Information about Europe Europa
Chapter

3. Developments Since the Reform Period

Author(s):
International Monetary Fund
Published Date:
November 2005
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a. The period to 1988

For two years following the beginning of reforms, macroeconomic balances in Turkey improved. The current account deficit in the balance of payments was reduced by about two-thirds, supported by rapid export growth, and the overall balance moved into surplus. Between 1980 and 1982, the central government’s budget deficit was halved, making it possible to cut the public sector borrowing requirement (PSBR) to 6 percent of GDP in the latter year. The rate of monetary expansion was reduced, and the velocity of money declined rapidly as interest rates on time deposits became positive in real terms. Inflation decelerated from over 100 percent in the course of 1980 to 25 percent in 1982. Real GDP, which grew at a negative rate in 1980, increased at the rate of 5 percent in 1982.

In 1983, a year of significant further steps in trade liberalization, the direction of macroeconomic policy was reversed. Unemployment had grown during the “debt shock” years, putting pressure on Government for an expansionary stance, and an election was scheduled for November, marking a return to civilian government. Although imports grew rapidly in this period because of trade liberalization, GDP growth accelerated to 6 percent in 1984; the PSBR expanded to 8 percent of GDP; catch-up SEE price increases after the election, followed by a sharp nominal devaluation of the lira, pushed the inflation rate to 50 percent.

The period 1983–97 was one of increasingly expansionary monetary and fiscal policies. The real growth rate of GDP climbed from 5 percent to 8 percent in response. Nevertheless, inflation remained in the range of 30–50 percent (measured by the GDP deflator). And while imports grew faster than exports, the current account balance remained financeable. Several events occurred in this period to keep the economy from becoming more inflationary. The global oil price fell sharply in the mid-1980s (Turkey’s terms of trade improved about 10 percent in 1986), so that the increase in import values was held down. The real exchange rate continued to decline slightly year by year, and exports continued to grow (though, except for manufacturing, not robustly). Real wages fell slowly in this period; collective bargaining agreements still required the approval of the High Arbitration Council, established by the predecessor military government. Moreover, cost-of-living adjustments (for unionized workers, generally those in large establishments) were influenced by the expectation that inflation would decline further in the aftermath of reforms and the opening of the external sector. In 1985 a value added tax (VAT) was initiated, with a very strong one-time effect on revenues beginning in 1986—an increase amounting to 5 percent of GDP (expenditure increased equally, however). Renewed foreign borrowing in the form of repatriation of bank accounts of Turkish nationals working abroad pushed the short-term share of external debt up to half again but provided a supply of foreign finance.

But the expansionary policies ultimately led to trouble. By 1987, the PSBR reached 9 percent (an election year), and civil servants insisted on two cost-of-living adjustments per year instead of one, the second to include compensation for inflation exceeding the official expected rate at the time of the signing of the labor agreement. Interest rates ceilings were reduced despite signs of a resurgence of inflation, and depositors shifted a significant share of bank funds to foreign-currency denominated accounts (which had became permissible in 1984). In December, the month following the election, catch-up increases in SEE prices led to a ten-percentage-point jump in the price level. By the end of 1987, the Turkish lira was discounted 15 percent in the foreign exchange market.

b. 1988–91

The year 1988 began with a foreign exchange crisis, downward pressure on the lira and an outflow of foreign capital. Mild monetary measures (higher interest rate ceilings and higher reserve and liquidity ratios) were implemented in February and eased somewhat in mid-year. A second foreign exchange crisis followed in October, and monetary policy was tightened again. On the fiscal side, steps were taken to reduce the borrowing needs of SEEs (higher prices, wage restraint, and a postponement of investment spending), and the PSBR fell from about 9 percent to 7 percent of GDP. The measures tended to slow the growth of output, which fell to 3½ in 1988 and to 2 in 1989; however, inflation accelerated to 66 percent. Inflation was to remain stuck in the range of 60–70 percent for five years, following a period of about equal length in the range of 30–50 percent.

In 1989 policies were loosened. A reflow of foreign capital after the 1988 crises added to money growth. Employees of state economic enterprises received pay increases amounting to an average of 142 percent (with inflation at 66 percent), and civil servants and the private sector managed to do almost as well. In the shorter run, the large wage increases were not reflected in an acceleration of inflation but in reduced profit margins (see the discussion in Part II, Chapter 1, Section e). To some extent the wage adjustment, while surprisingly large, was anticipated, although the correction was more than enough to make up for falling real wages in the years since 1980. The restrictive macro policies of the preceding year, taken in response to foreign exchange market turbulence, together with a drought, had a strong depressing effect on real growth in 1989, which was, at 2 percent, about equal to the increase in population. It was not a natural time to pass on cost increases in the form of fast-rising prices.

