On June 22, Turkish Finance Minister Kemal Unakitan unveiled plans to remove the 15% withholding tax for foreign investors and reduce it to 10% for their domestic counterparts, in the hope of restoring foreign investor confidence.
Unakitan made the announcement during a joint press conference in Ankara with Minister of the Economy Ali Babacan. "We have begun implementing the principles of domiciliary for taxation of investors settled abroad under the EU practices. Therefore, we decided to decrease the withholding tax for income and annuities of non-residents investing in financial instruments in Turkey to zero," he said.
The finance minister added that "the withholding tax for Turkish residents investing in shares and private sector bonds will also be re-arranged. We are planning to take the approval of the Council of Ministers to this end. We aim to reduce rates of withholding tax for Turkish residents from 15% to 10%."
"We just needed to take these measures. We are doing only what the global economy requires," Unakitan explained. He went on to add that if all goes according to plan, the changes will be confirmed by parliament prior to its summer recess, in early July.
In addition to the changes to the withholding tax, Unakitan also announced a variety of other, less dramatic measures amending laws on the taxation of financial instruments and, along with Babacan, he reiterated the government's commitment to tight monetary policies, stating that "we will reach our targeted 6.5% non-interest surplus by the end of 2006. We are determined not to exceed budget allocations."
The move came as part of an eight-point package designed to reassure foreign investors who have fled the Istanbul Stock Exchange (IMKB) in recent weeks, primarily over fears of rising US interest rates, driving share prices down sharply. US interest rates have risen for 17 consecutive quarters to reach 5.25%, with the Federal Reserve making the last such upward adjustment - by 25 base points - at its recent meeting on June 29. While the threat of continued interest rate hikes has prompted investors to pull money out of emerging economies worldwide over the past six weeks, the tone of the Fed's last statement was more muted, fuelling speculation on Wall Street and in world financial markets that additional rate hikes may not be necessary. Turkish markets reacted strongly to the move, with the IMKB 100 rising some 3.1% the following day, June 30.
This too should help to staunch the flow of money from Turkish markets, although several additional domestic factors continue to raise doubts for foreign investors. The recent appointment of Durmus Yilmaz as governor of the central bank has met with a mixed response from the market, which is unclear on his inflation-fighting credentials. To many market insiders, however, his move to raise interest rates by 1.75% three weeks ago came somewhat belatedly. Yilmaz, who replaced the widely respected former governor Sureyya Serdengecti, is seen as lacking his predecessor's charisma, though he is certainly qualified, with over 25 years of experience working at the bank.
Political events have also sparked concerns in recent months. Investors are worried that if an early election is called in late 2006 before parliament sits to select the next president, the ruling Justice and Development Party (AKP) may abandon its fiscal austerity programme and embark on a spending spree to shore up its support. Despite the government's pledge that no election will be held until 2007, the "will he or won't he?" debate over Prime Minister Recep Tayyip Erdogan's presidential aspirations will continue to linger, leaving investors uneasy over the potential for political upheaval.
There are concerns regarding the country's EU aspirations as well, particularly in light of the political upheaval over Cyprus, which stalled negotiations in the middle of June over the first of the 35 "chapters", science and technology.
Nonetheless, the outlook is becoming brighter and Unakitan's announcement will help to encourage further investment in Turkey. Representatives of the World Bank and the IMF hailed the plan as a strong move to shore up foreign investors' confidence in the Turkish economy.
Commenting on the proposal, World Bank Turkey Director Andrew Vorkink told daily The New Anatolian, "There was some uncertainty about the withholding tax. I think that what the government announced will end that uncertainty and encourage investors to be able to plan more effectively what it means in terms of investing in Turkish financial instruments. So it's a good move; it's a timely move, particularly to end uncertainty as to what the government's policy is."
With the finance minister's proposals heading to parliament for approval and a possible end to the rising US interest rates in near term, the capital outflow that has driven down Turkish markets for the past two months may soon kick into reverse.
