Ankara, Turkey,
September 29, 1999

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Camdessus:

2.   The outpouring of spontaneous, prompt, and generous support from the international community has been heartwarming and has gone a long way in alleviating the generalized sense of fear, loss, and bereavement. But the extent of the damage calls for even more support, which we hope will continue to be provided by friends of Turkey all over the world. Preliminary estimates suggest that official external financing to cover reconstruction costs, including from the World Bank, could reach US$ 2½–3 billion. To supplement these resources, which are likely to become available only gradually over the next 15 months, and to help the government meet its immediate financing needs arising from the earthquake without seriously depleting its resources, we request a purchase in an amount equivalent to SDR 361.5 million (equivalent to 37½ percent of Turkey's quota) under the Fund's guidelines for emergency assistance related to natural disasters. This purchase will help meet our immediate foreign exchange needs stemming from the crisis, ease potential pressures on the central bank's international reserves, and contribute to bolstering confidence in the currency.

3.   This tragic event will not derail our macroeconomic strategy, nor shall we allow it to jeopardize the hard-won disinflation achievements realized so far. Furthermore, the government intends to continue to work closely with the Fund on reaching agreement before the end of this year on a strong disinflation program that could be supported by a three-year SBA. In the meantime, our economic policies will continue to be monitored under the Staff Monitored Program (SMP) in place since mid-1998.

4.   In early 1998, the Turkish government embarked on a disinflation program centered around fiscal adjustment, structural reforms, and tight income policies. Significant progress was achieved in 1998, with the primary surplus of the central government rising to over 4 percent of GNP (excluding privatization receipts) and WPI inflation dropping to below 50 percent in early 1999, from more than 90 percent one year earlier. Further progress was hampered, however, by the fallout from the Russian crisis in mid-summer 1998, political uncertainties, and a significant deceleration in economic growth. Moreover, some fiscal relaxation in the run-up to the elections and the weakening of economic growth have led to a reduction in the primary surplus in the first half of 1999, while higher international oil prices have impeded further progress on inflation.

5.   The majority government that took office last June announced from the outset its intention to reverse these slippages, set the disinflation program on a stronger and more durable footing, and revive growth on a sustainable basis. Accordingly, it set as an immediate objective for the balance of 1999 the containment of inflation to the range of 50–55 percent. This was to be achieved by realizing a primary surplus for the central government of at least 2.1 percent of GNP (against a baseline about 1 percent of GNP lower), and by adopting supportive monetary, exchange rate, and incomes policies. This, together with the formulation of an ambitious structural reform agenda and the setting of a tight timetable for its implementation, was designed to prepare the ground for launching a major assault on inflation in the following year, with the aim of bringing it to single digits by end-2001. Persistent high inflation during the last 20 years has limited economic growth and increased social tensions and inequality in income distribution. We are determined to reduce inflation, which is itself crucial for achieving a better economic balance across different components of society, and is a major condition not just for financial stability but also for social stability. At the same time, in framing its disinflation policies, the government will endeavor to protect low-income groups, and distribute costs across all groups, thus promoting social harmony.

6.   The August 17 earthquake is the most devastating natural disaster that Turkey has suffered in the past 60 years. In addition to the human suffering, it has inflicted serious damage on the economy. While a full assessment is yet to be completed, preliminary estimates show the following:

• Damage to infrastructure (roads, schools, health facilities, bridges, water pipes, power lines, phone lines, and gas pipelines) could be in the range of US$0.5–1.0 billion (¼–½ percent of GNP);

• Damage to productive capacity resulting in a loss in value added for the remainder of 1999 equivalent to ½ to 1 percent of GNP; on this account, despite the signs of recovery of economic growth during the second quarter of this year, we now project a decline in GNP this year of around 1½ percent;

• Extensive damage to buildings, with an estimated 115,000–200,000 housing units and business premises completely destroyed or requiring repair. Although assessing the value of this loss is difficult, the cost of these destroyed and damaged buildings is estimated over US$2½ billion (1¼ percent of GNP). Indeed, the loss is likely to be even greater in light of the continuing aftershocks.

7.   The earthquake will also have implications for our balance of payments. We expect a weakening of the external current account in the order of 0.3–0.5 percent of GNP this year relative to the baseline (resulting in a deficit of about 0.8–1.0 percent of GNP), owing to higher imports, lower exports, and lower tourism receipts. In addition, the earthquake has led, at least in the short run, to increased capital account volatility, with an immediate loss of some US$1.3 billion of capital outflows in the first week after the earthquake, though these flows have partly reversed following the announcement of the availability of international official support and the strong policy response adopted by the government.

Policy response

Government plans to deal with the aftermath of the earthquake

8.   The government has taken a number of steps to address the most immediate economic needs of the population. A draft bill requesting the appropriation of TL 500 trillion (0.6 percent of GNP) has been sent to parliament. In addition to immediate disaster relief, these additional expenditures will include higher transfers and personnel costs (TL100 trillion), infrastructure repairs (TL 200 trillion), and housing and other related expenses (TL 200 trillion). We have also introduced measures to alleviate the debt burden of enterprises, farmers and individuals affected directly by the earthquake. To this end the three state banks will reschedule amortization and interest payments coming due over the next 12 months over a three-year period. These banks will also provide investment and working capital to small- and medium-term enterprises at preferential rates. The cost of this program will be borne by the budget, and we will ensure that this relief is well-targeted to those firms and individuals particularly afflicted by earthquake-related losses. Temporary tax relief has also been provided to affected individuals and enterprises. Altogether, the fiscal cost of the earthquake for this year is provisionally estimated at TL 750–800 trillion (about 1 percent of GNP), of which TL 500 trillion is additional expenditures, and the rest is revenue losses from lower output and tax relief.