The strong wage increases in 1989 led to a rebound of domestic demand and growth in 1990. The current account, which had been in surplus the year before when domestic demand was weak, slipped back into deficit. Then, in 1991, the economy was beset by an external shock, the Persian Gulf War. Turkey was to lose a major export market (Iraq) as a result, and generous oil pipeline fees, but initially the effect of the shock was to bring downward pressure on the lira. The central bank defended the currency and absorbed large trading losses as a result. The change in trade flows and in expectations generally due to the Gulf War brought an end to the economic expansion, with GDP growing 1.5 percent. The current account improved, as domestic demand stagnated, but no substantial change in the inflation rate occurred. The year 1991 was an election year, and in 1990 and 1991 there were further large wage increases. Partly in response to the sharply higher wages, private-sector firms let as many workers go as possible; they sought to reduce labor costs through sub-contracting, investment in labor-saving technologies, and reductions in seniority (workers with longer times in a particular job generally received somewhat higher pay). Labor turnover approached 30 percent in firms paying the large increases. As before, SEEs suppressed price increases before the election, and absorbed wage increases in the form of operating losses. Monetary and fiscal policy were lax in the period leading up to the election—in the case of fiscal policy, partly on account of increases in agricultural price supports.

c. 1992–9318

In 1992 there was a rebound of output, with real growth reaching 6 percent. The rebound would be easy to explain solely in terms of the very large wage increases of the preceding years and the end of the Gulf War. In addition, the PSBR increased from 11 percent to 14 percent, a strongly expansionary change, in part reflecting the wage increases in the public sector. In 1993 the expansion intensified, and imbalances became unmistakable toward the end of the year. The public sector deficit increased one more percentage point despite rising incomes, to 15 percent, an historical high. Real GDP growth accelerated to 8 percent, surprising in view of weakness in Turkey’s export markets (domestic demand expanded by 13½ percent). The volume of imports of merchandise increased 39 percent, and the current account deficit widened from 1 to 3½ percent of GDP. The debt-GDP ratio increased moderately from 35 percent to 37 percent at the end of 1993; at this point, one quarter of the debt was short term. In January 1994, two rating agencies downgraded Turkey’s credit rating. The loss of confidence on the part of creditors in the country’s ability to meet its external obligations was met by a tentative tightening of monetary policy and increases in interest rates. However, the limited measures only served to feed expectations of stronger action to come, and foreign lenders reduced their short-term exposure.

The central bank seemed intent on keeping monetary policy tight in this period to offset lax fiscal policy. It shifted financing of the central government from advances to securities, which had the effect of keeping interest rates high and attracting plenty of foreign capital to finance the current account deficit. The exchange rate tended to appreciate over the years 1990-93 as debt grew. Ultimately the confidence of foreign creditors was undermined by these two developments.

d. 1994–95

The central bank of Turkey lost 40 percent of its reserve assets in the early weeks of 1994 and eventually was forced to let the rate go. The lira depreciated 60 percent by early April. The crisis prompted the authorities to put together a stabilization program, which was announced in early April, and involved deep cuts in discretionary government spending, immediate price increases for SEEs (followed by a six-month freeze), and a tightening of monetary conditions.19 During the second quarter of the year, interest rates on three-month treasury securities averaged 275 percent (annual rate), moving for short periods as high as 400 percent.

The loss of access to international capital markets together with a tighter policy stance, and the effects of the exchange rate change and higher SEE prices on real wages, resulted in a dramatic fall in domestic demand, by over 12 percent in real terms in 1994. Real wages fell 15–20 percent for 1994 on average.20 The sharp fall in domestic demand was partly due to de-stocking; after unwanted inventories had been worked off, output in the industrial sector turned up again. Exports responded quickly to the exchange rate change and to slack domestic demand and rose by 35 percent in volume for the year as a whole; import volume declined 27 percent. Nevertheless, real GDP fell by 5.5 percent in 1994.

