As game changing goes, Turkeys latest move is
striking. The government announced in September a three-year
economic programme which aims to get a grip on public finances
while steering the economy out of recession and back to
But in doing so, Turkish authorities have at once thrown
down the gauntlet to the IMF on the terms for a possible loan,
while sending a strong signal to markets that the government
believes it can manage its debt just fine.
In an interview with Emerging Markets, Ali Babacan,
Turkeys deputy prime minister in charge of the economy,
is unambiguous in his message on economic reform: make no
mistake about it, were doing it our way.
Its a political choice at the end of the
day, says Babacan. This is the choice of our
government; this is the way we want to go; and others should
probably make their calculations according to what we have
The reforms envisaged are largely in line with IMF thinking:
the plans hinge on a commitment to tighten fiscal policy, to
help rein in a soaring budget deficit made worse by the
Turkey has lacked an external anchor for economic policy
since its IMF standby agreement expired last year. When it
failed to release a fiscal plan as expected in the spring, and
negotiations with the IMF dragged on inconclusively, fears grew
that the government didnt have a plan to turn the fiscal
But now, says Babacan, Turkey has provided the clearest
evidence yet that its economy is on the road to recovery
and that an IMF loan is not vital.
We are declaring a predictable but gradual return to
fiscal discipline, but we are not doing this too fast to choke
growth, he says. We are going to be one of the few
countries which has explicitly and openly declared its exit
Every government has to try and time its exit strategy
correctly from its fiscal stimulus programme. If its
premature, it can derail growth. If its too late, it can
lead to fiscal or inflationary concerns. The medium-term
economic programme is our exit strategy.
The government expects the economy to contract by 6% this
year, with growth probably beginning in the fourth
quarter, and then GDP growth of 3.5% in 2010, 4% in 2011 and 5%
in 2012, according to Babacan.
But things dont always go to plan. Having initially
believed the global economic crisis had bypassed
Turkey, in the words of prime minister Recep Tayyip Erdogan,
the government was forced to open up the public coffers this
March when it became clear that Turkeys economy
had been hard hit and it spent $10 billion on
infrastructure and tax cuts.
The measures were a response to the rapid contraction of the
economy in the first quarter, which shrank by 13.8%
year-on-year, as exports plummeted by 30% and domestic demand
also fell sharply. Turkey was one of the worst hit
economies by the credit crunch in the first quarter, according
to GDP figures, says Mahmut Kaya, chief economist at
The stimulus, and the fall in tax revenues from lower
economic growth, led to a 6% budget deficit not as big
as some of Turkeys peers in central and eastern Europe,
but still galling for a government that prides itself on its
fiscal prudence and on the fact that in 2007 it became the
first Turkish government to achieve a budget surplus in 23
It took a lot of effort to bring down the debt over
the last five years from the high levels of the beginning of
the decade. Now, some investors are worried we are going back
to the bad old days, says Kaya.
But Babacan says the stimulus is being withdrawn and that
there are no plans to increase government spending. We
are taking back all the stimulus plans we have enacted,
he says. There is a limit to fiscal expansion. I believe
we have reached that limit. The government says it will
not increase government spending up to 2011, when it faces a
general election, and will then begin reducing public debt in
2012. It also says it will reduce the budget deficit to the
Maastricht criteria of 3% by 2012. When we looked at the
overall fiscal picture, we found that it is good enough to hit
our targets, says Babacan.
Turkey will also for the first time introduce a fiscal
rule in 2011, which will define the level of available
spending according to the deficit level. Its the
first time in our history we have used such a rule, which will
bring long-term predictability to our fiscal framework and
reduce risk premiums, says Babacan.
He says he will not provide explicit debt to GDP targets
under a fiscal rule The deficit target will imply
a public debt to GDP ratio for the long term.
But the essence here is that if we are too far away
from our target then the annual fiscal targets will be higher.
If we are closer to the target, the adjustments will be
Similarly, the fiscal rule will also allow higher deficits
in years when growth is below the long-term average, and
conversely, lower deficits when growth exceeds expectations, he
says. In good times we are planning to save for bad times
this is the essence of the fiscal rule, Babacan
Market reaction to the medium-term programme has been mixed
so far. Standard & Poors and Moodys both raised
the countrys outlook to stable, while Turkish bond and
stock prices were mainly carried along by the broader emerging
Most investors have a wait-and-see attitude to Turkey
at the moment, says Tevfik Aksoy, economist at Morgan
Stanley in London. The government has a very gradual
fiscal adjustment plan, which envisages a slow recovery
3.5% growth next year is not much at all for a country with
such a fast-growing population.
But some observers are concerned that a delay to 2011 in
spending cuts is inviting trouble, as a fiscal rule wont
take effect in time to keep a lid on pre-election spending.
Moreover, the government has little room to manoeuvre if growth
We welcome the fiscal rule, but perhaps the government
could introduce it sooner than 2011, says Aksoy.
What worries me is there is no contingency plan if the
global recovery is slower than expected.
Independent Turkish economist Murat Ucer is more bearish:
The government has lost control on the expenditure side.
Primary budget expenditures started to grow very fast even
before the crisis they have grown from 17% to 22% in the
last two years, mainly on healthcare and municipal spending.
