Turkey - Postscript special economic report

FILE COPY Report No. 2918-TU Turkey: Postscript Special Economic Report "Turkey: Policies and Prospects for Growth", (2657a-TU, December 12, 1979) March 20, 1980 Country Programs Department II Europe, Middle East and North Africa Region FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties, Its contents may not otherwise be disclosed without Worid Bark authorization.   FOR OFFICIAL USE ONLY POSTSCRIPT Special Economic Report "Turkey: Policies and Prospects for Growth", (2657a-TU. December 12, 1979) 1. A Special Economic Mission visited Turkey in April/May 1979 to evaluate the Fourth Five-Year Plan (1979-83). Following discussions with the Government in mid-October 1979, its report entitled "Turkey: Policies and Prospects for Growth" (No. 2657a-TU dated December 12, 1979), was distributed to the Executive Directors on December 26, 1979. Since then, developments in the international economy have led to a substantial revision in projected prices of Turkey's imports (including oil) and in expectations of the levels of future interest rates in OECD countries. At the same time, on January 25, 1980, the Government of Turkey announced the devaluation of the Turkish Lira from TL 47.1/US$ to TL 70.0/US$, as part of a package of policy reform likely to have a profound impact on economic organization, exchange and trade regime, and prices and incentives. Consequently, the Report's assessment of Turkey's medium-term growth and balance of payments prospects, presented in Chapter VII of the Report, needs to be updated. Major Reasons for a Modified Prognosis 2. The principal external factors underlying the reassessment of the balance of payments and growth prospects of the economy presented in this Postscript are as follows: (a) A sharp rise in actual and anticipated rates of international inflation and hence, Turkey's import prices (including oil), implying a significant deterioration in the terms of trade. (b) Higher projected interest burden, in view of higher actual and expected rates of interest in OECD capital markets. 3. The Report was prepared on the basis of projected international prices (including oil prices) considered reasonable in mid-1979. These projections have been revised upwards in the light of recent developments in the international economy. Thus, even if oil imports are held to 1977 levels (around 14 million t-s) the cost, at presently forecast prices, would be around US$3.2 billx,n (compared to US$1.4 billion in 1977). Simi- larly, even if imports from OECD countries are maintained at 1977 levels, the cost would be US$5.7 billion (compared to US$4.0 billion in 1977). Export prices, on the other hand, have not kept pace with import prices. Nor are they expected to do so. As a result, the economy's import capacity is expected to be further curtailed, with consequences for growth and investment. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  4. With the sharp increase in international rates of interest, there has also been a marked increase in the projected interest burden arising from Turkey's commercial bank debts (of about $3.0 billion) rescheduled last year. The rescheduling was at 1.75 percent above the London Inter-Bank Offer Rate (LIBOR), then about 9 percent, but now around 18 percent. Furthermore, interest payments on other trade financing obligations have increased simi- larly. Together, these factors have significantly reduced Turkey's import capacity from what could be realistically anticipated at the time the Economic Report was prepared. 5. In reassessing Turkey's economic prospects, this Postscript also takes into account the Government's January 25 announcement of a major re- orientation of economic policies. The principal features of the Government program of economic reform can be summarized as follows: (a) Greater reliance on market mechanisms and forces, by both the public and private sectors, and lesser reliance on planning by decree and by administrative fiat. (b) Greater emphasis on reducing the rate of inflation and im- proving the balance of payments position, even at the expense of a temporarily lower rate of economic growth. (c) A shift to a development strategy based on export promotion, rather than import substitution, which, until recently, had been a cornerstone of Turkish development policy. Consequently, the present bias favoring production for the domestic market, is to give way to policies encouraging the public and private sectors to be efficient and internationally competitive. Also, the Government will implement rational exchange rate policies and measures encouraging exports. (d) Domestic resource mobilization efforts, unlike the past, must be substantially augmented through increased tax efforts, credit restraints, increased savings and the development of financial markets; the elimination of deficits of the public sector is an important objective of budgets from 1980 onwards. (e) SEEs have been allowed to set their own prices, so that they may generate sufficient revenues to cover operating costs and investment expenditures, and take steps to improve their management and productivity. (f) Investments priorities have been set with the aim of more in- tensive and fuller utilization of existing productive capacity and completion of ongoing projects, while new investments are to stress exports and employment or the removal of critical infrastructural bottlenecks.  - 3 - (g) Conditions to stimulate foreign investments in oil, industry and agriculture are being created, in contrast to the past when such investments are not encouraged; prudent external debt management policies are being pursued so as to create -onfidence in and flow of large external resources to Turkey. Modified Medium-Term Prospects 6. While it is not possible to undertake a more comprehensive updating of the Report on the account of these new external and domestic developments, this Postscript attempts to update the key medium-term projections, based on the economic model for Turkey developed within the Bank, by incorporating the broad outline of these changes to the extent possible. In sum, the Report's medium-term projections (Base Run) envisaged 6.1 percent per year growth in GDP during 1978-85, with average annual growth of 14.7 percent in exports and 5.0 percent in imports, Due to the changes outlined above, we now expect GDP growth over the same period to be closer to 4.2 percent per year, with average annual import growth of 3.3 percent, despite a higher rate of export growth of 18.0 percent. This would correspond to an average annual level of current account deficit on the balance of payments of US$2.2 billion (earlier, projected at US$1.5 billion) during 1981-85, and con- sequently, an average level of gross capital inflow of US$5.2 billion per annum (earlier, project at US$4.0 billion). The revised medium-term projec- tions, along with comparative numbers from the Report, are presented in Attachment 1 in greater detail. Attachment 2 presents background information on the assumptions underlying the revised projections. Conclusions 7. The major implications of the revised projections are as follows: (i) Turkey would require a somewhat higher level of gross capital inflow, than originally envisaged. Given the Government's recent effort to mobilize support from the OECD group of countries for its new economic program, a somewhat larger capital inflow appears realizeable. However, in the immediate years ahead, a significant proportion of the external assis- tance would have to be on concessional terms, if the economy is to avoid difficulties in the early 1980s when debt servicing obligations are heavily bunched. (ii) The debt service burden would remain very high throughout the 1980s, but the economy would remain viable, provided there is a reasonable export performance and vigorous implementation of export oriented policies. A cautious debt management policy will continue to be essential, and especially involve control of the growth of short-term liabilities and efforts to lengthen the maturity structure of the existing debt. This requires a resolution of existing debt problems, such as the measure to resolve the problem of unguaranteed trade credits of about $1.9 billion, announced as part of the January 25, 1980 program,  and further rescheduling of debt by the OECD member countries. It is clear that the terms of reschedulings which have taken place so far, are likely to create a potentially disruptive debt service burden during the early 1980s and, therefore, further rescheduling on more realistic and reasonable terms appears essential in the future. Overall, however, given the successful mobilization of capital inflow at the levels projected, the economy should be able to achieve reasonable growth rates with a feasible balance of payments. 8. In general, the events of the past six months underscore the importance of the recommendations contained in the Report. Turkey's historical strategy of development based on import substitution and minimal trade, is no longer sustainable. A history of minimizing imports and exports has resulted in more, rather than less, dependence on the vagaries of the world economy. The sensitivity of trade and growth to changes in prices and incentives, emphasizes the need for careful consideration of incentive policies that work, through the market mechanism in Turkish economic management. Recent events, which necessitate this Postscript, only serve to confirm that a shift to a more open development strategy which Turkey has now reaffirmed under its January 1980 program, is essential.  Attachment 1 Page 1 of 5 Revised Tables for Chapter VII Turkey: Policies and Prospects for Growth (I2657a-TU, December 12, 1979) Table 45-A Macroeconomic Aggregates: Medium Term Growth Rates /1 Run A-O (Base Run) Oriinal/2 Revised 19ih- 1978- 1981- 1985 1985 1985 GDP 6.1 4.2 4.5 Consumption 5.5 3.2 3.4 Gross Domestic Savings 7.9 4.7 7.5 Investment 5.6 3.0 5.2 Merchandise Exports 14.7 18.0 12.6 Merchandise Imports 5.0 3.3 4.2 /1 Annual average real growth rates in percent. /2 As in the Grey Cover of Special Economic Report, "Turkey: Policies and Prospects for Growth", December 12, 1979. (Table 45, page 153.)  