The large devaluation early in 1994 and the prices increases of SEEs (of 70–100 percent) initially pushed up the inflation rate. April over April, the rate was 125 percent, with perhaps a quarter of the acceleration due to the change in import prices in liras and half to the change in SEE prices.21 By mid-1994 the monthly rate of increase had slowed to only 2 percent. (At the time of harvest and of lower food prices, summer inflation rates are typically low.) However, with interest rates at very high levels and the expectation of a much reduced rate of nominal depreciation of the lira, short-term capital began to flow back into the economy by mid-year, enough that international reserves of the central bank were rebuilt and monetary expansion began to pick up. Besides the goal of continuing disinflation, and holding onto the competitiveness gains occasioned by the sharp devaluation early in the year, the central bank also needed to ease monetary tightness in order to reduce interest rates and the interest payments required on government debt. The tightness of stabilization policies was relaxed by autumn. The perceived resulting change in policy stance was interpreted as eroding public confidence in the sustainability of the anti-inflation program. Inflation re-accelerated, reaching 106 percent for the year on average. The real depreciation of the exchange rate for the year on average was 21 percent.

The economy rebounded in 1995, with GDP growing by 7 percent.22 Imports increased 33 percent in volume terms, throwing the current account again into modest deficit. Strong financial inflows were allowed to lift the exchange rate, by 13 percent in real terms for the year as a whole, to limit monetary expansion. Nevertheless, while inflation slowed early in the year, it accelerated in the second half. For the year on average the increase in the price level was 82 percent, 88 percent as measured by the consumer price index. These rates benefitted from the usual postponement of increases in prices of goods and services produced by the SEEs until after the election called for late December (see the final section, below), and from the real appreciation.

e. Fiscal developments in 1994–95

The stabilization program implemented in April 1994 was built around a large, front-loaded, fiscal correction. Under the program, the PSBR declined by 6 percentage points of GDP in 1994 and an additional three points in 1995. One percentage point of the decline in the PSBR in the first year came from the finances of SEEs. There were large increases in their prices, already mentioned, and a reduction in the stocks of agricultural goods held by SEEs involved in the price support program (the Soil Products Board). The larger improvement in SEE finances the following year included the effects of favorable crop prices (a decrease in the cost of price supports) and further postponement of investment projects. As it turned out, personnel costs for SEEs also declined because pay adjustments were delayed until the end of a strike by employees in October.

Tax measures yielded a decrease in the deficit amounting to 1½ points of GDP. They included a 10 percent surcharge on personal income and corporate profits tax liabilities. A ceiling was placed at the existing level on the number of employees in central government ministries and agencies for five years; new vacancies could be filled but there could not be an increase in the number of workers. Indexation of civil service salaries was ended. No unbudgeted wage increases were to be allowed in 1994; given the acceleration of inflation, this implied a fall in real wages. Personnel expenditure of government declined in relation to GDP from 11 percent in 1993 to 8 percent in 1995.

These fiscal savings taken together add up to more than the changes actually achieved in the PSBR because the savings were partly offset by increased interest payments. In a stabilization period, monetary policy is tightened and the cost to government of borrowing in the form of treasury bills and bonds increases, often markedly.23 If, as part of the reforms, a government intends to decrease monetary financing (advances by the central bank, which in general lead to money stock increases) by increasing the sale of securities, this will also lead to higher interest payments. The higher government interest expenditure frustrates the aim of reducing the PSBR relative to GDP.

Throughout the period 1991–93, the PSBR had been financed almost entirely through domestic borrowing. New external financing averaged 1 percent of GDP in 1992–93. But it turned negative in 1994–95 when Turkey’s access to international loans was interrupted. Net sales of government securities, which accounted for about 50 percent of domestic financing in 1991, rose to 82 percent by 1995 as financing from central bank advances was cut back. In its 1995 financing program, the Treasury sought to extend maturities on government paper over the course of the year and to resume external borrowing during the second half of the year. Substantial success was achieved in pursuing these objectives, with the Treasury selling unexpectedly large volumes of nine-month and one-year paper in the first half of the year, thereby shifting a portion of the interest burden into 1996 and reducing its borrowing need during the second half of 1995. However, with the heightened uncertainties created by the unexpected fall of the Government in September (see Section g), borrowing costs rose sharply during the last quarter while the maturities on new sales of government paper shortened considerably.

