THE TURKISH ECONOMY UNDER OZAL

Created: 3/29/1985

OCR scan of the original document, errors are possible

SicniT hotoiin hogontract on, con

. a

5

The Turkish Economy Under Ozal

Summary

Prime Minister Dial's political future is tied to the success of his economic program. Although Ozal's government n no immediate danger, we believe it will come under increasing pressure from the military and the public if the economy falls to improve markedly under his direction. Ozal's economic program has helped to strengthen Turkey's oalance-of-paynents position, but inflation and unemployment remain troub1esomely high. While soaring exports and worker remittances helped to reduce the current account deficit byercent,4 billion last year, the annual inflation rate rose to overercent. The outlook5 is mixed. We expect the economy, especially exports, to growood clip, but unemployment probably will creep even higher and inflation abate only modestly, if1 T1 nt lif, 0r

scciiLT nor qui,ucjii

Ozal will be looking for help from the US during his visit here next week, perhaps in rescheduling debt and lowering barriers to Imports of Turkish goods. In our view, the failure of his program would Jeopardize the long-term prospects for economic reform and possibly even endanger the democratic process In Turkey. '

Introduction

Prime Minister Ozal won election3 in part on the strength of his promise to revive the Turkish economy, which had begun to slip afteremarkable recovery from he economic crisis of the. Ozal pledged to revive the economic stabilization program0or which he, as economic czar under the conservative government of Prime Minister Suleyman Oemlrel, had been largely responsiblend to promote growth by making the economy more responsive to market forces. The Turkish military, which handed over the reins of government to Ozal, has permitted him a largely free hand in the running of the economy. In contrast to the decisive role it still plays in the formulation of securityrArTm'

Ozal has made commendable progresshittling down the government's traditionally huge role in the Turkish economy. He isong-term strategy, however, and the immediate results have been mixed. In particular. Improvements in economic growth and the balance of payments have been offset In the public mind by higher inflation and unemployment. With Turkey's foreign debt service scheduled to jump sharplyzal likely will be seeking additional aid during his visit here next week.

Ozal's Economic Program

Ozal acted quickly upon taking office to reinvigorate0 stabilization program, which combined economic liberalization with fiscal and monetary austerity. His stated Intention was to reduce inflation, promote economic growth through exports, attract sorely needed foreign investment, and shrink the state's large role in the itminwy

Ozal has taken several important steps to liberalize and strengthen Turkey's balance of payments, including reducing many import restrictions, providing new incentives for exports, and abolishing most foreign exchange controls. Products may now be freely Imported unless they are specifically listed as being prohibited or subject to licensing; previously, all imports were prohibited unless they were specifically listed as being importable. New regulations this year have lowered many tariffs and exempted several products from duty altogether. To encourage exports, Ankara shortened the list of exports subject to licensing and reduced bureaucratic obstacles. Exporters are now permitted to keepercentpercent of their foreign exchange earnings, and companies withillion in exports3 have additional incentives in the form of special

credit funds, duty-free Imports, and foreign exchange. In addition, commercial banks are free to buy and sell foreign currencyertain range around the official rate set by the Central Bank, while Turkish citizens are free to hold foreign currency and to travel and spend abroad. Last but not least, daily exchange rate adjustments have offset Turkey'sJ^ation rate, keeping exports competitive in foreign markets.

Even more importantly, Ozal has begun tackling the serious economic structural problems, particularly the oversized, inefficient bureaucracy and the pervasive role of the government in the economy. Because these reforms challenge Turkish traditions associated with Ataturk, the founder of modern Turkey, they are meeting the greatest resistance from the bureaucracy. Nevertheless, Ozal already has carried out highly successful sales of revenue shareshe Bosphorus Bridge and Keban Oam to private Investors and plans next to sell shares In the national airline, THY. Inill has been presented to the Parliament that would privatize the largely-nationalized mining sector and open it to foreign investment.

Last June, Ozal carriedajor reorganization of the bureaucracy and the State Economic Enterprisesove intended to increase efficiency and strengthen his control over the public sector. More than half of the committees, boards, and commissions within the various ministries were abolished. Moreover, the new framework law for the SEEswhich replaceseparate lawsmposed experience requirements for management positions. The notoriously inefficient SEEs dominate the Turkish economy, accounting for over half of all industrial production. In recent years they have accounted for almost all of the government budget deficit as well as the much larger public sector borrowing requirement. The SEEs demands on the government budget and the credit markets are to be reduced by charging market prices for their products.