Attachment 1 Page 2 of 5 Table 46-A Exports: Volume Growth Rates/i Run A-0 (Base Run) Origin) / Revised__ 1978- 1978- 1981- 1985 1985 1985 Agriculture!3 5.0 5.4 4.6 Mining 11.6 7.5 8.1 Manufactures 16.2 19.8 13.4 Consumer Goods/3 12.7 17.2 12.3 Intermediate Goods 37.7 36.0 17.4 Capital Goods 39.4 43.7 19.5 Infrastructure & Services 8.6 5.8 5.2 Total Merchandise 14.7 18.0 12.6 Merchandise + Services 12.4 13.9 10.5 /1 Annual average real growth rates, in percent. /2 As in the Grey Cover of Special Economic Report, "Turkey: Policies and Prospects for Growth", December 12, 1979. (Table 46, page 156.) /3 Definition of agricultural exports differs somewhat as between Fourth Plan and model: Plan includes tobacco, ginned cotton, dried fruits; model treats these commodities as manufactured consumer goods.  Attachment 1 Page 3 of 5 Table 47-A Imports: Volume Growth Rates /1 Run A-0 (Base Run) OriginaL /2 Revised 1978- 1978- 1981- 1985 1985 1985 Agriculture 8.7 6.1 -0.4 Mining /3 0.3 0.8 3.0 Manufactures 5.6 3.8 4.5 Consumer Goods 5.6 5.6 4.7 Intermediate Goods 6.0 4.4 4.7 Capital Goods 5.3 3.1 4.4 Infrastructure & Services 6.7 3.9 4.2 Total Merchandise 5.0 3.3 4.2 Merchandise + Services 5.1 3.3 4.2 /L Annual average real growth rates in percent. /2 As in the Grey Cover of Special Economic Report, "Turkey; Policies and Prospects for Growth", December 12, 1979. (Table 47, page 156.) /3 Includes manufactured petroleum products.  Attachment 1 Page 4 of 5 Table 48-A Production: Volume Growth Rates - Run A-O (Base Run) OriginalL Z Revised 1978- 1978- 1981- 19J5. 1985 1985 Agriculture 3.7 3.4 3.5 Mining 7.6 4.3 5.7 Manufactures 7.5 5.2 6.0 Consumer Goods 6.5 6.5 6.3 Intermediate Goods 9.0 5.0 5.7 Capital Goods 6.8 4.3 5.6 Infrastructure & Services/3 6.7 3.9 5.9 Total Gross Production 6.6 4.5 4.9 GDP 6.1 4.2 4.5 /1 Average annual growth rates for gross production, except for GDP which is value-added. /2 As in the Grey Cover of Special Economic Report, "Turkey: Policies and Prospects for Growth", December 12, 1979. (Table 48, page 157.) /3 Including construction.  Attachment 1 Page 5 of 5 Table 50-A: BALANCE OF PAYMENTS PROJECTIONS (Current Prices) Average Level Growth Rate 1981-85 1978-1985 (billion US$) Original/l Revised Original/I Revised Exports of goods and NFS 17.3 16.5 7.8 6.8 Imports of goods and NFS 11.9 14.1 10.2 10.4 Workers' remittances 6.4 19.412 2.0 2.9 Current A/C deficit .. .. 1.5 2.2 Gross capital inflow .. .. 4.0 5.2 Amortization .. 2.5 3.0 Net capital inflow .. .. 1.5 2.3 /1 As in the Grey Cover of Special Economic Report, "Turkey: Policies and Prospects for Growth"', December 12, 1979. (Table 50, page 161.) /2 Actual growth during 1978-80 is now estimated at around 115 percent. Source: IBRD; original and revised base run (A-0) projections.  Attachment 2 Page 1 of 3 Assumptions Underlying the Revised Projections 1. The revised projections presented in this Postscript to the Special Economic Report of Turkey (TU-2657a, December 12, 1979) correspond to the medium-term projections presented in Chapter VII of the Report, and are based on a general equilibrium model of Turkey developed within the Bank. 2. There are two critical assumptions which underlie these projections. First, it is assumed that given the policy initiatives, the Government's efforts to control inflation and achieve macro-economic balance over the medium-term would be successful. Thus, to reflect the current high rates of inflation, the average annual rate of increase in the Turkish GDP deflator during 1979-85 is now assumed to be 30 percent per year, rather than around 23 percent per year as was assumed in the Economic Report. Second, the Government is assumed to maintain the real value of the exchange rate by adopting essentially a "floating peg" system that corrects the nominal exchange rate for differences between the inflation rate in Turkey and the rest of the world. By and large, the institution of such a system is reflected in principle in the Government's January 1980 economic program. Besides, policies to promote a more open development strategy and achieve higher growth in the medium-term would not otherwise succeed in an environment dominated by explosive inflation, increasing macro-imbalances, and short-term crises. 3. These projections, discussed below, are essentially a revision of the base run A-0 described in Chapter VII. As in original run A-0, besides the assumption that the real exchange rate is maintained at its post-devaluation level, it is further assumed that the 50 percent retention scheme for industrial exporters will be maintained, along with the existing levels of tariffs and export subsidies. Workers' remittances are assumed to grow in nominal terms at 8 percent a year during 1980-85, roughly equal to the world inflation rate (excluding oil). Projections of capital requirements and capital inflows are discussed in greater detail in para. 9 of this Attachment, but in general, are heavily weighted by the projected consequences of the current debt burden likely to unfold during the early 1980s. Domestic savings grow more slowly than in original run A-0 and domestic rate of inflation is higher. These assumptions reflect the delay in the impact of the stabilization policies, the continuing impact of the crisis and the required adjustment to the rising oil price. 