turkey - international university of japan...turkey april 2004 the economist intelligence unit 15...

Country Report April 2004

Turkey

April 2004

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

Turkey at a glance: 2004-05

OVERVIEWThe Economist Intelligence Unit believes that the huge parliamentary majorityof the Justice and Development Party (AKP) and the absence of alternativesshould enable it to stay in power during the forecast period. However, achange of government or an early election should not be ruled out, given themedium-term risk of another economic crisis and the secular establishment’sdeep distrust of the AKP because of its Islamist roots. We expect EU accessionnegotiations to start in early 2005. GDP growth will slow to about 3% in 2004,from 5.8% in 2003, mainly because of a higher baseline and a slowdown instockbuilding. In 2005 a further slowdown, to about 2.5%, is forecast, triggeredby an assumed devaluation of the lira that will help to reduce the current-account deficit to a less worrying 1% of GDP. Inflation eased to 14% inFebruary, but further major reductions will be hard to achieve from Maybecause of the low baseline in the second half of 2003. A weaker lira will pushup inflation again to average about 25-30% in 2005.

Key changes from last month

Political outlook• At the end of March the UN secretary general, Kofi Annan, finalised a draft

settlement plan intended to end the division of Cyprus. The plan, which isto be submitted to separate referendums on both sides of the island on April24th, was fully endorsed by Turkey's prime minister, Recep Tayyip Erdogan.However, it is almost certain to be rejected in the referendum by the GreekCypriots, who could then veto a start to EU accession negotiations withTurkey to be decided at the end of 2004.

Economic policy outlook• The government's privatisation programme regained momentum in

February when the state sold its stake in the oil refiner, Tupras. However, thereal tests of the government's resolve will be the Turk Telekom tenderscheduled for May and the proposed privatisation of the state banks.

Economic forecast• Given the continued strength of the lira we have cut our 2004 consumer

price inflation forecast. We expect it to decline from 14% in February possiblyto below 10% in the next few months before rising from mid-year to a year-end and annual average rate about 14%.

The Economist Intelligence Unit

The Economist Intelligence Unit is a specialist publisher serving companies establishing and managingoperations across national borders. For over 50 years it has been a source of information on businessdevelopments, economic and political trends, government regulations and corporate practice worldwide.

The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where thelatest analysis is updated daily; through printed subscription products ranging from newsletters to annualreference works; through research reports; and by organising seminars and presentations. The firm is amember of The Economist Group.

LondonThe Economist Intelligence Unit15 Regent StLondonSW1Y 4LRUnited KingdomTel: (44.20) 7830 1007Fax: (44.20) 7830 1023E-mail: [email protected]

New YorkThe Economist Intelligence UnitThe Economist Building111 West 57th StreetNew YorkNY 10019, USTel: (1.212) 554 0600Fax: (1.212) 586 0248E-mail: [email protected]

Hong KongThe Economist Intelligence Unit60/F, Central Plaza18 Harbour RoadWanchaiHong KongTel: (852) 2585 3888Fax: (852) 2802 7638E-mail: [email protected]

Website: www.eiu.com

Electronic deliveryThis publication can be viewed by subscribing online at www.store.eiu.com

Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databasesand as direct feeds to corporate intranets. For further information, please contact your nearest EconomistIntelligence Unit office

Copyright© 2004 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication norany part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means,electronic, mechanical, photocopying, recording or otherwise, without the prior permissionof The Economist Intelligence Unit Limited.

All information in this report is verified to the best of the author's and the publisher's ability. However, theEconomist Intelligence Unit does not accept responsibility for any loss arising from reliance on it.

ISSN 0269-5464

Symbols for tables“n/a” means not available; “–” means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK.

Turkey 1

Country Report April 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004

Contents

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2004-057 Political outlook8 Economic policy outlook12 Economic forecast

15 The political scene

20 Economic policy

30 The domestic economy30 Output and demand30 Sectoral trends33 Employment, wages and prices35 Financial indicators

38 Foreign trade and payments

List of tables9 Alternative scenario excluding devaluation12 International assumptions summary13 Gross domestic product by expenditure15 Forecast summary22 Consolidated central government budget24 Government debt28 Yields on Treasury bills and government bonds at auction29 Domestic debt30 Gross domestic product31 Industrial production, monthly index32 Tourist arrivals33 Workforce and unemployment34 Inflation: consumer and wholesale prices37 Exchange rates38 Selected financial indicators39 Foreign trade40 Current account41 Capital account42 External debt stock

2 Turkey


List of figures

15 Gross domestic product15 Consumer price inflation23 Central government debt28 Treasury-bill yields and consumer price inflation36 ISE general index39 Trade balance

Turkey 3


Summary April 2004

The Economist Intelligence Unit believes that the huge parliamentary majorityof the Justice and Development Party (AKP) and the absence of alternativesshould enable it to stay in power during the forecast period. However, a changeof government or an early election should not be ruled out, given the medium-term risk of another economic crisis and the secular establishment’s deepdistrust of the AKP because of its Islamist roots. GDP growth will slow to about3% in 2004, from 5.8% in 2003, mainly because of a higher baseline and aslowdown in stockbuilding. In 2005 a further slowdown to about 2.5% isforecast, triggered by an assumed sharp devaluation of the lira that will help toreduce the current-account deficit to a less worrying 1% of GDP. Inflation easedto 14% in February, but further major reductions will be hard to achieve fromMay because of the low baseline in the second half of 2003. A weaker lira willpush up inflation again to average about 30% in 2005.

Determined to start EU accession talks in early 2005 Turkey's prime minister,Recep Tayyip Erdogan, has led a push for a settlement in Cyprus along the linesof a plan proposed by the UN secretary general, Kofi Annan. EU leaders haveresponded positively to Turkey’s efforts to meet the criteria for accession talks tobegin. However, the closure case against a pro-Kurdish political party and theongoing re-trial of an imprisoned Kurdish member of parliament will bemonitored. The AKP was the clear winner in the March 28th local elections.

IMF credit disbursement is slightly behind schedule, but the release of aUS$500m tranche is expected in April. In 2003 the central government deficitwas 11% of GDP. Central government debt rose by US$50bn to US$203bn.Minimum wage and pension hikes risked derailing the 2004 budget targets, butcorrective measures were passed in early March. The state sold its stake in the oilrefiner, Tupras, in February. The Central Bank of Turkey has cut interest ratestwice this year. Government borrowing costs have fallen to 24%. The Treasurytapped the international capital markets in January and February.

GDP rose by 6.1% in the final quarter of 2003. Industrial output has continuedto rise, with the automotive sector the star performer last year. There were arecord 14m visitors to Turkey in 2003. Falling participation rates helped to keepdown the unemployment rate to 10.5% in 2003. In January-February the CentralBank intervened in the foreign-exchange markets to check the rise of the lira.Consumer credit has expanded strongly as interest rates have fallen.

Despite strong export growth the foreign trade deficit increased sharply toalmost US$22bn in 2003 from US$15.5bn in 2002. The current-account deficitrose by US$4.3bn to US6.8bn (an estimated 2.8% of GDP). Turkey enjoyed strongcapital inflows in 2003, but net foreign direct investment was a meagre US$79m.

Editors: Robert O'Daly (editor); Jan Friederich (consulting editor)Editorial closing date: April 2nd 2004

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2004-05

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Turkey


Political structure

Republic of Turkey

Parliamentary republic

Based on European models and constitution of 1982

Unicameral Meclis (parliament) of 550 members directly elected for a five-year term

Universal direct suffrage over the age of 18. Only parties gaining more than 10% of thenational vote are eligible for seats in parliament

November 3rd 2002; next election due by November 2007

President, elected by an absolute majority of the Meclis for a seven-year term. Currentpresident is Ahmet Necdet Sezer, elected in May 2000. Next election is due in May 2007

The government coalition led by Bulent Ecevit, comprising the Democratic Left Party, theNationalist Action Party and Motherland Party, was heavily defeated in the November 3rdelection. The new government was formed by the Justice and Development Party

Islamist: Justice and Development Party (AKP) and Prosperity Party (Saadet, SP), bothsuccessors to the former Virtue Party, which closed in June 2001; centre-right: MotherlandParty (Anap), True Path Party (DYP); centre-left: Democratic Left Party (DSP), New TurkeyParty (YTP); Republican People’s Party (CHP); nationalist right: Nationalist Action Party(MHP); independent pro-Kurdish: Democratic People’s Party (Dehap, formerly Hadep).AKP and CHP were the only parties to enter parliament in the November election. Adeputy elected as an independent joined DYP, giving it one seat

Prime minister Recep Tayyip ErdoganDeputy prime minister & foreign affairs minister Abdullah GulDeputy prime minister & minister of state Abdullatif SenerDeputy prime minister & minister of state Mehmet Ali Sahin

Ministers of state Mehmet AydinAli BabacanBesir AtalayGuldal Aksit

Agriculture Sami GucluDefence Vecdi GonulEducation Huseyin CelikEmployment & social security Murat BasesgiogluEnergy & natural resources Hilmi GulerEnvironment Kursat TuzmenFinance Kemal UnakitanForestry Osman PepeHealth Recep AkdagHousing & public works Zeki ErgezenIndustry & trade Ali CoskunInterior Abdulkadir AksuJustice Cemil CicekTourism & culture Erkan MumcuTransport Binali Yildirim

Sureyya Serdengecti

Official name

Central Bank governor

Main political parties

Form of state

Legal system

National legislature

Electoral system

National elections

Head of state

National government

The Council of Ministers

Key ministers

Turkey 5


Economic structure

Annual indicators1999 a 2000 a 2001a 2002 a 2003b

GDP at market prices TL trn 77,415 124,583 178,412 276,003 361,125GDP US$ bn 184.9 199.3 145.6 183.1 240.6

Real GDP growth (%) -4.7 7.4 -7.5 7.8 5.8a

Consumer price inflation (av; %) 64.9 54.9 54.4 45.0 25.3a

Population (m) 67.2 68.3 69.3 70.3 71.3

Exports of goods fob (US$ m) 28,842 30,721 34,373 39,818 50,831c

Imports of goods fob (US$ m) -39,311 -53,131 -38,916 -48,130 -64,765c

Current-account balance (US$ m) -1,344 -9,819 3,390 -1,482 -6,808c

Foreign-exchange reserves excl gold (US$ m) 23,346 22,488 18,879 27,069 33,991a

Total external debt (US$ bn) 102.2 118.3 115.1 131.6 d 147.3d

Debt-service ratio, paid (%) 35.4 35.4 40.0 50.7 b 43.9Exchange rate (av) TL:US$ 418,782.9 625,218.5 1,225,587.0 1,507,226.7 1,500,885.0a

a Actual. b Economist Intelligence Unit estimates. c Based on full-year figures from the Central Bank of Turkey. d Based on national source datafor the full year.

Origins of gross domestic product 2002 % of total Components of gross domestic product 2002a % of totalAgriculture, forestry & fishing 11.9 Private consumption 66.7Industry (excl construction) 25.4 Government consumption 14

Construction 4.2 Gross fixed investment 16.7Services 58.5 Stockbuilding 4.7

Exports of goods & services 28.8

Imports of goods & services -30.5

Principal exports 2003b US$ m Principal imports 2003b US$ mTextiles & clothing 14,257 Chemicals & products 5,549Metals 5,062 Crude oil & gas 11,398

Motor vehicles & parts 5,245 Machinery & equipment 15,790Agricultural products 3,954 Metals 6,792

Food & beverages 1,789 Motor vehicles & parts 5,369

Main destinations of exports 2003b % of total Main origins of imports 2003b % of totalGermany 15.9 Germany 13.7US 8.0 Italy 7.9

Italy 6.8 Russia 7.9UK 7.8 US 5.0France 6.0 France 6.0

Russia 2.9 UK 5.1EU 51.9 EU 45.8

a Including statistical discrepancy. b Excluding “suitcase” trade.

6 Turkey


Quarterly indicators2002 20031 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Consolidated central government finance (TL trn)a

Revenue & grants 15,028 35,821 55,403 76,400 20,364 44,689 71,751 100,238Expenditure 27,663 53,696 79,982 115,486 31,253 69,448 101,576 140,054Balance -12,636 -17,875 -24,579 -39,085 -10,889 -24,759 -29,825 -39,816OutputGDP at constant 1987 buyers' prices (TL bn) 23,226 27,711 37,975 29,528 25,100 28,790 39,807 n/aGDP at constant 1987 buyers' prices (% change,

year on year) 2.1 8.9 7.9 11.4 8.1 3.9 4.8 n/aIndustrial production index (1995=100)b 117.1 121.7 120.5 122.7 125.3 128.5 133.2 138Industrial production index (% change, year on

year) 3.8 11.1 9 12.1 7.1 5.6 10.5 12.5Manufacturing production index (1995=100)b 115.6 120.4 120.4 121.5 125.9 127.8 132.6 138.5Mining production index (1995=100) 87 85 92 84 76 73 101 n/a

Employment, wages & pricesEmployment, manufacturing (‘000) 3,444 3,705 3,731 3,693 3,572 3,608 3,716 3,664Employment, manufacturing (% change, year on year) -0.6 8.8 4.7 0.9 3.7 -2.6 -0.4 -0.8Unemployment rate (% of the labour force) 11.5 9.3 9.6 11.0 12.3 10.0 9.4 10.3Hourly earnings, manufacturing (1995=100)c 2,897 2,946 3,198 3,362 3,481 3,441 3,653 n/aConsumer prices (1994=100) 6,158 6,407 6,710 7,319 7,858 8,329 8,393 8,742Consumer prices (% change, year on year) 70.3 47.0 39.5 31.6 27.6 30.0 25.1 19.4Wholesale prices (1994=100) 5,278 5,522 5,863 6,335 7,059 7,332 7,175 7,311Wholesale prices (% change, year on year) 86.7 51.2 43.5 33.2 33.7 32.8 22.4 15.4

Financial indicatorsExchange rate TL'000:US$ (av) 1,358 1,412 1,666 1,614 1,649 1,425 1,397 1,445Deposit rate (av; %) 57.4 48.7 49.5 46.4 45.9 42.1 34.7 28.0Interbank money market rate (av; %) 57.3 49.1 46.7 44.8 44.0 40.9 33.2 26.5M1 (end-period; TL trn) 10,552 12,135 12,989 14,814 13,889 16,069 18,173 n/aM1 (% change, year on year) 35.0 30.8 28.5 36.7 31.6 32.4 39.9 n/aM2 (end-period; TL trn) 109,318 124,264 131,947 138,494 138,994 135,355 142,081 n/aM2 (% change, year on year) 49.5 45.0 28.6 29.1 27.1 8.9 7.7 n/aStockmarket index (end-period; 1986=1)d 11,809 9,380 8,842 10,370 9,475 10,884 13,056 17,327Stockmarket index (% change, year on year) 45.6 -16.3 15.9 -24.8 -19.8 16.0 47.7 67.1Sectoral trendsCrude steel production ('000 tonnes) 3,582 4,087 4,381 4,423 4,496 4,471 4,659 4,670Cement production ('000 tonnes) 5,436 9,922 9,814 7,405 4,935 10,620 11,078 8,373Car production (‘000) 56.1 68.1 58.8 76.8 84.0 109.5 96.3 135.9Foreign trade (US$ m)Exports fob 7,910 8,514 9,298 10,337 10,345 11,302 12,140 13,092Imports cif -10,409 -12,454 -13,529 -15,162 -14,208 -16,406 -18,381 -19,740Trade balance -2,499 -3,940 -4,231 -4,825 -3,863 -5,104 -6,241 -6,648Balance of payments (US$ m)Merchandise trade balance fob-fobe -956 -2,260 -2,329 -2,792 -2,289 -3,200 -4,112 -4,333Services & income balanceef -525 682 2,495 673 -779 497 3,286 504Net transfer paymentse 844 769 864 1,013 777 840 1,060 941Current-account balancee -637 -809 1,030 -1,106 -2,291 -1,863 234 -2,888Reserves excl gold (end-period) 20,496 22,426 25,195 27,069 26,935 29,198 34,448 33,991

a Cumulative from the beginning of year. b Seasonally adjusted. c Gross earnings per production worker. d ISE National-100. e Central Bank ofTurkey. f Including other goods.

