-market sales to state-owned energy companies. The repayment of export rediscount credits in Lira instead of FX to the CBRT at below-market conversion rates should not be used as a tool to support FX liquidity conditions.

Authorities’ Views

20. The authorities acknowledged the risks of inflation inertia and FX-depreciation passthrough to inflation. They saw monetary policy as sufficiently tight, however, to bring inflation below 8 percent by the end of 2018. They considered that in 2017, despite a tighter monetary policy stance, aggregate demand and credit conditions delayed the improvement in inflation. They also argued that better coordination between fiscal and monetary policy and administrative measures to reduce inefficiencies along the agricultural supply-chain and boost its productive capacity would help the disinflation effort.

B. Fiscal Policy

21. Front-loaded fiscal consolidation would support internal and external rebalancing, and buoy investor sentiment.

  • Meeting the MTP target. The expiration of temporary tax breaks (on white goods, furniture, construction materials, and luxury housing) and new tax measures in 2018—such as the CIT rate increase, reductions of income tax exemptions, and an increase in consumption taxes on motor vehicles—were welcome. However, consolidation is likely to be slower and weaker than envisaged in the MTP, due to new tax exemptions, the continuation of the minimum wage subsidy, and new employment incentives. High outlays on security, public wage rigidities, and the conversion of temporary workers into permanent public employees added to overall spending pressures, which are expected to persist in the run-up to the 2019 elections. As a result, the general government primary deficit is expected by staff to remain at around 1.3 percent of GDP during 2018–19 on current policy intentions. This implies a required adjustment in the cyclically-adjusted general government primary balance of about 1 percentage point to meet the MTP’s deficit target of 0.4 percent by 2019. Annual public gross financing needs are projected at around 5–5½ percent of GDP, with around 20–25 percent of that total to be met by external borrowing.

  • Going beyond the MTP target. Stronger and front-loaded fiscal consolidation—aimed at achieving general government primary surplus of about ½ percent of GDP by 2019—would help counteract continued expansionary quasi-fiscal and financial policies. Such a target would be equivalent to an adjustment in the cyclically-adjusted, general government primary balance of about 1¾ percentage points during 2018–19 relative to the baseline.


Turkey: Cyclically-Adjusted Primary Balance of the General Government 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Turkish Authorities; and IMF staff calculations.1/ Primary balances presented are in the IMF-program definition.

22. Fiscal consolidation should be backed by well-defined and comprehensive revenue and spending measures.

  • On the revenue side, efforts to broaden the tax base and enhance revenue efficiency would be critical. As recommended by IMF TA, potential measures might include raising and unifying reduced VAT rates to be in line with international practice, as well as streamlining various tax exemptions. Revenues from direct taxes could also be mobilized further by revisiting the top personal income tax rates and improving coverage of the informal economy. On the VAT refund mechanism, the reform plan needs to be carefully designed in a simple and budget-neutral way, with its implementation accompanied by compensating revenue measures (Box 4).

  • On the expenditure side, savings could be achieved by withdrawing untargeted transfers and temporary subsidies, and refraining from ad-hoc incentives. Containing wage bill increases, as envisaged in the MTP, could provide additional gains, but need to be backed by concrete measures on public employment and wages, including reforming the current system of guaranteed real purchasing power through backward-looking inflation indexation. Given signs of over-investment and high private debt (see Annex I, which discusses Turkey’s private debt in an international context), cuts to discretionary investment incentives, state loan guarantees, and PPP activity are warranted (see below).

Turkey: Measure Options for Fiscal Consolidation

(Percent of GDP)

article image
Sources: IMF staff estimates.

23. Progress has been made in strengthening the risk management and reporting of quasi-fiscal operations, further curtailing of such activities and their full integration into the budget are called for. Public-private partnership (PPP) activity has risen sharply in recent years. Other fiscal risks—stemming from the expansion of state loan guarantees and public bank balance sheets, as well as the impact of energy price setting on SOEs performance—are also on the rise. A growing share of fiscal risks has fallen outside of Treasury’s approval and monitoring system (Box 1). The sovereign wealth fund (SWF)—not yet fully operational—carries added potential fiscal and financial risks. Progress in implementing international accounting standards for recording PPP activity and the fiscal risk report that was expected to be published shortly are welcome. At the same time, there is a need for further strengthening contingent liability management, including through (i) enhancing investment prioritization procedures with a strict selection of PPP projects that provide value-for-money even under adverse macroeconomic scenarios; (ii) establishing comprehensive PPP legislative and institutional frameworks with strong central oversight and a centralized database; and (iii) comprehensive and regular fiscal risk reporting. In addition, some of the objectives and planned activities of the SWF—such as managing state-owned enterprise assets and supporting infrastructure and economic development—would, when operational, add to existing quasi-fiscal operations. Hence, its governance and statistical treatment in public accounts need to be fully aligned with international best practices, including published annual reports, audited financial statements, transparent investment policy, and, reflecting the nature of its planned operations, categorization under general government in official statistics.