4. Both the original and revised projections are given in Tables numbered 45-A through 48-A (Attachment 1), which should replace Tables 45-48 in Chapter VII of the Report. Growth rates are shown for two periods: 1978-85 and 1981-85. The latter period reflects the return to a medium-term trend after a period of recovery from the current crisis. 5. First, the revised projected growth rate of GDP of 4.2 percent is much lower than the 6.1 percent projected originally. The reason for a lower growth rate is largely the more binding external resource constraint due to the increased price of oil and the increasing debt service burden, as well as  Attachment 2 Page 2 of 3 due to the lower projected savings rates. The oil price, of course, is not subject to policy control but the savings rate is, at least to some extent; so is the debt management, especially for new obligations. If the Government's January 1980 policy package works quickly, then it may well be possible to increase the domestic savings rate above the assumed levels and thus achieve a higher growth rate, provided the revised net capital inflow levels as given in Table 50-A materialize. 6. Sensitivity analysis of the revised projections clearly shows that the overall economic performance is quite closely related to export growth. Given how constrained the economy is currently due to the shortage of foreign exchange, any loosening of that constraint will have a significant impact on growth--a conclusion similar to the one presented in the Economic Report. 7. Tables 46-A - 48-A given the growth rates of exports, imports and gross production at a six-sector level of aggregation. The projected sectoral export growth rates are roughly comparable to those originally projected. Given the Government's strong commitment to export promotion and its willing- ness to undertake the necessary incentive policies, the proposed rates represent a reasonable prognosis as to the medium-term future. Again assuming that the January 1980 package works, the projections indicate a rapid export growth, in response to the recent dramatic change in incentives and the newly announced exchange rate policy. It must however be remembered that 1978-79 is the depth of the crisis, so the initial burst of growth starts from a rather low base. Also, there is at present, clearly a great deal of underutilized productive capacity in Turkey. Much of the expansion of exports should therefore come not from new production, but from diversion of goods from the domestic to the inter- national market. Table 48-A indicates that the projected sectoral growth rates of gross production are, indeed, rather low and certainly sustainable given the proper incentives. 8. The projected growth rates of sectoral imports in the revised base run, is significantly lower than in the original run. The high and increasing cost of oil, coupled with lower projected real foreign capital inflows, must result in tighter import rationing than was projected earlier, even assuming excellent export growth. It is the squeeze on essential imports that causes the decline in growth. It appears that through the first half of the 1980s, Turkey's growth will be continually constrained by shortages of foreign exchange and that trade policy must therefore be managed in a way that maximizes the contribution of essential imports to growth. 9. The revised balance of payments projections are given in Table 50-A. These results portray a foreign trade picture that emerges from the response of the economy to the export-oriented policy, as well as to the other external and domestic constraints. The external constraints largely refer to the availability of foreign capital (and export earnings) which determines, in turn, the import capacity of the economy. The domestic constraint largely would be able to divert production from domestic use to export. Given these assumptions, the nominal rates of exports and imports are as given in Table 50-A. These rates are roughly comparable to those projected earlier. But the important difference is, that they are anchored to a lower base in 1980, particularly in the case of exports ($2.3 billion for exports and $6.5 billion of imports) than was the case in the earlier runs. Hence, the level of foreign exchange earnings is relatively lower than projected earlier, while the foreign exchange requirements remain fairly high for reasons discussed earlier. Con-  Attachment 2 Page 3 of 3 sequently, the current account deficit in the revised base run projection, is higher than originally projected. There is also a slight increase in the debt amortization, because the larger current account deficit would require a larger external borrowing, other things remaining the same. Hence the projected debt service burden is higher than was originally envisaged.