Sources: Central Bank of Turkey; State Institute of Statistics; OECD, Main Economic Indicators; IMF, International Financial Statistics; Standard & Poor’s, Emerging Stock Markets Review.

Turkey 7


Outlook for 2004-05

Political outlook

Thanks to its commanding majority of 368 of the 550 seats in parliament, thecurrent government of the Justice and Development Party (AKP), headed byRecep Tayyip Erdogan, is more firmly established in power than any of itspredecessors since the 1980s. Under the constitution, general elections do nothave to be held until November 2007. The government may decide to go to thepolls before this, but still seems likely to stay in power during the outlookperiod, given the weakness of the opposition. Although support for the AKP fellshort of opinion polls ahead of the March 28th local elections, the AKP hasstrengthened its hold on power by winning about 43% of the national vote(compared with 34% in the November 2002 parliamentary vote), 57 of Turkey's81 provincial councils and mayorships of two of Turkey's three largest cities.

In the longer term Mr Erdogan’s main difficulties will be maintaining progresson economic reform to avoid a loss of investor confidence, which could triggeranother crisis (see Economic policy outlook); and keeping his party together,given its diverse constituency of conservative Islamists, the urban poor, middle-class businessmen in much of Anatolia, and a substantial proportion of Turkey’sKurdish citizens. So far he has succeeded in maintaining party unity, except inthe case of the exceptionally contentious issue of the proposed plan for co-operation with the USA in the invasion of Iraq, which was voted down byparliament on March 1st 2003. Within the AKP, the main opposition to thepresent leadership comes from the speaker, Bülent Arinç, but it is unlikely thathe could mount a decisive rebellion against the government. Some AKPdeputies will also be looking for more clearly pro-Islamist policies but, in the lastresort, they have nowhere else to go, given that the Felicity Party (SP), previouslyled by the veteran Islamist, Necmettin Erbakan, is now in apparent eclipse.

In the run-up to the local elections, the government postponed some importantlegislation, such as the lifting of the parliamentary immunities of somemembers of parliament, a new law on higher education, and changes to thestructure of the Constitutional Court. It can be expected to tackle some of thesethorny issues after the elections, but it is unlikely to press for more explicitlyIslamist measures, for example in education—in part because it wants to avoidopen clashes with the sternly pro-secularist military, and in part because itrealises that it now has the support of many pragmatic voters, who approve itsmanagement of the economy and widening of civil liberties, but are not pro-Islamist in their ideological sympathies.

The AKP has continued to make good progress with legislation required to bringTurkish laws into line with EU norms. However, if at the end of 2004 the EU isto approve the start of accession negotiations with Turkey, the government willhave to demonstrate that reforms are actually being implemented, especially inareas such as the elimination of torture by the police and allowing the use ofthe Kurdish language in broadcasting and education. The Economist IntelligenceUnit's baseline forecast remains that Turkey will have done enough to obtain a

International relations

Domestic politics

8 Turkey


start to negotiations in early 2005. However, the risk of a further delay remainsquite high, given the persistence of conservative attitudes in parts of thejudiciary and state bureaucracy; the lack of effective control over the police inmany instances; strong opposition to Turkish membership in some EU memberstates; and the re-emergence of tensions between the state and militant Kurdishgroups, notably the PKK/KADEK (Congress for Freedom and Democracy inKurdistan). An indefinite delay to the start of negotiations would be damagingfor the AKP and might trigger a loss of investor confidence and renewedeconomic instability.

Over the next few months, the future of Cyprus, with its potentially crucialeffects on Turkey’s bid to join the EU, will be at the top of the foreign-policyagendas of both Greece and Turkey. A favourable outcome in Cyprus wouldremove a major obstacle to Turkey’s EU ambitions. However, it is not made anabsolute condition, since officially Turkey is merely required to give fullsupport to Mr Annan’s efforts to broker a settlement. Hence, if the GreekCypriots voted "No" in their referendum, as seems increasingly likely, butTurkey were able to show that it had done everything it could to bring about asolution, the European Council might well decide to start accessionnegotiations regardless. Strictly speaking, in this scenario, the Republic ofCyprus (representing only the Greek Cypriots) could block the decision to startaccession negotiations with Turkey. However, it may not exercise its vetobecause of the risk of condemnation by all the other EU member states andthe European Commission.

The moves towards a settlement of the Cyprus dispute have overshadowedTurkey’s other main foreign-policy concerns—in particular its ties with the USand policies towards Iraq. Following the US decision to withdraw its request forTurkish troops to be sent to Iraq as part of the international stabilisation force,which had preoccupied policy makers between August and November 2003,relations between the US and Turkey have been restored. The generally co-operative relationship is also likely to continue after the US presidentialelections. In fact, it may well improve if there is a change in administration, sincea Democrat president is likely to work for improved relations with its NATOallies. Meanwhile, the Turkish government will continue to follow events in Iraqclosely. It will seek to limit the degree of autonomy and territorial control of theIraqi Kurds under the new Iraqi constitution. Since the signs are that this aim isshared by the Shi’ite as well as Sunni communities in Iraq, it will probably dobest to establish good relations with a future government in Baghdad.

Economic policy outlook

Despite some delays and slippages, Turkey’s IMF-backed economic stabilisationprogramme remains on track. In addition, at the request of the government theIMF agreed in August 2003 to ease Turkey's repayment schedule in 2004 bymoving some of the repayments from 2004-05 to 2005-06. Also, in lateSeptember Turkey successfully concluded negotiations with the US regardingloans worth US$8.5bn, which Turkey has not yet started to draw down. Thesedevelopments, combined with factors such as exceptionally low short-terminternational interest rates and the government’s good progress on political

Policy trends

Turkey 9


reforms required by the EU, have helped to sustain investor confidence andimprove Turkey’s short-term economic outlook.

There is less certainty beyond 2004, however. Turkey’s three-year stand-byagreement expires in December. The agreement has helped to boost investorconfidence, and the IMF still sees a role for itself in Turkey, as it recognises theneed to continue the current direction of economic policy if Turkey is tomaintain stability and reduce its government debt to a more sustainable level.The government, however, seems reluctant to commit itself to an arrangementthat would limit its room for manoeuvre, particularly in the area of fiscal policy.Thus, an extension of the current stand-by agreement seems unlikely.

In our view, the biggest immediate threat to Turkey’s economic stabilitycontinues to be the risk of a sudden loss of confidence in the lira. It isovervalued by historical standards, given Turkey's high debt levels andfinancing needs, which make it vulnerable to changes in international interestrates and investor perceptions, combined with a substantial current-accountdeficit (see Economic forecast, External sector). We continue to believe that asharp correction of the lira:dollar exchange rate is likely in the next 12 to 18months. The timing and extent of an exchange-rate adjustment, and the size ofthe impact on the real economy, are extremely difficult to predict. If theadjustment occurs gradually, the impact on economic growth and inflationwould be more limited than we are forecasting. Given past experience,however, a sharper, more disruptive adjustment seems more likely. In the lightof the unexpected stability of the lira following the terrorist attacks in Istanbuland the widespread acceptance in financial markets that the current-accountbalance will prove easy to finance in 2004, we expect the lira to remainbroadly stable in real terms during most of 2004, pushing the adjustment backto the end of 2004/early 2005, much later than previously assumed (seeEconomic forecast, Exchange rates).

The current-account deficit will continue to widen without anexchange-rate adjustment

Even assuming, as the Economist Intelligence Unit does, a substantial fall ininternational oil prices in 2004 and strong growth of exports of goods and services,our model shows that without a substantial exchange-rate adjustment (or a sharpreduction in import growth as a result of a dampening of domestic demand), thecurrent-account deficit widens to levels that could make the external financingrequirement unsustainable, especially when principal repayments on Turkey’sexternal debt rise in 2005-06.

Alternative scenario excluding devaluation2001 2002 2003 2004 2005

GDP growth (% change) -7.5 7.8 5.0 2.7 2.2

Inflation (% year end ) 68.5 29.7 18.4 14.0 20.4TL:US$ (av) 1,225,587 1,507,227 1,501,171 1,440,179 1,709,613

TL:US$ (year-end) 1,450,130 1,643,700 1,396,640 1,651,728 1,822,438Real exchange rate index

(1997=100) 100.7 114.3 127.1 131.5 131.7Current-account balance (US $ bn) 3,390 -1,482 -6,052 -9,947 -12,558

% of GDP 2.3 -0.8 -2.4 -3.4 -3.9

10 Turkey


The correction, we believe, is likely to be triggered by the re-emergence ofconcerns about a continued deterioration of the current-account balance thatwe are predicting, and the prospect of rising principal repayments on Turkey’smedium- and long-term external debt in 2005. Other factors that couldcombine to cause a loss of confidence in the lira are political issues such as afurther delay to the start of EU accession negotiations or increased internalpolitical tensions; any serious deviation from the current economic reformprogramme, especially after the IMF deal expires; and a general tightening ofinternational liquidity or an increase in emerging market risk aversion; or acombination of these factors. We also believe that the longer the exchange rateremains at its current level, the more likely it is that an adjustment will bedisruptive. A much weaker lira will increase the cost of servicing Turkey’sgovernment debt, given that a large share of it (about 45% in January 2004) iseither foreign-currency denominated or linked. We assume that Turkey willobtain sufficient multilateral and/or bilateral aid to avoid a debt crisis duringthe outlook period. However, the availability of such aid will depend to a largeextent on the government being able to convince its creditors that it willcontinue the reform process.

The government must keep fiscal policy tight for several years to come if it is toreduce Turkey’s large public debt burden (US$200bn, or an estimated 77% ofGDP at the end of 2003) to a more sustainable level and maintain investorconfidence. Under the IMF-backed programme the government agreed highlyambitious fiscal targets—particularly the public-sector primary surplus (thepublic-sector balance less interest payments on government debt) of 6.5% ofGNP a year in 2003-04. In 2003 it appears that the surplus will have been quiteclose to the agreed target at about 6% of GNP. However, to achieve this, thegovernment had to introduce additional measures at various stages during theyear, at times under pressure from the IMF, in order to bring expendituregrowth under control and increase revenue. From 2004 we believe that the taskof achieving such large primary surpluses will become more difficult, since weexpect political resistance to consolidation measures to strengthen after theconsiderable efforts made in 2003. Already in early 2004 the government’sactions have revealed a degree of vacillation. First, it announced substantialpension and minimum wage increases and then, under pressure from the IMF,introduced tax hikes and spending cuts to cover the costs. Also, although thereis ongoing reform of direct taxation to improve tax collection and widen the taxbase under the IMF programme, tax evasion is ingrained and it will take time toimprove compliance. The government has assured the IMF that there will be nomore amnesties for public receivables, but the 2003 tax amnesty mayencourage non-payment of future tax by creating the impression that penaltieswill never be enforced, and that there will always be a second chance to pay.

We are forecasting a primary surplus on the narrower consolidated centralgovernment balance of about 4% of GDP in 2004-05 (the official target was 5%of GNP in 2003 for this part of the public-sector primary balance). This figurewill have to be supplemented by large surpluses on off-budget parts of thepublic sector, particularly state enterprises, in order to achieve the broaderpublic-sector primary surplus targets. Even with substantial primary surpluses,

Fiscal policy

Turkey 11


the overall deficit will remain large, reflecting the high cost of servicing Turkey’slarge government debt. Interest payments are estimated to have been about 16%of GDP and about 70% of total tax revenue in 2003. The steady decline inTreasury-bill yields during most of 2003 should help to stabilise the interestpayments/GDP ratio at around 15%. As a result, the central government deficit isforecast to be about 11% of GDP in 2004-05, compared with a peak of almost20% of GDP in 2001.

In focus

The risk of a debt crisis remains high in the medium term

A government debt default does not form part of the Economist Intelligence Unit'sbaseline forecast for 2004-05. However, Turkey will remain vulnerable to a default inthe medium term because of the sheer size of its public debt (estimated at 75% ofGDP at end-2003), an overvalued lira and a widening current-account deficit, whichleave the country vulnerable to sudden shifts in investor sentiment. Theassumptions required to conclude that the public debt burden will stabilise over thenext five to ten years are, in our opinion, optimistic. These include steady annualGDP growth of around 4-5%, stable real interest rates on domestic debt, only modestdepreciation of the real exchange rate, and unprecedented, large primary public-sector surpluses of 6-6.5% of GNP a year. Even the IMF has admitted that acombination of poor fiscal performance, low growth, high interest rates and aweaker exchange rate—all assumptions that are at least as plausible, if not more so,than the baseline assumptions—would produce an unsustainable path for publicdebt over the medium term. Turkey is also vulnerable to external shocks, given itslarge external financing requirement.We believe that without continued external support the fiscal retrenchment requiredto reduce Turkey’s government debt burden to a more sustainable level in the nextfew years will be politically unacceptable (regardless of the government in power).With the stand-by loan agreed with the IMF in February 2003 already about 18 timesTurkey’s quota in the Fund (compared with six times for Argentina and about eight-and-a-half times for Brazil), it will be difficult for the IMF to lend Turkey additionalfunds. However, it can still provide some relief in the shape of a one-yearpostponement of some repayments, in accordance with the terms of the existingIMF agreement, as it did in August 2003. Apart from the US$8.5bn loan alreadyagreed by the US in connection with the Iraq war, we believe that the USadministration is unlikely to act as "lender of last resort", even though relationsbetween the two countries have improved recently.

