International Monetary Fund Executive Board

Statement on behalf of the Southern Cone Chair

May 2007

1. The Turkish economy is performing well under the SBA. Continued macroeconomic discipline and progress in structural reform have resulted in increased investor confidence and lower risk premiums. At the same time, the remaining risks are challenging. Mainly, the significant debt burden needs to be further reduced; and large financial inflows resulting from improved  market sentiment have made the economy more vulnerable to the risk of capital reversals. Additionally, the authorities need to persist in their reform efforts to lay the foundation for sustained growth and further reduce  vulnerabilities. In view of the authorities’ commitment to the program’s  objectives, we are willing to support the requested waivers. We broadly agree with the thrust of the staff papers, and provide the following comments for emphasis.

2. Achievement of a significant primary surplus (6.5 percent of GNP in the last four years), “the main policy anchor” in the program, remains key for further diminishing the debt burden. Although the target in 2006 was  missed, at 6.6 percent of GNP it nonetheless reflects remarkable discipline. While noting the staff’s observation that fiscal consolidation has relied more on expenditure cuts (some of them in priority items) than on measures on the revenue side, we welcome Mr. Kiekens and Mr. Veziroglu’s assurances that broadening the tax base is a priority, as reflected in the recent  establishment of a large taxpayers’ unit, and that the authorities are taking the necessary steps on the expenditure side to meet the 2007 target.

3. The Box on page 19 of the review paper highlights that, regarding the effectiveness of health government spending, Turkey lags behind comparator countries. We note the staff’s recommendation to put in place incentives to reduce unnecessary treatments and drugs, as well as the measures currently being implemented by the authorities to increase efficiency in the longer term. However, we would like to ask the staff to elaborate somewhat more on what comparator countries are doing differently to achieve better public health performance. Especially, we miss a mention of the international experience with the licensing of generic versions of patented drugs. The practice of issuing compulsory licenses for public health purposes is consistent with the WTO Agreement on Trade-Related Intellectual Property Rights (TRIPS), and can benefit large segments of the population by  dramatically reducing procurement costs. More generally, emphasizing policy recommendations geared to create fiscal space without running the risk of affecting the quantity and quality of service in socially sensitive areas will contribute to preserving the credibility and reputation of Fund advice.

4. There is broad recognition that social security reform is necessary to ensure medium-term fiscal sustainability and create fiscal space for tax easing and priority spending; and that, therefore, the system should move to greater integration and rationalization of benefits. However, the ruling out by a Constitutional Court of key provisions of the original Fund-supported reform contains an important lesson for the future —that Fund advice should involve in-depth juridical assessments to ensure consistency with a member country’s legal framework. Especially, Fund conditionality that raises constitutional issues will likely lead to politically disruptive conflicts of  powers and ultimately meet legal opposition. Thus, attention to legal feasibility of Fund advice is essential to secure program effectiveness and ownership and, again, avoid serious reputational implications.

5. We welcome the authorities’ commitment to the 4 percent inflation target, and that the monetary stance will remain cautious until disinflation firmly sets in after the recent inflation surge. Prudence is welcome, given the upside risks to inflation pointed out both by the staff and the authorities.  Additionally, we agree on the importance of building international reserves from its current low level (a ratio of reserves to short-term debt below unity). On a related subject, we note a certain ambiguity over whether the exchange rate is overvalued. In any case, we concur that monetary easing with fiscal tightening to ease upward pressure on the lira would not be warranted, given that an even tighter fiscal stance is not desirable and competitiveness does not seem to be an issue.

6. While we accept the staff’s strategy to reduce susceptibility to external shocks and country risk by maintaining high primary surpluses and tight inflation control, we suggest the staff to evaluate the scope for instruments used in some member countries for similar purposes, but which are not part of the staff’s standard toolkit. Specifically, perhaps capital controls could play a role in dealing with volatile capital movements. This could be relevant, since a main motivation for capital controls has been precisely to protect financial stability in the face of persistent capital flows and the risk of sudden stops. Moreover, we wonder if, at least in the short run, these controls could “buy” some flexibility to use some fiscal resources to increase much-needed investment spending. The staff’s comments are welcome.

7. Developments in the financial sector are encouraging. Especially, Mr. Kiekens and Mr. Veziroglu report significant progress in regulation and supervision in the context of the 2005 banking law. We agree that consolidated risk assessment is essential given that the financial system becomes increasingly complex; and that phasing out financial transaction taxes would contribute to bringing back onshore banking activity. Bank restructuring has proceeded with determination, financial indicators compare favorably with those in other emerging economies, competition is growing, and FSAP recommendations are being considered and  implemented. The recent mortgage credit law, which will both promote the expansion of housing credit and facilitate adequate monitoring, is a move in the right direction. The limited impact of the financial turbulence in May last year reflects the Turkish financial system’s growing resilience.

8. Legal considerations similar to the ones mentioned above may also be relevant regarding the initial plans for the privatization of Halkbank, which, according to paragraph 17 of the review paper, brought up fears of legal challenges. Fund advice is rightly oriented to reinforce market confidence, but should abide by the legal framework to preserve people’s confidence. We use the opportunity to add that, in our view, in order to prevent state banks to become a drag on growth, the key issue is to secure good financial  performance, and not necessarily to change their property regime.

9. Also in line with these reputational concerns, we support the staff’s remark that labor reform should seek to strike a balance between achieving greater flexibility and ensuring worker protection. However, we wonder if, in order to assess possible legal implications that could be brought up by labor reform proposals, the staff has sought advice from the ILO —as recommended by this Chair on several occasions.

10. Deregulation of the energy, telecommunications, and tobacco sectors, as well the reduction in red tape, underscored by Mr. Kiekens and Mr.  Veziroglu, will contribute to enhancing the business climate. Going forward, the authorities need to address financial difficulties in the energy sector. With these remarks, we wish the authorities continuing success.



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