Ozal has singled out infrastructure developmentajor responsibility of the state"! Inadequate Infrastructure in particular an insufficient supply of electricityasignificant hinderance to economic development. Ozal consequently has gone ahead with the massive Ataturk Oam project in southeastern Turkey and has given guarded support for the development of nuclear powern effort begun under the militarylthough Ankara has yet to decide which foreign consortium will build the first plant.

The remainder of Ozal's program focuses on fiscal and

^tUHtT NUHJKH WlJIITRAfai UlluUI*-

QRCON

monetary measures aimed at reducing government deficits and inflation. To promote saving and investment he has reduced personal and corporate income taxes although the rates are still highndalue-added tax ofercent. The Implementation of the VAT was confusing to many Turks, even though they generally support the tax. With regard to monetary olicy, Ozal's objectives are to maintain positive real rates of interest whilj* gradually slowing the growth of the money supply. tfi-T

alance Sheet

Ozal's efforts appear to have produced positive results in two key-areas: economic growth and the balance of payments. Real GNP expandedercent last year, upercent Industry and commerce led the way, with growth ratesercentercent, respectively, while agricultural outputercent. Meanwhile, the current account deficit narrowed fromillion toillion, in spite of an increase in Interest payments and the liberalization of imports and foreign travel. (fj -

The Improved GNP and current account performances were both due In large measureurgexports. After near-stagnationxports roseercent4 billion Exports of industrial goods soared nearlyercent and now equal nearly three-fourths of total Turkish exports. With Imports risingercentillion,'the trade deficit held steady last year. Benefitting from the moderationil prices. Imports of crude oil roseercent4 billion; Imports of consumer goods nearly doubled but still accounted forercent of total imports. The Improvement in the current account deficit resultedpercent risehe Invisibles surplusueurnharp Increaseorker remittances, following two years of substantial declines. (See Table lj IS^"

The capital account of the balance of payments showed some modest Improvement. Oirect investment in Turkey nearly doubled even though in absolute terms it remains at very low levels. Ozal has encouraged foreign Investment by eliminating many restrictions on the repatriation of profits and reducing red tape and other obstacles. Some revisions in the current law governing foreign investment are under review as part of an effort to attract further foreign capital. In addition, Ozal has the confidence of the international financial community, according to several banking sources, enabling Turkey to attain increasing amounts of credit. Ankara's recent difficulties inon credit were mainly the resultew type of loan

-4-

SECREI NUKJ-W NULUHIRAJI UllLuf*

facility beinglivL.

Ozal's program thus far has had little success in reducing inflation and unemployment, partly because he has failed to meet his own fiscal and monetary targets:

inflation rate4 wasercent p from aboutercent3 partly because of substantial price increases in several state-produced products. It has continued strong in the first two monthsising at an annual rate ofercent in the first two months The accelerationhe Inflation rate

-represents the introduction of value-added tax in January. The February rate was running at an annual rate ofercent.

has climbed to roughlyercent as growth in the labor force has outstripped gainsivilian employment. The job outlook is uncertain because of the continued growth in the labor force and because many firmsspecially smaller ones re in severe financial difficulty.

While Ozal can place some of the blame on the looseof the military government after he resigned asminister tnnd to long overdue price hikesproducts, he nevertheless has pursuedmonetary policies. Money supply grew and Ankara ran into trouble with the IMF last it had exceeded the Fund's monetary targets. Inthe IMF's threatened suspension of credit to Ankara, Ozalraised interest rates and brought money growth back Intonewly agreed upon targets. T j

Ozal's decision to cut Income and corporate taxes, as well as the continued depredation of the lira, have helped to keep the budget deficit very high. The fiscal deficit4 is estimated by the IMF to be5 billion,ercent of GOP, while press reports and new government figures indicate it is much higherloseercent of GOP. Inadequate tax revenues appear toajor problemtax revenues account for justoercent of GNP, one of the lowest rates in the OECO. The recently introduced VAT should help to raise revenues, despite the short-term inflationary effects. _jr flci_

Outlook

Ozal's political future is inextricably intertwined with

Turkey's economic progress or lack thereof. If the economy fails to prosper under his direction. Ozal's government will almost certainly come under increasing pressure from the military and the public and could eventually fall. The Prime Minister is already under strong attack for his failure to control inflation, reduce unemployment, or relieve the financial stresses of many rivate business firms. The political opposition began calling for the formationnational unity" coalition this past fall to replace him. The two corruption scandals which rocked his governmenthree-month period this past winter heightened dissatisfaction with Ozal, as did the rather chaotic implementation of the VAT in January. IEJ^

The outlook5 is mixed, and it could end upepeat GNP growth should remain strong atercent, while we expect the current account deficit to narrow somewhat to about SI toillion. Exports, we believe, will increase byoercent and importslower rate, thus reducing the trade deficit slightly. The invisibles balance also shouldit, ise in interest payments. On the negative side, unemployment is likely to creep even higher because of strong growth in the labor pool, while the Inflation rate abates only modestly to perhapsercent. jX

Ankara's grace period on rescheduled foreign debt essentially ended last year, with the result that principal repayments will jump sharply Total service costs on medium and long-term debt will exceedillion thisboutercent of current account earningsnd will remain near that level for the remainder of. esult, Turkey will continue to be dependent on foreign aid from the West as well as require new borrowing in private financial markets.