We expect the Central Bank of Turkey to maintain a cautious approach tomonetary easing, despite pressure to adopt a more accommodating stance fromvarious sources, including exporters hurt by the current strength of the lira andmembers of the government who want interest rates on Treasury bills to fall inorder to reduce government borrowing costs. So far the Central Bank hasresisted pressure, and rate reductions (the latest, in early March 2004, broughtthe bank’s overnight borrowing rate down by 200 basis points to 22% andreduced the lending rate from 27% to 25%) have generally followedimprovements in Turkey’s inflation outlook and other positive developmentsunder the IMF-backed reform programme. Reductions in inflation expected inthe second quarter may be followed by further interest rate cuts However, we

Monetary policy

12 Turkey


believe that there is limited scope for cuts to continue over the short to mediumterm if, as we expect, inflation starts to rise again in the second half of this year.Under these circumstances the Central Bank may have to start to tightenmonetary policy. Failure to do so would seriously damage the credibility of itsrecently established independence and contribute to an erosion of investorconfidence. At the same time, however, higher interest rates would raise debt-servicing costs, which are already high, given the size of Turkey’s largegovernment debt. The Central Bank plans to remove six zeros from the lira atthe beginning of 2005 and to move from "implicit" inflation targeting to a fullyfledged policy of inflation targeting. This may be problematic in the event ofcontinued exchange-rate volatility and fiscal slippages.

Economic forecast

International assumptions summary(% unless otherwise indicated)

2002 2003 2004 2005Real GDP growthWorld 2.9 3.8 4.6 4.1OECD 1.6 2.1 3.2 2.6EU 1.0 0.7 1.9 2.1

Exchange rates¥100:US$ 1.25 1.16 1.05 1.06US$:€ 0.945 1.132 1.300 1.377SDR:€ 0.729 0.808 0.859 0.887Financial indicators€ 3-month interbank rate 3.33 2.33 1.93 2.23US$ 3-month Libor 1.80 1.21 1.26 3.24Commodity pricesOil (Brent; US$/b) 25.0 28.8 27.0 22.1Gold (US$/troy oz) 310.3 362.8 421.3 375.0Food, feedstuffs & beverages (% change in US$

terms) 12.7 6.6 6.4 2.5Industrial raw materials (% change in US$ terms) 2.2 12.7 19.1 -3.1

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

The performance of the global economy has begun to improve, suggesting thata recovery is under way, although there are still downside risks. US GDPgrowth is strengthening, boosted by tax cuts feeding through to consumerdemand, and a further strengthening is expected in 2004. A recovery in the EU,Turkey’s main export market, driven by improving business and consumerconfidence in most countries and the rising need for replacement investment, isalso under way, although it is likely to be moderate, reflecting fiscal constraints,a renewed appreciation of the euro, and concerns about global economicinstability. Although the downside risks to global economic recovery havelessened, they are still significant. The main concern continues to stem from thehuge imbalances in the US economy, specifically the large current-accountdeficit (more than 5% of GDP) and high levels of private-sector debt.

International assumptions

Turkey 13


Gross domestic product by expenditure(TL bn at constant 1987 prices; % change year on year in brackets unless otherwise indicated)

2002a 2003 b 2004c 2005c

Private consumption 74,847.0 79,704.9 84,468.5 82,213.9(2.0) (6.5) a (6.0) (-2.7)

Public consumption 9,940.0 9,697.7 9,901.7 9,633.2(5.4) (-2.4) a (2.1) (-2.7)

Gross fixed investment 22,612.0 24,861.9 28,591.2 26,704.2(-0.8) (9.9) a (15.0) (-6.6)

Final domestic demand 107,399.0 114,264.6 122,961.4 118,551.2(1.7) (6.4) (7.6) (-3.6)

Stockbuilding 6,008.0 9,714.0 3,500.0 -1,200.0(7.0)d (3.1) d (-5.0)d (-3.6)d

Total domestic demand 113,407.0 123,978.6 126,461.4 117,351.2(9.2) (9.3) a (2.0) (-7.2)

Exports of goods & services 46,723.0 54,175.7 62,954.8 71,539.9(11.0) (16.0) a (16.2) (13.6)

Imports of goods & services 41,313.0 52,496.5 59,959.6 56,114.1(15.7) (27.1) a (14.2) (-6.4)

Foreign balance 5,410.0 1,679.2 2,995.2 15,425.8(-0.9)d (-3.1) d (1.0)d (9.6)d

GDPe 118,440.0 125,364.8 129,081.6 132,402.0(7.8) (5.8) a (3.0) (2.6)

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d

Contribution to real GDP growth. e The total includes a statistical discrepancy.

GDP rose by 7.8% in 2002 and by 5.8% in 2003. However, the need to keep fiscaland monetary policies tight, still high real interest rates (despite falling nominalrates), high unemployment, limited foreign investment and the ongoing impactof unwinding problems related to banking and corporate debt will checkeconomic expansion over the outlook period as a whole. In 2004 we expectGDP growth to slow to about 3%, reflecting the high baseline in 2003 and asharp slowdown in stockbuilding. The terrorist bombings in Istanbul inNovember 2003 did not have a negative impact on tourist arrivals in the finalmonths of last year. However, it remains to be seen whether the strong growthrates achieved in this sector in 2002-03 can be maintained, particularly giventhe recent terrorist bombings in Istanbul and Madrid. Based on our assumptionthat there will be a sharp exchange-rate adjustment at the end of 2004/early2005, we are forecasting GDP growth to slow further in 2005, to about 2.5%,with all the components of domestic demand expected to record declines.However, the resulting fall in imports of goods and services and strong growthof exports driven by a weaker Turkish lira should ensure a large positivecontribution to GDP growth from the foreign balance.

Year-end consumer price inflation was 18.4% in December 2003, below the IMF-agreed target of 20% and well down from almost 30% at end-2002. In the firsttwo months of 2004 the annual rate of increase declined further to 14.2% inFebruary. The steady decline, following a brief pick-up in the early months of2003, mainly reflects the impact of a sharp appreciation of the lira (even againstthe euro) since April 2003, which has curbed import prices. Wage increaseshave also been modest, as the government has sought to tailor its incomes

Economic growth

Inflation

14 Turkey


policy in 2003 to the inflation targets agreed with the IMF. There would alsoappear to have been a downward adjustment in overall inflation expectations.Given the high baseline in the first half of 2003 the year-on-year rate could dipbelow 10% in the next few months. However, we expect it to start edging upagain in the second half of the year to average about 14% in 2004. This reflectsour expectation that the exchange rate will stabilise and no longer act as abrake on import prices, that some demand pressures on prices will result fromabove-inflation-target wage and pension increases agreed at the beginning of2004. To offset the cost of the minimum wage and pension increases thegovernment has also had to increase some indirect taxes as well as the price ofpetrol and petroleum products. The adjustment that we are forecasting in thevalue of the lira towards end-2004/early 2005 will feed through into higherimport prices in 2005, when inflation is forecast to average 25-30%.

The Turkish lira has experienced a prolonged period of real appreciation againstthe US dollar since mid-2002, with the exception of a few brief periods ofvolatility, most recently in the second half of October 2003, when it fell byabout 7% in nominal terms against the US dollar (the depreciation against theeuro was only slightly larger in the same period). In late-March 2004 the lirawas valued at about TL1,320,000:US$1. According to the Central Bank’s realeffective exchange-rate trade-weighted indices, the lira was close to its historicalpeak in February (148.6 according to the consumer price index-based index,compared with 148.1 in January 2001 and 151.5 in September 2003). Theappreciation in 2003 and the beginning of 2004 occurred despite Central Bankintervention in the foreign-exchange markets, a 1,300-basis point reduction inCentral Bank borrowing rates, and a widespread belief that the lira isovervalued against the US dollar. The Central Bank’s ample foreign-currencyreserves, which it has rebuilt since the 2001 crisis, should help to prevent asharp fall in the lira in the coming months. However, with the current-accountbalance forecast to deteriorate in 2004, as the economy continues to expand,we expect the lira to undergo a sharp correction. The adjustment is nowassumed to take place at the end of 2004/early 2005. As a result, the lira isforecast to remain more or less stable in real terms in 2004, according to ourreal effective exchange-rate index, before depreciating by 10-15% in 2005. It isassumed that the lira will average about TL1,440,000:US$1 in 2004 andTL2,000,000:US$1 in 2005.

With principal repayments on medium- and long-term external debt expectedto start rising again from 2005, large current-account deficits will make itincreasingly difficult for Turkey to meet its external financing requirement in thenext few years. Even assuming a sharp fall in international oil prices and alimited impact on the tourism sector from the terrorist attacks in Istanbul andMadrid, we believe the government and IMF projections of steady economicgrowth of 5% combined with exchange-rate stability in 2004-05, would result incontinued high rates of import growth and widening current-account deficitsthat are, in our opinion, not sustainable. As a result of the lira devaluation thatwe expect at end-2004/early 2005 and the resulting slowdown in domesticdemand growth in 2005, we expect a sharp reduction in the current-accountdeficit from about 3-3.5% of GDP in 2004 to a more sustainable level of about

Exchange rates

External sector

Turkey 15


1% in 2005 (we assume that, as was the case in past devaluations in Turkey,there will be no J-curve effect).

Forecast summary(% unless otherwise indicated)

2002a 2003 a 2004b 2005b

Real GDP growth 7.8 5.8 3.0 2.6

Industrial production growth 9.0 8.9 c 6.0 1.8Gross fixed investment growth -0.8 9.9 15.0 -6.6

Unemployment rate (av)d 10.4 10.5 10.8 10.7Consumer price inflation (av) 45.0 25.3 14.0 26.6

Consumer price inflation (year-end) 29.7 18.4 14.2 27.3Short-term interbank rate 49.5 36.2 25.0 39.0Government balance (% of GDP) -14.5e -11.0 c -10.9 -11.0

Exports of goods fob (US$ bn) 39.8 50.8 f 62.1 71.1Imports of goods fob (US$ bn) 48.1 64.8 f 79.5 81.1

Current-account balance (US$ bn) -1.5 -6.8 f -9.8 -2.7Current-account balance (% of GDP) -0.8 -2.8 c -3.4 -1.0External debt (year-end; US$ bn) 131.6g 147.3 g 156.8 151.6

Exchange rate TL '000:US$ (av) 1,507.2 1,500.9 1,436.8 1,983.0Exchange rate TL '000:¥100 (av) 1,202.4 1,295.0 1,361.9 1,861.9

Exchange rate TL '000:€ (av) 1,424.2 1,699.4 1,867.9 2,731.5Exchange rate TL '000:SDR (year-end) 2,234.6 2,075.4 2,391.8 3,235.8

a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit estimates. d Breakin the series from 2000. e Derived from official government figures. f Based on full-year figuresfrom the Central Bank of Turkey. g Based on national source data for the full year.

The political scene

On May 1st 2004 the Republic of Cyprus will join the EU as part of the Union'senlargement into eastern Europe and the Mediterranean. This deadline is ofcritical importance to the Turkish government, since if, by then, there is nosettlement of the long-running dispute between the Greek and TurkishCypriots, then Turkey would be left in military occupation of part of an EUmember state. (Because the north is not recognised internationally, except by

Cyprus issue moves to the topof Turkey’s political agenda

16 Turkey


Turkey, without a settlement the whole island will legally become part of theEU, but EU law will not apply to the Turkish Cypriot zone). Turkey, meanwhile,is also looking to December 2004 as the date of the meeting of the EuropeanCouncil, at which the EU will decide whether Turkey has met the so-calledCopenhagen political criteria required to start accession negotiations. If Turkeyis successful, negotiations would probably begin in early 2005. This would givea major boost to the Justice and Development Party (AKP) government, whichhas made EU membership its main policy priority. It would also help to sustaininvestor confidence, thereby easing concerns about the sustainability ofTurkey's external financing requirement.

Strictly speaking, the EU has not insisted that a settlement in Cyprus will be asine qua non for the start of accession negotiations, but it is widely recognisedon both sides that the lack of a settlement will seriously damage Turkey’schances of entering the EU eventually (July 2003, The political scene). If theCyprus problem is not settled by December 2004, as now seems likely, but theTurkish government is able to show that it did all it could to facilitate a solutionand has made sufficient progress towards implementing the political reformsthat have been introduced during the last 2-3 years, it would have a goodchance of obtaining a start to accession negotiations. However, without asettlement in place by the end of 2004, the Greek Cypriots might choose to usetheir power of veto within the EU, perhaps hoping that by further delaying astart to EU accession talks with Turkey they will be able to extract moreconcessions from Turkey and the Turkish Cypriots on Cyprus.

Following the publication of a draft settlement plan by the UN secretary general,Kofi Annan, in November 2002, talks between the Greek and Turkish Cypriotleaders broke down in March 2003. The failure resulted largely from the refusalof Rauf Denktash, the president of the self-proclaimed Turkish Republic ofNorthern Cyprus (TRNC), which is recognised only by Turkey, to accept theAnnan plan as the basis for negotiations (April 2003, The political scene). At thisstage, the policy of the Turkish government seemed wavering, with Mr Annansaying on April 1st 2003 that he would not restart negotiations unless a solutionwere genuinely in prospect. However, Mr Denktash’s domestic political positionwas severely weakened by the results of parliamentary elections in the TRNCon December 14th, which produced an even split between parties favouring theAnnan plan and those opposing it. Mr Erdogan’s government then took twoimportant initiatives: first, taking a decisive stand in favour of a settlement alongthe lines of the Annan plan; and second, establishing a new government in theTRNC to take the peace process forward.

On January 8th 2004 Mr Erdogan brought together the leaders of all fourparties represented in the new TRNC parliament, apparently with the aim ofproducing a broad-based government running across the party spectrum. Hewas unable to secure this, but on January 12th a coalition was formed betweenthe Republican Turkish Party (CTP), now the biggest party in parliament, andthe Democratic Party (DP), which between them have 26 of the 50 seats. Thenew government, led by Mehmet Ali Talat (CTP), committed itself to trying to

A new government in theTRNC helps to restart talks

Mr Erdogan leads the push fora settlement on the island

Turkey 17


reach a settlement with the Greek Cypriots by May 1st, and to acting in "fullharmony" with Turkey.

Meanwhile, following a meeting on January 24th of Turkey's National SecurityCouncil, which brings together the armed forces chiefs, the president and thegovernment leaders, the government announced that it would continue tosupport Mr Annan in his quest for an agreement, and was committed "to a rapidachievement of a settlement through negotiations, based on the realities of theisland and taking the Annan plan as a reference". The reference to the "realitiesof the island", and the proposal that the Annan plan would only be a "reference"caused some critics to suggest that the Turkish side would still be obdurate, but itwas evident that there had been a change in the previously hard-line stance ofthe Turkish armed forces, possibly as a result of personnel changes at the top ofthe army in August 2003 (October 2003, The political scene).

At a meeting with Mr Annan on the sidelines of the World Economic Forum inDavos, Switzerland, on January 24th, Mr Erdogan apparently told the UNsecretary-general that if the Greek and Turkish sides could not agree on allpoints of a settlement, then Turkey could allow him to "fill in the gaps", if theGreek Cypriots agreed to this procedure. Referendums could then be held onboth sides of the island to legitimise the settlement. Following the Davosmeeting, Mr Erdogan returned to Ankara for a meeting with Mr Denktash onJanuary 25th. Afterwards, the TRNC president announced that he would acceptthe Annan plan as a "reference" in future talks, and would not object to holdingreferendums if the two sides agreed to a settlement plan. It was assumed thatthis apparent change of heart by Mr Denktash came about as a result of strongpressure by the Turkish government (on which the TRNC administration isheavily dependent for financial support) as well as the realisation that,following elections in the TRNC, his domestic political position was far weakerthan it had been in the past.

