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Turkey is at a crossroads. After hitting the most severe crisis of its recent history in 2000-2001, the economy bounced back and is now among the fastest growing economies in the OECD. A new institutional framework for monetary and fiscal policies as well as for product, labour and financial markets, infrastructure industries, and agricultural support opened a window of opportunity to escape from the three traps of low confidence, weak governance and high informality which underpinned the boom and bust cycle of the past and to embark durably on a higher growth path. Success will depend on fully implementing and completing the new policy framework.
Strong growth, sharply falling inflation, large productivity gains and relatively low job creation characterise the ongoing recovery. Yet it is too early to determine at this point to what extent the rebound reflects a transition to a higher medium term growth path. Tight monetary and fiscal policies increased confidence, reduced risk premia and thereby fostered growth; however, the current account deficit has widened. Macroeconomic policy should continue to be based on a high primary budget surplus to improve debt sustainability, and tight monetary conditions to keep disinflation on a steep downward path. Given the strength of the economy and the risk of a further widening of the current balance deficit, the authorities should resist any temptation to loosen the fiscal stance and use additional revenues from higher growth for debt reduction. Monetary policy should remain focused on the requirements of continuing disinflation and smoothing out erratic exchange rate fluctuations.
The quality of fiscal consolidation needs to be improved by reorienting expenditures to priority and growth enhancing areas. A new public expenditure management system has been introduced, based on functional multi-year budgeting and integrated general government accounting. It should be fully implemented by rapidly diffusing the necessary technical know-how in line ministries, and by putting in place an effective audit infrastructure which should help build credibility for the new system and diffuse best expenditure management practices. In the core public services which are particularly critical for growth, such as justice, education and infrastructure services, more proactive policies to rapidly improve service quality are required. As a response to entrenched cost-inefficiencies and low responsiveness to user and local needs in public administration, an ambitious fiscal decentralisation is now in the pipeline, transferring large service and spending responsibilities to sub-central layers of government. The reform will also fully separate public funding from private provision of services, and new regional development agencies will co-ordinate infrastructure enhancement and private-sector based economic development initiatives. The principles of these reforms are in line with OECD best practices, but implementation risks loom concerning fiscal drift, diseconomies of scale and quality shortcomings in decentralised services. The authorities need to ensure that fiscal discipline, cost-efficiency and service quality are guaranteed.
The business environment has improved and exhibits many strengths. However, a major problem is the significant extent of unregistered activities, which account for more than 50 per cent of total employment and lead to a narrowing of the tax base. A strategy based on enforcement and economic incentives is needed to reduce the size of the informal sector. This should include less onerous regulations in product and labour markets and shifting the burden of tax and social security charges away from labour. Privatisation should be advanced in order to increase economic efficiency. It would also help to attract FDI inflows. The bank restructuring following the 2001 crisis improved banking regulation and supervision significantly and there are early signs of improving credit funding for investment. However, ongoing reforms of corporate governance structures should be pursued in order to further improve the integrity of the banking system, and the privatisation of public banks would be an important step in that direction. Despite liberalisation efforts in infrastructure industries, competition and private investment in electricity, natural gas and parts of telecommunications remain underdeveloped and services are offered at high costs, especially for business users. Independent sectoral regulators and competition authorities should be fully operational in enforcing competition and adequate rules for price formation and market entry in those industries where monopolistic incumbents prevail.
For Turkey to truly establish a new “economic regime” for growth based on macroeconomic and structural policy renewal, it is of crucial importance that confidence in government policies remains intact. So far, the convergence with the EU acquis, and the close co-operation with the IMF and the World Bank have contributed critically to the momentum of policies. The recent recommendation by the EU commission to start EU accession negotiations – if confirmed by the European Council in December – promises to strengthen the international anchors and could underpin Turkey’s shift to a new economic regime.
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