Guiding the Economy

With Ankara able to boast of a range of fiscal and monetary achievements in recent months, the International Monetary Fund (IMF)'s October decision to grant Turkey another loan had been widely expected.



On October 25, Fund officials announced that they would release a further $1.6bn of a $10bn stand-by deal with Turkey this December.



Amongst recent good indicators, analysts have applauded in particular Turkey's performance in fighting inflation. This year, a rate of 7.1% is expected, after the target was set for 8%. The monetary and fiscal discipline of the government - and the ground laid by its predecessor - has much to do with this.



Yet analysts also worry that the Central Bank's inflation target of 5% for 2006 may not be met, with some economists expecting a close miss. They link this assessment to a number of factors, including continuous price inertia in services, the delayed and continuous effects of high oil prices, a probable wage-price spiral, inflationary pressures associated with heightened domestic demand and an associated spill-over into consumer prices.



Analysts also point out that a weaker lira - overshadowed by Turkey's large current account deficit - would increase the cost of imported goods flowing into Turkey. This would make it that much more difficult to curb inflation.



But such talk has not dampened confidence, with inflation still heading downwards next year and continuous reform on the cards. The battle against inflation should also be aided through a switch to inflation targeting, starting in January 2006. This will bring Turkey in line with a more orthodox central banking practice, as experienced elsewhere in the West. The initiative will also mark an important step in ensuring that monetary policy is transparent, consistent and institutionalised, argues the governor of the Central Bank, Sureyya Serdengecti.



Many analysts see inflation targeting as an important ingredient to maintaining long-term confidence in the market. Further measures should help in this regard also. Up until now, the Central Bank governor has had the power to cut and raise interest rates, but from January this authority will be handed to the bank's monetary policy council. This marks something of a step-up for a body that once had a purely advisory function.



Still, there is some debate as to whether a specific inflation target should be set, or whether the Central Bank should stick to a more flexible range. Volatility in the price of oil and agricultural produce makes the band option more attractive, providing the Central Bank with some room to manoeuvre when global conditions become difficult. On the other hand, the bank wants to avoid giving the impression that it is easing from its commitment to disinflation.



Price hikes have not been the only preoccupation of economists recently though, with the current account deficit a continual theme of discussion.



However, Serdengecti recently told OBG that this deficit was largely under control.



"The budget deficit to GNP ratio has been coming down over the years and we have seen good progress by the government," he said.



Deputy Prime Minister Abdullatif Sener recently endorsed this view. Commenting on the 2006 consolidated budget, Sener said that the budget deficit to GNP ratio was expected to hit 2.5% in 2006, after averaging around 3% so far this year.



The Ministry of Finance and the Central Bank have taken further comfort too from the inflow of foreign investment, which has helped fill the hole in government coffers.



Official statistics in early October revealed that in the first nine months of the year, the government raised as much as $18bn in asset sales to foreign or local investors. Analysts expect to see more than $10bn of foreign investment flowing into the economy by the end of this year, a massive hike on previous performance.



This influx of foreign investment also marks a steady shift towards capital that is less susceptible to shocks in confidence and less likely to flow straight out again.



"There is a lot of noise about hot money," Serdengecti told OBG. "But when we look at the numbers, we see that the composition of the capital account is steadily changing and this is a process that started back in 2004."



The capital account has become more medium and long-term oriented, thanks in no small part to mergers, acquisitions and privatisations.



However, it will be some time before the government's portfolio contains enough of the more resilient forms of investment for it to rest easy.



Meanwhile, painful reforms still have to be implemented elsewhere despite of the government's economic discipline.



The unregistered economy poses a major dilemma, accounting for between 50-60% of total GNP and an associated major loss in potential tax revenue.



Yet a new tax system is on the way and due to be implemented at the beginning of 2006. This is not intended to claw in a greater amount of tax revenue, but rather to lay down a simpler and fairer system of taxation. It is also designed to tax stock equities and bonds.



The IMF in the meantime remains concerned about the reform of Turkey's troubled social security system, with the release of an $800m tranche frozen in July due to the lack of progress on this matter.



This decision to freeze was made after parliament failed to adopt a reform law before the agreed deadline.



While so far, the government's record of reform in economic matters has been pretty impressive, Turkey's financial and political authorities still have some difficult moves to make if they are to eliminate some important structural deficiencies in the economy.