24. Turkey has some fiscal space to cushion negative shocks, but discretionary measures should not be used given current imbalances. Public debt is low and sustainable over the medium term, being most sensitive to the contingent liability shock (Annex IV). The use of Turkey’s fiscal space is best preserved for systemic events, and remains conditional on maintaining market access.

Authorities’ Views

25. The authorities pointed to the important role that fiscal policy has played in stimulating the economy, while reaffirming their commitment to fiscal discipline as a key policy anchor. They argued that tax exemptions and employment incentives would encourage businesses to increase investment and employment, both of them crucial drivers of economic growth. Higher economic activity and growth would, in turn, help raise tax revenues and ensure that the overall MTP fiscal targets are met. In addition, they emphasized that as the new employment incentives are likely to be financed by the Unemployment Insurance Fund, the planned stimulus would not result in central government budget overruns and higher government borrowing.

26. The authorities considered fiscal risks to be low—given the economy’s resilience and ample fiscal buffers—but agreed that there were merits to better monitoring and management. Plans were in place to expand the disclosure of fiscal risks beyond the central government and strengthen PPP management, including through improving inter-agency cooperation, central supervision, and fiscal risks analyses. The authorities were also considering seeking early views of Eurostat and the IMF’s Statistics Department on the appropriate statistical treatment of the sovereign wealth fund.

C. Financial Sector Policies

27. State loan guarantees should be phased out over time and limited to cases of clear market failure. The CGF expansion helped counteract the 2016 economic dip, but at close to half of the stock of end-2016 SME loans and 7 percent of GDP, it was large and frontloaded and, in the event, ended up contributing to a procyclical credit increase. There are also indications that most of the outstanding CGF-backed loans were used for working capital, with some ending up rolling over existing loans, on the back of favorable risk weighting and provisioning requirements (Box 5). Tight domestic Lira initially put pressure on Lira deposit rates, and subsequently on swap rates (as FX deposits were swapped into Lira). The government has announced that it will release the unused capacity of the CGF (about TL 50 billion), which will be targeted to supporting investment and credit to exporters. The move to better target the CGF is appropriate, but there is scope to further focus the scheme on SMEs. Support should not be made permanent, nor should its use for multiple loan restructurings be allowed.

28. Macroprudential tools should be used to build buffers and contain systemic financial vulnerabilities. Such tools should focus on risks rather than demand management and, as such, some aspects of the post-2015 relaxation of the macroprudential regime could be revisited, in particular for the corporate sector where bank exposure has grown significantly and vulnerabilities are high. Although now late in the cycle, the build-up of pockets of vulnerability in the construction and real estate sectors could be tackled through a tightening of prudential regulations.

29. Further progress could be made on bank governance and supervision. Progress in implementing recent FSAP recommendations in bank supervision and regulation is uneven and could be stepped up (Annex VI). In particular, the independence of the BRSA and the quality of NPL data could be strengthened, loan restructuring activity fully accounted for, and bank loan classifications and bank governance standards further strengthened. The authorities should evaluate and revise the definition of credit classifications and intensify enforcement in this area.

30. Recent initiatives to manage the large, negative, net FX position of the private sector are steps in the right direction but need to be strengthened. Banks continue to rely on wholesale FX funding and the corporate FX debt burden is high and increasing, specifically, in some sectors with limited FX revenues, such as energy and construction. The authorities have put in place measures to restrict new FX borrowing by SMEs, by introducing FX debt to FX-income limits and banning new FX-indexed corporate loans starting in May 2018. Though the new framework contains exemptions and covers just 16 percent of FX borrowers, it is a first step in implementing the 2017 FSAP recommendation of restricting FX borrowing without natural hedges (Annex VI). Staff commended the authorities’ plans to introduce additional measures targeting large companies. Ongoing efforts to assess and adequately monitor the vulnerabilities of the corporate sector, in particular through stress-testing exposure to FX and interest rate risks, are being supported by Fund technical assistance.

