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The following OECD assessment and recommendations summarise Chapter 2 of the Economic Survey of Turkey published on 18 October 2006.
Monetary policy credibility needs to be bolstered
The Turkish central bank has gained much credibility and achieved an impressive record in lowering inflation since being made independent in 2001 and charged with the task of disinflation. Tight fiscal policies, structural reforms and high productivity growth also contributed to the disinflation process. Furthermore, exchange rate appreciation played a particularly important role in reducing inflation while price rises in non-traded goods remained sticky at around 12–14% per annum. To a large extent, this seems to be due to remaining barriers to competition, and other structural rigidities – such as in the labour market – which keep prices artificially high and slow the pace of disinflation, making it more difficult for the Central Bank to lower interest rates. The challenge faced by the Central Bank has become even more acute in recent months following an unexpected up-tick in inflation, together with significant exchange rate depreciation. The Bank responded to the inflation surprise by abandoning its previous course of interest rate cuts and raising the short-term policy rate in three consecutive rounds by a total of 425 basis points, pushing the short-term interest rate up to 17.50%. Although the Bank acknowledged that the 2006 end-year inflation target of 5% (with an uncertainty band of +/-2%) would not be achieved, it stressed its commitment to achieving the medium-term inflation target of 4%. Given the circumstances, the Bank’s policy action was essential. But surveys indicate that over the summer medium-term inflation expectations have risen sharply and despite a recent small decline are still significantly above the medium-term target. The Bank thus faces significant challenges in restoring inflation to the desired path and further sensible policy measures will be required, together with strong communication of the analysis underpinning these measures, to convince the public that the deviation of inflation from target is temporary. More generally, a broad-ranging structural reform programme is needed to facilitate the disinflation process and bolster credibility.
The prudential regulatory framework should be further reinforced
Following the 2001 crisis, bank regulation and supervision was significantly upgraded, and this limits the potential risk that increased foreign indebtedness of the private sector and the recent boom in domestic credit pose to the soundness of the banking system. The new banking law implemented in 2005 further improved the prudential regulations and, according to the 2006 Financial Stability Report of the Central Bank, banks are in a healthy situation. In particular, the direct exchange-rate risk of the banking sector is reportedly low – although mainly through renewable hedging instruments contracted with other domestic financial intermediaries. But banks remain exposed to the exchange rate through the credit risk of domestic borrowers with unhedged foreign currency liabilities. In the current risky financial market environment it is crucial to ensure that prudential banking supervision is sound. To this end the quality of financial supervision should be stepped up further, in particular by improving the efficiency and governance of the Banking Regulation and Supervision Authority, as recommended by the Imar Commission. The authorities should also consider additional mechanisms to reduce the indirect foreign exchange exposure of banks.
Maintaining fiscal discipline is crucial
Since the 2001 crisis, Turkey has achieved some impressive fiscal outcomes – in particular, an increased primary fiscal surplus, although this was achieved partly by raising taxes which were already at a high level. Lower interest rates led to a sharp decline in government interest payments and the overall general government deficit has declined from around 30% of GDP in 2001 to around 1% in 2005. Similarly, net public sector debt declined from 91% of GDP in 2001 to 56% in 2005. While the overall fiscal stance has been relatively tight over the past few years, the practise of targeting the actual primary balance means that it became less tight during the recent cyclical upswing. In order to prevent such pro-cyclical behaviour in future, the government has recently announced an intention to complement the annual primary balance target with an expenditure target. Expenditure targets should be introduced within the multi-year budgeting framework and extended to all layers of general government, including health care institutions and local governments.
Fiscal transparency and the quality of fiscal institutions should be further improved
A number of new laws introduced since the 2001 crisis aim to improve fiscal transparency and budgeting practices. These have included the introduction of a three-year budgeting framework and a reduction in the room for extra-budgetary and quasi-fiscal spending. However, further progress with implementation is important, and uncertainty in the legislative environment should be reduced. In addition, although fiscal notification to the EU represents progress, transparency continues to suffer from the absence of consolidated general government fiscal accounts prepared according to National Accounting Standards. At present, the IMF closely monitors fiscal performance through a range of indicators, as part of Turkey’s Stand-By Arrangement, and this provides market participants with a significant degree of reassurance. Fiscal data prepared according to National Accounting Standards should be published prior to the end of the current programme with the IMF in spring 2008. The government should also take steps to ensure that key fiscal laws cannot be easily weakened in the future, to improve the coordination of fiscal responsibilities, to steadily expand the scope of performance-based budgeting and to incorporate all extra-budgetary funds into the general government accounts. Revolving funds should either be incorporated into the budget or the relevant institution should be corporatised. Pushing ahead with these reform steps would significantly improve the international perception of the quality and reliability of Turkey’s fiscal institutions and facilitate a renewed decline in the risk premium.
Key indicators of economic vulnerability
1. For TL denominated debt instruments only.
2. General government revenue for 2005 is a government estimate.
Source: Turkish Treasury, SPO, TURKSTAT, CBRT, JP Morgan.
Positive macroeconomic fundamentals
1. Primary market treasury bill interest rate (compound) (weighted by net sales).
2. Turkey's secondary market bond spread over US Treasuries.
Source: JP Morgan, Central Bank of Turkey and OECD.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of Turkey 2006 is available from:
For further information please contact the Turkey Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by Rauf Gonenc, Anne-Marie Brook, Ugur Ciplak, Gökhan Yilmaz and Rina Bhattacharya under the supervision of Wilhem Leibfritz.
Policies to improve Turkey's resilience to financial market shocks