Uneven Progress

One of the key conundrums in Turkey's economic development has long been how to tackle the uneven spread of financial and industrial might across its many and diverse provinces. With much of the nation's income generation concentrated in the north-western Marmara region, other areas - notably the east and south-east - are lagging far behind in per capita incomes.



Attempts to tackle this regional disparity have traditionally taken the form of central government intervention, often in the form of giant infrastructure projects, such as the South-East Anatolian (GAP) scheme, or via state largesse distributed through compliant local municipalities. The history of such schemes has also been largely poor, the results dubious and the incentives politically clouded.



Thus, when the government of Prime Minister Recep Tayyip Erdogan announced recently that it was pressing ahead with plans for a regional incentive scheme, it was little surprise that the International Monetary Fund (IMF) and many market watchers were quick to voice their objections.



The idea is that the government will back investment in poor regions through incentives such as lower tax, subsidised social security and cheaper energy. Currently, some 36 provinces are already receiving similar benefits, with the new scheme extending this coverage to include 13 more.



Yet with the IMF board still deliberating whether or not to give the final go-ahead to a $10bn stand by agreement finalised in Istanbul back in December, the Fund's officials have reacted by questioning the financial soundness of such an idea. The danger is that a tussle over the issue may delay the stand-by agreement coming into force, and thereby generate more uncertainty.



IMF External Relations Department Director Thomas Lawson told the press on February 16 that the regional incentives were "a source of concern for us since we think it would increase distortions, weaken the social security system and have a significant fiscal cost."



However, the Turkish authorities seem set on going ahead. Economy Minister Ali Babacan said the same day that "[Agreeing the incentives] is a final decision and there is no return from this."



Social security and fiscal margins are naturally enough two key areas of concern for the IMF when it comes to the Turkish government's budgeting. The Fund's programme envisages a 6.5% of GDP primary surplus for 2005 and a capping of the social security deficit at 4.5% of GDP. Both targets are threatened by the regional incentive scheme, the Fund argues.



Yet how much room for manoeuvre there really is within the budget columns is being strongly questioned by Ankara.



In particular, Finance Minister Kemal Unakitan told reporters February 16 that the government was also considering altering its revenue and expenditure streams elsewhere in order to finance regional development.



"It is possible to cut some spending items and investments in particular in 2005, as we did in 2004, and after that [a rise in] indirect taxes will be considered," he said.



The minister then said that the primary surplus target would therefore be met and there was no thought of changing such a crucial aim. To do this, he suggested tax hikes could be considered for fuel oil, cigarettes and alcoholic beverages.



Yet if such hikes were to go ahead, there would likely be major complaints from consumers and producers of the latter products. The government has already introduced three major price hikes for alcoholic drinks since taking office, with a fourth coming in on February 1. All these rises have been massively higher than anywhere else - excise tax on beer, for example, being hiked 33% in January 2003, 161% in October 2003, 8% in March 2004 and most recently, 50% on February 1. This has left excise taxes on beer in Turkey at 3.5 times the EU average.



Taxing alcohol in particular appeals to a certain section of the government's traditional supporters, as, of course, do regional incentive schemes. It is, however, this suspicion of a "slide into populism" that the market has long been watching out for.



At present though, there is still a large amount of goodwill towards the government prevalent amongst most market analysts. Many point to previous confrontations with the IMF over contrary schemes for boosting public expenditure and the fact that an agreement has always been reached that preserves fiscal balances. Political pressure may be on the government to open the coffers - indeed, there were even calls for a general strike this week from many of the country's unions over poor pay - but it has the strength and resolve to keep to the programme.



Yet the question remains as to how best to help the country's many poor regions reach higher standards of living. The IMF is not opposed to regional development schemes in principle either, with Dawson calling for the government to "improve" its incentive plan. "In particular," he said, Ankara should "make it more targeted and... take measures to compensate for any fiscal cost."



Unakitan remains optimistic though. "From our point of view there is no problem in talks with the IMF. There is nothing on which we cannot reach agreement," he said on February 16. Hopefully, he's right.