Authorities’ Views

31. The authorities considered the rapid CGF expansion and the macroprudential relaxation as necessary to deal with the severe economic uncertainty in the wake of the failed coup attempt in 2016. Although they pointed to the good asset quality performance, thus far, of the CGF backed loans to date, they acknowledged that the framework of the CGF needed more focus and strengthening and had reflected this in their plans for this year. The authorities viewed their macroprudential policies as being in line with international best practice and as helping them manage credit growth.

D. Contingency Planning

32. In case tail risks materialize, the authorities should raise the policy rate, allow an orderly depreciation of the exchange rate and let automatic stabilizers play out. In case of a “sudden stop” of capital inflows, the policy rate would need to be increased sharply to avoid a more damaging and disruptive depreciation of the Lira. The policy response should be proportionate and take into account the balance of risks (especially to the corporate sector) stemming from exchange rate and interest rate movements. Automatic stabilizers should be allowed to cushion negative shocks, while discretionary measures should be reserved in the event of a serious recession. The use of fiscal space would be conditional on maintaining market access. Given that net international reserves are low, the scope for credible FX intervention would be limited. Preemptive build-up of FX reserves and strengthening of bank and corporate balance-sheets—through restrictions on the structure of liabilities and higher risk weights or provisioning on lending to NFCs in FX—would help insulate the real economy from any negative shocks.

Authorities’ Views

33. The authorities highlighted the strengths of the fiscal position and the banking system as being sufficient to absorb negative external shocks. They concurred that further build-up of FX reserves over time would help improve Turkey’s buffers.

E. Structural Reforms

34. Focused structural reforms would help underpin medium-term growth. The sustainability of the current growth model, which relies on rapid accumulation of capital and a growing labor force, is approaching its limits, as the marginal boost to real activity from additional credit expansion diminishes and labor market rigidities become more binding constraints on growth. Advantage should be taken of the current strong cyclical growth conditions to implement structural reforms to address the lackluster total factor productivity growth over the past decade:

  • Improving labor market conditions. The formal labor market could be made more flexible by reforming the severance pay system, which is overly burdensome for employers in the formal sector and discourages labor mobility due to the non-transferable built-up rights. The backward-looking component of public wage indexation should also be reformed, as it can increase disinflation costs and, with spillovers to private sector collective wage bargaining, that can lead to negative wage-inflation spirals as well as exacerbating informality. Future minimum wage increases should be aligned with expected inflation and tied to productivity gains. Other priorities include the full implementation in practice of the liberalized regime for temporary employment and measures to increase access to childcare facilities with its potential to boost the still-low female labor force participation (33½ percent in 2017). Improving educational outcomes and further supporting vocational training would help reduce skill-mismatches.

  • Promoting productive private investment. Recent initiatives seek to enhance the ease of doing business by simplifying the procedures for setting up new companies and shortening bankruptcy proceedings. At the same time, policy uncertainty is found to negatively affect productive investment. It is, therefore, important to restore policy certainty by addressing investors’ concerns about public institutional capacity, the predictability of the regulatory environment, and commitment to structural reforms.


Turkey: Total Factor Productivity

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: TurkStat and Staff estimates.

Ratio of Female to Male Labor Force Participation Rates


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: Turkstat and World Bank Development Indicators (for EU).

35. Further progress is needed with some long-standing reform priorities:

  • Further reforming the pension system. Private pension automatic enrollment started in 2017, but participation has been limited. Areas for improvement include centralizing collection, fostering more competitive asset management practices, and removing the age limit for participation.

  • Easing refugee integration. Turkey’s generosity in hosting refugees—the numbers hosted is estimated at more than 3½ million—serves as a global example. The introduction of work permits for those under temporary protection is an important step, but the informal sector remains the main employer for Syrian and other refugees. To ensure formal labor market integration, the application process for work permits and business creation could be simplified. The authorities’ effort to develop an active communication strategy related to refugee work permits are welcome.

Authorities’ Views

36. The authorities expressed their continued commitment to structural reforms. They highlighted the following priorities:

  • Structural reforms to enhance the business climate include simplification of administrative and bureaucratic procedures, and provision of investment incentives and technological support to high value-added sectors.