The political developments connected with the election at the end of 1995 also caused the wage increase for civil servants that would normally have taken place in early 1996 to be brought forward to November 1995. During the course of the year, wages of civil servants were raised on three occasions, by 19.6 percent in January, 36.2 percent in April, and 57.6 percent in November. An additional increase of 50 percent was agreed for mid-1996.

f. Monetary developments in 1994–95

The monetary objective of the program of April 1994 was to stabilize the value of the lira as a basis for bringing down the inflation rate over time. Higher interest rates, and a tighter stance of monetary policy generally, were expected to contribute to this result. However, there was considerable uncertainty at the time on the part of lira holders. For example, there was apparent doubt that the liberal policy regime that permitted deposits in foreign currencies would survive the crisis, and large-scale withdrawals of foreign exchange occurred. The central bank therefore moved rapidly to re-establish confidence in the banking system, extending the system of deposit insurance and opening new credit facilities for commercial banks experiencing liquidity problems. There was also a cessation of central bank advances to the central government, which was therefore forced to borrow completely at market rates. Interest costs were extremely high, as mentioned above.

The program to shore up the banking system was broadly successful. Only three small banks failed. It was supported eventually by the initial effects of fiscal measures to reduce the need for government borrowing from the banking system and by a strengthening of the lira (in real terms) in foreign exchange markets. However, the increase in confidence in the banking system was accompanied by an easing of monetary policy. In addition, capital flight was reversed by the later months of 1994, which added to upward pressure on the rate of growth of broad money. Unfortunately the growth of liquidity came at a time of renewed inflationary pressures and other factors undermining confidence of the public in the disinflation program (a constitutional court invalidated plans to hasten privatization of SEEs). Confidence of lira holders again ebbed. The monetary authorities, at the same time, declined to defend the lira with higher interest rates, seeking instead to lower the government’s financing costs. Inflation speeded up substantially toward the end of 1994.

Despite the easing in the stance of monetary policy toward the end of 1994, there was a restoration of confidence the following year, based especially on a strong recovery of economic activity. Foreign currency substitution was reversed in Turkish deposit money banks, international reserves in the central bank increased, and the recovery in economic activity brought a rise in the demand for credit from the private sector. The central bank bought foreign exchange to limit lira appreciation, with the result that the rate of growth of the money supply early in the year was substantially above the inflation rate (around 130 percent per year, not seasonally adjusted). By the middle of the year the central bank eased credit policy further; it undertook large foreign exchange purchases without sterilization to ease the liquidity shortage, and rapid money growth continued. After the political uncertainties at the end of the third quarter, the increase in the money supply accelerated significantly.

g. Political factors at the end of 1995 and prospects for 1996

In September 1995 the governing coalition in Turkey dissolved when one major party withdrew from participation. The prime minister, Ms. Ciller, refused to meet the demands of her former partner for public sector pay raises fully commensurate with inflation in the year. She resigned, and subsequently was asked by the president, Mr. Demirel, to form a new government. After talks lasting for several weeks, Ms. Ciller announced the formation of a coalition with partners from the far right and the center left. The new coalition failed a vote of confidence in parliament on October 15, and it was announced subsequently that national elections would take place on December 24. In that election, the voters gave no single party sufficient support to constitute a government on its own, so that either there will again be an attempt to form a coalition, perhaps with little more success than previously, or else another general election will be called. A long strike by employees in State Economic Enterprises occurred in October, and the government, in the pre-election atmosphere, ultimately gave in to generous wage increases; the wage increase for civil servants scheduled for January of 1996 was moved forward to late 1995, as already mentioned, and there were unscheduled cost-of-living increases to pensioners in mid-November. Financing for these expenditures involved the central bank, and the money supply grew rapidly during the final months of the year (in excess of 150 percent at an annual rate, private credit at a 280 percent annual rate), stimulating capital outflows and a drop in central bank reserves as the bank sought to avoid a rapid decline in the exchange rate of the lira without raising short-term interest rates. An extended period of political uncertainty was expected, while with the new year the government would have increased limits for borrowing from the central bank. The lira began to drop more rapidly on the foreign exchange market as the year closed despite central bank purchases. The annualized interest rate on treasury paper approached 240 percent.