According to an agreement brokered by Mr Annan in New York on February13th, the four parties involved in the dispute (that is, the Greek and TurkishCypriot leaders, with their respective mainland governments) agreed to a rigidtimetable, under which Mr Annan would arbitrate any remaining differencesbetween the two sides before putting the draft settlement to separatereferendums on the two sides of the island prior to Cyprus joining the EU onMay 1st. Neither side could leave the negotiations, or prevent the referendums,without abandoning the commitments entered into in New York.

As a result, the main hurdle to be overcome to achieve a settlement is thereferendums. The Turkish Cypriots have a strong incentive to vote in favour ofthe settlement plan, since this would allow them to join the EU, lifting theeconomic embargoes from which they currently suffer. For the Greek Cypriots,the incentive is far weaker, since they will enter the EU on May 1st even if thereis no settlement, and would have to concede some power to the Turks in thefederal government. Many Greek Cypriots also fear the costs of resettling therefugees who fled from the north when Turkey invaded Cyprus in 1974.Although they would suffer some serious costs by rejecting the plan (inparticular, international isolation and the hardening of the present territorial

Mr Annan establishes a rigidframework for talks

18 Turkey


division, which leaves them at a disadvantage) opinion polls carried out in thesouth suggest that over 60% of the Greek Cypriots will vote "No".

In the first phase of direct talks, which began in Nicosia on schedule onFebruary 19th, Mr Denktash and Mr Papadopoulos appeared from the outset tobe waiting for Greece and Turkey to join the talks and so failed to make anyreal progress towards a settlement. With EU accession on May 1st already acertainty for the Greek Cypriots and opinion polls in the south indicating that amajority opposed a settlement based on the Annan plan, Mr Papadopoulosadopted a tougher stance than he had done before March 2003 when theprevious round of talks broke down. Mr Denktash, who appeared increasinglyobdurate as the negotiations went on, insisted particularly on the need to haveEU derogations established in primary law to prevent them from beingoverturned in a future appeal to the EU’s European Court of Justice. In part thisreflected his desire to ensure that the bicommunal, bizonal nature of theproposed settlement would not be undermined by legal challenges after asettlement is agreed, but also to try to delay the negotiations.

Under the rigid framework for talks, failure to break the impasse betweenMr Denktash and Mr Papadopoulos by March 22nd led the UN to invite Greeceand Turkey to send representatives to join the next round of negotiations,which began at Burgenstock, near Lucerne, in Switzerland on March 26th.Mr Erdogan immediately made it clear that he would attend. After a briefperiod of hesitation, Greece’s new prime minister, Costas Karamanlis, whoseparty, New Democracy, won the Greek general elections on March 7th, alsoagreed to participate. Despite strong pressure from Turkey to attend,Mr Denktash eventually decided not to attend. He was replaced by the TRNCprime minister, Mr Talat, and Serdar Denktash, the deputy prime minister,foreign minister and son of Rauf Denktash. At the end of March, after a briefperiod of inconclusive negotiations, the Greek and Greek Cypriotrepresentatives refused to give their backing to the final draft of Mr Annan'splan, with Mr Papdopoulos declaring after the talks ended that he wouldcampaign for a "No" vote in the referendum, which is to be held on April 24th.Mr Erdogan gave the draft plan his full support. Mr Karamanlis appeared toback away from taking a position.

While immediate attention has been concentrated on Cyprus, the governmentis also seeking to ensure that it obtains a favourable decision from theEuropean Council in December 2004, by meeting the EU’s requirements forradical improvements in its human-rights regime, and treatment of the Kurdishminority. In general, the main EU member states are appreciative of theimportant legal and constitutional reforms that have been enacted over thepast two years. Since the start of 2004 the president of the EuropeanCommission, Romano Prodi, the EU commissioner for enlargement, GüntherVerheugen, the German chancellor, Gerhard Schröder, and the British foreignsecretary, Jack Straw, have all issued strong signals that they favour a positiveresponse to Turkey. Mr Karamanlis also confirmed that he favoured Turkey’seventual accession, provided it met democratic criteria. Recent statements onTurkey by the French President, Jacques Chirac, have been positive, but there is

EU leaders appear positive onTurkey accession negotiations

The first phase of talks endswithout an agreement

Mr Erdogan supports MrAnnan's final draft

Turkey 19


still some uncertainty as to whether France will agree to support the start ofaccession negotiations. In November 2004 the Commission is due to issue itsannual report on Turkey’s progress towards accession. The verdict given in thereport will have an important influence over the European Council’s decisionin December.

Besides emphasising that a settlement in Cyprus would be highly desirable, EUleaders have also pointed out that the Turkish government must be seen tohave put into practice improvements in legislation regarding human rights,freedom of expression and protection of minorities. On February 20th theminister of justice, Cemil Cicek, announced that the government would tablefurther constitutional reforms in April, to improve Turkey’s position with regardto charges against it in the European Court of Human Rights (ECHR).Nonetheless, European opinion is likely to be critical, if current charges in theConstitutional Court against the pro-Kurdish Democratic People’s Party(DEHAP) result in the closure of the party.

Similarly, the European Parliament is keeping a close watch on the re-trial ofLeyla Zana, which began in 2003. Ms Zana, a former member of parliament ofthe pro-Kurdish Democracy Party (DEP), was imprisoned in 1994 along withthree other Kurdish members of parliament for collaborating with the KurdistanWorkers’ Party (PKK). In 2001 the ECHR ruled that their initial trial was unfair.The four were able to ask for a judicial review under democratisation reformsTurkey has adopted as part of its EU membership bid. Calls have come fromthe European Parliament for the defendants to be released during the re-trial. Sofar this has been denied.

While Europe’s main political leaders have been taking a more positiveattitude towards potential Turkish accession, a different note has been struckby Germany’s Christian Democratic Union/Christian Social Union(CDU/CSU), which has long opposed the proposal on the grounds that Turkeyis not a "European" country. On a visit to Ankara on February 16th, AngelaMerkel, the leader of the CDU, offered Turkey what she called a "privilegedpartnership" with the EU, as an alternative to full membership. This idea waspromptly rejected by Mr Erdogan, since it would give Turkey little more thanthe benefits of its existing customs union with the EU. The proposal was alsofirmly rejected by Mr Verheugen, as well as by Mr Schröder, since it is directlycontrary to the undertakings accepted by the European Council at its Helsinkisummit in December 1999, at which it was clearly agreed that Turkey could bea candidate for eventual membership. The CDU-CSU is unlikely to come topower in Germany before 2006. By then, it would probably not be able single-handedly to reverse a clearly stated policy of all the main EU member states.In fact, during her visit to Ankara, and in a private conversation with OnurOymen, the deputy leader of Turkey’s opposition Republican People’s Party(CHP), Ms Merkel is reported to have admitted that if accession negotiationswith Turkey started before her party came to power, then it would bepowerless to stop them.

Germany's CDU/CSU opposesTurkey's EU accession

Leyla Zana retrial and DEHAPcase will be watched closely

20 Turkey


On March 28th Turkey elected the members of all the country’s 80 provincialcouncils, and the mayors and municipal councils for around 3,200municipalities. Strictly speaking, local elections do not directly affect thenational government's hold on power since local authorities in Turkey havelimited functions, and the AKP currently has a commanding majority in thenational parliament of 368 of the 550 seats. However, since the local electionsare held throughout the country, and the turnout rate is high by internationalstandards, it was an important test of the AKP's popularity. Although the AKP'ssupport was significantly below that reflected in some opinion polls carriedout before the elections, it won convincingly with about 42% of the nationalvote (compared with 34.3% in the last general election, held in November 2002).It also won control of two-thirds of Turkey's 81 provincial councils and gainedthe mayorship of Turkey's two largest cities, Istanbul and the capital, Ankara.The result provides a major boost to the party’s morale, will help to tightenMr Erdogan’s hold over his own rank and file, and may give him a strongermandate in the Cyprus negotiations.

In the local elections the gap widened sharply between the AKP and the CHP,the main party in opposition. However, the CHP fared considerably better thanin pre-election opinion polls. It held onto the mayorship of Izmir and wonabout 18% of the vote, which was slightly down on the 19.4% that it won in theNovember 2002 parliamentary election, but well above the 12% suggested inopinion polls before the March 28th vote.

However, it remains to be seen whether the AKP's showing in the localelections will be sufficient to avert a challenge to the party’s current leader,Deniz Baykal, who has failed to present the party as a convincing alternative tothe present government. Kemal Dervis, the successful minister in charge of theeconomy in the previous government during 2001-02, is commonly mentionedas a possible candidate. On the other hand, Mr Dervis frequently proclaims hisloyalty to Mr Baykal, and would be a reluctant challenger. While widelyrespected, he appears to have little crowd-pulling flair among ordinary voters.Ismail Cem, a respected foreign minister in the former government, wouldprobably have some support, but he would first have to merge his tiny NewTurkey Party with the CHP before he could start to bid for the party leadership.A similar problem affects Murat Karayalcin, a former and popular mayor ofAnkara, who currently heads the separate Social Democrat Populist Party.

Economic policy

An IMF delegation visited Ankara in January and again from February 26th toMarch 12th for the seventh review of the February 2002 standby accord. Thesevisits followed the completion of the sixth review and the consequent releaseof a US$500m credit tranche in December (January 2004, Economic policy).The latest review was complicated by the government's decision at thebeginning of 2004 to grant substantial increases in the minimum wage andpensions. Together with concern about tax revenue, these moves putunexpected pressure on fiscal balances. Tight fiscal policy is needed to stabilise

AKP is the clear winner oflocal elections on March 28th

IMF credit disbursements areslightly behind schedule

The CHP fares betterthan expected

Deniz Baykal still facesserious challenges

Turkey 21


the high government debt and is central to the IMF-agreed policy programme.The government introduced a series of corrective measures in early Marchpaving the way for the seventh review to be concluded. Approval by the IMFexecutive of a US$500m credit tranche is expected in April followingcompletion of the government's letter of intent to the IMF.

While fiscal policy has been the main focus of attention in recent months (seebelow), the government has also promised the IMF that it would adopt a seriesof structural reforms, often requiring parliamentary approval. In this context,further legislation on direct taxation was approved by parliament on January28th. This legislation sets out incentives for underdeveloped regions whilegradually curbing some of the tax breaks enjoyed by businesses operating infree zones. Parliament also adopted amendments to the Execution andBankruptcy Act on February 12th. Legislation on restructuring the taxadministration, on state enterprise management and on a code of ethicalconduct for civil servants has yet to be debated in parliament, even though itwas due to have been approved by the end of 2003 under the IMF accord.

The government and the IMF are assumed to have agreed a new schedule forthe adoption of such measures. The minister of treasury, Ali Babacan, has saidthe IMF will carry out three further reviews before the current (February 2002)standby accord expires at the end of 2004, instead of four as previouslyplanned, with credit tranches of around US$660m attached to each review,rather than US$500m.

Within the next two to three months Turkish and IMF officials are expected tostart discussing how to follow up the stand-by agreement, which was firstsigned in December 1999, subsequently extended in February 2002 and expiresat the end of 2004. Although the government would prefer not to seek a furtherstandby, it has appeared amenable to some kind of close monitoringarrangement for 2005 onwards. This would ensure that IMF officials wouldremain involved in policy-making, and that the government's creditors, and thefinancial and business world more generally, would continue to receivefrequent signals from the IMF concerning the government's performance.Turkey's total Fund credit and loans outstanding amounted to about US$23bn atthe end of February 2003. About US$5.2bn is scheduled to be repaid to theFund this year, US$7.8bn in 2005 and about US$10bn in 2006 (October 2003,Economic policy).

Turkey has yet to make use of another important source of external financing:the US$8.5bn credit facility agreed with the US last September. The governmentis understood to be trying to negotiate alterations to the terms of theagreement, which binds it to co-operate with US policy on Iraq and not to takeany unilateral action in northern Iraq. The disbursement of the loan is alsoconditional on Turkey following IMF-prescribed policies.

The IMF's role in Turkeybeyond 2004 is not yet clear

22 Turkey


Consolidated central government budget(TL trn)

2001 % of 2002 % of 2003 % of 2003 2003Outturn GNP Outturn GNP Target GNP Rev. Tgt Outturn

Total revenue 51,543 29.2 75,592 27.6 100,782 28.4 100,782 100,238Tax revenue 39,736 22.5 59,632 21.8 85,955 24.2 85,955 84,334 Direct taxes 16,081 9.1 20,077 7.3 28,444 8.0 28,444 27,801 Indirect taxes 23,655 13.4 39,554 14.5 57,511 16.2 57,511 56,533Other revenue 11,807 6.7 15,960 5.8 14,827 4.2 14,827 15,904 Income from state property 4,491 2.5 3,514 1.3 5,085 1.4 5,085 5,105 Funds 2,933 1.7 1,961 0.7 3,557 1.0 3,557 2,463

Total expenditure 80,579 45.7 115,682 42.3 145,949 41.2 142,300 140,054Interest payments 41,062 23.3 51,871 19.0 65,450 18.5 59,198 58,609 On domestic borrowing 37,494 21.2 46,807 17.1 58,050 16.4 53,000 52,719 On foreign borrowing 3,568 2.0 5,064 1.9 7,400 2.1 6,198 5,890Non-interest expenditure 39,517 22.4 63,812 23.3 80,499 22.7 83,102 81,445 Personnel 15,212 8.6 23,089 8.4 28,036 7.9 28,036 30,201 Other current expenditure 5,236 3.0 8,019 2.9 9,280 2.6 9,030 8,218 Investment 4,150 2.4 6,892 2.5 7,999 2.3 6,990 7,165 Tax rebates 2,918 1.7 5,666 2.1 6,762 1.9 8,593 8,336 Social security 5,112 2.9 11,205 4.1 14,923 4.2 16,145 15,922 Agricultural support 1,033 0.6 1,868 0.7 2,545 0.7 2,805 2,805 Funds 1,480 0.8 234 0.1 200 0.1 280 280Primary budget balance 12,026 6.8 11,781 4.3 20,283 5.7 17,680 18,793Budget balance -29,036 -16.5 -40,090 -14.7 -45,167 -12.7 -41,518 -39,816Memorandum itemGNP 176,484 100.0 273,463 100.0 354,575 100.0 - -

Source: Ministry of Finance, General Directorate of Public Accounts.

The 2003 consolidated central government budget deficit was TL39,819trn(about US$27bn at the average 2003 exchange rate). This was well below thegovernment’s target of TL45,167trn projected at the beginning of 2003. Thisstrong performance compared with the original target was entirely the result oflower-than-projected interest payments, reflecting lower borrowing costs andthe impact of the strong lira on the lira value of the foreign-currency-denominated portion of the central government debt. The primary budgetsurplus—that is, the budget balance when interest payments are excluded—wasworse than had been projected at the beginning of the year. It came in atTL18,793trn compared with an original target of TL20,283trn. Personnelexpenditure, transfers to social security institutions and tax rebates were allhigher than originally anticipated, and tax revenue was lower. Against this,investment and other current spending were lower than anticipated and non-tax revenue were higher.