  • Labor market policy would focus on improving human capital quality and labor force participation. Provisions of vocational education, relevant training, and effective traineeship programs will be enhanced and coordination with the private sector on required skills will be strengthened. Greater supports for childcare facilities and flexible employment will facilitate more female labor force participation. More progress is needed on the severance pay reform, but this may take time given a need for careful and broad-based consultation with stakeholders to support successful implementation.

  • The coverage of the new auto-enrollment pensions system has been extended as planned. The authorities have been working to remove design weaknesses and improve the communication strategy.

Staff Appraisal

37. Following a slowdown in 2016, growth recovered sharply last year, helped by strong policy stimulus and favorable external conditions. In 2017, a sizeable credit impulse—driven by state loan guarantees—and fiscal policy (including increased PPP activity) supported the economy, which had, in the previous year, shown signs of weakness. Exports also increased sharply, due to stronger external demand, against the backdrop of a softer Lira.

38. As a result, external and internal imbalances have widened, increasing Turkey’s potential exposure to changing global conditions. Such has been the strength of the recovery that the economy shows signs of overheating: a positive output gap, inflation well above target, and a wider current account deficit. This adds to underlying vulnerabilities, which include large external financing needs, limited foreign exchange reserves, increased reliance on short-term capital inflows, and high corporate exposure to foreign exchange risk. Signs of possible oversupply in the building and construction sector are also emerging. While risk triggers are, by their nature, difficult to project, they could stem from domestic developments, regional or international geopolitical developments or changes in investor sentiment towards emerging markets.

39. The economy has so far been resilient to a series of shocks, yet more difficult challenges may lie ahead, underscoring the need for recalibration of policies. The input-intensive growth model is increasingly ripe for a reset as the marginal boost to real activity from additional credit expansion diminishes and labor market rigidities become more binding constraints on growth. Accommodative international financing conditions have allowed a sharp increase in private sector leverage, helping increase growth, and masking an underlying deceleration of total factor productivity growth. External financing conditions and commodity prices cannot be relied upon to remain supportive and hence the focus of policies should shift toward addressing Turkey’s short- and medium-term challenges.

40. The immediate policy challenge is to recalibrate macroeconomic policies in a measured yet credible manner that fosters sustainable growth and guards against downside risks. This should be accompanied, over time, by focused structural reforms.

41. Monetary policy should be tightened further in a frontloaded manner. This will help contain inflation, re-anchor expectations, underpin the Lira, and allow reserves to be rebuilt. Over time, a move should be made to more conventional instruments to help underpin the transparency and effectiveness of monetary policy.

42. Fiscal and quasi-fiscal policies need to be further contained, as do associated contingent liabilities. Further measures will be needed to achieve a general government primary surplus next year. Potential steps include broadening the revenue base, raising direct taxation, improving VAT efficiency, limiting public wage rigidities, and containing ad-hoc subsidies. Measures to strengthen the PPP risk management and reporting framework, supported by IMF and World Bank technical assistance, are welcome. Building on this would help preserve fiscal space. More broadly, the scope and role of extra-budgetary and other non-central government entities, and institutions such as the newly created SWF, need to be carefully defined and monitored, with the maximum degree of transparency.

43. Financial sector policies should aim at further strengthening the oversight, stability and governance of the banking sector. Steps have been taken to enhance the risk management and reporting of quasi-fiscal operations, including the CGF, and to introduce limits on borrowing in foreign currency, starting with SMEs. Further efforts are needed to strengthen bank supervision and macroprudential policies, in the latter case in areas where vulnerabilities are highest, in particular in the corporate sector.

44. Focused structural reforms would help underpin medium-term growth. Total factor productivity growth has been lackluster over the past decade. Advantage should therefore be taken of current strong cyclical growth conditions to implement needed growth-friendly reforms. Maintaining strong institutional capacity and improving the predictability of the regulatory environment would help strengthen the investment climate. Labor market reform is also crucial. Skills gaps risk undermining what should be Turkey’s natural demographic advantage. Equally important is raising the improving, but still low, female labor participation rate. Further reforms could focus on: improving educational outcomes including vocational training; enhancing opportunities for more flexible work; and reforming the severance pay system.

45. Other structural reforms could also help growth prospects. Creating conditions conducive to long-term local currency borrowing—including the institutional aspects, and generating a deeper pool of domestic saving—would help alleviate one of Turkey’s main vulnerabilities, the sizable current account deficit. In this regard, fostering higher participation in the voluntary private pension system would also help.