It appears doubtful that the tightened stance of fiscal policy can avoid a fairly sharp increase in the PSBR relative to GDP in 1996. Measures taken to reduce SEE cost overruns—postponing wage increases, hiring, price-support increases, and investment projects—tend to depress spending and boost surpluses artificially. A return to a deficit in the neighborhood of the historical ratio of 3 percent of GDP for SEEs is to be expected following the small surplus in 1995 attributable to the emergency measures in 1994. In addition, the deficit in the social security budget is expected to increase from 1 percent of GDP in 1995 to 2 percent in 1996. Government investment was reduced to 4 percent of GDP in the crisis but had been 8 percent in 1991, and can be expected to recover significantly in 1996 and subsequent years. Tariff reductions scheduled for January 1 will reduce revenues by 0.3 percent of GDP. While personnel costs could grow more slowly in real terms following the freeze on the number of civil service positions imposed in 1994, similar policies have proved difficult to sustain in the past as the economy edged away from financial crises. There are a number of reasons to expect that interest payments will increase.

Table I.1.Turkey: Selected Indicators of Economic Performance, 1991-95
19911992199319941995
(Annual percentage changes unless otherwise indicated)
National income and prices
Real GDP1.05.98.1-5.57.3
Real domestic demand0.95.213.5-12.412.7
GDP deflator58.863.867.7106.581.9
Consumer price index66.070.166.1106.388.1
External sector
Export volumes9.13.51.535.30.3
Export prices 1/-3.84.52.8-12.819.2
Import volumes-2.78.639.2-26.933.4
Import prices 1/-3.00.1-7.68.215.1
Terms of trade-0.84.511.2-19.43.6
Real effective exchange rate (1992=100) 2/105.9100.0103.081.892.6
Debt service ratio 3/29.230.727.030.528.7
Current account (percent of GDP)0.2-0.6-3.62.0-1.4
Overall balance (percent of GDP)-0.70.90.20.22.8
External debt (end-year, percent of GDP) 4/33.434.937.350.244.5
Gross convertible reserves of the central bank
in months of imports 5/2.52.32.83.3
Net reserves of the central bank
in months of imports 6/2.22.02.42.8
Monetary sector
Broad money (M2)67.854.0114.2102.5
Broad money incl. foreign currency deposits (M2X)78.164.4145.3103.6
Average M2X 7/69.31 14.7115.7
Domestic credit92.794.191.7118.2
Credit to private sector83.984.571.3134.9
Average credit to private sector 7/84.375.9111.4
Velocity, average M2X4.64.94.54.0
Market interest rate 8/89.498.6125.6169.9
(As percentage of GDP)
Public sector borrowing requirement10.813.915.19.46.2
General government
Revenue19.019.726.126.725.1
Expenditure26.230.438.534.632.1
Current17.823.133.530.828.3
Capital and net lending8.47.35.03.83.8
Nonfinancial state economic enterprises
borrowing requirement3.63.22.81.5-0.8
Source: OECD data base and IMF, Turkey—Recent Economic Developments, 1996 and 1997.

In U.S. dollars.

Average period. Increase signifies an appreciation. Based on the nominal exchange rates and wholesale price indices weighted by the shares in Turkey’s imports of the U.S., Germany, Belgium, the Netherlands, Switzerland, Italy, the U.K., and Japan.

Interest plus medium- and long-term debt repayments as percent of current account receipts (excluding official transfers).

GDP converted to dollars using average-period exchage rate. If debt is converted to liras using end-period rates the shares are larger—by around 5 percentage points for these years.

Average of beginning- and end-of-year reserves; imports of goods and services.

Gross convertible assets net of liquid foreign liabilities; average of beginning- and end-of-year reserves.

Average of beginning- and end-of-year stocks.

Percent per year. Three-month treasury bills, period average (average of December-December rates).

Source: OECD data base and IMF, Turkey—Recent Economic Developments, 1996 and 1997.

In U.S. dollars.

Average period. Increase signifies an appreciation. Based on the nominal exchange rates and wholesale price indices weighted by the shares in Turkey’s imports of the U.S., Germany, Belgium, the Netherlands, Switzerland, Italy, the U.K., and Japan.

Interest plus medium- and long-term debt repayments as percent of current account receipts (excluding official transfers).

GDP converted to dollars using average-period exchage rate. If debt is converted to liras using end-period rates the shares are larger—by around 5 percentage points for these years.

Average of beginning- and end-of-year reserves; imports of goods and services.

Gross convertible assets net of liquid foreign liabilities; average of beginning- and end-of-year reserves.

Average of beginning- and end-of-year stocks.

Percent per year. Three-month treasury bills, period average (average of December-December rates).

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