The deviations from the expenditure targets had been anticipated. In Novemberparliament had approved a supplementary budget drawn up by thegovernment, which facilitated extra spending on certain items while cuttingallocations for others (January 2001, Economic policy). This resulted indownward revisions of the original targets for both the overall budget deficitand the primary budget surplus. The actual budget performance bettered theserevised targets.

2003 primary budget surplustarget is narrowly missed

Turkey 23


The main IMF fiscal target for 2003 was a primary public-sector surplus of 6.5%of GNP. The public sector incorporates both the consolidated centralgovernment budget and off-budget institutions (mainly state enterprises andextra-budgetary funds). The changes made to the budget in Novemberacknowledged that the contribution of the budget to the wider public-sectorprimary surplus would be about 5% of GNP rather than the 5.7% previouslyprojected. According to Ministry of Finance full-year budget figures andofficially estimated nominal GNP, the final primary budget surplus figure willbe around 5.3% of GNP. However, the nominal GNP figure had not beenpublished at the time of writing. Little data is available as yet concerning theoff-budget parts of the public sector, although the Unemployment Fund isknown to be running a significant surplus and some state enterprises, includingTurk Telekom, are understood to have made large profits.

The large primary budget surplus (which limits the need for fresh borrowing),privatisation receipts to be used to pay down debt, and falling borrowing costsare expected to slow the increase in government debt stock. For the time being,however, the total central government debt stock (TCGDS)—which encompassesalmost all of Turkey's public-sector debt, domestic and foreign, other thanCentral Bank of Turkey liabilities—has continued to rise steadily. However, inrelative terms, the Economist Intelligence Unit estimates that centralgovernment debt has declined from a peak of almost 100% of GDP at end-2001to about 79% at the end of 2003.

In lira terms, the TCGDS rose from TL263,200 trn at the end of September toTL282,900trn at the end of January. In dollar terms, the TCGDS fell by aboutUS$10bn to US$182.6bn between the end of September and the end of October2003, but then surged to US$213.8bn at the end of January 2004. Thesedevelopments were mainly the consequence of exchange-rate movements andof the issue of Treasury bonds to the Savings Deposit Insurance Fund (SDIF) inDecember in order to finance the compensation of Imar Bank customersfollowing the collapse of the bank last July (see below).

The total central governmentdebt is still rising

The public-sector primarysurplus is not yet known

24 Turkey


The external portion of the TCGDS increased from US$61.4bn at the end ofOctober to US$64.7bn at the end of January. This period saw continuedborrowing from the IMF and the international bond markets, as well as debtrepayments. At the same time, the weakness of the dollar against the euro andother international currencies pushed up the dollar value of the part of thedebt that is denominated in the other currencies. (See Foreign trade andpayments for more information on foreign debt, including the foreign debt ofthe rest of the public sector and the private sector). The domestic portion of theTGDS, as measured in dollar terms, rose to US$149.1bn at the end of Januaryfrom US$129.8bn at the end of October. This steep rise was also mainly theresult of dollar weakness, which increased the dollar value of Turkish lira-denominated debt.

Government debtUS$ bn year end

2001 2002 2003 2004Year 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Jan

Debt by lender:Domestic market 28.8 35.4 38.1 43.3 46.4 62.6 67.7 72.9 84.5Public sector 56.0 45.4 38.1 48.4 48.7 60.7 15.6 66.4 64.6Foreign market 26.0 28.0 27.9 29.4 29.8 31.6 32.3 33.0 34.3Bond issues 20.1 22.0 21.8 23.1 23.7 25.7 26.4 26.8 28.2Other 5.8 5.9 6.1 6.3 6.1 5.9 5.9 6.2 6.1International institutions 12.3 12.8 13.2 13.4 13.4 13.4 13.4 13.7 13.7IMF credit 0.5 11.4 13.6 13.9 14.0 15.0 15.6 16.7 16.7Total central government debt 123.6 133.0 139.8 148.5 152.3 183.3 191.2 202.7 213.8By currency Turkish lira n/a n/a n/a 62.2 66.0 90.4 97.8 108.7 118.3 Foreign currency denominated or linked n/a n/a n/a 86.3 86.4 93.0 93.4 94.0 95.5

Domestic debt n/a n/a n/a 91.7 95.2 123.3 129.8 139.3 149.1External debt n/a n/a n/a 56.8 57.1 60.0 61.4 63.4 64.7By currency US$ n/a n/a n/a 22.8 23.7 24.7 25.8 25.7 27.2 Yen n/a n/a n/a 4.4 4.1 3.8 4.1 3.7 3.8 € n/a n/a n/a 14.9 14.7 15.8 15.2 16.7 16.5 SDR n/a n/a n/a 13.9 14.0 15.0 15.6 16.7 16.7 Other n/a n/a n/a 0.7 0.7 0.7 0.7 0.6 0.6

Source: Turkish Treasury.

The 2004 budget approved by parliament in December foresees revenue ofTL114,500trn (27.3% of anticipated GNP) and total expenditure of TL160,900trn(38.3% of GNP), of which TL94,700trn (22.6% of GNP) is to go on non-interestexpenditure and TL66,200trn (15.8% of GNP) on interest. The budget foresees adeficit of 11.1% of GNP and a primary surplus of 4.7% of GNP compared withan official estimate for the deficit of 11.2% of GNP. Off-budget parts of the publicsector will therefore be required to generate a primary surplus equivalent to1.8% of GNP if the main IMF-agreed fiscal target—unchanged from 2003—of aprimary public-sector surplus equivalent to 6.5% of GNP is to be achieved.

Problems quickly arose in January when the government announced increasesin pensions, the cost of which had not been fully incorporated in the budget,and then an increase in the minimum wage, which also placed an unexpected

Wage and pension rises put2004 budget targets at risk

Turkey 25


burden on the public finances. Pensions paid by two of the three social securityinstitutions (the SSK and Bag-Kur) were increased by 10% at the beginning of2004, with a further 10% increment promised for July. The minimum wage wasincreased by 34% net (See Employment, wages and prices), and the governmentpledged to help employers foot the bill by subsidising the additional socialsecurity contributions that the increase would entail. In addition, we believethat the government's economic growth projection of 5% in 2004, on which itsfiscal targets are predicated, is over-optimistic (see Outlook).

The government later submitted a supplementary budget to parliament, whichwas approved on March 4th. The supplementary budget legalised the extratransfers of around TL3,500trn that will have to be made to social securityinstitutions in 2004 in order to finance the pensions increases and minimumwage subsidy. At the same time, it cut most expenditure allocations, other thanpersonnel and interest costs, by 13% in order to ensure that the extra spendingdoes not affect the targets for the overall budget balance.

Extra fiscal measures were also made necessary by the shortfall in tax revenuein 2003, which threatens to replicate itself in 2004. On February 26th thegovernment increased the Special Consumption Tax (SCT) on transport fuelsand on cigarettes. Fuel prices rose by an average of about 3% the next day.Prices of most cigarettes rose by up to 12% within the following two weeks.Additional revenue is also expected as a result of the 10% price hike introducedat the end of February by the new owners of the privatised TEKEL alcoholicdrinks enterprise (see below). The government increased minimum rates ofSCT on alcoholic drinks on March 14th. The government, meanwhile, reducedthe rate of value-added tax (VAT) on pharmaceutical products from 18% to 8%effective as of March 1st. Although this will reduce VAT receipts, the VAT ratecut is expected to make a positive net contribution to the public finances sincemost medicines are purchased by the state social security institutions.

The government approved the sale of the state's 66% stake in oil refiningcompany Tupras to Efremov Kautschuk, a German firm linked to Russian oilcompany Tatneft, for just over US$1.3bn on February 9th. The outcome of thetender had been announced a month earlier, shortly after it became knownthat Efremov—one of only two bidders—was being partnered by localconglomerate, Zorlu Holding. Bids were originally received on October 24th2003. The buyer is due to sign a contract and make an initial payment in Aprilor early May. The decision to accept the modest bid made by Efremov contrastswith November's rejection of the highest of two offers made for the Tekelcigarette business (January 2004, Economic policy). This may reflect pressurefrom the international financial institutions and the private sector as well as thedetermination of the government—which set an ambitious US$4bn target forprivatisation in 2003—to achieve its first major sell-off. However, on January30th the tender for the state's 88% stake in petrochemicals plant, Petkim, wascancelled because there was only one bidder.

Tenders for two fertiliser companies and for the urban gas distributionnetworks in Bursa and Eskisehir were concluded in January. These tenders havea total value of US$350m. In 2003 the largest privatisation deal was the award

Additional budget measuresare approved in early March

Privatisation accelerates withrefinery sale

26 Turkey


of the former state alcoholic drinks monopoly to a consortium consistingmainly of Turkish contracting companies for US$292m. The sales contract wassigned on February 27th. Buyers were also found for assets such as portoperating rights and paper mills. The total value of privatisation deals reachedsince the beginning of 2003 stands at about US$2.2bn. However, most of thedeals are still subject to contract or approval, so cash revenue is much lower. Asof the end of February, the Privatisation Administration said it had receivedUS$173.6m in cash revenue in 2004, compared with just US$141.7m for thewhole of 2003.

In its letter of intent (LOI) to the IMF in October (made public in December), thegovernment said it was expecting cash receipts from the sale of state assets ofaround US$3bn in 2004. The tender process for Turk Telekom is to begin by theend of May (January 2004, Economic policy). A new strategy is to be finalisedfor selling the Tekel cigarette business. However, privatisation prospects for thiscompany do not appear to be good.

In March a strategy was drawn up for the power sector that may enable workto begin on the long-delayed sale of regional distribution networks. On March18th the Supreme Planning Board, a cabinet sub-committee, adopted a strategyfor the delayed transition to a free power market, meeting a condition for aUS$375m World Bank Economic Reform Loan. The plan envisages theprivatisation of regional distribution networks between March 2005 and theend of 2006. There will be a maximum of 21 regional networks rather than the33 previously foreseen. Each network will be incorporated prior to the sell-off.The sale of the state's generating assets is not set to begin until mid-2006. Thepower plants will be grouped into packages in an effort to make sure that allare sold. Spreading the privatisation process over time may make it possible towin the confidence of private and foreign investors, which has been damagedas a result of previous unsuccessful attempts to attract private capital to thesector. It will also allow time for the current excess of supply to be soaked up.Meanwhile, the government is trying to provide potential investors with a clearpicture of the future regulatory environment. Separately, efforts continue topersuade private operators of build-operate (BO) and build-operate-transfer(BOT) plants to relinquish their long-term electricity sales agreements with thestate and compete in the proposed free market.

The National Lottery, Petkim, the sugar refineries and state land are also to goon sale. Preparations are continuing for the sale of state banks, but no dateshave been set as yet. More shares in Turkish Airlines and leading steel mill,Erdemir, may also be offered to the public.

The spectacular collapse last July of Imar Bank, then owned by the Uzan family,left the SDIF—in effect, the government—facing a bill of close to US$6bn incompensation to savers (January 2004, Economic policy). On February 14th thisyear, using powers made available to it under changes made to bankinglegislation in December, the new government-appointed board of the SDIFselected new management to 219 companies belonging to the troubled Uzangroup. The companies include the mobile-phone operator, Telsim, severalcement plants and the "Star" media empire. The takeover is intended to keep

More privatisations areplanned for 2004

The government moves torecover Imar Bank losses

Turkey 27


the companies operating and prevent their assets from being syphoned off bythe Uzans. The companies (or their assets) are expected to be sold as part of theeffort to collect public claims against the Uzans. However, there is concern thatsome of the 219 companies may turn out to be illiquid themselves, and that thegovernment may have to take responsibility for their debts too. Telsim isknown to owe at least US$2.7bn to suppliers Motorola and Nokia. The primeminister, Recep Tayyip Erdogan, met Motorola officials during his visit to the USat the end of January.

The Central Bank continues to follow a policy of implicit inflation targeting,with a 2004 target of 12% for year-end consumer price inflation. On February5th, following the announcement of the January inflation figures (see Thedomestic economy/Employment, wages and prices), it cut its benchmarkovernight borrowing rate from 26% to 24% in view of a lack of inflationarypressure and falling inflation expectations. It was the first rate cut since Octoberand many felt it was overdue. The Central Bank had resisted cutting rates inJanuary because of uncertainty over fiscal policy (See above). The cut inFebruary was accompanied by a warning to the government that it should stickto agreed fiscal targets and try to achieve these by means of expenditure cutsrather than by price or indirect tax increases, which could fuel inflation.

On March 17th the Central Bank made a further two-point cut in rates, bringingdown its overnight and one-week borrowing rates to 22% and its overnightlending rate to 27%. The Bank cited February's satisfactory inflation data andthe government's expenditure-cutting measures as motives for cutting rates. Italso said that the decline in inflation, a lack of domestic demand pressure,exchange-rate stability and falling inflation expectations all supported the beliefthat the end-year consumer price inflation (CPI) target for 2004 was attainable.

At the same time, IMF-agreed targets for base money and net internationalreserves remain in force. Base money averaged TL14,657trn during the last fiveworking days of December. This figure was within the revised ceiling ofTL14,900trn set in the October LOI. The ceiling had previously been set atTL14,300trn, but it was revised upwards because of reverse currencysubstitution—growing confidence in, and hence demand for, the lira. Netinternational reserves, as defined for IMF purposes, stood at -US$536m as at theend of December, well above the revised floor of -US$2bn, and far higher thanthe original target of -US$6bn.

The decline in typical secondary market lira-denominated government bondyields resumed in December 2003 after an interval of several weeks. Thisreflected financial market optimism about Cyprus, IMF relations, inflation andthe likelihood of a Central Bank interest rate cut. By early January typical yieldswere about 24% compared with 29% at the end of November. Subsequently, theuncertainty over fiscal policy and IMF relations, the ebb and flow ofexpectations on Cyprus, and the Central Bank's caution in cutting rates causedtypical yields to fluctuate around the 25% mark for several weeks. By mid-March, typical yields had fallen again to about 24%. In parallel with thesedevelopments, the average cost of the government's fresh lira-denominated

The Central Bank cutsinterest rates

Government borrowing costsdrop in mid-March

28 Turkey


borrowing inched downwards from about 29% in October, November andDecember to about 27% in January and about 26% in February.

The Treasury carries out a small part of its domestic borrowing each month inUS dollars, enabling banks to maintain their foreign currency asset portfolios.Interest rates on this kind of debt have also fallen. On January 13th a 546-daydollar bond was issued at 4.12% annual interest. At a swap auction in January,the Treasury offered foreign-exchange-indexed bonds due in June 2004 inexchange for Tukish lira-denominated bonds due in November 2005. However,demand at this auction was low.

Yields on Treasury bills and government bonds at auction(%)

2001 2002 2003 2004Dec Dec Jun Jul Aug Sep Oct Nov Dec Jan Feb

6-month bill ratea 73.6 49.0 46.0 44.5 41.6 35.1 30.5 27.5 27.8 25.9 24.63-month bill rate 71.0 45.5 39.5 36.1 34.3 30.8 26.5 26.0 25.7 27.7 25.4

a Or nearest maturity, excluding three-month.