Ozal's dilemmahat his program is aimed at the long run, but he needs short-term results to avoid jeopardizing his government and even the democratic process in Turkey. While we believe hen no Immediate danger, the mixed economic outlook5 means that Ozal's political problems will not abatehe near future and that he will need all of his tactical skills to fend off critics and keep his program on track. Should Ozal be forced from the scene, Turkey would lose Its most influential champion of badly-needed economic reforms, and successor regimes would almost certainly lack Ozal's commitment to long-term economic restructuring. The failure of the Ozal program could also contributeise in terrorism because impoverished and unemployed young people would be potential recruits for extremist organizations. Ozal's failure could also lead to the

ZLZ?.IJ rjOF?PM ^pntiTI">rT noma

disintegration of his partyeturn to theand chaotic politics of the. Inthe military might decide it had to step inhim, particularly if the generals concluded thatprogram had failed to control inflationhe

indicator for them and that he had loit the confidence of the international financial community.T)

Implications for the United States

Ozal will be looking for help in dealing with his economic and political problems In his visit here. He may raise the issue of rescheduling debt owed to the USerhaps including forgiveness of FMS creditsas well as try to gain US support in rescheduling debt owed to the IMF. Because another request for concessionary debt relief might damage Turkey's growing international creditworthiness, Ozal probably will want the issue treatedommercial operation Intended only to smooth out the bulge in repayments duehe next several years, mf ,nt. fir j

Ozal Is likely to complain that the strength of the dollar and high US Interest rates have added to Turkey's debt burden. ajor portion of external debt Is denominated in dollars, with military creditsignificant portion of the debt owed to the United States. Consequently, he probably will ask for Increased US economic aid and security assistance, and for more concessionary terms. Helso likely to press Turkey's case that export growth Is essential to the country's ability to meet its external debt obligations, and that US restrictions on Turkish textile products hinder export growth.

-7-

SECftETnrnilTninT nr.

TABLE 1

Turkey: Balance of Payments (According to Old and New Methodologies^)

(million US dollars)

Trade balance

on Invisibles

(net)

remittances

payments

debt relief)

(net)

Account Balance

In consultation with the IMF, Turkey has just revised its balance of payment methodology in order better to reflect underlying transactions. One major difference Is that imports are shown fob rather than elf, while several changes have been made in the recording of invisible transactions. For example, import transportation costs paid to Turkish flag carriers will no longer appearhe balance of payments. Also, goods sent home by Turkish emigrant workerswithill be shown as being financednilateral transfer ratherapital flow, and thus will not add to the current account deficit. The net effect of these changes is to reduce significantly the reported current account deficitby as much as SI billion All balance of payments references in the text are based on the new figures.

ThisOLA5SIFIE0

Turkey: General Economic Indicators

Real GOP

Inflation 7 1 0

Unemployment 0 0 0

Budget deficit (percent of

Sector Borrowing

Requirement (percent of GNP) Debt *

(billion US 3 0 0

Oebt Service ratioPercent of current account

8 0 0

Thlf tahln it COnirIDCMTIAL NOfOfW

.preliminary ^projected

Excludes military debt. The US Embassy estimated military debt owed to the United States at6 billion at the end

Turkey: Projected Debt Service Payments on Existing Medium- and Long-Term

(million US dollars

Debt service Principal Interest

r. >vn

organ excl. IMF Principal Interest -

230

m

231

lenders OECD countries

Principal

Interest Other countries

Principal

Interest

236

$

44

2

TOS 36

ri6

29

T7 24

banks Principal Interest

sector Principal Interest

SI

JO

TOT 29

1

6

2

Repurchases Charges

m

174

m

160

3

44

Item: Debt relief Principal Interest

ra

Oata provided by the Turkish

IMF

estimates.

rnnfin>nt1fll Mofrtrn.

Payments are shown after debt relief. Projections are based on disbursed and undisbursed external debt as of

Based on purchases outstanding as of3 and on the assumption that all purchases will be made under the current stand-by arrangement.

Original document.

Comment about this article or add new information about this topic:

CAPTCHA