There are no signs the government will make cuts; just more
Babacan wont be drawn on what spending cuts will be
made, or when. There are savings we can definitely make,
but we have to be very careful on the savings side that we
dont do things that can influence growth in a negative
way. We are looking at the sensitivities of expenditure and
He says that tax revenues will be the main source for
shrinking the budget deficit: When we return to positive
growth next year, automatically our tax revenues will start to
There are signs the governments tax policy is already
paying dividends. One of the reasons the economic crisis has
not been worse in Turkey, despite the high level of foreign
debt of the private sector and the declining risk appetite of
foreign lenders, is the $18 billion in unaccounted foreign
capital that has entered the country since the start of the
Morgan Stanleys Aksoy says: No one is sure where
this money came from, but our view is its Turkish
corporates offshore funds, which they brought back into
the country following the governments announcement at the
beginning of the year of a tax amnesty for offshore funds. If
it hadnt been for those inflows, the crisis would have
been a lot worse.
While the credit crunch clearly had a sizeable impact on
Turkey, there is cause for cheer. For a start, the economic
slowdown has helped bring down the inflation rate to around
7.5% its lowest level in 40 years compared to 45%
when the AKP party came to power in 2002.
Kaya of Garanti Securities says: Its a
phenomenal achievement. The decline in inflation is one of the
few bright spots in an otherwise gloomy picture. Perhaps Turkey
needed a crisis to bring down inflation from the low teens to
The disinflation caused by the economic slowdown has allowed
the central bank to cut rates aggressively governor
Durmus Yilmaz has eased policy by a total of 9.5% since
November 2008. The central bank cut rates again, to a record
low of 7.25%, in September, saying the easing bias would
continue for some time.
Yilmaz maintains the central banks first priority is
still targeting inflation: There are some people saying
that we have put the growth concerns before inflation; it is
not so. Economic activity is important, but our first and main
concern is price stability, he tells Emerging Markets in
an interview. Our domestic economy is recovering, but
because of the international environment and its impact on
exports, economic activity is not as good as we
Yilmaz says the unemployment rate is increasing to around
13% and will probably edge up further before the end of the
year. This is impacting domestic demand conditions,
To offset this, the central bank is cutting rates and has
increased credit market activities to ease consumer access to
credit. The credit markets have somewhat softened
but not by as much as we would like, he says.
If Turkey is hoping for a domestic-led recovery, one bright
spot is the continued resilience of its banking system, which
was radically overhauled after the 2001 banking crisis, and is
now well capitalized and well placed to increase corporate and
No Turkish bank has so far been downgraded since the crisis
began, according to rating agency Fitch. And banks net
income has been boosted by the declining rate environment.
Babacan says: Our most important strength is our
banking system. Were one of the few countries in the
OECD, if not the only country, that didnt have to provide
any state support to the bank sector, not even deposit
insurance. In this sense, the prime minister was right to say
the crisis has bypassed Turkey.
STRONG TURKISH BANKS
Mehmet Sami, executive board member of Ata Invest, one of
Turkeys largest brokerages, says: Turkish banks
have a capital adequacy ratio of around 17%, and a
non-performing loan ratio of around 5%. They are making huge
profits on their Treasury bill portfolios. We expect
banks earnings growth to be 40% this year.
But whats good for the banking sector is not
necessarily good for the economy. The banks are making such
strong profits in T-bills that they have no forceful incentive
to expand their lending to the private sector.
We need to reduce the budget deficit so that the
Treasury does not dominate the debt markets, says
Babacan. The rollover of Treasury bills on the domestic
markets is more than 100%. Resources are scarce, and the
private sector needs funding. It is no longer appropriate for
the Treasury to crowd out the markets. As we withdraw, there
will gradually be more and more capacity for private
But the key word may be gradually. If the
Turkish government agreed on a loan with the IMF, then it would
reduce its need to borrow either domestically and
internationally, immediately creating more breathing space for
According to a recent research note by Barclays Capital:
With external demand providing limited support,
Turkeys potential strength would be a domestic growth-led
recovery helped by its comparatively unleveraged consumers,
relatively healthy banks and historically low interest
But the bank points out that, without an IMF programme, the
government will be forced to continue to roll over debt at
greater than 100% rates, leaving less room for private-sector
lending and possibly raising the risk premium on Turkish
assets. This leaves the domestic demand channel less
effective than it otherwise could be, the bank says.
Babacan counters: With the measures we have taken and
the fiscal targets we have declared, the rollover rates will
come down gradually.
When we consider that the total assets of our banking
system are continuously growing, and with a decreasing
public-sector borrowing requirement, there will be less and
less pressure of public-sector borrowing on the banks. That is
how our medium-term programme is designed.
NO IMF DEAL
Nevertheless, prospects for an IMF deal appear to be
receding by the day. Prime minister Erdogan seems set against
opening another IMF programme, partly to assert Turkeys
new financial maturity, and partly to protect government
spending from cuts before the 2011 elections.
The IMFs Turkey mission chief Rachel van Elkan has
welcomed the medium-term programme. But while applauding its
aims in particular the planned adoption of a fiscal rule
she has also mentioned a need for supporting
measures and structural reforms, including policies to address
key spending pressures.
IMF chief Dominique Strauss-Kahn was quoted more recently as
saying that he sees no need for now for Turkey to
agree on a loan deal with the international lender.
Babacan says that if ongoing discussions are
successful then we would prefer to have a standby agreement
with the Fund... but this is, of course, conditional on whether
we can actually agree. If we cant agree, I
dont think this is going to be the end of the
world.Yet as both Babacan and his boss know, the AKP
government faces a bumpy ride in the coming years one in
which IMF support cannot be ruled out.
Gazi Ercel, the former central bank governor, says: By
2011, per capita income will be down by 20%; GDP will not be
higher than it was in 2008; unemployment is going to hit record
levels; and even inflation of 5% means public-sector salaries
will go down. The government was lucky from 2002 to
2007. It needs its luck to come back.