Source: Under-secretariat of the Treasury.

In lira terms, the level of domestic debt rose steadily from TL180,200trn at theend of October 2003 to TL194,400trn at the end of December and TL199,400 trnat the end of January 2004. Net borrowing in December alone amounted toTL11,000trn. This was the month in which TL6,800trn-worth of bonds wereissued to the SDIF to meet the cost of compensation to former Imar Bankaccount holders. These "non-cash" bonds were issued in maturities of 3-42months, so as to fall due as the payments to the Imar Bank customers are made.All are lira-denominated and carry variable rates of interest (mostly indexed toconsumer price inflation), again matching the terms of the payment plan.

The Imar Bank-related bond issues temporarily interrupted recent trends in thecomposition of the domestic debt stock. Until December the share of "non-cash" bonds and of debt owed to public institutions in the total domestic debtstock had been declining gradually. This reflected the declining weight in thedebt stock of bonds issued to support troubled banks in past years. InDecember, however, "non-cash" debt —consisting of bonds issued mainly during

Imar Bank collapse adds to thedomestic debt stock

Turkey 29


the course of bank rescue operations without any cash being borrowed inreturn—rose from 31% to 33% of the total domestic debt stock, before falling backto 32% in January. Likewise, the share of the domestic debt owed to publicinstitutions (including the Central Bank and state banks) rose from 46.5% at theend of November to 47.7% as at the end of December. In January, however, theImar Bank-related debt was reclassified as debt owed to the "market", and thispercentage fell to 43.3%.

Domestic debt(TLtrn unless otherwise indicated)

2000 2001 2002 2003 2004Year Year Year 2 Qtr 3 Qtr 4 Qtr Jan

Borrowing 32,469 209,613 125,303 49,571 29,497 45,710 17,469Debt service 37,577 164,361 141,059 54,438 36,538 40,607 17,491 Principal 18,968 123,877 97,591 26,859 26,055 30,035 12,497 Interest 18,609 40,484 43,469 17,579 10,483 10,573 4,993Total domestic debt stock (end-period) 36,421 122,157 149,870 175,270 178,712 194,387 199,358 (average no. of months to maturity) 15.5 38.9 32.1 28.0 26.2 25.1 24.7

Cash debt 29,423 58,354 89,271 116,664 120,377 130,484 136,136 (average no. of months to maturity) 9.4 20.2 12.8 13.3 12.5 12.4 12.8

Non-cash debt 6,998 63,804 60,599 58,606 58,335 63,903 63,222 (average no. of months to maturity) 41.4 55.9 60.4 57.3 54.3 51.2 50.3By lender (end-period):Public sectora n/a 80,574 79,107 86,249 85,577 92,626 86,339Markets n/a 41,584 70,763 89,021 93,135 101,760 113,019By instrument (end-period):Fixed-rate TL n/a 17,745 37,576 57,265 61,945 68,614 73,213Floating-rate TL n/a 60,938 64,118 71,190 72,686 83,176 84,890Foreign-exchange-denominated/indexed n/a 43,474 48,176 46,814 44,079 42,597 41,255

a Central bank, state banks, Savings Deposit Insurance Fund (SDIF) and other public institutions

Source: Under-secretariat of the Treasury

The Imar Bank-related bond issues also resulted in a slight increase in the shareof floating-rate debt in the total domestic debt stock. As of the end of Januaryfloating-rate debt accounted for 43% of the domestic debt stock, the sameproportion as at the end of 2002. The share of fixed-rate lira-denominated debtin the total domestic debt stock has continued to edge upwards, reaching 37% atthe end of January 2004 compared with 25% at the end of 2002. Fixed-rate lira-denominated bonds are the instrument most favoured by the Treasury and thebond markets. The share of foreign-currency-denominated/linked debt in thetotal domestic debt stock slipped back to 22% at the end of 2003 and 21% at theend of January 2004 from 32% at the end of 2002. This is partly because of thestrength of the lira as well as the limited amounts of fresh foreign-currencybonds recently issued in the domestic market.

Strong demand for emerging market debt related to high international liquidityenabled the Treasury to make two large international bond issues in early 2004:a 30-year dollar bond dated January 14th issued in the amount of US$1.5bn at316 basis points over US treasuries, and a ten-year euro-denominated bonddated February 10th issued in the amount of €1bn at 246 basis points overbunds. According to the Treasury, the return to investors worked out at 8.23% for

The government issuesmore eurobonds

Almost 80% of the domesticdebt is now lira-denominated

30 Turkey


the dollar bond and 6.625% for the euro bond. Despite the relatively longmaturities, these were the lowest costs at which Turkey has ever borrowed ininternational markets.

The domestic economy

Output and demandGross domestic product(% real change, year on year; 1987 prices)

2000 2001 2002 2003Year Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year

Private consumption 6.2 -9.2 -1.8 3.2 2.5 4.2 2.0 7.8 2.9 5.8 10.3 6.6Public consumption 7.1 -8.5 2.2 2.6 12.0 4.5 5.4 -2.3 -2.0 -0.7 -4.2 -2.4Gross fixed investment 16.9 -31.5 -28.8 -2.3 5.9 22.2 -0.8 11.7 6.3 3.0 19.2 10.0 Public sector 19.6 -22.0 -18.1 3.0 29.8 22.7 14.5 -34.8 -14.6 -22.7 5.0 -11.5 Machinery & equipment 20.3 -39.0 -19.3 10.8 71.2 52.8 29.3 -41.2 5.0 -43.3 -0.9 -19.2 Building construction 31.6 -20.0 -17.8 27.1 34.1 25.2 23.9 -37.5 -47.9 -34.9 -8.7 -26.7 Other construction 12.2 -10.3 -16.8 -13.0 12.7 6.5 1.1 -25.1 0.1 -4.2 19.2 4.0 Private sector 16.0 -34.9 -30.9 -4.2 -3.7 21.8 -7.2 22.6 14.2 16.4 30.1 20.3 Machinery & equipment 37.2 -49.6 -40.8 6.8 15.2 71.0 1.4 54.0 32.2 47.5 54.5 46.1 Construction -9.7 -8.0 -15.1 -16.7 -16.3 -14.7 -15.8 -11.8 -11.8 -11.7 -10.0 -11.4Exports of goods & services 19.2 7.4 10.4 5.0 15.8 12.3 11.0 14.5 12.3 19.4 16.9 16.0

Imports of goods & services 25.4 -24.8 2.1 20.3 19.3 22.1 15.7 22.0 24.7 28.3 33.0 27.1GDP by expenditurea 7.3 -7.5 2.1 8.9 7.9 11.4 7.8 8.1 3.9 5.5 6.1 5.8GNPb 6.3 -9.5 0.4 10.4 7.9 11.5 7.8 7.4 3.6 5.6 7.2 5.9

a Including change in stocks and excluding statistical discrepancy. b Including net factor income from abroad.

Source: State Institute of Statistics.

Upward revisions to third-quarter data and stronger than expected growth inthe final months of 2003 resulted in GDP expanding by 5.8% last yearcompared with our estimate of 5%. Helped by growing consumer and businessconfidence, falling interest rates and lower inflation, there were sharp increasesin private consumption (particularly of durable goods) and private investmentin machinery and equipment (building construction investment continued todecline). In contrast, public consumption declined compared with the fourthquarter of 2002, reflecting government efforts to reduce public spending(purchases of goods and services fell by 7.4% year on year). Accumulation ofstocks also continued, albeit making a smaller contribution to overall GDPgrowth than in the first half of the year. Exports of goods and services showedrobust growth, despite an appreciation of the lira. However, imports of goodsand services increased at almost twice the rate of exports as a result ofaccelerating domestic demand growth and the stronger currency, which hasmade imported goods cheaper.

Sectoral trends

According to national-accounts data by sector, manufacturing, energy, wholesaleand retail trade and transport and communications all recorded strong growth

GDP increases by 5.8% in 2003

Industrial output rises furtherin late 2003 and early 2004

Turkey 31


in the fourth quarter of 2003 and the year as a whole. However, agriculturaloutput contracted by 9.6% year on year in the final three months of 2003 andby 2.5% for the year as a whole. Despite a record number of foreign visitors toTurkey last year (see below), hotel and restaurant services fell by 3% in 2003(but by just 0.4% year on year in the last three months of the year) Theprolonged decline in the construction sector came to an end in the fourthquarter thanks to, it would appear from expenditure-based data, publicinvestment in non-building construction. However, the sector still contracted bya further 9% in the year as a whole.

The State Institute of Statistics' monthly industrial production index, althoughnot a comprehensive survey, provides more recent data on the performance ofindustry. It points to year-on-year increases of 12.7%, 4%, 21.6% and 6.5% inindustrial production year on year in October, November, December 2003 andJanuary 2004. In the case of manufacturing industry, which accounts for over85% of industrial output, the increases were 13.3%, 4.7%, 23.2% and 7.5%,respectively. The relatively low November increase and the extraordinarily highDecember increase reflect the timing of a three-day public holiday, which in2003 fell in November, but in December in 2002.

Industrial production, monthly index(1997=100; % change year on year in brackets)

2003 2004Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

Total 87.2 107.9 102.7 107.9 110.1 111.4 108.0 117.3 124.7 110.7 124.9 109.4(3.4) (5.3) (2.8) (3.8) (9.8) (10.2) (9.3) (11.2) (12.7) (4.0) (21.6) (6.5)

Manufacturing 85.2 106.7 102.9 108.5 110.4 109.4 105.6 117.1 125.8 110.9 124.7 108.1(4.0) (5.5) (3.8) (3.8) (10.6) (10.6) (9.4) (10.7) (13.3) (4.7) (23.2) (7.5)

Mining 61.7 75.5 59.1 64.1 74.2 91.0 87.6 93.7 88.1 70.7 82.2 65.9(-22.4) (-13.8) (-27.4) (-9.2) (-5.4) (5.1) (4.7) (21.2) (3.9) (-11.5) (19.3) (-12.6)

Utilities 124.1 140.1 126.2 127.2 128.6 144.3 146.0 133.4 135.2 132.1 152.2 148.9(10.7) (10.8) (5.4) (8.1) (8.2) (7.9) (10.5) (11.6) (10.8) (3.5) (9.6) (5.8)


Each sub-sector of manufacturing industry has followed its own trajectory.Food and tobacco industry output fell by 8.2% year on year in January, partly asa result of falling output of cigarettes and sugar by the respective stateenterprises. Main metal industry output (mostly iron and steel) rose by only2.2%, perhaps partly because of problems in obtaining scrap iron inputs. Bycontrast, the increase in clothing production, which lagged other sub-sectors formuch of 2003, picked up to 44.4% in December and 17.1% in January, suggestingrenewed export demand.

The automotive industry has continued to register the largest increases inoutput. The Automotive Industry Association (OSD) reported that 562,466vehicles were manufactured in Turkey in 2003—an increase of 57% comparedwith 2002 and the highest annual figure on record. Ford Otosan, OYAK Renaultand Tofas (Fiat) each produced about 130,000 vehicles. Production ofcommercial vehicles (notably by Ford) rose particularly sharply. Over 70% ofthe vehicles produced were exported. Exports, including parts, reached

The automotive industrycelebrates a record year

32 Turkey


US$6.5bn. Domestic demand also grew, but imported vehicles increased theirmarket share to 55% (68% in the case of passenger cars).

According to the monthly industrial production index, automotive industryoutput rose by 80.6% year on year in December and by 51.9% year on year inJanuary. The OSD says 58,237 vehicles were produced in the first month of2004—81% more than in the same month of 2003 and the highest ever forJanuary. Turkey has come to play a significant role in the internationalproduction strategies of manufacturers like Renault, Fiat and Ford in recentyears, and upgrades of the local Toyota and Hyundai plants are planned.

Turkey received almost 14m foreign visitors in 2003 according to the StateInstitute of Statistics, setting a new record. The 5% increase in visitor numberscan be regarded as a success in view of the high baseline in 2002, the deterrenteffect of the Iraq War on early season bookings, the strength of the lira andNovember's Istanbul bomb attacks. The aggregate number of visitors fromTurkey's main markets in western Europe was almost unchanged, but therewere increases in visitors from central Europe and neighbouring countries.

According to the Ministry of Tourism, the number of visitors from Russia roseby 33% to 1.26m, making Russia Turkey's second-largest source of foreign visitorsafter Germany (3.33m). Visitors from Bulgaria rose by 20% to 1.01m, so thatBulgaria became the fourth-largest source of visitors after the UK (1.09m). Inaddition, the number of visitors from Iran and Israel rose by 14% and 19%,respectively, to 495,000 and 321,000. The figures include nearly 688,000 daytrippers, up from 466,000 in 2002. The number of visitors from the US fell by10% to 222m.

Sectoral organisations are confident of a further, large increase in touristnumbers in 2004. However, it is unclear what effect the terrorist bombings inIstanbul in November and in early March will have, as they occurred outsidethe main summer tourist season of June-August. The impact that the MarchMadrid bombing will have on tourism sectors across Europe is also difficult toquantify at this stage

Tourist arrivals(% of total in brackets)

2001 2002 2003Year Year % change Year % change

OECD countries (Europe) 6,854,504 7,947,397 15.9 7,986,524 0.5(59.0) (60.0) (57.2)

OECD countries (non-Europe) 646,143 443,107 -31.4 399,361 -9.9(5.6) (3.3) (2.9)

Other European countries 1,353,101 1,756,168 29.8 1 870 139 6.5(11.6) (13.3) (13.4)

Commonwealth of Independent States (CIS) 1,431,190 1,661,767 16.1 2,072,103 24.7(12.3) (12.5) (14.8)

Asia 1,074,877 1,203,394 12.0 1 398 315 16.2(9.3) (9.1) (10.0)

Total incl others 11,619,909 13,248,176 14.0 13,956,405 5.3


Russians ensure record visitornumbers in 2003

Turkey 33


Employment, wages and prices

The economic recovery ceased to create new jobs in 2003. In the fourth quarterof the year the number of people in employment fell to 20.81m—a decline of3.9% compared with the same period of the preceding year. It was the thirdsuccessive quarter in which the number of people in employment had declinedyear on year. One major reason for the negative trend was a fall-off inagricultural employment, which declined by as much as 10.8% year on year inthe fourth quarter. However, non-agricultural employment also fell by between0.2% and 0.7% in each of the last three quarters of 2003. This was because of alower level of employment in industry. Employment in services—whichaccounts for 42-43% of all employment—rose year on year, except for a smalldecline in the fourth quarter. Employment in construction, although stagnantthroughout the summer months, picked up in the fourth quarter on a year-on-year basis. Public-sector employment was measured at 3,245,000 in the fourthquarter of 2003, 2.8% lower than a year earlier.