9.   Based on preliminary damage reports, the World Bank's Marmara Earthquake Assessment Report estimates the fiscal cost of the earthquake including housing and infrastructure rehabilitation, revenue loss and credit programs, social assistance, disaster mitigation at approximately US$1.7–2.3 billion for 2000. The government is seeking external assistance, including from the World Bank and the Fund, to help cover the fiscal and balance of payments costs of the earthquake in 1999 and 2000. All such assistance will be used either directly for earthquake-related expenses or to replenish foreign exchange reserves following earthquake-related losses, and the government will ensure that there is full transparency and public accountability in the use of earthquake assistance.

Fiscal and macroeconomic implications

10.   The earthquake has not reduced our resolve to pursue sound fiscal and financial policies, and to proceed speedily with our structural reform agenda. At end-August, we sent to parliament a tax package which is expected to raise revenues by about 0.4 percentage point of GNP for the remainder of this year. The government is committed to securing passage of this package by parliament in the very near future. The package includes: (i) an extraordinary surcharge on personal and corporate income taxes; (ii) a one time doubling of the motor-vehicle tax; and (iii) a special temporary tax on the use of mobile telephones. We will also submit to parliament a bill allowing individuals to reduce the duration of their military service in exchange for a payment to the government. This measure is expected to yield about 0.3 percent of GNP in 1999 and 2000. In addition, the withholding tax on repurchase agreements and deposits has been increased.

11.   Moreover, we intend to implement additional revenue and expenditure measures sufficient to bring the primary surplus of the central budget (excluding privatization receipts) to TL 900 trillion (1.1 percent of GNP)—short of the targets set in the SMP by around 1 percentage point of GNP. The overall deficit this year is projected at 11.7 percent of GNP. This deviation, however, is expected to be financed mainly by external resources, and to be reflected partly in a widening current account deficit. Taking also into account that the Turkish economy is currently working below capacity, the inflationary consequences of the earthquake should be modest. Thus, in spite of recent increases in international oil prices, we do not expect a major deviation of inflation with respect to the target range of 50–55 percent for the WPI indicated in the SMP.

12.   Monetary and exchange rate policy has been managed during the third quarter of this year in line with our commitments under the SMP, with the NDA quantitative benchmark for September likely to be met. Looking ahead, we will continue to manage monetary and exchange rate policies prudently, with the aim of containing the resurgence of inflationary pressures, maintaining competitiveness and stemming any pressure on reserves.

13.   Before the earthquake struck, we had made considerable progress in structural reform. First, a constitutional amendment allowing international arbitration in contracts involving the state and foreign investors—which was the major bottleneck facing the government's ambitious privatization program—has been approved. The passage of this constitutional amendment will, among other things, allow quick progress in transferring operating rights for power plants and distribution grids and in attracting vital foreign investment in the energy sector. We now intend to move speedily in enacting all the necessary supporting legislation to allow privatization in energy and telecom sectors. Second, a long-awaited new banking law, establishing an independent regulatory and supervision agency, has been passed. This new law will strengthen bank regulation and supervision and raise supervision standards in line with international norms. In coming weeks and months, the government will take specific steps to strengthen the financial position and institutional structure of the banking system, through a comprehensive plan of action. The limit on the banks' open foreign exchange position has been lowered from 30 percent to 20 percent (effective September 30, 1999).

14.   But the most telling sign of the government's resolve to forward structural reform has been the recent approval of the social security reform, which was completed soon after the earthquake. The passage of this new law is a major breakthrough. The deficit of the social security system had grown rapidly in recent years and was set to reach almost 20 percent of GNP by the middle of the next century. This new law: (i) introduces a minimum retirement age of 58/60 (female/male) for new entrants to the system and 52/56 for current contributors, with a ten-year transition period; (ii) increases the minimum contribution period for new entrants to SSK (the largest of the three existing systems) from 13.9 years to 19.4 years, with a lower, but still sizable, increase for current contributors, and also increases in the ceiling on contributions; (iii) raises gradually the reference period for calculation of pensions to the employee's entire working life; and (iv) establishes an automatic indexation of pension benefits to the CPI. According to our estimates, the reform will not only prevent the trend deterioration in the accounts of the pension funds, but bring about a steady and sizable improvement in the social security balances: over the next ten years, instead of increasing by some 2½ percent of GNP, the deficit is projected to fall by 1 percent of GNP.

15.   Our policy objectives for 2000 and beyond are to achieve rapid disinflation, promote sustainable growth of output and employment, and strengthen the structure of the external capital account to reduce the economy's vulnerability. We intend to achieve these goals through a macroeconomic and structural adjustment program that could be supported by a stand-by arrangement from the Fund.

16.   In the meantime, the government will continue to cooperate with the Fund in the context of the existing SMP. The government does not intend to introduce new or intensify existing restrictions on the making of payments and transfers for current international transactions, introduce new or intensify existing trade restrictions for balance of payments purposes, or enter into bilateral payments agreements which are not consistent with Article VIII of the Fund's Articles of Agreement.

Very truly yours,