ECONOMY: Bold promises in the search for stability

15 July 1994

Bold moves to tackle the economic crisis and restore confidence are reaching a critical stage this summer. The challenge facing the government is an awesome one. Essentially, it must bring the public deficit under control or risk losing the war against inflation and the recession.

The government is not going into battle alone. It has the support of the IMF as it attempts to implement the austerity measures it announced in the spring. Commitments in a letter of intent have been recommended to the IMF board and approval of a $713 million standby facility is expected in early July,

The government has set itself exacting targets. It hopes to cut inflation from 90 per cent to 20 per cent by 1995, by which time the economy will be growing by 3 per cent. There is zero economic growth at present. According to the letter of intent, the foreign exchange reserves of the central bank will grow by $1,000 million by the end of this year and by $2,000 million in 1995.

The public sector borrowing requirement, which stood at 17 per cent of gross domestic product (GDP) in 1993, is due to come down to 8.6 per cent this year and 5.5 per cent in 1995. The huge public deficits are generated largely by the loss-making state sector which is the target of the privatisation programme. The borrowing has also been a prime cause of inflation which was running at a record 117.8 per cent in annual terms at the end of May.

Public expenditure as a percentage of GDP has been growing inexorably. It accounted for 35 per cent in 1988 but this had risen to 45 per cent by 1993. The government's heavy borrowing requirements had the undesirable consequence of driving up interest rates and fuelling inflation. High interest rates had led to the lira becoming grossly overvalued - by a margin of 22 per cent against a basket of major currencies at the end of 1993, according to officials.

The strong currency damaged Turkey's export competitiveness and boosted purchasing power at the same time. As the recession in Turkey's main European markets set in, export growth slumped. Strong consumer spending in 1993 boosted imports by 7.3 per cent, contributing to a record $6,380 million current account deficit by the end of the year.

However, Turkey was still attracting capital, drawn by the opportunity for quick returns from high interest rates and the steady appreciation of a freely convertible currency. An undesirable by-product of this process was a sharp rise in the foreign debt stock, which grew by 21 per cent in 1993 to end the year at $67,356 million.


Hopes that the new prime minister could work economic miracles, after her predecessors had so lamentably failed, did not last long. Ciller's plans to fix the budget deficit by sweeping privatisation, hastily announced when she became prime minister a year ago, quickly ran into opposition, much of it from within the ranks of the ruling coalition. Instead, the government was forced to try and convert its short-term public debt obligations into long-term instruments. At this point the country's increasingly complex finances began to unravel. The government now needed to bring down interest rates, which had risen to punitive rates in defence of the currency and in the battle to stay ahead of inflation. Confidence was shaken and bank lending to the government dried up. The treasury turned instead to the central bank for large short-term advances, and borrowed more abroad.

By January the run on the lira had begun. The lira has lost more than half its value against the dollar since the start of this year. Further lending by international banks towards the treasury's $2,200 million external borrowing requirement for 1994 has not been forthcoming. And, interest rates on government paper soared as the treasury desperately searched for funds.

Fears of an electoral backlash in local elections at the end of March stayed the government's hand until 5 April when it finally announced its austerity measures. The delay was very damaging. The combination of high interest rates and soaring import costs had pushed many companies perilously close to collapse. Firms have slashed output and laid off workers in their thousands. The automotive sector has been one of the worst-hit. The recovery will take two or more years, business and industry leaders say.

The spring strategy was to restore financial stability first. Several issues in June of three-month treasury bonds, paying net interest of 50 per cent over the period, were well received by investors.

This took pressure off the central bank, which had been forced to set exorbitant interbank rates to stop the steady drift into dollars. Foreign exchange rates stabilised and the financial markets have attained a fragile stability, for the time being at least.

The government is also acting to boost the tax take dramatically. There is to be a one-off levy on corporate assets; tax exemptions are to be cut by up to two-thirds and auditing and collection are to be tightened. At the same time capital spending will be cut by around 20 per cent.

Senior treasury officials are now more optimistic. They say that, net of interest payments on foreign and domestic debt, there is actually a sizable budget surplus. The budget could be balanced with the extra revenue from bonds and tax reforms and the flow of funds from privatisation by the end of the year, they say.

According to this view, there will be no further need for short-term advances from the central bank, and borrowing, interest rates and inflation will all start to fall.

The recession will dampen import demand and exports should benefit from a cheaper lira. The current account will move back into balance, and may show a large surplus by year-end.


There is also a sceptical view of how things will work out. The first hurdle will come in August when the treasury's capacity to meet its obligations on maturing bonds plus interest will be tested. A longer term test will be of the government's ability to deliver the structural adjustments outlined in the IMF letter of intent.

The government may simply not be allowed to do what it wants. Its attempt to reform by decree is blocked in the constitutional court although it has won a relatively free hand to begin privatisation. The government is in a hurry, but bankers warn that successful sell-offs are rarely made in haste. They say major enterprises such as Eregli Iron & Steelworks, the Turkish Petroleum Refineries Corporation (Tupras), refined products distributor Petrol Ofisi, and Turk Hava Yollari (THY - Turkish Airlines) are unlikely to be ready for privatisation within the present tight schedule.

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