Turkey

Reforms under Özal

In January 1980, the government of Prime Minister Süleyman Demirel (who had served as prime minister 1965-71, 1975-78, and 1979-80) began implementing a far-reaching reform program designed by then Deputy Prime Minister Turgut Özal to shift Turkey's e conomy toward export-led growth.

The Özal strategy called for import-substitution policies to be replaced with policies designed to encourage exports that could finance imports, giving Turkey a chance to break out of the postwar pattern of alternating periods of rapid growth and defl ation. With this strategy, planners hoped Turkey could experience export-led growth over the long run. The government pursued these goals by means of a comprehensive package: devaluation of the Turkish lira and institution of flexible exchange rates, main tenance of positive real interest rates and tight control of the money supply and credit, elimination of most subsidies and the freeing of prices charged by state enterprises, reform of the tax system, and encouragement of foreign investment. In July 1982 , when Özal left office, many of his reforms were placed on hold. Starting in November 1983, however, when he again became prime minister, he was able to extend the liberalization program.

The liberalization program overcame the balance of payments crisis, reestablished Turkey's ability to borrow in international capital markets, and led to renewed economic growth. Merchandise exports grew from US$2.3 billion in 1979 to US$8.3 billion i n 1985. Merchandise import growth in the same period--from US$4.8 billion to US$11.2 billion--did not keep pace with export growth and proportionately narrowed the trade deficit, although the deficit level stabilized at around US$2.5 billion. Özal's polic ies had a particularly positive impact on the services account of the current account. Despite a jump in interest payments, from US$200 million in 1979 to US$1.4 billion in 1985, the services account accumulated a growing surplus during this period. Expan ding tourist receipts and pipeline fees from Iraq were the main reasons for this improvement. Stabilizing the current account helped restore creditworthiness on international capital markets. Foreign investment, which had been negligible in the 1970s, now started to grow, although it remained modest in the mid-1980s. Also, Turkey was able to borrow on the international market, whereas in the late 1970s it could only seek assistance from the IMF and other official creditors.

The reduction in public expenditures, which was at the heart of the stabilization program, slowed the economy sharply in the late 1970s and early 1980s. Real gross national product (GNP--see Glossary) declined 1.5 percent in 1979 and 1.3 percent in 19 80. The manufacturing and services sectors felt much of the impact of this drop in income, with the manufacturing sector operating at close to 50 percent of total capacity. As the external-payments constraint eased, the economy bounced back sharply. Betwe en 1981 and 1985, real GNP grew 3 percent per year, led by growth in the manufacturing sector. With tight controls on workers' earnings and activities, the industrial sector began drawing on unused industrial capacity and raised output by an average rate of 9.1 percent per year between 1981 and 1985. The devaluation of the lira also helped make Turkey more economically competitive. As a result, exports of manufactures increased by an average rate of 45 percent per annum during this period.

The rapid resurgence of growth and the improvement in the balance of payments were insufficient to overcome unemployment and inflation, which remained serious problems. The official jobless rate fell from 15 percent in 1979 to 11 percent in 1980, but, partly because of the rapid growth of the labor force, unemployment rose again, to 13 percent in 1985. Inflation fell to about 25 percent in the 1981-82 period, but it climbed again, to more than 30 percent in 1983 and more than 40 percent in 1984. Altho ugh inflation eased somewhat in 1985 and 1986, it remained one of the primary problems facing economic policy makers.

Economic Performance in the Early 1990s

Turkey benefited economically from the Iran-Iraq War (1980-88). Both Iran and Iraq became major trading partners, and Turkish business supplied both combatants, encouraged by government export credits. With limited access to the Persian Gulf, Iraq als o came to depend heavily on Turkey for export routes for its crude oil. Iraq had financed two pipelines located next to one another from its northern Kirkuk oilfields to the Turkish Mediterranean port of Çeyhan, slightly northwest of Iskenderun. The capac ity of the pipelines totaled around 1.1 million barrels per day (bpd). Not only did Turkey obtain part of its domestic supplies from the pipeline, but it was paid a sizable entrepôt fee. Some sources have estimated this fee at US$300 million to US$500 mil lion.

Turkey's economy was battered by the 1991 Persian Gulf War. The UN embargo on Iraq required the ending of oil exports through the Çeyhan pipelines, resulting in the loss of the pipeline fees. In addition, the economy may have lost as much as US$3 bill ion in trade with Iraq. Saudi Arabia, Kuwait, and the United Arab Emirates (UAE) moved to compensate Turkey for these losses, however, and by 1992 the economy again began to grow rapidly.

