Summary:KEY ISSUES Context: Turkey’s economy has grown on average by 6 percent annually since 2010, but this has come at the expense of a persistently large external deficit making the economy sensitive to changes in external financing conditions. Inflation is high and above the authorities’ target, and real policy interest rates remain negative. The exchange rate continues to be stronger than suggested by fundamentals. Challenges: Policies should focus on rebalancing the economy, reducing the external deficit—by boosting savings rather than decreasing investment—and lowering inflation to preserve competitiveness. Over the medium term, implementation of the ambitious structural reform agenda is critical to raising potential growth. Key policy recommendations: • Fiscal policy should be tighter, raising domestic savings by increasing the primary surplus by 2 percent of GDP by 2017. • Renewing the focus of monetary policy on the inflation target, by setting and sustaining a positive real policy interest rate. • Expanding the (macro)prudential toolkit to contain risks to financial stability, in particular the banking system’s wholesale external foreign exchange funding. Traction of past Fund advice: The authorities and staff agree that the external imbalance should be reduced, and that this should be done while preserving investment. They also concur that lowering inflation is a key objective. Moreover, to preserve financial stability, the authorities introduced well-targeted macroprudential measures to slow the rise in household leverage and encourage banks to increase core funding. They plan to tackle structural issues through the 10th Development Plan. However, the authorities believe risks are lower than what staff believes and that the economy has enough buffers to withstand reasonable shocks. Thus fiscal and monetary policies would remain more accommodative than recommended by staff.
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