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

Recent Developments in the External Position1/

In 2017, the current account deficit (CAD) widened and gross external financing requirements increased to over 25 percent of GDP. This was against the backdrop of increased reliance on external financing through short-term flows and reserve use. Staff assess the external position as weaker than implied by fundamentals. However, staff assess the real effective exchange rate as broadly consistent with fundamentals, following the sizable depreciation over 2016–17.

Widening external imbalances are reflected in a growing negative NIIP, which at around 53 percent of GDP is estimated to be the lowest among G20 EMs. While valuation factors contributed 5 percent of GDP to the 10 percent of GDP decline in the NIIP in 2017, large current account deficits have been the main driver of the decline in NIIP since 2010. External liabilities increased to nearly 80 percent of GDP, with FDI comprising less than a quarter of the total, a low share relative to peers despite a relatively open capital account. External assets, half of which are gross reserves, are mostly liquid. Gross liquid external assets (reserves + currency and deposits + other liquid assets) are nearly sufficient to cover short-term debt at remaining maturity, but they have been on a decline since the global financial crisis. At around 50 percent of GDP, Turkey’s external debt is sustainable, but has increased rapidly, and is sensitive to exchange rate valuation risks, as well as liquidity risks stemming from the large annual rollover needs of around 20 percent of GDP (Annex V). More than a third of external debt falls due within the next 12 months.


External Liabilities Composition, 2017 (Proj)

(Percent of total external liabilities)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: IMF staff estimates.

Net Liquid Asset Position

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Haver Analytics; and IMF staff calculations.

The CAD is higher than warranted by fundamentals. The CAD reached 5.5 percent of GDP in 2017. Staff estimates the underlying cyclically-adjusted CAD to be around 4 percent of GDP, after controlling for the output gap and the one-off impact of large non-monetary gold imports. The EBA CA approach gives a deficit norm of close to 0.5 percent of GDP, while the external sustainability (ES) approach suggests a medium-term norm of 2.5 percent. With a higher weight placed on the ES approach given the relatively low NIIP, staff assesses the CA gap as −0.5 to −2.5 percent of GDP consistent with a norm in the range of −0.5 to −2.5 percent of GDP.

article image

External financing has increasingly relied on reversible flows and reserves drawdown. Net FDI declined to less than 1 percent of GDP in 2017. The share of non-resident net purchases of government and bank debt securities in total net inflows more than doubled in 2017 (Figure 6), reflecting the broader emerging markets rally and attractive carry yields. However, financing became increasingly reliant on easily reversible flows, with net inflows into government domestic securities and through short-term debt and deposits, making up a rising share of net funding. Capital outflows in the first and fourth quarters of 2017 triggered a sizable drawdown of reserves.


The Composition of Debt Financing

(Billion of U.S. dollars)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Haver Analytics; and IMF staff calculations.

Reserves are relatively low. Net international reserves declined by 13 percent in 2017, as the central bank allowed exporters to repay rediscount credits in Lira instead of FX, continued direct sales to energy importing SOEs, and provided FX liquidity through deposit auctions. Gross reserves were at around 82 percent of the IMF reserve adequacy (ARA) metric at end-2017 continuing a declining trend since 2013. Gross reserves cover only around half of the external financing need. With the bulk of reserves constituting liabilities to banks for reserve requirements, net reserve coverage is significantly lower when compared to peers.


Reserves ARA Metric


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: IMF staff estimates.

Net Reserves ARA Metric, 2017


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: IMF staff estimates and Statistics Department’s IRFCL database.

The share of Turkey in global exports increased by 42 percent since 1999. More recently, the share of exports of goods and services is now 0.94 percent compared to 0.84 in 2010, helped in part by the REER depreciation. The improvement in export shares was significant relative to most EMs, but still weaker than EMs more integrated into the global supply chain, such as Mexico and Poland.


Country Shares in Global Exports of Goods and Services


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: IMF and staff estimates.

Staff assesses the REER as broadly consistent with medium-term fundamentals. EBA REER index and level estimations indicate a slight to moderate undervaluation (the EBA index approach gives a 9 percent undervaluation, while the level approach gives a 2 percent undervaluation). However, drawing on the external sustainability approach and the other indicators above, staff considers the REER to be broadly aligned with fundamentals following the significant recent depreciation. (Box 2 discusses the wedge between REER and CA developments.)

