Economic outlook, analysis and forecasts

Economic Survey - Turkey 2004: Macroeconomic policies - strengthening confidence and reducing risk premia

 

The reform agenda following the 2000 01 crisis, based on the National Convergence Programme to the EU acquis and on the Stand-By Arrangement with the IMF, and later reinforced by the Urgent Action Plan of the current government, has indeed aimed to address these problems.  This agenda includes ambitious macro-stabilisation and institutional reforms and has been endorsed by two successive governments. The new policies are perceived as pre-requisites for the possible opening of accession negotiations with the EU and enjoy remarkable public support. Ongoing efforts to overhaul the macroeconomic policy framework, to strengthen the key public institutions and services, and to fully establish an open and business-friendly environment amount to building a new “regime” for economic growth. They have a potential to durably increase the confidence of domestic and international investors, enhance public governance and help the business sector to increase investment and productivity. Turkey’s success in implementing and further developing this ambitious reform agenda will determine its ability to shift to a stronger, sustainable and job-rich growth path. Political stability is supporting this process. If micro-and macroeconomic reforms result in stronger growth, additional resources will become available to pursue social and environmental objectives. If the public perceives that social and environmental dimensions of sustainable development are not left behind but form an integral part of the reform agenda, support for pro-growth initiatives will strengthen.

The establishment of the new macroeconomic settings was of key importance for improving confidence. It started in response to the 2000 01 crisis and has concerned fundamental changes in both monetary and fiscal policy-making. On the monetary side, the Central Bank became independent from the government in April 2001, with an explicit price stability objective, and is no longer allowed to lend to the Treasury. While interest and exchange rates continue to be heavily influenced by fiscal policies due to the large public sector borrowing requirements, the Central Bank has been successful in building up credibility over time and is increasingly shaping inflation and interest rate expectations. The process of disinflation has been impressive with the inflation rate declining from 54 per cent in 2001 to 25 per cent in 2003 and to 12 per cent in the first half of 2004. The Secretariat estimates that the inflation rate will continue to decline to 8 9 per cent in 2005. For the first time in three decades Turkey would then have attained single-digit annual inflation. This assumes, however, that monetary and fiscal policies remain on track and that there are no headwinds from exchange rate developments. Both fiscal and exchange rate developments are interrelated; with the high government debt, any loss in confidence would increase interest rates and government net interest payments and raise concerns about fiscal sustainability, thereby triggering a depreciation of the Turkish Lira and an increase in import prices. This would make it difficult for the Central Bank to control inflation. However, with ongoing progress in fiscal consolidation and disinflation, financial market confidence should continue to strengthen so that the monetary authorities could then gradually reduce interest rates further to improve investment conditions. Moreover, after having achieved a good track record in meeting end-of-year inflation targets, the monetary authorities should eventually move from the current “quasi inflation targeting” to a formal targeting framework, which would entail increased transparency and visibility, and hence further strengthen their commitment to achieving price stability. In parallel, the Central Bank should continue to smooth temporary imbalances of foreign currency supply and demand in order to avoid sharp exchange rate fluctuations with their potentially adverse impacts on the economy.

On the fiscal side, the post-crisis agreement between the government and the IMF on an ambitious primary surplus target of 6.5 per cent of GNP has marked a break from the past and the success in broadly meeting this target has played a key role for macroeconomic stabilisation. The fiscal stance is now more closely managed, as most off-budget funds have been phased out and quasi-fiscal activities are much harder to undertake without corresponding budget appropriations.  Nevertheless the Treasury’s borrowing requirements and interest payments remain very high. It is therefore essential to continue with strict fiscal consolidation and the generation of sizeable primary surpluses to foster trust in the government’s new fiscal prudence and further reduce risk premia and interest rates over time. In this context, the new general government accounting system should be fully and swiftly implemented and integrated with national accounts. The government should continue to stick to existing international policy anchors, such as the close collaboration with the IMF, in order to add credibility to its fiscal policy objectives, to maintain and strengthen investor confidence, and to reduce interest payments on sovereign debt.


Has the sustainability of public debt improved?

The level and growth rate of public debt became the primary source of macroeconomic vulnerability in Turkey following the crisis, with a public net debt to GNP ratio around 90 per cent in 2001 and concerns in domestic and international markets about its sustainability. The debt stock’s short maturity and the large share of foreign-currency linked securities implied particularly high rates of rollover on domestic and international markets, increasing the vulnerability to interest rate and currency rate shocks. Although Turkey has made remarkable progress in restoring debt sustainability with high primary surpluses, lower borrowing costs, currency appreciation and high growth    which all helped reduce the public net debt to GNP ratio to about 70 per cent at the end of 2003     risk factors remain, albeit to a lesser extent. Any rise in risk premia not only increases the government’s current borrowing costs, but immediately reflects on the financing costs of the large stock of liabilities. The latter easily increase or decrease by several percentage points of GNP in response to fluctuations in risk premia. This exposure to market sentiment makes fostering confidence and reducing risk premia particularly important. Indeed, political tension, even that arising from non-economic issues, has a major impact on markets. As a result, maintaining today’s welcome political consensus in support of the reform agenda is very important. Improvements in communication policies could in this context play a role, in particular stressing the widely shared commitment to the reform agenda. The recent introduction of a more transparent debt management and reporting system will also contribute to better market information and reduce risk perceptions.

This reporting system should be fully applied to all general government liabilities and non-guaranteed borrowings of sub-central governments and other public sector entities.

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