The Turkish economy again was plunged into crisis in 1994. The central government's moves in 1992 and 1993 to grant large salary increases to civil servants and to increase transfers to state enterprises enlarged the public-sector borrowing requiremen t to a record 17 percent of GDP in 1993. This high government spending sharply boosted domestic demand's rate of growth to 6.4 percent in 1992 and 7.6 percent in 1993. In turn, inflation rates went up, with the annual rate peaking at 73 percent in mid-199 3. The resulting rise in the real exchange rate translated into increased imports and slowed the expansion of exports. The trade deficit rose in 1993 to US$14 billion, while the current account deficit reached US$6.3 billion, or 5.3 percent of GDP.

Turkey's impressive economic performance in the 1980s won high marks from Wall Street's credit-rating agencies. In 1992 and 1993, the government used these ratings to attract funds to cover its budget deficits. International bond issues over this peri od amounted to US$7.5 billion. These capital flows helped maintain the overvalued exchange rate. In a market economy, a high level of government borrowing should translate into higher domestic interest rates and even possibly "crowd out" private-sector bo rrowers, thereby eventually slowing economic growth. But the government's foreign borrowing took the pressure off domestic interest rates and actually spurred more private-sector borrowing in an already overheated economy. Sensing an easy profit opportuni ty during this period, commercial banks borrowed at world interest rates and lent at Turkey's higher domestic rates without fear of a depreciating currency. As a result, Turkey's foreign short-term debt rose sharply. External and internal confidence in th e government's ability to manage the impending balance of payments crisis waned, compounding economic difficulties.

Disputes between Prime Minister Tansu Çiller (1993- ) and the Central Bank governor undermined confidence in the government. The prime minister insisted on monetizing the fiscal deficit (selling government debt instruments to the Central Bank) rather than acceding to the Central Bank's proposal to issue more public debt in the form of government securities. The Central Bank governor resigned in August 1993 over this issue. In January 1994, international credit agencies downgraded Turkey's debt to belo w investment grade. At that time, a second Central Bank governor resigned.

Mounting concern over the disarray in economic policy was reflected in an accelerated "dollarization" of the economy as residents switched domestic assets into foreign-currency deposits to protect their investments. By the end of 1994, about 50 percen t of the total deposit base was held in the form of foreign-currency deposits, up from 1 percent in 1993. The downgrading by credit-rating agencies and a lack of confidence in the government's budget deficit target of 14 percent of GDP for 1994 triggered large-scale capital flight and the collapse of the exchange rate. The government had to intervene by selling its foreign-currency reserves to staunch the decline of the Turkish lira. As a result, reserves fell from US$6.3 billion at the end of 1993 to US$ 3 billion by the end of March 1994. Before the end of April, when the government was forced to announce a long-overdue austerity program following the March 1994 local elections, the lira had plummeted by 76 percent from the end of 1993 to TL41,000 agains t the United States dollar.

The package of measures announced by the government on April 5, 1994, was also submitted to the IMF as part of its request for a US$740 million standby facility beginning in July 1994. Measures included a sharp increase in prices the public-sector ent erprises would charge the public, decreases in budgetary expenditures, a commitment to raise taxes, and a pledge to accelerate privatization of state economic enterprises (SEEs). Some observers questioned the credibility of these measures, given that the tax measures translated into a revenue increase equivalent to 4 percent of GDP and the expenditure cuts were equivalent to 6 percent of GDP.

The government actually succeeded in generating a small surplus in the budget during the second quarter of 1994, mainly as a result of higher taxes, after running a deficit of 17 percent of GDP in the first quarter. The slowdown in government spending , a sharp loss in business confidence, and the resulting decline in economic activity reduced tax revenues, however. The fiscal crisis resulted in a decline in real GDP of 5 percent in 1994 after the economy had grown briskly in 1992 and 1993. Real wages also fell in 1994: average nominal wage increases of 65 percent were about 20 percent below the rate of consumer price inflation.

Analysts pointed out that despite the fragility of the macroeconomic adjustment process and the susceptibility of fiscal policy to political pressures, the government continued to be subject to market checks and balances. Combined with a stronger priv ate sector, particularly on the export front, the economy was expected to bounce back to a pattern of faster growth.

Data as of January 1995

Turkey - TABLE OF CONTENTS