Alternative measures of the REER confirms the sizable recent depreciation. In line with the REER depreciation in CPI-based measures, the REER based on manufacturing unit labor costs has depreciated by around 10 percent since 2016 and by 26 percent from its peak in 2010. In addition, a new unit-labor cost REER index covering 75 percent of exports reflect a similar trend.2


Turkey: Real Effective Exchange Rates

(Index, 2010=100)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: IMF.Notes: Increase = appreciation. G-20 EMs = average for other G-20 emerging economies (Brazil, Mexico, India, Indonesia, South Africa).

Notwithstanding rising market shares, there is significant scope to improve competitiveness through reforms. Structural indicators point to relative weaknesses in the solvency regime, the ease of starting a business, and labor market flexibility (the Global Competitiveness Index ranks Turkey 127 out of 137 countries on labor market efficiency with noted weakness in female labor participation and severance costs.)

1 Prepared by K. Ismail.2 Extending the Coverage of the Unit Labor Cost Based Real Effective Exchange Rate Index” Erduman and Yavuz, CBT Research Notes in Economics No. 17/10, December 26, 2017.

Current Account and Real Effective Exchange Rate1/

Since 2013, the estimated gap between the current account deficit and that implied by fundamentals has persisted despite significant REER depreciation. This box aims to explain the drivers for this.


Exports of Goods by Commodity Group

(Percent of total exports)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Haver Analytics; and IMF staff calculations.

The orientation of exports towards import-intensive sectors played a role in slowing the current account adjustment. Exports of manufacturing sectors with lower import-content (textiles, food processing) declined slightly, while import-intensive sectors, such as vehicles, became more dominant. (Since 2013, vehicle exports increased by nearly 40 percent, far outpacing growth in other exports.) This resulted in raising the import intensity of exports over time, blunting the transmission of REER depreciation to trade balance improvements in the short term.


REER Changes and Fuel Import Growth

(Percent, 12-month moving average of annual growth rates)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: TurkStat, Haver Analytics, and IMF staff estimates.

A relatively inelastic fuel trade balance to energy prices also muted the narrowing of the CA gaps. The relationship between prices and quantities in the energy sector is weak. Despite a sizable increase in real fuel prices in 2017, real fuel imports are estimated to have increased by nearly 20 percent year-on-year. This is partly due to lags in the adjustment of administered energy prices.

The increase in quasi-fiscal activities may have led to some decoupling of imports from REER movements. The rise in investment underwritten by the government through PPPs, including megaprojects, may have also muted the impact of REER depreciation on import demand. The high tradable intensity of capital spending resulted in import leakage without commensurate pressures on the price of non-tradables, leaving the REER on a declining path while the CAD remained high. As an example, since the 2013 increase in PPP activities, Turkey has become a net importer of steel and iron, both staples of construction activity.


Turkey: REER, Public Investment and Current Account Gap

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: IMF staff estimates; CBRT and Undersecretariat of Treasury.1/ The cyclically adjusted current account is adjusted by the output gap, cyclically terms of trade changes, and the demeaned non-monetary gold trade balance.2/ Public investment is the sum of on-budget capital spending, investment by SOEs, and PPP investment.
1 Prepared by K. Ismail.

Fiscal Risks from Public-Private Partnership Projects1/

The size of the overall Public-Private Partnership (PPP) investment portfolio in Turkey has increased rapidly in recent years. The investment size is currently estimated at about US$61 billion (covering 221 projects), six times more than the level observed a decade ago and with a concentration in the transportation, energy, and health sectors. Of the total PPP portfolio, a total investment value of US$36.6 billion or 60 percent of the total portfolio is still under construction.


Cumulative PPP Investment Portfolio

(Billion of US dollars)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Ministry of Development; and World Bank.

Fiscal risks related to PPP projects arise from both direct and contingent liabilities. Direct liabilities come from government-funded PPPs. Meanwhile, contingent liabilities could stem from demand, exchange rate, and investment guarantees, as well as contract termination clauses and any debt guarantees, issued either by the Treasury or other procuring public institutions. Besides the potential reclassification of PPP debt into the general government in case of any bailout of PPP projects or loan guarantees, many PPP projects in Turkey involve explicit minimum revenue guarantees (MRGs) and components expressed in FX terms, which exposes the government to demand and exchange rate risks.

