Fiscal Fanfare

Having already stunned international financial institutions with its economic performance in 2004, Turkey has once again been flexing its fiscal confidence. The unveiling of its pre-accession economic programme to the European Union last week not only confirmed Ankara's intention to tread the straight and narrow in 2005, but also confirmed it would be pushing forwards the barriers of economic achievement by another degree.



The pre-accession programme anticipates annual GDP growth to be sustained at 5% over the next three years. Exports, in the meantime, are expected to jump by 14%, 12% and 10% in 2005, 2006 and 2007, respectively. Meanwhile, fixed capital formation is projected to increase by 9.9%, 8.8% and 7.9% per annum up until 2007. No slowing the Turkish economy then, so long as business confidence is up, and no deviation allowed either.



"Nobody should expect a different policy from the three-year economic programme," Turkish State Minister in Charge of the Economy Ali Babacan told reporters.



Importantly, such economic projections remain fully in synch with those of the Organisation for Economic Co-operation and Development (OECD). After an anticipated growth rate of 10% in 2004, the OECD expects Turkey to register a rate of 6.4% in 2005 and 5.8% in 2006. Ankara hopes to beat expectations, as it did this year by registering single-digit inflation, despite an IMF-dubbed target set at 12%. Meeting the OECD-anticipated inflation rate of 8% in 2005 is thus well within reach. Meanwhile, maintaining a primary surplus of 6.5% of GDP is proof of the government's success, according to Kemal Unakitan, minister of finance. This has certainly helped keep economic imbalances to manageable levels.



However, many analysts also rightly hold that Turkey's current account deficit cannot be ignored. But here, even the pessimists are now wavering. The ratio of net debt to GDP has fallen from an estimated 95% in 2001 to a projected 65% by 2004 year-end, according to Sonal Desai, an economist at Dresdner Kleinwort Wasserstein. This trend has been anchored by the government's fiscal discipline, permitting a rise in GDP.



According to State Minister Babacan, the budget deficit-to-GNP ratio will decline by an estimated 6.5% in 2004, down to 4.5% in 2005 and 3.5% in 2006. Meanwhile, the public net debt stock to GNP ratio will fall below 60% in 2007 from 71% at the end of 2003.



No coincidence either that the ratio of lira-denominated deposits to dollar-denominated deposits has almost doubled to 1.25 in the last three years, according to the Turkish Treasury. The real appreciation of the lira, according to Sureyya Serdengecti, governor of the Turkish central bank, was derived from short-term capital inflows from portfolio investors and Turks repatriating savings. This is not to deny that the de-dollarisation of the economy was most significant in 2003 and early 2004, with something of a recent slowdown noted.



One of the chief interests of economists and businesspeople alike has been the anticipated level of foreign investment inflows. The government expects to see $15bn worth of foreign direct investment (FDI) over the next three years. Not bad considering that the flow of FDI for 2004 is expected to top a comparatively modest $2.9bn, according to official sources. But as with all projections, much will hinge on the outcome of the December EU summit in Brussels, with Turkey's potential future as a member state up for debate.



Whatever the decision though, a deluge of foreign firms heading for Turkey is unlikely in the short term.



"Foreign investment will not rush into Turkey after December 17," US Ambassador to Turkey Eric Edelman said during a recent trip to Izmir. "It will come slowly. When the first comers become successful, others will follow."



Equally, much will depend on the momentum of privatisation. The sale of such heavyweights as the tobacco arm of TEKEL, along with Turk Telekom and some electricity generators, is expected to contribute a large chunk of the $2.8bn in FDI already anticipated in 2005, according to the International Institute of Finance (IIF). Turkey is thus well placed to seize as much as 60% of portfolio equity inflows to the emerging European region. This seems quite a plausible prediction given the recent upturn in FDI levels, which nearly tripled in the first four months of 2004 compared to the same period in 2003.



Meanwhile, the government is preparing to dangle carrots in front of corporate noses to further encourage investment. Though subject to be confirmed under the imminent standby agreement with the IMF, the Turkish authorities are pushing to cut value-added tax and corporate tax by 3% and 10% respectively in 2005. If realised, this could translate into a 19.9% decrease in total tax revenue, bringing it to $80.25bn. The real question is how this loss in government revenue will be covered. Analysts suggest that hikes in special consumption taxes and stamp duties may compensate. Indeed, the government has made it more than clear that any deviation from the government's tight-buckled fiscal discipline is essentially out of the question.



Talk about tax cuts and increased levels of FDI has not defused concern over the need to spur the privatisation process along. International institutions have not minced their words on the issue either. During a November statement, Hugh Bredenkamp, the IMF's senior representative in Turkey, commented on the need to encourage foreign and domestic investments. "There are still issues to be dealt with, especially in the areas of state enterprises," Bredenkamp warned.



Reducing the size of the unregistered economy will pose as much of a challenge - particularly given that it accounts for perhaps as much as 50% of total employment. But narrowing the size of the grey sector will be essential for reform of the tax system and the creation of more jobs.



Analysts meanwhile do not expect a massive spike in jobs over the coming years. According to the pre-accession economic programme for the EU, Turkey's unemployment rate will only marginally decline - to 9.3% in 2007 from 9.8% in 2005.



However, the financial benefits that stem from strong growth should be increasingly injected into government coffers to cover internal debts, the OECD asserts. Whether such advice is needed or appreciated remains to be seen, given that the government appears to have the economy more or less under control. The real concern for Ankara is Brussels and the impact that the EU decision in December will have on business confidence and the economy at large.