IMF Executive Board Concludes 2017 Article IV Consultation with Turkey

February 3, 2017

On January 11, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Turkey. [1]

Following a strong performance in 2015, growth has slowed. The July failed coup attempt heightened the spectrum of political uncertainty, and Russian sanctions have also negatively affected confidence. Growth remains consumption-driven. Investment is weak amid heightened uncertainty and a sharp deceleration of credit growth. Inflation has moderated but is still well above target. The current account deficit remains sizeable, as the decline in tourism offsets savings from low energy prices. Progress on structural reforms has been slow.

Fiscal policy turned expansionary in 2016. Higher government spending is driven by an increase in the minimum wage and related subsidies, hiring in the education and health sectors, as well as higher security outlays. The government granted a number of temporary tax reductions/exemptions and expanded investment incentives during the second half of the year to revive growth.

The central bank of Turkey (CBRT) eased monetary conditions, by cutting the overnight lending rate by 250 basis points in the process of narrowing the interest rate corridor between March and September 2016. After a sharp depreciation of the Lira in November, the CBRT raised the repo rate to 8 percent and partly withdrew the liquidity provided to banks in the wake of the failed coup attempt.

Bank capital levels remain high, although some buffers are decreasing. Higher profits boosted capital adequacy, reflecting in part lower overnight borrowing costs and relaxation of prudential norms. Non‑performing loans are increasing from a low level that partly reflects accommodating rules for loan restructuring. Credit growth slowed markedly in 2016, due to both demand and supply factors. Progress in strengthening the financial stability framework was assessed in detail during this Article IV consultation as part of the IMF’s Financial Sector Assessment Program (FSAP), which analyzes financial sector health and associated policies. The FSAP’s findings are summarized in the accompanying Financial System Stability Assessment (FSSA).

Growth is projected to be below potential in 2016–17. The political focus on transitioning to a presidential system; renewed questions over the future of the EU-Turkey relations; and tense security situation in the South-East and conflicts in neighboring countries are expected to prolong the uncertainty, keeping domestic demand subdued. Fiscal stimulus and the expected completion of the gradual lifting of Russian sanctions are expected to support growth. Over the medium-term, growth is projected to firm around 3.5 percent. Inflation is expected to stay above target and the current account deficit to remain sizeable.

Executive Board Assessment 2

Executive Directors welcomed the Turkish economy’s resilience in the face of severe and increasing challenges and the authorities’ efforts to avoid an excessive slowdown in the near term. At the same time, Directors cautioned that the economy faces considerable downside risks—with high inflation, external imbalances, and substantial reliance on external financing continuing to generate vulnerabilities—while dealing with complex geopolitical and security challenges. They underscored the overarching priority of rebalancing the economy through policies aimed at increasing domestic savings and raising potential growth, while ensuring strong and credible public institutions and policy frameworks that are clearly communicated.

Most Directors supported a near‑term moderate fiscal expansion to address cyclical developments, given the current available fiscal space. However, Directors advised that a tighter fiscal stance is required in the medium term to reduce external imbalances and lower inflation. They encouraged the authorities to strengthen the fiscal risk management framework, given that contingent liabilities are increasing, in particular due to a continued expansion in infrastructure‑related PPPs.

Directors welcomed the authorities’ steps to simplify the monetary policy framework. Continued efforts in this area would further improve communications and enhance monetary policy transmission and credibility. Directors emphasized that the authorities should remain vigilant and tighten monetary policy to address sharp lira depreciation, contain high and rising inflation, and counteract intensifying external pressures. Directors also recommended rebuilding international reserve buffers as conditions permit.

Directors welcomed that the banking sector remains well capitalized, and encouraged continued vigilance in light of a deterioration in asset quality. Directors cautioned that banks face substantially higher credit risks, and called for further strengthening of supervision and bank governance. Directors recommended that macroprudential policy should be strengthened, focusing on foreign exchange and other systemic risks, and not be used for demand management. They welcomed the FSAP’s findings and recommendations, and highlighted the desirability of further strengthening the independence of financial sector supervisory authorities, deepening and broadening the risk assessment nature of financial supervision and follow up, and strengthening the role of the Financial Stability Committee to support more effective systemic risk oversight and management.

Directors encouraged the authorities to intensify the pace of structural reforms to promote economic rebalancing and boost productivity. They welcomed progress made to reform the voluntary pension system, and urged continued efforts to increase domestic saving. Directors also underscored the importance of improving the investment climate and labor market competitiveness. They commended the authorities for hosting a large number of refugees and for their efforts to integrate them into the labor market, while stressing the importance of continued international assistance.

Turkey: Selected Economic Indicators, 2014−21

Population (2015): 78.2 million

Per capita GDP (2015): US$9,182

Quota (2015): SDR 1,455.8 million

2014

2015

2016

2017

2018

2019

2020

2021

Proj.

(Percent)

Real sector

Real GDP growth rate

3.0

4.0

2.7

2.9

3.3

3.6

4.0

3.9

Contributions to real GDP growth

Private domestic demand

0.9

3.2

2.5

1.5

2.8

3.0

3.4

3.6

Public spending

0.1

1.1

1.8

0.6

0.4

0.4

0.4

0.4

Net exports

2.0

-0.3

-1.6

0.7

0.1

0.2

0.2

-0.2

GDP deflator growth rate

8.3

7.4

7.4

7.4

7.4

7.5

7.3

7.0

Nominal GDP growth rate

11.5

11.7

10.2

10.5

10.9

11.4

11.6

11.2

CPI inflation (12-month; period-average)

8.9

7.7

7.7

8.0

7.9

7.4

7.3

7.0

Unemployment rate

9.9

10.3

10.5

11.0

11.0

10.5

10.0

10.1

(Percent of GDP)

Nonfinancial public sector

Primary balance

0.6

0.7

-0.6

-1.3

-0.7

0.5

0.8

0.9

Net interest payments

2.2

2.1

2.1

2.0

1.8

1.8

1.8

1.8

Overall balance

-1.6

-1.5

-2.6

-3.4

-2.5

-1.3

-1.0

-0.9

Debt of the public sector

General government gross debt (EU definition)

33.5

32.9

34.6

35.8

36.6

35.8

35.2

34.8

External sector

Current account balance

-5.5

-4.5

-4.5

-5.3

-5.5

-5.0

-4.7

-5.0

o/w Nonfuel current account balance

0.7

0.2

-1.3

-1.4

-1.5

-1.0

-0.8

-1.1

Gross financing requirement

26.5

27.9

27.2

30.7

31.5

30.9

29.6

29.2

Foreign direct investment (net)

0.7

1.7

1.1

1.2

1.3

1.4

1.5

1.6

Gross external debt 1/

50.4

55.4

59.6

67.1

67.8

66.6

64.9

63.5

Net external debt

30.8

35.7

38.7

44.6

45.9

45.8

45.1

44.6

Short-term external debt (by remaining maturity)

21.0

22.6

23.8

27.1

27.4

26.6

25.7

24.4

Monetary conditions

Average real policy rate 2/

-0.2

-0.1

-0.2

…

…

…

…

…

Nominal growth of broad money (percent)

11.9

17.1

11.1

…

…

…

…

…

Sources: Turkish authorities; and IMF staff estimates and projections.

Notes: 1/ The external debt ratio is calculated by dividing external debt by GDP in U.S. dollars estimated by Staff. 2/ Using central bank's one-week repo rate. In current year, the average is up to the latest observation.

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

2 At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm .

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