Donal McGettigan

Almost five years after the 2000–2001 economic crisis, the Turkish economy has been transformed. The economy has grown rapidly for four successive years, inflation is in single digits, interest rates have dropped sharply, and the government debt ratio has fallen significantly. Maintaining and advancing these gains will be the key policy challenge in the coming years. Against this backdrop, recent IMF research has focused on policy performance in the key areas of growth, inflation, debt, fiscal and financial sector reform, and labor markets. The analysis aims both to assess the effectiveness of reforms pursued since the crisis and to provide guideposts for the future direction of economic policy.

Improving Turkey’s growth performance through both macroeconomic stabilization and structural economic reform has been a key objective of recent IMF-supported programs. Mody and Schindler (2005) examine Turkey’s growth record and the factors that explain it. Their analysis shows that performance has been slightly better than the world average, especially since 1980, mainly because of increased openness to trade, financial market liberalization, and broader economic reform efforts. But they also show that Turkey’s growth during this period became highly volatile and that it began to tail off in the late 1990s. The paper shows that one key factor holding back the country’s growth has been the lack of discipline in fiscal, monetary, and financial policies. Looking ahead, their analysis suggests that Turkey has the potential to grow at a rate similar to that of East Asia, provided recent macroeconomic policy discipline is maintained and structural reforms accelerated.

Reducing high and persistent inflation has been another focus of the reform program. Inflation first took off in the 1970s, peaking at more than 100 percent with the second oil shock, and then rising again in the mid-1990s. With such high inflation over such a long period, there was a concern that price-setting had become more backward-looking, which would have complicated the task of reducing inflation. Instead, Celasun and McGettigan (2005) find that much of Turkey’s persistent inflation was self-fulfilling: the inflation process was driven more by expectations of future high inflation than by formal backward indexation. Their analysis also finds that fiscal policy has been a key determinant of these expectations, so the reform program’s focus on generating sustained, high primary surpluses has been central to the success of disinflation. Complementing this analysis, Rossi and Rebucci (2004) present an empirical measure of disinflation credibility and find that it has improved markedly in Turkey over the postcrisis period, boding well for the future of disinflation in the country.

Looking back, it is clear that balance sheet weaknesses in the financial and corporate sectors have contributed to Turkey’s propensity to fall into crisis. Keller and Lane (2005) document these preexisting weaknesses and show how they were magnified by the depreciation of the Turkish lira in 2001 and the increase in interest rates during the crisis. Their analysis also shows how private sector balance sheets have since been restored, in part because of the economic recovery and success in macroeconomic stabilization, but also because some of the vulnerabilities have been transferred to the government, which has taken on greater foreign currency and interest rate risk. For example, the government has issued bonds that improve banks’ balance sheet exposures and used official external financing to provide foreign currency liquidity to the market in the wake of the crisis. Finally, the analysis also shows that, despite the many balance sheet improvements in recent years, Turkey remains vulnerable, due in part to the level and composition of public debt and remaining extensive dollarization.

Helping rectify these balance sheet weaknesses, Turkey’s large fiscal adjustment has been one of the most impressive features of recent IMF-supported programs. Debrun (2005) estimates the factors that determine primary surpluses across countries, and finds that Turkey’s fiscal adjustment since 2000 has been particularly impressive in size and longevity, marking a clear break with past performance. However, the risk is that this break cannot be sustained, and that Turkey’s primary surplus will revert to the lower levels predicted by Debrun’s cross-country analysis. Ramirez Rigo (2005) finds that Turkey’s fiscal adjustment has not borne the typical hallmarks of sustainability: he finds that the adjustment since 2000 has relied mainly on tax increases, with current expenditures increasing, and investment spending being cut, until recently. The emergence of a stronger and more disciplined government has helped, backed by efforts to curtail off-budget spending. Looking ahead, however, a redirection of the adjustment toward current spending cuts and less reliance on temporary tax increases would help sustain the current fiscal adjustment.

Complementing these fiscal reform efforts, recent IMF-supported programs have stressed efforts to improve the sustainability of public debt and its structure. Klingen (2005) surveys the literature on the appropriate level of public debt for emerging market economies such as Turkey, and concludes that achieving debt sustainability is not enough. Turkey’s high level of public debt continues to raise concerns about fiscal dominance, which could undermine the effectiveness of monetary policy in reducing inflation. These considerations suggest the importance of targeting a further substantial reduction in government debt over the medium term. Effective management of the public debt is essential to ensure that it is safely rolled over and that its structure is made more resilient to shocks. Lim (2005) reviews the authorities’ debt management strategy and gauges their success in issuing securities that more closely match investor needs, widening the investor base, deepening the liquidity of benchmark bonds, and improving the treasury’s debt management. The challenge is to continue to lengthen maturities and reduce reliance on foreign exchange indexed borrowing.

Reform of the financial sector has also been at the heart of the program, so that a recurrence of the 2000–2001 crisis can be prevented. Josefsson and Marston (2005) first describe the outbreak of the banking crisis and the measures taken by the authorities to contain it. They then explain the reforms that have been introduced, including the restructuring of state banks and the recapitalization of private banks. This strategy has largely succeeded in strengthening the banking system and enhancing the confidence of depositors.

Finally, despite Turkey’s impressive growth record in recent years, unemployment remains high. Verghis (2005) analyzes recent developments in Turkey’s labor market, particularly its low employment and labor force participation rates, especially for women. He notes that one obstacle to employment growth is the cost of complying with recent legislation on statutory employment protection, the amount of which is more than twice the average of the members of the Organization for Economic Cooperation and Development.