The FINANCIAL — On March 30, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Turkey.
Following a slowdown in activity in 2016, growth recovered strongly last year. Large fiscal stimulus (including increased PPP activity) and policy-driven credit impulse boosted consumption and investment in 2017. Exports also increased sharply, but a pick-up in imports in the second half of the year tempered the growth contribution of net exports. Such has been the strength of the recovery that the economy now faces clear signs of overheating: a positive output gap, inflation well above target, and a wider current account deficit. Signs of possible oversupply in the building and construction sector are also emerging.
Fiscal and quasi-fiscal policies have become more expansionary. The fiscal deficit increased in 2017, due to temporary tax reductions, continued minimum wage subsidies, and employment incentives. Contingent liabilities are increasing, due to still-high public-private partnerships (PPP) activity and the expansion of state loan guarantees, according to IMF.
Monetary policy has been tightened but inflation rose to almost 12 percent during 2017. The central bank (CBRT) increased the effective cost of funding to banks by almost 500 basis points since November 2016 to contain inflation spillovers from the large Lira depreciations in the last quarters of 2016 and 2017. The ex-post, real effective policy rate has, however, remained close to zero until recently.
The sizeable expansion of state loan guarantees was the main driver behind the acceleration of bank credit growth in 2017, although the relaxation of macroprudential measures also contributed. Commercial loan growth has since moderated, as the impulse from state loan guarantees fell towards the end of the year.
Bank capital levels remain high, although some buffers are decreasing. Higher profits improved capital adequacy in 2017, reflecting in part the relaxation of prudential norms and the conservation of capital through the use of state loan guarantees. The headline non-performing loans ratio remains low, but a broader definition of loan impairment signals emerging loan quality weakness and signs of difficulties in some large corporate borrowers are emerging.
In 2018, economic activity is expected to decelerate to close to 4½ percent. Continued accommodative monetary, fiscal, and financial policies will support growth, but inflation is projected to remain well above target and the current account deficit is expected to remain elevated.
Executive Board Assessment
Executive Directors welcomed Turkey’s solid economic performance last year, driven by strong policy stimulus and favorable external conditions. At the same time, Directors noted that rapid growth has contributed to economic overheating, in the form of widening internal and external imbalances, including a positive output gap, high inflation and a wider current account deficit.
Directors noted that large external financing needs, limited foreign exchange reserves, changes in investor sentiment towards emerging markets, and persistent domestic and geopolitical risks also pose challenges. Noting that the economy has been resilient thus far, Directors emphasized that, looking ahead, macroeconomic policies should be geared towards addressing the imbalances, lowering inflation, and strengthening buffers. In addition, comprehensive structural reforms will be necessary to boost Turkey’s growth prospects.
Directors called for frontloaded monetary tightening to help contain inflation, re‑anchor expectations, underpin the Lira, and allow reserves to be rebuilt. They agreed that moving over time to more conventional monetary instruments would help underpin the transparency and effectiveness of monetary policy. Directors underscored the importance of central bank independence.
While noting the low starting point for public debt, Directors emphasized that rising risks call for fiscal prudence and further containing fiscal and quasi‑fiscal policies. They highlighted that sustained measures are needed to achieve a general government primary surplus next year. These could include broadening the revenue base, raising direct taxation, improving VAT efficiency, limiting public wage rigidities, and reducing ad‑hoc subsidies.
Directors welcomed the authorities’ initiatives to strengthen the PPP risk management and reporting framework. They underscored that building on this work would help preserve fiscal space. Directors indicated that the scope and role of extra‑budgetary and other non‑central government entities, and institutions such as the newly created Sovereign Wealth Fund, should be transparent as well as carefully defined and monitored.
Directors called for further strengthening the oversight and governance of the banking sector, as outlined in the FSAP assessment. They supported the authorities’ decision to better target the Credit Guarantee Fund and introduce limits on SME foreign currency borrowing. Directors encouraged continued efforts to strengthen bank supervision and to make the macroprudential regime more robust, in particular, addressing the risks related to non‑financial corporates, given their increased leverage and large negative foreign exchange positions.
Directors encouraged the authorities to take advantage of the current strong growth environment to push ahead with structural reforms to increase productivity and Turkey’s medium‑term growth potential. They emphasized that reform efforts should give priority to maintaining strong institutional capacity and improving regulatory predictability to strengthen the investment climate. Directors also noted that labor market reform is crucial, especially on public wage indexation, minimum wages, addressing skills gaps, and further increasing female labor force participation, including by promoting flexible work options. They saw merit in further reforms of the voluntary pension system to increase domestic savings. Directors commended the authorities for hosting the large number of refugees and for their efforts to integrate them into the labor market.