Report No. 4287-TU Turkey FILE COP Country Economic Memorandum Recent Economic Development and Medium-Term Prospects (In Two Volumes) Volume 1: The Main Report June 3, 1983 Country Programs Department II Europe, Middle East and North Africa Region FOR OFFICIAL USE ONLY Document of the World Bank This document has a restncted 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 TURKEY CURRENCY EQUIVALENTS (Annual and Quarterly Averages) Value of US$ 1959 TL 2.80 1970 TL 11.50 1971 TL 14.92 1972 TL 14.15 1973 TL 14.15 1974 TL 13.93 1975 TL 14.44 1976 TL 16.05 1977 TL 18.00 1978 TL 24.28 1979 TL 31.08 1980 First Quarter TL 61.60 Second Quarter TL 75.53 Third Quarter TL 80.10 Fourth Quarter TL 86.93 1981 First Quarter TL 94.59 Second Quarter TL102.84 Third Quarter TL118.89 Fourth Quarter TL128.56 1982 First Quarter TL142.25 Second Quarter TL153.27 Third Quarter TL171.86 Fourth Quarter TL182.85 1983 First Quarter TL194.15 May 2 TL208.00 FISCAL YEAR Republic of Turkey March 1 to February 28 - through 1981 March 1 to December 31, 1982 January 1 to December 31 - from 1983 SEEs and TCZB January 1 to December 31 ABBREVIATIONS CGE - Computable General Equilibrium Model EEC - European Economic Community ICOR - Incremental Capital Output Ratio IMF - International Monetary Fund LIBOR - London Inter-Bank Offer Rate M< - Medium and Long-Term NFS - Non-Factor Services OECD - Organization for Economic Cooperation Development RMSM - Revised Minimum Standard Model SEE - State Economic Enterprise SPO - State Planning Organization TCZB - Turkish Agricultural Bank TSKB - Turkish Industrial Development Bank FOR OFICIAL USE ONLY This report is based on the findings of a joint World Bank and IFC Economic Mission that visited Turkey in June - July 1982. The Mission consisted of the following: Jayanta Roy (Mission Chief) Joel Bergsman Geoffrey Gowen Seok Hyun Hong Jeffrey Lewis Malvina Pollock Sherman Robinson Joseph Solan Firouz Vakil Fan Fan Walker 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. TURKEY COUNTRY ECONOMIC MEMORANDUM RECENT ECONOMIC DEVELOPMENTS AND MEDIUM-TERM PROSPECTS Table of Contents VOLUME I: THE MAIN REPORT Page No. COUNTRY DATA SUMMARY AND CONCLUSIONS i-xiv INTRODUCTION Chapter I: RECENT ECONOMIC DEVELOPMENTS 1 A. The Legacy of the 1970's: Emerging Problems 1 B. Launching the Structural Adjustment Process - 1980 2 C. The Reform Program in Action - An Evaluation of 1981 Performance 3 1. External Debt Situation as of end 1981 5 D. Developments in 1982 6 1. General Considerations 6 2. National Accounts 7 3. Public Sector Investment 7 4. Prices and Wages 8 5. Budget Estimates 9 6. SEE Accounts 9 7. Balance of Payments 10 8. OECD Pledges 13 E. Concluding Remarks 14 Chapter II: THE MEDIUM-TERM FRAMEWORK: 1983-1990 15 A. Introduction 15 B. Medium-Term Projections 16 C. The Base Case 16 1. Guiding Considerations for the Base Case 16 2. Binding Constraint 16 3. The Results 18 D. Sensitivity Analysis 25 1. Sensitivity 1 - Lower Oil Price Scenario 26 2. Sensitivity 2 - Lower Export Growth Scenario 27 E. The Downside Risk Case 28 F. Concluding Remarks 31 - ii. - Page No. Chapter III: DEVELOPMENT ISSUES AND STRATEGY 32 A. Introduction 32 B. Resource Mobilization and Efficiency in Resource Use 32 1. SEE Reforms 33 2. Financial Sector Reforms 34 C. Rationalization of Public Sector Investment: Size and Sectoral Strategies 36 1. Size of the Program 36 2. Sectoral Strategies 37 D. External Trade Issues 37 1. Export Sustainability 37 2. The Process of Import Liberalization 41 3. Foreign Exchange Reserve Policy 41 4. Debt Management, Creditworthiness, and Access to Commercial Markets 42 5. Borrowing Prospects and Access to Commercial Markets 43 6. Creditworthiness 44 E. Unemployment 46 F. Private Manufacturing Investment Outlook 47 1. Policy Requirements to Encourage Private Investment 48 2. Prospects for Private Manufacturing Investment 51 G. New Role of Agriculture 51 H. Additional Policy Concerns in the Medium-Term 52 I. Concluding Remarks 52 MAP - iii - LIST OF TEXT TABLES VOLUME I: THE MAIN REPORT Page No. Chapter I: RECENT ECONOMIC DEVELOPMENTS Table 1.1 Turkey - National Accounts 4 1.2 Level and Distribution of External Debt 1977-1981 5 1.3 Savings and Investment Targets and Realizaton 8 1.4 Merchandise Exports 10 1.5 Exports by Destination 11 1.6 Construction Activities in the Middle East (end 1981) 12 1.7 Structure of OECD Pledges 13 Chapter II: THE MEDIUM-TERM FRAMEWORK: 1983-1990 Table 2.1 Base Case - Summary of Balance of Payments Projection 18 2.2 Base Case - Summary of Projected National Accounts 20 2.3 Base Case - Public Sector Projections 22 2.4 Base Case - Savings & Investment Flow of Funds 23 2.5 Oil Price Assumptions: Base and Sensitivity 1 25 2.6 Lower Oil Price Scenario - Projections of Selected Economic Indicators 26 2.7 Lower Export Growth Scenario - Projections of Selected Economic Indicators 27 2.8 Downside Risk Case - Projections of Selected Economic Indicators 29 Chapter III: DEVELOPMENT ISSUES AND STRATEGY Table 3.1 Exports from Turkey and Comparator Countries 38 3.2 International Liquidity and Debt Profile, 1978-1990 Base Case 45 TURKEY - COUNTRY DATA Population: 45.5 million (1981) GNP Per Capita: US$1540 (1981) Amount Average Annual Increase (%) Share of GDP at Market Prices (%) (million US$ (at constant 1980 prices) (at current prices) Indicator at current prices) 1981 1965-70 1970-75 1975-80 1965 1970 1975 1980 NATIONAL ACCOUNTS Gross domestic product /a 57,655 6.6 7.5 2.8 100.0 100.0 100.0 100.0 Agriculture 11,903 3.1 4.4 2.7 30.7 26.4 26.2 21.4 Industry lb 14,218 9.5 9.5 2.8 16.6 17.2 18.0 28.6 Services 28,130 8.2 8.0 3.7 42.9 46.5 46.0 44.3 Consumption 46,717 5.8 7.0 2.7 84.6 82.8 85.2 81.8 Gross investment 14,392 11.7 12.9 0.6 16.7 20.1 23.3 26.4 Exports of goods and NFS 6,372 7.9 7.3 4.4 6.1 5.8 6.1 7.1 Imports of goods and NFS 9,826 11.2 13.8 -3.1 7.4 8.7 14.5 15.2 Gross national savings 12,317 11.6 11.9 2.4 15.8 18.8 18.1 18.3 Average Annual Increase (x) Composition of Merchandise Trade (2) (at constant 1980 prices) (at current prices) 1972-75 1975-80 1972 1975 .1980 MERCHANDISE TRADE /c Merchandise exports 4,703 -6.1 2.8 100.0 100.0 100.0 Primary 2,4L3 -6.3 4.0 72.6 .64.1 64.0 Industrial products 2,290 -5.8 0.9 27.4 35.9 36.0 Merchandise imports 8,933 11.2 1.2 100.0 100.0 100.0 Agriculture and livestock 125 27.9 -23.8 2.2 4.3 0.7 Mining and quarrying 221 17.4 6.8 1.2 1.6 1.8 Petroleum 3,878 5.4 11.0 9.9 17.1 48.8 Machinery and equipment 1,996 14.0 -12.1 45.0 35.6 18.2 Other industrial products 2,713 9.9 4.5 41.7 41.4 30.5 1977 1978 1979 1980 1981 PRICES AND TERMS OF TRADE GDP deflator (1980 - 100) 20.2 29.0 49.4 100.0 141.9 Exchange rate 18.0 24.3 31.1 76.0 111.2 Export price index 63.8 63.0 78.2 100.0 99.3 Import price index 61.2 61.2 71.9 100.0 109.3 Terms of trade index 104.3 102.9 108.8 100.0 90.6 As % of GDP (at current prices) 1965 1970 1975 1980 PUBLIC FINANCE Current revenue 15.0 22.6 22.0 19.8 Current expenditure 10.0 11.8 12.6 11.5 Surplus (+) or deficit (-) -2.0 -2.3 -0.4 -4.8 Investment expenditure 4.7 5.7 4.2 3.9 Transfers 5.0 7.5 5.5 9.2 Foreign financing 1.8 1.6 0.3 0.2 1965-70 1970-75 1975-80 OTHER INDICATORS GNP growth rate (Z) 6.8 7.7 2.6 GNP per capita growth rate (X) 4.1 5.0 0.3 ICOR . 2.9 2.9 5.7 Marginal savings rate (%) 28.2 19.5 30.8 Import elasticity 1.7 1.8 -1.3 /a At market prices; components are expressed at factor cost and will not add due to exclusion of net indirect taxes and subsidies. 7T Includes mining and quarrying, manufacturing, and electricity, gas, and water. 77 In accordance with Turkish Government's specifications, which are not compatible with SITC's. TURKEY - BALANICE OF PAYhENTS. EXTERNAL CAPITAL, AND DEBT /a (million US* at toreren prices) Population: 45.5 million (1981) GNP Per C.pit.: US$1540 (1981) Actual Estimate Pro jected 1970 1977 1978 1979 1980 1981 1u9t82 1983 1984 1985 1986 BALANCE OF PAYMENTS Net exports of goods 4 NFS 342 3880 1984 2442 4658 3476 -2021 -1960 -1788 -1771 -1956 Exports of goods 6 NFS 754 2556 3075 3247 4102 6416 7620 8894 10613 12523 14545 Imports of goods & NFS 1096 6436 5059 5689 8760 9892 9641 10853 12402 14293 16501 Workers' remittances 273 982 983 1694 2071 2490 2187 2350 24,50 2622 2779 Net transfers 91 12 - - - - - - - - - Current accont bolance -58 -3572 -1741 -1771 -3207 -2089 -1035 -870 -693 -485 -602 Direct private investment 92 169 147 200 148 129 125 127 131 144 158 Public X1< (gross) /b 271 997 1017 4321 2354 2188 2076 1690 1593 1487 1671 Amorti-ation on M6LT7b -146 -234 -336 -414 -434 -545 -1230 -1105 -1258 -1783 -2040 Public MALT (net) /b 125 763 681 3907 1920 1643 846 585 335 -296 -369 Other capital /c 27 2074 1061 -2410 1642 983 264 130 29 924 1151 Change in reserves (- increase) -186 566 -148 74 -503 -667 -200 28 199 -288 -339 International reserves 612 726 874 800 1303 1970 2076 2549 1850 2138 2477 Reserves *c oonths of imports 7 1 2 2 2 2 2 2 2 2 2 Actual 1972 1977 1978 1979 1980 1981 GdROSS DISBURSEMENTS Gross diebur.-teoto of M< loans 372 759 857 4198 /d 2279 2116 Officisl grants - - - - - 300 Concesoional 261 193 228 588 812 522 Bilateral 139 100 129 406 749 499 IDA 4 19 8 3 - - Other nultilsters1 118 74 91 179 63 23 Non-co-cession-l 111 566 629 3610 /d 1466 1294 Official export credits 1 47 133 250 288 355 IBRD 25 146 165 277 313 454 Other nultilateral 27 5 35 15 150 162 Private /d 58 368 296 3068 /d 715 323 EXTERNAL DEBT Debt outstanding sod disbursed 2450 4293 6322 10942 13415 13804 Official 2273 3657 5489 7189 8281 8906 IbRD 92 512 648 890 1158 1546 IDA 99 181 188 190 189 188 Other 2082 2964 4653 6109 6934 7172 Private 177 636 833 3753 /e 5134 4898 Debt outstanding incloding -ndiab.rsed 3560 7128 9879 14620 16807 17093 DEST SERVICE Total debt service /e 224 363 428 627 1001 1168 Psy-enta 161 196 264 403 405 510 Interest 63 167 164 224 596 658 Total debt service as 2 exporta of goods + NFS + workero' re-ittances 11.8 10.3 10.6 12.7 16.2 13.1 Total debt service as X GNP 1.3 0.8 0.9 0.9 1.7 2.0 Averare interest rate on nev loans (2) 4.4 7.7 6.9 11.3 6.5 7.9 Official 4.5 7.7 5.6 3.5 5.5 5.3 Private 6.8 7.8 8.2 13.6 10.6 15.4 Average .at.rity of new loans (years) 22.1 11.6 13.3 11.1 17.4 15.0 Official 26.0 12.7 15.2 25.1 16.6 16.3 Private 11.0 9.2 7.6 7.1 6.4 4.5 BANK GkOUP EXPOSURE (X) IERD DOD/total DOD 3.7 11.9 10.2 8.1 8.6 11.2 I8RD disbursemtnrs/total gross disbursements 6.7 19.1 18.4 6.5 13.7 25.0 IBRD debt service/total debt service /e 5.1 17.2 19.2 16.8 13.3 14.0 IDA DOD/total DOD 3.9 4.2 3.0 1.7 1.4 1.4 IDA di.bursement./Lotal gross disbursements 1.1 2.5 0.9 0.1 - - IDA debt service/total debt service /e 0,4 0.6 0.5 0.4 0.3 0.2 As . of Debt Outstanding at End of Most Recent Year (1981) TERMS STRUCTRE Maturity structure of debt outstanding (X) Maturities due Within 5 years 37,4 Maturities due within 10 years 76.4 Interest structure of debt ootstanding (X) Interest due vithin first yea- 6.5 Ia All entries on external debt are defined as in the Bank's Debtor Reporting System (only public and priv-te guaranteed debt). 7T Includes private guaranteed and non-guaranteed debt, debt relief, and grants. T e I-ludes errors and emissions, and for projected years it includes net IMF, short-tern, and unidentified capital inflows. 7d Includes $2,638 million of consolidated short-term debt. SUMMARY AND CONCLUSIONS I. Recent Economic Developments Background 1. Turkey's economic structure and growth process proved to be exceedingly vulnerable to the various exogenous shocks of the 1970's, including the rises in world oil prices, stagflation in the OECD economies, and the consequent deterioration in the terms of (external) trade. After attaining a favorable growth record throughout the First and Second Plan periods (1963-1972) with moderate reliance on external resources, Turkey opted to maintain its growth momentum in the Third Plan (1973-77) and financed a large part of its growing investment and import requirements through rapid reserve decumulation and heavy external borrowing including short-term. The rapid GNP growth, averaging around 7.7 percent per year in 1973-76, came to an abrupt halt in mid-1977, as the massive external debt burden led to a sharp deterioration in creditworthiness, severe shortages of imports and disruptions in industrial production with a rise in urban unemployment. GNP growth slowed down rapidly, to 4.0 percent in 1977 and to a negative figure in 1979. At the same time, domestic inflation accelerated from 24 percent in 1977 to 64 percent in 1979. 2. By the end of 1979, domestic inflation had become an issue of critical importance. Although international price increases, domestic cost-push factors and commodity imbalances influenced the inflationary process, a large monetary expansion was the main cause. The monetary imbalances originated mainly from the Government's budget deficits and the huge financing requirements of the State Economic Enterprises (SEEs). Political and social unrest aggravated the economic difficulties. It was in these exceptional circumstances that the January 1980 reform measures were adopted. Launching the Structural Adjustment Process - 1980 3. In response to the continuing foreign exchange shortages and disruption of the economy, the Turkish authorities initiated a major shift in development strategy. The basic outline of the new strategy which evolved during 1977-80, was set forth in the economic program announced in January 1980 and its main principles included: (i) greater reliance on market forces and incentives, rather than on quantitative controls; and (ii) policies designed to achieve high export growth rates sustainable over the medium-term. 4. The program was designed to stabilize the economy while laying the foundation for a sustainable medium-term growth path. The transition from an industrial strategy based on import substitution to one with a strong - il - outward-orientation was to be achieved through an adjustment program including the adoption of a realistic and flexible exchange rate, incentives to encourage producers to export, tight monetary conditions to restrain domestic demand and steps to improve institutional efficiency in key sectors. 5. Despite positive developments on the export front in the last three months of the year, 1980 was the second consecutive year of GDP decline. Buffeted by restrictive monetary policies and stagnant demand, domestic private investment decreased in real terms. The current account deficit increased markedly to $3.2 billion or 6 percent of GDP. The $3.9 billion oil import bill alone was bigger than total commodity exports of $2.9 billion. Inflation surpassed 100 percent mainly on account of one round of price increases for most SEE products. An Evaluation of 1981 Performance 6. The new policies gathered momentum in 1981 during which most of the key program targets were met. The adjustment of the exchange and interest rates helped to bring about an impressive growth in exports (which rose at 62 percent in dollar terms) and workers' remittances (which increased by 20 percent), as well as a marked turnaround in short-term capital flows. The increase in external current receipts combined with a reduction in the volume of non-oil imports resulted in a lowering of the current account deficit to 4 percent of GNP from 6 percent in 1980. The determination with which the policies related to constraining demand and income growth were implemented was instrumental in bringing downward pressure on prices, and the rate of increase in the GNP deflator slowed to 40 percent from more than 100 percent in 1980. The strengthening in the real foreign balance, meanwhile, contributed to an upturn in economic activity and real GNP, after falling for two consecutive years, expanded by 4.1 percent. 7. Turkey's overall external indebtedness in 1981 increased only marginally in dollar terms ($17.6 billion at end 1981 as against $17.5 billion at end 1980). Short-term debt, which declined 65 percent between 1978 and 1980, dropped a further 15 percent in 1981 (to $2.1 billion). 8. Both commitments and disbursements of medium and long-term external capital assistance fell sharply in 1981, signalling an end to the high levels of emergency aid and program assistance extended by the OECD countries. There was a decline of almost 50 percent in commitments extended by the OECD countries, which was only marginally offset by a shift to grant aid on the part of the USA. Overall commitments declined 33 percent from their 1980 level of $3.0 billion to $2.0 billion. The multilateral institutions, primarily the World Bank, partially offset the fall in OECD lending. Developments in 1982 9. While the 1981 economic performance was impressive, it represents too short a period to serve as a firm basis for medium-term projections. Therefore it is crucial to scrutinize the developments in Turkish economic - iii - performance during 1982 to assess the success in lowering the rate of inflation, since this would influence whether the stabilization policies would need to be continued. It would moreover indicate how the austerity measures would affect the revival of domestic demand and thus the level of private investment and eventually the sustainability of the export drive. 10. On the basis of the data for 1982, there emerge two significant points of importance for both the short-term (1983) and the medium-term prospects (1984-1990). These are: (i) the 1981 export upsurge has continued, albeit at a lower rate, into 1982, with industrial exports leading the way; (ii) progress on the stabilization program seems to have slowed down with slippages in the monetary and fiscal areas aggravated by a banking crisis, and a shortfall in government tax revenues. 11. In 1982, GNP is expected to grow at 4.6 percent; the GDP deflator is expected to increase by about 27 percent with the measured wholesale price increase around 25 percent, and the current account deficit is expected to be about $1.0 billion, bringing it down to about 2 percent of GNP. This is due both to the continuation of the export upsurge (up 22 percent in dollar terms) and the lower growth of imports. The latter development can be explained in terms of price advantages in oil and raw materials imports, the stronger US dollar, a reduction in stocks, and the elimination of a risk premium previously paid by Turkish importers. 12. In the fiscal area, progress is in the right direction although the indicators show a deterioration by comparison with the program targets mainly because of tax collection problems in the consolidated budget. The 1982 budget balance was somewhat worse than expected due to a shortfall in tax revenues. The budget deficit was 1.2 percent of GNP (compared to a target of less than 1 percent and 1.4 percent level achieved in 1981). The Public Sector Borrowing Requirement showed an improvement over 1981 (as a percentage of GNP, 5.5 percent versus 6.3 percent) though worse than programmed (5 percent). 13. The acceleration in the year-on-year growth in broad liquidity (M2), a shortfall in 1982 tax revenues implying a higher than expected budget deficit/GNP ratio in 1982,, an expected shortfall of SEE surpluses from the original estimate along with the Government's inability to check stock accumulation, implied that: progress in the 1982 stabilization program was slower than initially envisaged. These slippages in the financial program suggest increasing the time horizon for the stabilization effort well into 1984. 14. To sum up, the evidence of performance under the structural adjustment program from 1980-82 supports a growing optimism about Turkey's medium-term prospects. Progress on the export front is remarkable, but there - iv - have been some slippages in the fiscal and monetary areas. Of particular concern is the absence of a medium-term framework that would outline the adjustment policies against which the year-to-year adjustments can be gauged. II. The Medium-Term Framework 15. The shift in development strategy implies a change in the approach to planning. Until the recent economic reforms and shift in development strategy, Turkey depended heavily on a system of Five Year Plans to guide economic development. The Government used direct and indirect intervention to implement its policies. As the country developed, however, and the economic system became more complex, the reliance on quantitative controls led to increasing inefficiencies and misallocations of resources. 16. The Government, intent on correcting the more immediate balance of payments disequilibrium and the inflationary situation, set aside the Fourth Five-Year Development Plan (1979-1983) and concentrated on shorter term stablization measures. The urgency of the situation required "crisis management" rather than a medium-term plan, and the Government responded appropriately. Ihe focus is now beginning to shift to the medium-term suggesting a shift from prescriptive to indicative planning which would enable private firms to freely make their decisions with the incentive system ensuring that private and social profitability coincide. Medium-Term Prospects 17. There is as yet no official medium-term framework for economic development. The Government is expected to issue the draft Fifth Five Year Plan (1984-88) in June 1983. The medium-term projections presented in this section were obtained with the aid of two Bank models and based on a specific policy package discussed w-ith the Government and highlighted in Chapter III. The selection of the Base Case scenario is made on the assumption that the policy environment underlying the scenario will be maintained. The issues involved are highlighted inI Chapter III. 18. Two basic assumptions, on export sustainability and on fiscal discipline have guided the modelling effort. Thus it is assumed that the performance of exports will lend credence to the view that the 1981-82 upsurge was not a temporary phenomenon. Secondly, it is also assumed that the monetary and fiscal policy slippages observed in 1982 will not disrupt the basic shift in development strategy. 19. The equilibrium scenario is defined as, ceteris paribus, a growth path which is deemed feasible within the projection horizon, and which, from a creditworthiness point of view, does not overextend Turkey's capacity to borrow externally. Consequently, the Base Case opts for a debt service ratio range of 16-20 percent as a binding constraint on the growth path. 20. Merchandise exports are projected to continue to grow at 9.5 percent in real terms into the late 1980s on the basis of a continuation of present policies on export promotion. Such a scenario would also require some degree of import liberalization in order to reduce profit biases against exports. 21. Merchandise imports are projected to grow slowly in real terms through 1984 and then to pick up from 7-8 percent to an average of a little over 9 percent for the 1985-90 period. This is in line with the prescribed attempts to regain the normal growth path as soon as inflation has been brought under control, as well as the pursuance of policies towards import liberalization. 22. The current account balance, under these assumptions, would show a decreasing deficit for 1982-85 as stabilization curtails imports while encouraging exports. As growth sets in, the trend would be reversed for the 1985-90 period and Turkey's current account deficit would increase again. The terminal year 1990 would show a deficit of $1.8 billion as compared to a 1985 projected deficit of $485 million. 23. The projected capital account would remain in equilibrium throughout the projection period given the constraint on the growth of debt and debt service ratio. The latter is projected to decrease from a high of 24.2 percent in 1982 to 20.6 percent in 1985 and finally to 18.1 percent in 1990. This would permit Turkey to meet the amortization and interest payments arising from the $9.2 billion of debts rescheduled during the 1978-82 period and maintain an exchange reserve equivalent to two months' imports. 24. Consistent with this scenario, the Base Case projections indicate a GDP growth of 5 percent per annum for 1982-85 (stabilization period), and a higher figure of 6.1 percent per annum for 1985-90 (growth period). Achievement of these growth rates will be necessarily dependent on the growth of the productive sectors, namely agriculture, industry, and manufacturing. The success of sectoral growth depends to a large extent on the Government's determination to render the public sector more efficient and to create a more favorable investment climate for the private sector. 25. The Base Case assumes an increasingly important role for private sector investment in line with the policy of rationalizing public sector investment in the manufacturing sector. Accordingly, private investment is expected to grow at an average annual rate of 10.5 percent during 1983-1990. 26. The realization of the Base Case faces many uncertainties. Hence, a scenario was developed to highlight the downside risk based on a confluence of negative factors, such as lower export growth, higher oil prices, and less progress in the public investment area. Since Turkey's avowed policy, in the medium to long-term, is a restoration and maintenance of creditworthiness in the international market, and especially among the commercial banks, the downside risk case was iterated on the assumption that the debt service ratio in the terminal year (1990) would not significantly exceed the 16-20 percent range used in the Base Case. - vi - 27. The downside risk case inevitably leads to a lower growth path resulting from foreign exchange constraints and would lead to an average annual real growthL rate in GDP of 4.7 percent during 1985-90 as compared to 6.1 percent in the Base Case. Turkey's external debt exposure is much higher in the downside risk case with a total debt outstanding in 1990 of nearly $28 billion as against $25.6 billion in the Base Case. Interest payments on the debt are higher and although exports and imports are lower, the current account shows a higher deficit through the period ($2.7 billion in 1990 as against $1.8 billion in the Base Case). As a result the debt service ratio is expected to reach 20.6 percent in 1990. This contrasts with the Base Case ratio of 18.1 percent and the general framework of the study which had argued for an upper limit of 20 percent. Required external capital in 1990 to cover the current account deficit, the capital account deficit and the changes in reserves is higher by $1 billion. There is therefore a much greater need for concessionary financing, even after a downward adjustment in the growth path which is reflectedl in real import growth rate of 7.3 percent per year during 1985-1990 as opposed to the Base Case figure of 9.1 percent per year; and real export growth of 6.8 percent per year during 1985-1990 as against 9.5 percent per year in the Base Case. III. Development Issues and Strategy 28. The basic shift of policy from the inward-oriented development strategy Turkey had followed in the previous decades towards opening up to external trade, appears sound. The medium-term strategy should be a continuation of the new policies. The following discussions highlight the main development issues which will need to be dealt with in formulating a medium-term framework that would generate the Base Case medium-term projections described above. Resource Mobilizaition and Efficiency in Resource Use 29. Sustained growth in the mid-to-late 1980s would require greater reliance on domestic resources in light of the anticipated decline of concessional external borrowing and the modest prospects of obtaining significant commercial money. Such resources will not be forthcoming in adequate measure without reforms in the financial sector, tax reform measures affecting foreign direct investment, appropriate incentives for new investment, technological policy, continued restraint in private and public consumption growth and a more efficient functioning of the SEEs. SEE Reforms 30. The reduction of the financial burden of the SEEs through improvements in t!heir efficiency is a major issue to be resolved. The objective should be to reach a consensus that the SEEs' prime objectives should be profitability and productivity, that their operations should be under professional, not political management, and that their investments - vii - should be primarily in infrastructure, agriculture and energy, with manufacturing increasingly left to the private sector. For that purpose the Government would need to take a number of interim measures to improve short-term financial performance, redirect their investment programs and finance them increasingly from non-budget sources, while at the same time undertake legal reforms to institutionalize these changes. 31. The core of the Government's program for SEEs is a wide-ranging reform law. 1/ While the Government recognizes the challenge is to change deep-rooted attitudes, not laws, the new law should have considerable impact and long-term effects signalling the new official attitude towards SEEs. 32. The ultimate challenge for the Government in implementing the reforms will be to integrate the SEEs in the market economy where they would survive or flourish while competing with private sector firms, on an equal footing, especially with regard to their prices of output, cost of factor inputs, and credit facility. Financial Sector Reforms 33. An important determinant of the success of the domestic resource mobilization effort as well as the revival of private investment will be the restructuring of the financial system. The present structure and the working of the financial sector is not conducive to enhanced efficiency in either domestic resource mobilization or allocation of resources. The capital market is underdeveloped, enterprises are undercapitalized, cost of financial intermediation is high and the large industrial groups are closely linked with the banking system to the detriment of new entrepreneurs. The economic crisis of 1977-80 and freeing of interest rates in July 1980 leading to a current real interest rate of about 30 percent on average for credits have caused serious liquidity problems for many private firms and banks. 34. The mission endorses the following major recommendations made by the recent Financial Sector Mission: (i) reducing non-concessional interest rates by lowering the deposit rates and gradually eliminating the transactions tax. This will give the private sector better access to working capitaL at reasonable cost; (ii) streamLining selective credit policies to ensure a rational allocation of resources by reducing the dispersion of interest rates applied to preferential credits and raise them to the rate oi- inflation; (iii) revitalizing the bond market by issues of treasury bills and bonds at competitive rates and by encouraging bond issues by development banks and SEEs; 1/ This law has been recently approved by the Government. - viii - (iv) formulating a plan for the development of the bills and notes market; (v) improving the system of monitoring bad debts in the banking system and revising the tax regulations in order to enlarge the possibilities of deducting the losses from such loans from taxable income; (vi) introducing a legislation to permit industrial firms to revalue their fixed assets and accumulated depreciation. 1/ Depreciation charged to the income accounts should be based on the revalued gross fixed assets value. The surplus on revaluation should be credited to a revaluation reserve exempt from the caDital gains tax; (vii) improving the accounting and auditing standards and practices in private (enterprises and SEEs as well as a standardized accounting system for the banks; and (viii) introducing a system of floating interest rates for medium and long-term crcedits. Rationalization of Public Sector Investment: Size and Sectoral Strategies 35. The rationalization of public sector investment is critical to the success of Turkey's medium-term development strategy. Implied is an investment strategy that: (i) restrains the growth of public investment thus allowing the expansion of private investment without creating excessive pressure on domestic and external resources. The aim would be to restore the share of public to total fixed investment to its historical level of 50 percent by 1990 as against 60 percent :in 1982; (ii) focuses public sector investments on high priority projects in infrastructure, agriculture and energy, with manufacturing increasingly left to the private sector; (iii) establish raites of return criteria for all new investments while improving project evaluation methods; 1/ The Government has recently enacted such a law. - ix - (iv) complete projects more quickly and make provisions to as to concentrate the public investment program on a smaller number of projects; and (v) progressively raise the share of SEE investments out of their own resources. 36. It must, however, be recognized that these objectives can only be attained over a number of years. The sheer size of the present program (including over 6000 projects), means it can only be modified to a limited extent in any single year. Despite recent effort to trim the program, considerable work remains to be done. It is therefore most important that progressive annual targets be established within the framework of a medium-term strategy. External Trade Issues 37. Efficient production for exports in line with comparative advantage and encouraged by the application of a flexible exchange rate policy and appropriate incentives are essential prerequisites for the medium-term prospects delineated in the Base Case. (i) Export Sustainability 38. Sustaining the growth of exports is central to the new development strategy. In the short-run, it seems that the Government's target of manufactured exports can be met if domestic demand continues to be weak, if the real financial costs for nonexporters remain high, and if explicit export incentives are not reduced. 39. As to longer-run export prospects, however, it is not clear how far an "export mentality" has spread and taken root in Turkish manufacturing, nor whether the present incentive structure is strong enough to continue to motivate exports when domestic demand revives. As local conditions become more prosperous, the time will come when incentives must be designed more carefully, if manufactured exports are to continue at the desired level. Under more "normal" conditions, the two "incentives" that are now the most important will lose much of their force: domestic demand will revive, and interest rates for non-exporters will fall. Thus, in an environment where potential exporters enjoy stronger domestic demand and therefore will require reasonable profit margins on exports, Turkey will need to strengthen its incentive structure if exports are to continue. Such a structure would consist of: (i) continued lower-interest loans to exporters, perhaps for longer terms (e.g. 12 to 18 months) A separate program of multi-year credits for exporters of capital goods to develop Turkey's considerable potential in that sector; (ii) continued rebate of all indirect taxes; (iii) continued free access to imported inputs, free of duty; (iv) continued progress in streamlining Government administrative procedures and stable rules of the game; (v) strengthening supporting infrastructure, including in teLecommunications and financial institutions; (vi) implementing a system of export credit insurance; (vii) introducing a system of credits for indirect exporters; and (viii) most important of all, a foreign trade regime including a tariff policy that removes the incentive bias favoring the domestic market against exports. 40. Management of a flexible exchange rate during the last two years has been a major incenitive to exports. But the bias favoring the domestic market over exports is still too strong. This is reflected in a level of protection that is still too high. Since explicit export subsidies cannot be increased beyond present levels (because of their financial burden and because they may provoke retaliation), the practical solution would be a reduction in protection of domestically produced goods that compete with exports. 41. In order to meet the target of industrial exports, promotion of research and product development is a priority task. This would permit, in particular, the exploitation of Turkey's long-term comparative advantages in the electrical and non-electrical machinery, machine tool and electronics industries. The promotion of R&D would best be accomplished in the framework of a medium-term pLan of science and technology. Apart from public programs, incentives for research and training by private industry would be necessary for this purpose. (ii) The Process of Import Liberalization 42. In order to reduce the existing bias favoring the domestic market against exports and to promote efficient investments in line with Turkey's comparative advantage, a policy of lowering import protection assumes greater importance. Such a process should be carefully conceived, gradually introduced and should draw upon the results of the ongoing protection studies in order to: (i) rationalize the existing tariff system; (ii) gradually shift from a licensing system of import control to one relying on tariffs; and (iii) undertake liberalization selectively in order to avoid jeopardizing the balance of payments situation. - xi - 43. Parallel with the abolition of import licensing, existing excessively high tariffs need to be lowered. This may involve establishing a tariff ceiling, to be reached in stages over a transitional period of five years, and reducing inter-industry differences in tariff rates. Additional incentives could be granted to inifant industries on a temporary basis. Creditworthiness and Access to International Markets 44. