For years, economic dramas in the emerging markets followed
the same familiar script. Turkey, duly playing its part, would
post chronic inflation, a surging public debt, a rise in
unemployment and, as in 2001, a crisis in the banking
This time round, the countrys exports have slumped,
unemployment has risen to around 12.5% and most worrying, youth
unemployment is at 25%. In the last quarter of 2008, the
economy contracted 6.2%, the first shrinkage in seven years.
Last month, central bank governor Durmus Yilmaz warned of a
double digit contraction in gross domestic product and a
slower and more gradual recovery in 2010 than was
anticipated in his January report.
Public finances have deteriorated too with the government
more than quadrupling its 2009 budget deficit target to TL48.3
billion ($30.37 billion) from the previous TL10.4 billion. And
the IMF, meanwhile, expects Turkeys economy to shrink
5.1% this year, after it grew nearly 7% annually between 2001
Turkeys economic rehabilitation since 2001 has relied
in no small part on abundant foreign capital. But the flow of
foreign capital has dried up fast, with the IMF estimating that
private capital flows to emerging markets will decline from
some $600 billion in 2007 to just $180 billion in 2009.
However, the slump in commodity prices and a dramatic
contraction in demand has ensured that inflation remains, for
now, under control and according to Yilmaz, is tipped to range
between 4.8% and 7.2% in 2009, significantly undershooting the
central banks target of 7.5%. This has left the central
bank with room to manoeuvre on rates, and in an attempt to
stimulate growth, it has cut seven percentage points off the
benchmark rate in the last six months, the latest rate cut
coming at the banks April 16 meeting, when it slashed
rates by 75bp to a record low of 9.75%.
Promoting the package
Fairly or unfairly, IMF assistance packages have tended to
play badly with the Turkish electorate. The perception that
seeking outside help is an embarrassing admission of economic
failure has been compounded by domestically unpopular fiscal
reforms required by the IMF.
This tension between what is economically best for Turkey
and what plays well with voters has left the AKP (Justice and
Development Party) facing an unenviable tightrope walk between
holding onto power on the one hand and implementing much needed
fiscal reforms on the other.
And, as in IMF negotiations of the past, its these
fiscal reforms that have become the sticking point in
negotiations between the IMF and the Turkish government.
On both the income and expenditure side, changes are needed
to bring the ratio of central government debt to GDP
expected to rise to between 7% and 8% by Gazi Ercel, president
of Ercel Global Advisory onto a declining
Structural reforms to make the tax system less pro-cyclical
are also yet to materialize. Some 70% of the countrys tax
revenues are derived from indirect taxes, with only 1520%
of revenues coming from corporate and income tax, ensuring the
rise in government spending has coincided with a dramatic fall
in revenues. The underground economy constitutes around 50% of
The IMF is said to want the introduction of an independent
revenue and taxation administration and for some indication
that government spending will be controlled.
The April G20 summit in London tripled IMF resources to the
IMF to tackle the economic crisis. For its part, the Fund has
softened its stance by relaxing its lending terms and dropping
the structuring conditionality of its stand-by agreements. The
G20 also made provisions for a new flexible credit line
facility conditional on a good track record of sound
macro policies. Investors have welcomed flexible credit
line facilities in Mexico, Poland and Colombia as a sort of IMF
seal of approval of sound fundamentals and economic
The main aim of the IMF facility will be to support
growth and bring down the debt to GDP ratio by increasing the
primary surplus, says Mehmet Mazi, head of emerging
markets, EMEA (Europe, the Middle East and Africa) at HSBC.
In the past, the IMF has imposed strict limits on public
spending, but this time, because the aim is to facilitate
growth and to keep the credibility of the sovereign, the
IMFs caveats will be less stringent.
While discussions regarding a new IMF arrangement remain
centred on a replacement standby agreement with $25
billion$35 billion of funding, the IMFs gentler
stance may indicate a flexible credit line for Turkey too.
According to Turker Hamzaoglu, EMEA analyst at Merrill
Lynch, assuming a refinancing rate of between 75% and 80% for
corporate and banks, Turkeys external funding gap will
reach some $23 billion in 2009, but could increase to $35
billion should refinancing slip to 50%.
The IMFs bearish forecasts suggest a more generous
package may be likely, and speculation is mounting that the
package could be as much as $45 billion$50 billion.
But Turkish experts remain sceptical as to whether the
country will be eligible for such a flexible credit line of
such scale. The IMF insists on a necessary correction in
revenues and the structure of the budget because the fiscal
deficit is rising and debt is concentrated on the
short-term, says Ercel.
The Fund wants to establish an independent revenue
department an independent tax administration and
wants a plan for cuts to government expenditure.
Ercel believes a standby arrangement is more likely than a
flexible credit line facility, mainly because unlike the
governments of Poland and Mexico, the AKP has yet failed to
indicate an intention to implement fiscal reforms in the coming
If the Turkish government shows it is taking measures
to counteract fiscal imbalances, it will be eligible for a
flexible credit line, says Ercel. The IMF just
needs some indication of an intention to control the government
deficit over the next two to three years, he adds.
