Although Turkey has not borrowed from the International Monetary Fund (IMF) since the expiration in May 2008 of its 19th Stand-by Arrangement, the IMF continues to assess annually Turkish economic developments and policies, as required by its “country surveillance” mission under Article IV. The conclusions of the IMF staff report containing the latest assessment were released in December. Last Friday, the IMF released the full staff report, with analytical and informational annexes, as well as a statement on Turkey by the IMF Executive Board.
The report is mostly critical of recent Turkish economic policies. Its main message is, despite “the dynamic rebound from the 2008-09 global crisis, Turkey's hard-earned resilience, built up following its 2000-01 financial crisis, has been weakened by the recent unbalanced growth episode.” The IMF finds Turkey still prone to boom-bust cycles due to heavy reliance on volatile short-term foreign capital flows, mostly channeled through banks to the private sector, for financing economic growth. Often disagreeing with the recent policies, despite praising the many economic achievements of the Justice and Development Party (AK Party) government since 2002, the report proposes alternative policies to preempt a potential crisis. The IMF is worried about the current account deficit (CAD) that had rapidly risen, financed mostly by volatile short-term capital inflows, resulting from the surge in credit-financed, import-intensive domestic demand. It singles out “loose” monetary and fiscal policies and a large competitiveness gap, as well as Turkey's low savings rate, as the source of the problem. The government, according to the report, accepts some but not all of the IMF's advice. The report aims its major criticism of “loose” macroeconomic policies at the Central Bank's “overburdened” unorthodox and controversial monetary policies pursued since November 2010 (see my columns “Turkish Central Bank aims to hit two birds with two stones” (1), (2) and (3), Dec. 31, 2010, Jan. 3 and 10, 2011). It argues those policies suffer from a “potentially conflicting set of objectives and no clear evidence of effectiveness.” It advises the Central Bank to replace those policies -- intended to discourage short-term carry-trade inflows, extend maturity of bank lending and control domestic credit growth -- with a transparent conventional policy of a single short-term policy interest rate within a tighter inflation-targeting framework. The Central Bank is urged to keep interest rates higher and inflation rates lower to match those in other emerging markets (EMs).
The report also advocates fuller and more effective use of fiscal, prudential and structural policies. Although it commends the government's fiscal discipline, exercised through the three-year Medium-term Programs, to control the actual or recorded budget deficits, it finds the achievements inadequate and precarious. Toward more fiscal stability and less dependence on volatile short-term foreign capital inflows that trigger boom-bust cycles, it urges the government to focus on the structural primary balance, which it estimates deteriorated from surpluses around 5 percent of the gross domestic product (GDP) during 2003-06 to deficits around 1 percent during 2010-11. (The structural primary balance is the actual or recorded budget balance that excludes expenditures and revenues associated with the business cycle as well as interest payments on public debt.) It proposes setting a structural primary surplus target of 1 percent to guard against large negative revenue shocks and help keep interest and inflation rates at levels similar to those in other EMs. According to the IMF Executive Director for Turkey, the government disagrees with that proposal, claiming its fiscal policies based on actual instead of structural budget balances are prudent enough to guarantee long-term fiscal stability. The government argues there is no consensus on how to define and measure structural primary balances. The Central Bank's latest quarterly inflation report, released last Tuesday, includes annual estimates of Turkey's structural primary balance as percentage of potential GDP. They show rising surpluses during 2009-2011, contradicting the IMF's deficit estimates. The IMF's estimates are based on lower hypothetical tax receipts cyclically adjusted for “transient” revenues “due to unsustainable macroeconomic conditions” and tax amnesties. The IMF report admits that these estimates, presented in one of the analytical annexes, involve “an element of judgment.”
This controversy on the structural primary balance brings to mind the discussion almost two years ago on the government's own proposed and aborted fiscal rule, aimed at long-term fiscal stability. (See my columns “Turkey chooses fiscal rule over IMF role,” March 15, 2010; “Turkey's proposed fiscal rule” (1) and (2) May 17 and 24, 2010; “Turkey's aborted fiscal rule” (1) and (2), Sept. 13 and 14, 2010.) Although the IMF was supportive of and hopeful about that fiscal rule in its 2010 Article IV staff report, it is not even mentioned in the current report. I urge the government to reconsider its political misgivings about enacting the fiscal rule and even give serious thought to embedding the rule in the new constitution it has promised if it is genuinely committed to lasting fiscal stability.