Workforce and unemployment('000 unless otherwise indicated)

2001 2002 2003Year 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Workforce 23,491 24,347 23,818 23,088 24,115 24,739 23,206

Workforce participation rate (%)a 49.8 50.3 49.6 47.5 49.4 50.5 47.1Total no. in employmentb 21,524 21,658 21,354 20,244 21,696 22,411 20,811 Agriculture 8,089 7,618 7,458 6,639 7,731 8,389 6,799 Industry 3,774 3,953 3,954 3,769 3,798 3,881 3,836 Construction 1,110 913 958 676 1,006 1,107 1,026 Services 8,551 9,173 8,984 9,160 9,162 9,034 9,150Unemployment rate (%)c 8.4 11.0 10.3 12.3 10.0 9.4 10.3Underemployment rate (%)c 6.0 5.1 5.4 5.0 4.6 4.6 5.0

a Percentage of the population aged 15 or over in the workforce. b Including underemployed. c Percentage of workforce.


The official unemployment rate (the percentage of the workforce out of work)fell to 10.3% in the fourth quarter of 2003 compared with 11% a year earlier. Thisputs the unemployment rate for 2003 as a whole at about 10.5%, comparedwith 10.3% in 2002. The fourth-quarter decline in unemployment was entirelythe result of a contraction in the size of the workforce on the basis of which therate is calculated. The workforce has been contracting despite past strongpopulation growth of around 1m per year. In the final quarter of 2003 theworkforce participation rate was as low as 47.1% compared with 50.3% in thesame period of 2002. In urban areas overall workforce participation was only43.1%; for women it was only 25.1%. The sharp rise in the number of non-workers—up by 2m, or 8.4%, between the fourth quarters of 2002 and 2003—isattributable to a lack of adequate job opportunities and to the reclassificationof unpaid female agricultural workers as housewives, in parallel with thedecline in agricultural employment. The ability of households to support full-time housewives, students and pensioners may have improved too, but this isless certain.

The economic recovery fails tocreate more jobs

Low participation holds downunemployment in 2003

34 Turkey


The rate of unemployment among young educated people fell from 29.8% inthe fourth quarter of 2002 to 25.4% in the fourth quarter of 2003. Meanwhile,the rate of underemployment—referring to employed people who are workingpart time but not by choice or those who do not consider themselves fully orproperly employed for other reasons—dropped from 5.1% to 5%.

Public servants received a pay increase of just 6% at the beginning of the year.However, the government raised the net monthly minimum wage by 34% toTL303m (about US$230) for the first half of 2004. The government alsoannounced steps to subsidise social security contributions for those earning theminimum wage, in order to cushion the cost of the wage increase to employers.Prior to the announced increase, the prime minister, Recep Tayyip Erdogan, haddescribed the minimum wage as "inhuman". Following sharp falls in 2000-01,the real value of the minimum wage recovered partially in 2002 and 2003.

Up to 4m-5m workers are said to earn the minimum wage. It serves not only asthe basic wage for unskilled labourers, but also as an entry-level wage in awide variety of workplaces. It can act as a guide to minimum acceptable payrates even in the informal sector. The minimum wage rise may also affect theincomes of those who are paid more than the minimum wage for reasons ofseniority, extra responsibilities, extra skills etc.

According to the most recent data for real wages in the manufacturing sector,real hourly wages of production workers were 3.9% lower in the third quarterof 2003 than a year earlier. The decline in earnings per production worker wasgreater, at 8.5%, showing that hours worked are still falling year on year, eventhough output has increased more rapidly than employment. The real wages ofmanufacturing industry employees not directly involved in production fell by2.3% year on year in the third quarter. Real wages have been declining since the2001 crisis. It is possible that the decline will come to an end in 2004, given theminimum-wage increase and the continuing decline in inflation.

Inflation: consumer and wholesale prices(% change, year on year; % change month on month in brackets)

2002 2003 2004Dec Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb

Consumer prices 29.7 29.5 30.7 29.8 27.4 24.9 23.0 20.8 19.3 18.4 16.2 14.3(1.6) (2.1) (1.6) (-0.2) (-0.4) (0.2) (1.9) (1.4) (1.6) (0.9) (0.7) (0.5)

Wholesale prices 30.8 35.1 33.7 29.6 25.6 22.7 18.1 16.1 16.2 13.9 10.8 9.1(2.6) (1.8) (-0.6) (-1.9) (-0.5) (-0.2) (0.1) (0.6) (1.7) (0.6) (2.6) (1.6)


The annual rate of consumer price inflation (CPI) ended 2003 at 18.4%, belowthe IMF-agreed target of 20%. In the first two months of 2004 it fell further,aided by the firming of the lira and the baseline effect of high monthlyinflation figures at the end of 2002 and in early 2003. In February consumerprice inflation was down to 14.3%. 2003 was the second successive year inwhich the official year-end inflation target was achieved. This performance hasstrengthened expectations in business and the financial markets that CPI in2004 will be close to the 12% year-end target. Among the general public, too,

The government raises theminimum wage sharply

Real wages in industrycontinue to decline in 2003

Strong lira and baseline effectscut inflation in February

Turkey 35


scepticism may be giving way to a growing perception that almost threedecades of high (30%-100%) inflation are over.

The most negative aspect of the inflation figures for recent months has been asharp increase in wholesale prices for agricultural products. This has beenlinked to storms and floods in the Mediterranean region as well as to normalseasonal trends. Wholesale prices in agriculture rose month on month by 9.3%in January and 5.4% in February, accounting for the greater part of successivemonthly increases of 2.6% and 1.6% in the wholesale price index (WPI). In spiteof this phenomenon, the year-on-year increase in WPI fell to single figures(9.1%) in February from 13.9% at the end of 2003, as a result of a strong baselineeffect. Wholesale prices in private manufacturing industry—sometimes referredto as "core inflation", since they are least susceptible to seasonal factors orgovernment decisions—rose by just 0.9%, 0.6% and 0.1% in December 2003 andJanuary and February 2004, respectively.

A closer examination of the CPI figures shows seasonal factors at work in thepricing of food, clothing and services. Food prices rose by about 1.4% per monthin December, January and February. Prices for some services such as medicalservices and financial services rose by up to 20% in January and February,reflecting price adjustments at the start of the year. By contrast, clothing pricesdeclined by 0.4% in December and by 4.7% in each of January and February,because of end-of-season sales. Rises in food prices to the consumer have beenrelatively modest by comparison with the sharp rise in wholesale prices inagriculture, which suggests a lack of demand pressures, at least in this sector.On the other hand, housing rents rose by a relatively high 1.8% per monthbetween December and February. Rents have started to "catch up" after fallingin real terms during and after the 2001 crisis.

Higher prices for petroleum and tobacco products as a result of governmentincreases in special consumption taxes (see Economic policy) may lead to apick-up in monthly inflation as of March, while seasonal falls in agriculturalprices may not be apparent until May. Nevertheless, "headline" inflation figureslook set to go on declining in the coming months and may dip into single digitfigures, reflecting the relatively high monthly CPI inflation rates recorded inMarch, April and May 2003 (3.1%, 2.1% and 1.6% respectively).

Thereafter, year-on-year inflation figures may stabilise or even rise in somemonths. This outlook would change considerably in the event of a substantialweakening of the lira, which would raise the domestic cost of imported fuels,internationally traded commodities and industrial inputs, and indirectly affectthe prices of most manufactured products, transport and electricity. A weakerlira would also tend to reduce competition from imports in retail markets,perhaps enabling manufacturers more rapidly to increase their prices in linewith services prices and rents.

Financial indicators

Turkish share prices recovered quickly from the shock of the Istanbul bombingsin November 2003, and in December they resumed their recent upward trend.

CPI may fall further, despitepublic-sector hikes

Optimism over Cyprus buoysshare prices in early 2004

36 Turkey


The Istanbul Stock Exchange (ISE) index closed 2003 at 18,625. This representedan increase of 79.6% during the course of the year in lira terms, and 111.4% indollar terms. Total market capitalisation reached US$69bn at the end of 2003compared with US$34.4bn at the end of 2002. Such high levels have not beenwitnessed since the boom of 1999-2000. Likewise, the daily average value oftrading was US$407m in 2003, the highest for any year other than 2000, whenthe figure was US$740m.

Share prices were volatile in the first three months of 2004, but optimism thatthe government's efforts on Cyprus had improved the country's chances ofstarting accession negotiations with the EU in early 2005 and the ruling party'sclear victory in local elections in late March helped to move the index higher.After falling from 19,926 on January 9th to 16,966 on February 6th, it thenpicked up, rising to almost 21,000 by the end of March. The average daily valueof trading declined to about US$700m over the three-month period.

Although volatile for much of the last two years the lira has appreciatedsharply in real terms against the dollar, but to a lesser extent against the euro.After rising by 16% against the dollar and almost 10% against the euro in 2002,the lira appreciated in real terms in 2003 by an average of about 23% against theUS dollar and by about 3% against the euro. In nominal terms the liraweakened in the run-up to the Iraq war, but strengthened from April onwards,with the exception of a brief, but sharp, dip against both the euro and thedollar in October. In November and December it stabilised again, strengtheningagainst the dollar and weakening only marginally against the euro. At the endof 2003 the lira traded at about TL1,400,00:US$1 and TL1,750,000:€1.

As of January the lira made further gains against both the dollar and the euro.In response the Central Bank of Turkey reintroduced the daily foreign-exchangepurchase auctions that it had ceased to hold in October. Between January 23rdand the end of February, the Central Bank had bought U$1.1bn at theseauctions. The Bank also intervened directly in the foreign-exchange markets onFebruary 16th, as the lira/dollar rate looked set to go below TL1,300,000:US$1.The Bank purchased almost US$1.3bn-worth of foreign exchange during theintervention, which knocked the lira price back to about TL1,330,000:US$1. In

Central Bank checks the riseof the lira against the dollar

Turkey 37


the second half of February the lira strengthened again slightly to end themonth at around TL1,320,000:US$1 and TL1,640,000:€1. As a result of a slightweakening of the euro against the dollar the Turkish lira remained steadyagainst the dollar at about TL1,320,000:US$1 on March 25th, but hadappreciated against the euro to TL1,400,000:€1.

Exchange rates(TL'000 per currency unit unless otherwise indicated; end-period; Central Bank buying rates)

2000 2001 2002 2003Dec Dec Dec Mar Jun Sep Oct Nov Dec Jan Feb

US$ 671.8 1446.6 1,639.7 1,700.1 1,407.6 1,384.4 1,478.9 1,455.3 1,393.3 1,337.0 1,321.3

€ 618.6 1281.3 1,718.9 1,850.4 1,609.5 1,615.2 1,720.4 1,742.8 1,757.5 1,656.7 1,639.7Real exchange rate a 147.6 116.3 125.4 123.5 140.6 151.5 142.9 140.6 140.6 146.8 n/a

a Trade-weighted; 1995=100; CPI-based. Provisional data for December 2002-January 2003.

Source: Central Bank of Turkey.

The Central Bank's real effective exchange-rate index, which measures the realinternational value of the lira (after allowing for different rates of inflation inTurkey's main trading partners), was 148.6 points in February—just 2.5 pointslower than the record of 151.5 set at the end of September 2003 and above thelevel of 148 reached just before the February 2001 currency crisis.

As in 2003 the strength of the lira in early 2004 can be attributed to formal andinformal inflows of financial capital and the exchange into local currency offoreign currency held for savings purposes. Underlying these developments arethe recent weakness of the dollar, low interest rates in the major economies,high real interest rates in Turkey (assuming inflation will remain subdued), theeconomic recovery and financial market expectations that these favourableconditions will persist in view of the IMF-agreed policy programme andTurkey's EU membership bid. The lira may weaken if any of these factorsappears to be changing.

Turkish inter-bank rates (TRLibor) have fallen gradually from their end-November 2003 levels of 27-31%, in line with Central Bank rates andgovernment bond yields (See Economic policy). In January medium-termTRLibor rates fell below short-term rates because of expectations of fallinginflation and interest rates. At the end of February the TRLibor rate for all termsfrom overnight to one year was about 24%. Deposit rates at major banks variedfrom 20-25% for all maturities.

Lower interest rates have helped to induce a real expansion in credit.Particularly striking has been the increase in consumer credit, which in liraterms rose by 33% in the final quarter of 2004 and by another 12% in January.Recent increases in consumer credit, which is overwhelmingly denominated inlira, have stemmed primarily from loans—typically for automobile purchases—but credit card borrowing has also grown. Consumer credit rates have fallen tobelow 2% per month in some cases. Another factor encouraging the use ofcredit may be the "wealth effect" of gains in the value of privately held sharesand bonds.

Consumer credit expandsrapidly as interest rates fall

38 Turkey


Selected financial indicators(TL trn unless otherwise indicated; end-period; % change quarter on quarter/month on month in brackets)

2001 2002 20034 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Jan

Money supplyM1 (currency & sight deposits) 11,073 11,486 12,871 13,707 14,259 14,622 16,869 19,160 21,564 23,795

(5.9) (3.7) (12.1) (6.5) (4.0) (2.5) (15.4) (13.6) (12.5) (10.3)Deposits and reposTL bank deposits 45,035 47,334 49,691 52,166 56,481 58,850 63,309 70,042 75,979 82,470

(14.7) (5.1) (5.0) (5.0) (8.3) (4.2) (7.6) (10.6) (8.5) (8.5)Foreign currency bank deposits 58,732 54,777 65,865 71,823 74,537 71,770 64,742 65,409 71,372 66,183

(-3.4) (-6.7) (20.2) (9.2) (3.8) (-3.7) (-9.8) (1.0) (9.1) (-7.3)Customer repos (banks + brokers) 2,798 3,690 3,707 3,391 2,763 3,925 2,440 2,998 3,079 2,806

(-30.7) (31.9) (0.5) (-8.5) (-18.5) (42.1) (-37.8) (22.9) (2.7) (-8.9)CreditsBanking system credit volume 39,049 37,748 38,391 38,546 39,469 45,949 45,711 49,584 57,170 58,523

(-5.6) (-3.3) (1.7) (0.4) (2.4) (16.4) (-0.5) (8.5) (15.3) (2.4)Domestic loans of deposit money banks a 31,249 30,911 30,610 30,318 31,845 36,559 37,077 40,860 48,019 49,395

(-3.3) (-1.1) (-1.0) (-1.0) (5.0) (14.8) (1.4) (10.2) (17.5) (2.9)Consumer credits and credit cards 4,768 4,627 5,408 5,992 7,001 7,897 9,237 11,386 15,212 17,047

(-6.2) (-3.0) (16.9) (10.8) (16.8) (12.8) (17.0) (23.3) (33.6) (12.1)Past due loans (PDL) 6,421 6,845 8,204 9,639 10,122 9,393 9,342 8,987 8,750 8,429

(-23.5) (6.6) (19.9) (17.5) (5.0) (-7.2) (-0,5) (-3.8) (-2.6) (-3.7)PDL as % of banking system credit volume 16.4 18.1 21.3 24.8 25.6 20.4 20.4 18.1 15.3 14.4

a Excluding loans to the financial sector.