But at this point in time, there has been no such signal.
On the contrary, the government is offering tax rebates and an
increase in spending in the municipalities.
Murat Ucer, senior economist at Istanbul Economics agrees.
At this point, there is no option for Turkey
its going to have to be a standby agreement. Like
everybody, Turkey has used fiscal policy in this economic
crisis but now has a huge deficit a government deficit
of 6% of GDP would not be an exaggeration. The question is: how
do we get back to a more reasonable level?
And a $50 billion credit line is unlikely, Ercel says.
Turkey has a funding gap in 2009 of $15$20 billion,
and in 2010 of around $20$25 billion, says Ercel.
The total is more likely to be $20 billion$30
The reports about a $40 billion facility are
bogus, Ucer adds. It would take an enormous amount
of fiscal adjustment for the IMF to agree to that kind of
money. Sure, the IMF will be easier on Turkey we are in
a Keynesian world, but there is a limit to how far Turkey can
go with fiscal stimulus.
The limit, of course, is the ever-present risk of inflation.
Ercel warns that inflation, while currently at a manageable
level, could be reignited if the government fails to rein in
spending. From my reading, he says, the
government wants to use the IMFs funds for budgetary
purposes or to extend credit lines to SMEs [small and
medium-size enterprises] that is, purposes other than
the balance of payments. The IMF was very stringent on this
issue but is more flexible these days, and Hungary has used its
IMF funds to assist its banks with their foreign currency
However, Ercel warns that using the IMFs funds to
stimulate growth could reignite inflation. With the
central bank easing monetary policy, the government needs to
protect fiscal policy but is doing the opposite, says
Ercel. Inflation is an ever-present problem in Turkey,
and we need to remain vigilant.
The problems in emerging Europe are, in many respects,
reminiscent of Turkeys banking and balance-of-payments
crisis of 2001. Twenty-two banks were taken over by the State
Deposit and Insurance Fund, wages fell by 20%, unemployment
rose by four percentage points to 10.6% and public debt
skyrocketed. The result was a 6% year-on-year contraction in
the Turkish economy, and the country embarked on a bank
restructuring the cost of which reached 30% of GDP.
It was, perhaps, the banking sector reforms that followed
the crisis which have ensured that Turkeys banking system
remains the most stable in the region. Turkeys low
domestic credit penetration has effectively insulated its banks
from the crisis of non-performing loans that is plaguing their
eastern European counterparts. Total credit to GDP is just 37%,
and the mortgage system remains tiny. HSBCs Mazi
estimates the total volume of mortgages outstanding at $10
billion$15 billion out of $25 billion of total home
loans, which corresponds to only 4% of total GDP.
The Turkish banking sector has one of the strongest balance
sheets among its regional peers regulatory capital is
around 17% and non-performing loans only 4%. And unlike their
peers in the CIS, Turkish banks also have low-level exposure to
international wholesale funding markets.
But fears remain that a wave of corporate defaults could be
in the wings, and this has made banks reluctant to lend. This,
combined with the evaporation of foreign capital flows into
Turkey, has ensured that monetary policy has thus far been
largely ineffective in stimulating economic growth. While the
government initially hesitated, aggressive fiscal expansion has
followed with higher public spending, trade credits and funding
facilities for exporters and SMEs.
The long-standing tendency in Turkey for economic crises to
spill over into political ones has thus far at least been
avoided. On the contrary, the country is enjoying one of the
longest periods of stable government it has known. While
support for the market-friendly AKP fell from 46% in the 2007
parliamentary elections to 39% at the March local poll, the
governments mandate is decent enough to ensure that few
anticipate intervention by the military.
Politically, a bold cabinet reshuffle in early May saw the
appointment of cabinet heavyweight Ali Babacan, Turkeys
former economy minister, as the new deputy prime minister in
charge of the economy, with responsibility for the banking
system and the treasury. The reshuffle also replaced the
ministers of justice, finance, education, housing, industry and
trade and energy.
By combining economy minister and the deputy prime
minister job, you bring decision-making and influence of the
prime minister into one person, says Christian Keller,
Barclays Capital Emerging Markets strategy director. This
is definitely an improvement compared with the previous
administration, but it wont change around the economy
Memories of the 2001 crisis remain fresh, but so too do the
benefits of the economic reform programme that came in the
aftermath of the crisis. In 2001, as Turkey negotiated its IMF
programme, the country was facing low domestic savings, high
inflation, a weak banking system and poor public finances. But
sweeping reforms, tight fiscal policy (until recently), a
floating exchange rate, inflation targeting and an
unprecedented flow of funds from the IMF have brought about a
dramatic improvement in the countrys economic
We maintain that Turkey is experiencing its first
mature business cycle without a full-blown crisis, which we
define as a deep contraction in economic activity, sharp
deterioration in macro prices and significant balance sheet
impairment, says Hamzaoglu at Merrill Lynch.
Economic growth faces strong headwinds from much weaker
external and domestic demand and tighter credit. But as
Hamzaoglu notes, While this is clearly painful, as
millions of people are losing their jobs, the silver lining is
that this recession should still be less costly and destructive
than crises of the past.