Tighten monetary policy urges IMF


The International Monetary Fund in an Article IV consultation has said that Turkey needs to raise domestic savings and forge ahead with structural reforms. The Fund forecasts growth of 3.8% in 2013 and 3.5% in 2014.

The full press release as published on the IMF website is as follows:

“Turkey: Concluding Statement of the IMF Mission for the 2013 Article IV Consultation1/

September 30, 2013

In 2012, Turkey achieved a welcome reduction of imbalances while maintaining positive growth. In 2013, growth is accelerating and rotating back to domestic demand. With imbalances still high and the global financial environment less forgiving, reducing these vulnerabilities should be the overarching focus of short- and medium-term policies. In the short run, monetary policy needs to be tightened further to meet the authorities’ inflation target and provide an adequate nominal anchor. Fiscal policy should also be tightened to increase the structural primary surplus in 2014. In the medium term, the main challenges for Turkey remain raising domestic savings and pressing ahead with structural reforms. Both would serve to increase the long-term growth potential of the economy, while maintaining a sustainable external position.

1. The authorities’ policies delivered a welcome rebalancing in 2012 while maintaining low unemployment. This set the stage for the acceleration of economic activity in 2013. The rebound, led by private consumption and public investment, was driven by the policy stimuli since the second half of 2012. Unemployment stayed low, while household balance sheets remained relatively healthy, as leverage increased from a low base. With domestic demand gathering strength, full year growth is expected to come in at 3.8 percent. Under current macroeconomic policies, next year’s growth is forecast at 3½ percent.

2. The domestic demand-led recovery is exerting upward pressures on the current account deficit and inflation. The current account deficit is projected to widen to above 7 percent of GDP this year, in part on account of an increase in gold imports, and is likely to stay close to that level next year. Inflation trends and the currency depreciation are likely to result in inflation again above the target of 5 percent both this and next year.

3. The market reappraisal of advanced economies’ monetary policies has exposed Turkey’s main vulnerability—its external imbalance. While the timing and magnitude of the normalization of interest rates is uncertain, the recent portfolio rebalancing has led to a re-pricing of Turkish assets and caused lira depreciation. In this context and with gross external financing needs projected to remain high over the next few years, a weakening or a reversal of capital flows present a major challenge for the Turkish economy. Therefore, policies need to focus on mitigation of these risks.

Re-anchor Macroeconomic Policies

4. The authorities’ immediate priority should be to reduce imbalances. In the short run, the monetary stance and framework should focus squarely on inflation to provide a nominal anchor. Fiscal policy should be tightened by means of expenditure restraint. Taken together, these policies will serve to reduce both external financing requirements and inflation. With that, the odds of a reversal of capital flows triggered by global portfolio rebalancing would decrease significantly.

Monetary Policy

5. The monetary stance needs to be tightened further to be consistent with the authorities’ inflation target. High credit growth, inflation (both headline and core) well above the end-year target of 5 percent, and the high and widening current account deficit, all warrant positive real policy rates, in particular the one week repo rate. Without this, it would be hard to bring inflation and expectations in line with the authorities’ target.

6. The CBRT should re-consider its monetary policy framework. Ultimately the success of a monetary policy framework is tied to its ability to achieve the inflation target and anchor expectations. The current framework might not be helping to deliver the authorities’ inflation target and may have weakened the monetary transmission mechanism. It is complex and has too many objectives. With a more unforgiving external environment, the framework is increasingly questioned by markets and complicates the communication of policies. Normalizing the framework would boost policy credibility and simplify communication.

7. The authorities should use sales of foreign exchange reserves only to address excessive volatility, as foreign exchange rate interventions cannot substitute for the right monetary stance. This would preserve limited net foreign exchange reserves, which should be increased through sterilized intervention if inflows resume.

Fiscal Policy

8. The authorities are on track to meet the fiscal targets for 2013, but the fiscal stance is expansionary and should be reined in. Revenue performance year-to-date has been strong, with some help from one-off effects. As a result, the authorities are broadly on track to meet their 2013 budget deficit target, further reducing public debt from already modest levels. However, buoyant revenues have led to large nominal expenditure increases. Therefore, the government will exceed the approved 2013 budget expenditure ceilings, notably due to investment spending.

