On November 20, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Turkey.¹

The Turkish economy achieved a welcome reduction of imbalances in 2012. In 2013, growth has accelerated significantly on the back of a monetary and fiscal policy stimulus. The economy is projected to expand by 3.8 percent this year with private consumption and public investment as the main contributors. With this rotation back to domestic demand-led growth, the current account deficit is widening again, while inflation remains above target.

The authorities are on track to meet their 2013 budget targets, despite rapid spending growth. As one-off factors boosted revenues beyond projection, the government made use of these windfalls to increase capital expenditure significantly beyond the budget ceiling, while maintaining its overall deficit targets. The banking system remains well capitalized, with capital ratios well above regulatory minima and non-performing loans (NPLs) remaining subdued, despite some uptick over the last year.

Executive Board Assessment²

Executive Directors noted the faster growth of the Turkish economy this year, due in part to policy stimulus. Nonetheless, they observed that the domestic demand-led growth is leading to a renewed deterioration in inflation and the current account deficit. In the period ahead, Directors encouraged the authorities to tighten their macroeconomic policies and step up structural reforms to strengthen external performance and bolster economic growth.

Directors considered a less accommodative monetary stance to be more appropriate in light of still-high inflation. Most Directors agreed that normalizing the monetary policy framework would help improve communications and strengthen monetary transmission. Some Directors noted the challenge faced by the monetary authorities in dealing with volatile capital flows and noted the improvements in inflation relative to the past. Directors suggested building up net foreign reserves through sterilized intervention when capital inflows resume.

Directors generally agreed that a tighter fiscal policy would help reduce external vulnerabilities and relieve pressure on monetary policy. They encouraged the authorities to contain current spending and save any revenue overperformance. They cautioned that discretionary stimulus should be reserved for a scenario of potential negative economic outturn. Over the medium term, fiscal consolidation would raise public saving and contribute to real exchange rate depreciation. Greater budgetary flexibility would be needed to allow greater spending on priority areas such as education and infrastructure.

Directors expressed satisfaction that the Turkish financial system is generally sound. They noted, however, that banks’ indirect exposure to foreign exchange risk requires careful monitoring. They considered that macroprudential measures should be targeted at household credit and corporate foreign exchange lending. Directors encouraged further efforts to address the deficiencies in the regime for anti-money laundering and combating the financing of terrorism identified by the Financial Action Task Force.

Directors noted the Turkish economy’s low saving rate and reliance on external financing. They underscored the importance of raising both private and public saving and stepping up structural reforms to raise competitiveness, attract foreign direct investment, and enhance growth while reducing external imbalances. The authorities’ efforts to decrease energy dependence, increase labor market flexibility, reduce the informal sector, and reform private pension are in the right direction. Further efforts to improve the business climate will also be important.