So Far, So Good
OBG: In general, how well thus far has Turkey met the tenets and expectations of the 2001 economic programme?
CHHIBBER: Turkey’s economic programme - put together by a very competent economic team - has shown impressive results in 2002 so far. Turkey has shown a very quick turn-around after the crisis - similar to the recovery seen in Brazil and Korea after their crises. In contrast, much slower recovery was seen in Thailand and Indonesia. After declining over 9% in 2001, GNP growth turned around and reached an annualised level of 5% in the first half of 2002 - well above the target growth of 3%. Inflation has fallen sharply - despite a floating exchange rate and cumulative CPI inflation in the first eight months of 2002 of 16.1% - well within the programme target of 35% by end 2002. Turkey also appears to be on-track to reach its fiscal and balance of payments targets. Tourism and to some extent exports have played a key role in helping boost the economy. It is important that these trends are maintained in the run-up to the elections and beyond. For a more sustainable recovery - not just a bounce back from the 2001 recession - Turkey needs to attract more durable long-term capital especially through FDI. Real interest rates, however, remain very high and need to be brought down further to help sustain the positive trends.
OBG: Has the financial/banking sector been significantly cleaned up? Or are further changes in order to strengthen this sector?
CHHIBBER: Turkey learnt lessons from other crisis countries and concentrated early on in a rapid and thorough clean up of the banking sector. It did not delay the banking sector reforms unlike some other countries where lingering problems and unresolved issues in the banking sector eventually led to slow and delayed recovery. Some 20 small- and mid-sized banks - the weak tail of the banking system - were taken over and closed - Demir Bank was sold to HSBC. The state banks were also restructured and cleaned up. Emlak Bank was closed and Halk Bank and Ziraat Bank were re-structured very extensively. For the remaining private banks a re-capitalisation scheme was introduced which has helped identify remaining weaknesses in those banks that are now being dealt with through independent audits. These reforms would have been impossible without an independent banking authority. For the future credibility of the programme the independence of the banking authority should be maintained, and banking reforms should not be reversed. Turkey has relied heavily in the past on the banking sector for the bulk of its financial intermediation. The banking sector overshadows other financial intermediation instruments such as the equity and bond markets as well as insurance and private pensions. For a healthier and more resilient financial system these need to be developed so that the financial system has more depth. Measures to encourage the growth of the non-bank financial sector should be encouraged.
With the banking reform well underway it is important also to begin focusing on improving the health of the real sector. This would require more rapid debt re-structuring and reactivation of credit lines between banks and companies. A corporate debt-restructuring framework dubbed the “Istanbul Approach” has been formulated and work has started under this framework for debt and corporate restructuring. But the process is moving slowly and needs to be accelerated. The World Bank is prepared to provide up to $500m in new financing that may be needed to help accelerate the process. It is important that where needed the restructuring goes beyond simple financial re-structuring. There has been considerable discussion around the establishment of an asset management company. To be successful, such an approach would require stronger bankruptcy procedures that are under preparation.
OBG: Do you think further bank seizures are likely?
CHHIBBER: At present there are no indications of this - and if the economy continues to improve the prospects of further bank failures would be greatly reduced. Banking supervision has improved and risk management by banks is being conducted more seriously. Over time, more voluntary consolidation in the banking sector encouraged by incentives would also be very welcome.
OBG: What about privatisation? How important is progress on this front to the overall health of the programme?
CHHIBBER: Privatisation is important because it will help improve the governance of the companies involved, because it will bring in resources, and help attract FDI. Privatisation has slowed down, partly because of external market conditions, as for example for Turk Telekom and Turkish Airlines (THY). The latter has instead followed a tough fiscal plan and restructuring, including negotiating a workable arrangement with its unions. As a result it is now showing profits - a unique feature in today’s airline industry. Turk Telekom is following a revised corporatisation programme - with the intent of unbundling the company and preparing it for privatisation in the future.
But despite difficult market conditions, many state enterprises could be closed, merged and privatised. A major privatisation agenda is in the energy sector - where previous attempts at privatisation based on the BOT, TOOR model have not been terribly successful. Previous BOT contracts have been very expensive and have locked Turkey into a costly state guaranteed structure - with the end result that Turkey’s energy costs are amongst the highest in Europe. This model is being pushed further by energy companies - but needs to be re-examined. Turkey has introduced new legislation to bring more competition in the energy sector and has established a new independent energy regulator. As the energy regulatory authority is being established, Turkey also needs to find a smooth transition out of the costly BOT, TOOR model to outright privatisation of energy assets. Fortunately, Turkey is likely to have surplus capacity in electricity until 2007 and has the breathing room to bring about this transition in a clean and transparent manner.
OBG: While the government has brought down inflation substantially, do you think the government’s target of implementing inflation targeting at the start of 2003 is wise or even necessary?
CHHIBBER: The decline in inflation despite the very rapid devaluation last year is one of the significant successes of the programme. This year, Turkey is well on its way to achieving its inflation target of 35% and could even come below it. This result was achieved largely by credible fiscal and monetary policy and Turkey’s economic team deserves tremendous credit for its achievement. Going forward it’s important to continue with this strategy - and introduce inflation targeting at an opportune time. Bringing inflation to the 20-30% level has been historically relatively easier to achieve, but bringing inflation below 20% is often much harder and it is here that inflation targeting can be very helpful.
OBG: You talked last year of the importance of three elements in helping Turkey weather the affect of the crisis: early activation of social insurance, better targeted social assistance focused on women and children, and implementation of direct farmer support scheme. Briefly, how has progress been on each?
CHHIBBER: Progress on all these areas has been very impressive. What distinguishes Turkey’s economic programme from many others is the importance placed on social aspects. Despite a primary surplus of over 6% of GNP, Turkey has committed to increase its social programme and has been able to do so. There are three main planks of this social programme. First, targeting assistance to poor families through their children. As a result of child attendance benefits, school enrolment did not drop in 2001, despite the crisis. We hope this will be repeated in 2002. In addition Turkey has expanded its food and fuel assistance programme through the Social Solidarity Fund. The second plank was the introduction of the Direct Income Support programme that had a successful launch in 2001 and is being further expanded in 2002 - with a renewed registration programme. Some 3m farmers applied for the benefits in 2001. Lastly, unemployment insurance was launched in March 2002. Based on accrued benefits, workers can begin to benefit from the system.
We are very happy to have supported these programmes and further expanded our support for basic education. Enrolment has increased by over 1m and new expansion plans are underway for secondary and vocational education as well. Turkey has also managed to achieve such a tough programme without major labour unrest - largely due to careful crafting of its labour retrenchment programme. Over time, as private sector employment picks up, a more rapid state employee retrenchment programme can be achieved.
It is of course important to emphasise that while these social programmes can help poor families cope with the crisis, the restoration of stable and high growth is important for lasting improvements in their living conditions.
OBG: Regardless of their outcome, the upcoming elections will ultimately affect the prospects of the Turkish economy in the coming year. In your view, what should any government emphasise in keeping the Turkish economy on track?
CHHIBBER: The elections will be an important test of the resilience of the programme and the extent of de-politicisation that has been introduced, as well as of course introducing some risk to an improving economic situation. We hope that with an independent Central Bank, an independent Banking Authority, a new debt law, and a clearly articulated fiscal programme, as well as numerous other checks and balances in the system, the typical election year spending can be avoided. It is important also to ensure that key structural reforms - especially in banking, energy and agriculture, are not reversed or diluted in any way. If the fiscal programme is kept on track and reversals on structural reform are avoided, economic stability could be maintained and the gains Turkey has made in 2002 maintained. It is heartening to see that the economic programme of many political parties has a core component that perpetuates the reforms. Careful and delicate management is needed to avoid upsetting the improving macro-economic balances - especially in view of Turkey’s high public debt. It is critical that the political establishment pay very careful attention to these issues in the run-up to elections.