9. Fiscal policy has a critical role to play in reducing external vulnerabilities. Higher public savings are needed to dent the external imbalance. Thus, the 2014 budget should target the primary spending levels set by the government in the 2013-2015 medium-term fiscal plan and save any revenue over-performance. Such a policy objective—which implies a 0.7 percent of GDP improvement of the structural deficit—would make a critical contribution to the envisaged gradual reduction of Turkey’s macroeconomic imbalances and reassure markets that fiscal discipline is intact.

10. It will also be important to revisit the structure of the budget as it is becoming increasingly rigid. Non-discretionary primary spending has grown to almost 60 percent of total spending, in part allowed for by the reduction in interest spending. Containing current expenditure would increase room for public investment. At the same time, it would increase flexibility and buffers in the budget, enabling fiscal policy to better respond if unexpected adverse shocks were to occur. The welcome ongoing efforts to broaden the tax base and improve tax administration will further enhance the structure and resilience of the budget.

Preserve Financial Stability

11. The Turkish financial system continues to perform well, although risks remain. Banks’ leverage and the level of non-performing loans are low relative to peers; the capital adequacy ratios remain high; loans are largely funded by deposits; and their open FX positions are not large. Still, risks are being taken in this period of rapid credit expansion, and so continued careful monitoring is needed. In particular, more attention to FX credit to corporate clients is warranted, as FX-induced liquidity or solvency problems in the corporate sector can quickly lead to rising non-performing loans. On the other side of the banks’ balance sheets, keeping an eye on the amounts and structure of FX funding of the sector remains important, especially given the current external environment.

12. Prudential policies should be targeted at the household credit and corporate FX lending segments. Data gaps with respect to all aspects of FX lending to the non-financial corporate sector need to be addressed. Increasing risk weights or reserve requirements for such loans could be considered. In the rapidly growing household credit segment, the authorities’ plan to link clients’ credit cards exposure limits to income is welcome and could be helpfully extended to general purpose consumer loans. Meanwhile, in the absence of microeconomic distortions, use of prudential policies to stimulate credit to specific sectors is not warranted.

Boost Savings to Permanently Reduce the External Imbalance

13. In the medium-term, the challenge is to boost growth without increasing imbalances. Turkey’s demographic structure, strategic geographical location, and dynamic economy present many opportunities. However, it will be difficult for Turkey to sustain an average growth of 4 to 5 percent per year while continuing to accumulate large external liabilities year after year. The present low level of domestic savings implies that investment is determined by the availability of highly volatile external inflows. Without structural reforms, growth would have to be below the historical trend to avoid increases in external imbalances and accompanying bouts of instability.

14. The authorities have correctly identified the need to increase domestic savings. Last year’s private sector pension reform has started to bear some results and is a positive initial step. However, the public sector must also lead the way with a sizeable contribution to raise savings. In that sense, the 1¼ percent of GDP increase in public savings envisioned in the 10th development plan is commendable. Nevertheless, the authorities are encouraged to target over the medium-term a more ambitious primary surplus in line with the levels observed before the onset of the global financial crisis.

15. Structural reform should further boost competitiveness and growth. Turkish private sector has demonstrated an ability to adapt to shocks. Further improvements in the business climate could enhance this resilience further and would attract more foreign direct investment—a stable source of external funding. Increasing educational outcomes to boost productivity should be another priority. Reducing energy dependence further—in line with government policies and recent reforms—would help decrease the energy import bill, which represents a significant part of Turkey’s trade deficit. Efforts to address the large informal sector have met with some success and need to be sustained. Lastly, reforms to improve the functioning of the labor market could boost productivity and employment.

The IMF team would like to thank the authorities and our counterparts in the private sector for their hospitality and open and constructive discussions.

1 An IMF team visited Turkey from September 18 to September 30, 2013 for the annual evaluation of the economy as part of the regular consultations under Article IV of the IMF’s Articles of Agreement. This statement describes the preliminary findings of the staff.”

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