Information on PPP projects to assess related fiscal risks remains limited and the legal and institutional PPP framework is fragmented. Total commitments on PPP contracts and investments published by the Ministry of Development (MoD) do not include some PPP projects contracted by SOEs and municipalities, and Private Participation in Infrastructure (PPI) projects related to energy and ports. In addition, there is neither detailed information on all issued guarantees and associated risks nor on the structure and risks composition of the overall PPP portfolio. Debt Assumption Commitments (DACs) reported in the monthly Public Debt Management Report covers only the Treasury’s loan guarantees to five PPP projects with a total investment value of US$14.6 billion or a total loan amount of US$11.3 billion. Furthermore, the legal and institutional framework for PPPs is fragmented across sectors, projects, and public agencies without a strong central overview unit in charge of assessing, monitoring, reporting, and managing the entire PPP portfolio.

Staff’s analysis shows that the stock of contingent liabilities related to revenue guarantees is sensitive to the macroeconomic assumptions underlying PPP revenue projections. With limited information, macroeconomic shocks are simulated on the stock of contingent liabilities related to MRGs of just under half of the total PPP investment portfolio. Staff’s simulation shows that macroeconomic shocks could trigger an increase in primary expenditure to finance the materialized contingent liabilities, and hence result in an increase in the fiscal primary deficit of about 0.2–0.25 percent of GDP a year.2/


Sensitivity of Contingent Liabilities Related to MRGs

(Percent of GDP)

Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Source: IMF staff estimates.
1/ Prepared by R. Çeçen, F. Jirasavetakul, I. Rial, and A. Zdzienicka.2/ For instance, a permanently lower GDP growth by 2 percentage points and a 5 percent depreciation of the Lira could increase the stock of contingent liabilities by 0.25 percentage point of GDP per year. The 2-percentage point lower growth could be seen as equivalent to staff’s medium-term growth projection of 3.5 percent, compared with the 5.5 percent growth envisaged in the MTP.

VAT Efficiency and Reform Priorities1/

Turkey’s VAT collection performance is relatively weak compared to other European countries. VAT revenue collection captures less than 40 percent of the potential VAT base, and collection efficiency has also worsened over time, mainly due to increasing use of reduced rates and exemptions, weakening compliance, and shortcomings of the overall VAT design.2/ In addition, VAT collection is helped by “deferred” VAT refunds incurred from the requirement for taxpayers to carry forward their excess input VAT credits until fully offset against the output VAT.3/ The current stock of deferred VAT refunds is estimated to be more than 5 percent of GDP.


VAT Collection Efficiency


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Ministry of Finance; IMF database; and IMF staff estimates.1/ Adjusted for deferred VAT.

A comprehensive VAT reform, as planned by the authorities, should focus on improving revenue potential, removing distortions, and simplifying the VAT system. The reform package should focus on eliminating the zero rate for domestic supplies, limiting the use of reduced rates, and enhancing compliance by revisiting anti-avoidance and anti-fraud measures. In addition, adopting a clear principle-based VAT legislation and a modern VAT system without too many permanent and temporary exemptions and with a limited number of special regimes, could help simplify the overall system and enhance compliance.

A reform to improve the VAT refund mechanism has to be designed carefully. To eliminate the burden on business and encourage voluntary compliance, the system needs to allow for unrestricted refunds of excess input VAT credit and the existing stock of deferred VAT refunds needs to be amortized. However, these actions have to be carefully undertaken in a simple and budget-neutral way. The reform of the VAT refund system will result in revenue losses, and hence has to be implemented in tandem with compensating revenue measures. Reforms to increase VAT revenue collection efficiency—for instance by unifying and raising reduced rates, eliminating exemptions, and implementing a unified flat rate of VAT on real property—could enhance revenues and offset the cost of fixing the VAT refund mechanism.

1/ Prepared by F. Jirasavetakul, A. Swistak and A. Zdzienicka.2/ The VAT legal system is complex with a large number of legal provisions and temporary legislative amendments that create uncertainty and can distort business decision.3/ Only exporters and taxpayers with zero-rate domestic supplies, subject to reduced rate and VAT withholding, are entitled to claim VAT refunds.

Credit Guarantee Fund1/

Background. Initially created in 1993, the Credit Guarantee Fund (CGF) was expanded tenfold in 2017 to a total size of about 7 percent of GDP. The state guarantee (100 percent of export loans, 90 percent of SME loans, 85 percent of commercial loans) applies as long as the individual bank portfolio does not reach an NPL ratio of 7 percent. 80 percent of the guarantee-supported credits are selected directly by banks. The maturity of the portfolio is about 3 years on average, and the average interest rate stands at 15 percent (vs. 17 percent for non-CGF backed corporate loans). The usage fee charged to banks is just 0.03 percent of the face value of the guarantees made. Compared to the CGF, mechanisms in other countries (e.g., Chile, Korea) typically provide a lower level of guarantee coverage, charge much higher fees, are restricted to SMEs, and occasionally provide other types of support for SMEs (technical guidance etc.).

Impact on credit and the economy. In 2017, the CGF contributed close to half of overall corporate credit growth and three quarters of TL-denominated corporate loan growth. Its impact on 2017 GDP growth has been estimated by private sector analysts at around 1½ percentage points in total. The quick take up (in about four months) and the heavy use for working capital purposes (90 percent of CGF loans are recorded as such) suggest that it has been used for a variety of purposes, including rolling over loans, liquidity, and even purchase of consumption goods. Three sectors (trade, manufacturing, construction) took more than 80 percent of guarantee-supported loans.


Turkey: Bank Credit Impulse and Real GDP Growth


Citation: IMF Staff Country Reports 2018, 110; 10.5089/9781484353196.002.A001

Sources: Hwer Analytics; aid IMF staff calculations

Effect on banks. The portion of the loan guaranteed by the CGF is currently risk weighted at zero, while the remainder of the loan, if any, is risk weighted in line with the risk weight of the counterparty. This has provided a powerful incentive for banks to supply credit, with an estimated capital adequacy relief of about 0.7 percent in 2017. However, it has also amplified banks’ needs for TL funding, further increasing TL loan-to-deposit ratios (now at 145 percent), exerting pressure on Lira deposit rates and driving up swap costs when banks seek Lira with FX.

Fiscal impact. The government provided the CGF with an amount equivalent to 0.8 percent of GDP to cover a maximum exposure equivalent to 8 percent of GDP. From that envelope, the government has paid out the equivalent of 0.02 percent of GDP in 2017, and budgeted 0.1 percent of GDP for 2018. NPL ratios at 0.4 percent are currently low, but loan vintages are too recent to show a deterioration in asset quality.

Future of the CGF. In February 2018, the Turkish authorities announced a new protocol for the still-unused amount of 50 billion Lira and 5 billion Lira in returned guarantees. It envisages up to 18 billion Lira loan guarantees to be granted for capital investment and up to 14 billion Lira to exporting firms, and with other stated specific beneficiaries as well (for companies located in regions benefiting from an investment incentive package, for agriculture, and for female and young entrepreneurs). Additional funds are also expected to be available, as earlier loans are repaid under the previous protocol, and a possibility to roll over those was granted in December. This would bring the maximum amount of guarantees in 2018 to 135 billion Lira (equivalent to 3¾ percent of GDP), with a smaller credit impulse than in 2017.

Recommendations. The scaling down of new guarantees and the focus away from working capital and towards investment are steps in the right direction. Other measures to improve the functioning of the CGF and to limit risks include: (1) revisiting the possibility granted to roll-over loans for up to 36 months under the old protocol; (2) making sure the support goes only to SMEs, and not to larger companies (currently a quarter of the usage) that do not suffer from market imperfections associated with the lack of collateral; (3) increasing fees which would allow the funding of enhanced monitoring and a greater risk management capacity for the CGF; (4) revising downwards the level of guarantee coverage (e.g., for rolled over loans).

1 Prepared by J. Vacher.
Table 2.

Turkey: Medium-Term Scenario, 2016–23

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

In percent of potential output. Estimated using the absorption gap method and excludes one-off operations.

The discrepancy between the current account and the sum of public and private saving-investment balances is due to different definitions of exports and imports in national and BOP statistics.

The external debt ratio is calculated by dividing external debt in U.S. dollars by staff forecasts of GDP in U.S. dollars.

Table 3.

Turkey: Summary of Balance of Payments, 2016–23

(Billions of US$, unless otherwise noted)

article image
Sources: Turkish authorities; and IMF staff estimates and projections.
Table 4.

Turkey: External Financing Requirements and Sources, 2016–23

(Billions of US$, unless otherwise noted)

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

Includes CBRT and the general government, excluding eurobonds issuance.

Includes sales and purchases of portfolio assets by the government, banks, and other private sectors; and sale of assets classified under Other Investments.

Includes currency and deposits of non-residents;

Includes errors and omissions and other liabilities.

Table 5.

Turkey: Public Sector Finances, 2016–23

(Percent of GDP, unless otherwise noted)

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

Excluding privatization proceeds, transfers from CBRT, and interest receipts.</