The money supply and the volume of deposits also continued to rise over andabove the level of inflation in the fourth quarter of 2003 and the early weeksof 2004. The increase in deposits was exaggerated by the inclusion in thesystem as of the second week of January of the compensation payments madeto Imar Bank victims, totalling about TL7,6000trn (US$5.7bn). Thecompensation took the form of sight and time deposits at the state-ownedZiraat Bank. Although most of the sight deposits of TL2,700trn wereimmediately withdrawn, the increase in banknotes in circulation was morelimited. Most of the amounts withdrawn appear to have been used to opentime deposits at the same bank or at other banks, or to make payments intoother accounts, with only a relatively small amount being retained as cash orused to buy foreign exchange.

Foreign trade and payments

Turkey had a formal trade deficit of almost US$22bn in 2003, up fromUS$15.5bn in 2002 and US$10bn in 2001. Nevertheless, the 2003 figure fell shortof the record US$26.7bn recorded in the boom year of 2000. The dollar value ofimports and exports rose strongly, reflecting the continuing economic recoveryand the ongoing re-orientation of industry towards export markets. Importstotalled almost US$69bn, while exports were valued at US$47bn. Imports andexports rose substantially even when allowance is made for the weakness ofthe dollar against the euro, in which a large portion of Turkey's trade is

The foreign-trade deficit nearsUS$22bn in 2003

Turkey 39


conducted. The State Institute of Statistics' export volume index rose by 21.9%year on year in 2003; imports increased by 33.2%.

Foreign trade(US$ m unless otherwise indicated; customs basis; excl "suitcase" trade)

2001 2002 2003Year % change Year % change Year % change

Total exports fob 31,334 12.8 36,059 15.1 46,878 30.0 Capital goods 2,630 22.9 2,740 4.2 4,308 57.2 Intermediate goods 13,403 15.8 14,637 9.2 18,372 25.5 Consumption goods 15,253 8.9 18,533 21.5 23,909 29.0Total imports cif 41,399 –24.0 51,554 24.5 68,734 33.3 Capital goods 6,964 –38.6 8,492 21.9 11,222 32.1 Intermediate goods 29,971 –16.1 37,443 24.9 49,536 32.3 Consumption goods 4,084 –43.4 5,008 22.6 7,511 50.0

Trade balance –10,065 –62.3 -15,495 53.9 -21,856 41.1


Exports and imports still appeared to be growing strongly at the end of 2003and the beginning of 2004. In December imports amounted to anunprecedented US$8.1bn, compared with an average of about US$6bn in thepreceding months. The surge is partly attributable to a seasonal year-endupturn in monthly imports and to imports delayed by the holiday in lateNovember. Exports in December were also slightly above the average of thepreceding months, at US$4.5bn. According to unofficial returns from exporters'organisations, exports rose by 33% year on year to a total of US$8.5bn in thefirst two months of 2004.

Almost all subsectors recorded strong increases in the value of exports in 2003.The largest increase, however, came in the automotive industry. Automotiveexports (including parts) rose in value by 59% year on year to US$5.2bn. Theincrease in the exports of the textiles and clothing industries—which account forclose to 30% of total exports—was approximately 24%. Over 90% of exports aremade up of manufactured goods and just over 50% of consumer goods.

Intermediate goods, made up mainly of industrial materials and fuels, continueto account for the bulk of imports. Intermediate goods accounted for 72% of thedollar value of total imports in 2003. The share of investment goods in totalimports remained at about 16%. There was a slight rise in imports of consumergoods, which accounted for about 11% of total imports. Crude oil, natural gasand refined products accounted for 17% of imports. Imports of agriculturalcommodities, which rose by almost 100% in 2002, increased by a further 50% in2003. Even so, agricultural commodities continue to account for only 3.7% oftotal imports.

The growth of Turkey's trade in goods in 2003 was shared fairly evenly amongits trading partners. Once again, EU countries, headed by Germany, accountedfor about 52% of exports and 46% of imports. Turkey had small surpluses withthe US and the UK. However, it had a formal trade deficit of US$4bn with gassupplier Russia, a deficit of over US$7bn with the EU, and deficits of overUS$2bn with Switzerland, Italy and China. Formal imports from China rose by

A surge in imports from Chinaworries Turkish firms

Almost all sectors recordstrong export growth

40 Turkey


90% to US$2.6bn in 2003, so that many domestic companies expressed alarmabout low-price competition from Chinese products, which have benefitedfrom favourable currency movements (the strength of the lira against the dollarto which the Chinese renminbi is pegged). Imports from Iran rose by 102% toUS$1.9bn, reflecting natural-gas purchases. Exports to Iraq were included in thetrade figures for the first time in many years and were put at US$780m.

The current-account deficit widened by US$4.3bn in 2003 to US$6.8bn as aresult of the sharp increase in the merchandise trade deficit and a deteriorationin the investment income balance. According to balance-of-payments data,which unlike customs-based data includes an estimate of informal "suitcase"trade with the former Soviet Union) exports rose by almost US$11bn to$50.8bn, while imports (excluding customs and freight) rose by US$16.3bn toUS$64.8bn. The trade deficit was partly offset by an US$8.9bn surplus inservices—up by just over US$1bn compared with 2002. The rise in the servicessurplus was primarily the result of a 14% increase in net tourism earnings toUS$9.7bn. Remittances from Turks working in other countries bounced back byalmost 20% to US$2.3bn, perhaps spurred by the stability of the lira, but werestill some 50% lower than their peak in the late 1990s. The deficit on theinvestment income balance continued to increase, rising to US$5.4bn, comparedwith US$4.6bn in the previous year, reflecting Turkey's large net debtor positionin relation to international investment.

Current account(US$m)

2000 2001 2002 2003Year Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year

Total exports of goods 30,721 34,373 8,829 9,448 10,407 11,460 40,124 11,102 12,256 13,222 14,251 50,831 "Suitcase" trade 2,946 3,039 919 933 1,090 1,123 4,065 757 954 1,082 1,160 3,953

Total imports of goods -53,131 -38,916 -9,785 -11,708 -12,736 -14,252 -48,461 -13,391 -15,456 -17,334 -18,584 -64,765Foreign trade balance -22,410 -4,543 -956 -2,260 -2,329 -2,792 -8,337 -2,289 -3,200 -4,112 -4,333 -13,934Services income: credit 20,364 16,030 2,242 3,746 5,396 3,400 14,783 2,480 3,629 7,034 4,293 17,436 Travel income 7,636 8,090 896 2,087 3,813 1,684 8479 803 1,862 4,912 2,099 9,676Services income: debit -8,996 -6,900 -1,540 -2,048 -1,824 -1,494 -6,904 -1,727 -1,882 -2,403 -2,488 -8,500

Services balance 11,368 9,130 702 1,698 3,572 1,906 7,879 803 1,747 4,631 1,805 8,936Investments income: credit 2,836 2,753 610 674 513 689 2,486 600 611 532 503 2,246 Interest 1,168 1,139 248 186 137 213 784 134 238 111 151 634Investments income: debit -6,838 -7,753 -1,837 -1,690 -1,591 -1,922 -7,040 -2,132 -1,861 -1,877 -1,804 -7,674 Interest -4,825 -5,497 -1,059 -1,082 -1,116 -1,160 -4,417 -1,172 -1,108 -1,134 -1,173 -4,587

Investments income balance -4,002 -5,000 -1,227 -1,016 -1,078 -1,233 -4,554 -1,532 -1,250 -1,345 -1,301 -5,428Current transfers 5,225 3,803 844 769 865 1,013 3,491 777 840 1,059 941 3,618 Workers' remittances 4,560 2,786 477 505 539 415 1,936 440 537 733 611 2,321Current-account balance -9,819 3,390 -637 -809 1,030 -1,106 -1,522 -2,291 -1,863 234 -2,888 -6,808


The 2003 current-account deficit, Turkey's second-highest ever in dollar terms, isestimated to have been just under 3% of GDP. Nevertheless, it was substantiallylower than the record US$9.8bn deficit of 2000, which contributed to the 2001financial crisis. Of the total current-account deficit for the year, about two-fifthswas incurred in the final quarter. This was mainly the result of a high importbill in December and a seasonal fall in tourism revenue in this period.

The current-account deficitwidens

Turkey 41


Turkey enjoyed strong net financial inflows in 2003, although foreign directinvestment was even lower than in previous years, at about US$600m (thefigure barely exceeded Turkish direct investments in other countries). However,in contrast to 2001 and 2002, there were large net inflows of portfolioinvestment. Foreign purchases of Turkish shares and government bondsoutpaced similar Turkish portfolio investments in other countries by aboutUS$2.3bn, reflecting increased confidence in the Turkish economy and stronginternational demand for "emerging market" assets in general. For similarreasons—and in parallel with economic growth—Turkey received net inflows of"other investments" amounting to about US$3.3bn. Banks and companiesobtained more foreign credit, particularly short-term credit, and non-residentdeposits with Turkish banks rose. (In 2002 Turkey enjoyed inflows of overUS$7bn in the "other investments" category. However, most of this amount wasmade up of IMF credits. In 2003 IMF credit disbursements were fully offset byrepayments to the Fund.)

Looking at a quarterly breakdown of the capital account, however, these netfinancial inflows were interrupted in the final quarter of 2003. Net inflows ofportfolio investment slowed to about US$180m as banks increased theirforeign-securities portfolios and the government made repayments tointernational bond-holders without issuing any fresh bonds. In the same periodthere were net outflows of US$1.1bn under "other investments"—although thiswas partly the result of an increase in banks' own reserves. While credit use bythe banks and private sector continued to rise, and the IMF released aUS$500m credit tranche in December, non-residents' deposits with Turkishbanks declined. These adjustments were most marked in October, when thelira briefly lost value, and December, ahead of the year-end accountingdeadline. As a result of the overall inflows official foreign-exchange reservesincreased by US$4bn in 2003, but fell by US$1.8bn in the final quarter.

Capital account(US$ m)

2000 2001 2002 2003Year Year 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year

Current-account balance -9,819 3,390 -1,106 -1,624 -2,291 -1,863 234 -2,888 -6,808

Financial account balance 12,935 -4,413 1,563 7,764 3,344 -138 3,635 -1,207 5,634 Direct investments (net) 112 2,769 220 863 -15 2 56 36 79 Portfolio investments (net) 1,022 -4,515 670 -593 -75 934 1,606 -178 2,287 Other investments (net) 11,801 -2,667 673 7,494 3,434 -1,074 1,973 -1,065 3,268 IMF credits 3,351 10,230 0 6,365 -175 483 -52 -306 -50Net errors & omissions -2,762 -1,671 493 13 -1,714 3,195 1,431 2,309 5,221

Overall balance 354 -2,694 950 6,153 -661 1,194 5,300 -1,786 4,047Reserve assets (- indicates increase) -354 2,694 -950 -6,153 661 -1,194 -5,300 1,786 -4,047 Reserve position in Fund 0 0 0 0 0 0 0 0 0 Official reserves -354 2,694 -950 -6,153 661 -1,194 -5,300 1,786 -4,047


Turkey enjoys strong netfinancial inflows

42 Turkey


In addition to net capital inflows of about US$5.6bn from portfolio and otherinvestment investments, balance-of-payments figures also included anunprecedented positive US$5.2bn figure for "net errors and omissions" for 2003as a whole. Much of this sum probably corresponds to "informal capitalinflows"—that is, entries into the formal financial system of foreign-exchangecash, including savings formerly held in foreign currency banknotes, or heldabroad and brought into the country in the form of banknotes. Such inflowsmay have been related to the weakness of the dollar, the strength of the liraand improved stability in the Turkish financial system and markets. In the finalquarter inflows classified as net errors and omissions amounted to US$2.3bn.However, as in previous quarters, this figure may later be revised downwards,with some of the inflows redistributed to other capital and current-accountitems that are found to have been underestimated.

External debt stock(US$ m; end-period)

1999 2000 2001 2002 2003Year Year Year Year 1 Qtr 2 Qtr 3 Qtr

Short-term debt 22,921 28,301 16,241 15,220 16,724 16,767 18,624Medium- & long-term debt 80,054 90,384 97,570 116,044 116,321 121,169 123,413Total outstanding debt 102,975 118,685 113,811 131,264 133,045 137,936 142,037By lender: Short-term debt Commercial banks 11,540 17,306 7,775 5,187 6,595 6,148 7,896 Private creditors 11,381 10,995 8,466 10,033 10,129 10,619 10,728 Medium- & long-term debt Official creditors 16,870 20,047 30,614 40,158 40,041 41,364 41,942 Bilateral lenders 9,128 8,669 8,552 9,193 9,091 9,213 9,237 Multilateral organisations 7,743 11,379 22,062 30,965 30,950 32,151 32,705 Private creditors 63,183 70,337 66,956 75,886 76,280 79,805 81,471 Private lenders 46,445 48,202 45,618 52,042 51,820 53,379 54,336 Bond issues 16,738 22,135 21,338 23,844 24,460 26,426 27,135By borrower: Short-term debt General government 0 1,000 0 0 0 0 0 Central Bank of Turkey 686 653 590 451 444 436 357 Deposit money banks 13,172 16,900 7,997 6,344 7,808 7,317 9,171 Other sectors 9,063 9,748 7,654 8,425 8,472 9,014 9,096 Medium- & long-term debt Public sector 42,375 47,803 46,329 63,920 64,152 66,959 68,141 General governmenta 37,629 42,374 41,178 59,104 59,412 62,257 63,474 Other governmentb 863 1,193 1,117 1,038 1,008 1,042 1,086 State-owned enterprises 3,883 4,236 4,034 3,778 3,733 3,660 3,581 Central Bank of Turkey 10,312 13,429 23,753 21,544 21,971 22,929 23,228 Private sector 27,367 29,153 27,488 30,580 30,198 31,281 32,044 Financial institutions 7,482 7,581 4,789 4,701 4,589 4,663 4,709 Non-financial institutions 19,885 21,571 22,699 25,879 25,609 26,618 27,335

a Central and local government, universities and extra-budgetary funds. b Export-import Bank and Turkish Development Bank.

Source: Under-secretariat of the Treasury.

A large net errors andomissions item is recorded

Turkey 43


The total public and private-sector foreign debt stock stood at US$142bn as ofthe end of the third quarter of 2003, according to the Treasury. This representedan increase of US$4.1bn in the third quarter, following a rise of US$6.7bn in thefirst half of the year. The increase over the course of 2003 was partly a functionof the weakness of the US dollar against other countries in which Turkey hascontracted foreign debt.

Some 45% of the total foreign debt is denominated in dollars, 32% in euro, 17%(IMF lending) in Special Drawing Rights, 4% in yen and 2% in other currencies.Rises in the value of the latter currencies against the dollar causes the dollarvalue of the debt to rise. According to the Treasury, exchange-rate movementsaccounted for US$5.2bn of the US$10.8bn increase in Turkey's total foreign debtin the first nine months of 2003. The foreign debt is likely to have grownfurther in recent months as a result of the continuing weakness of the dollaragainst the euro in the fourth quarter of 2003, government bond issues in early2004 and private-sector borrowing related to the strength of the economy.

Total foreign debt rises to overUS$140bn

turkey - international university of japan...turkey april 2004 the economist intelligence unit 15...

Documents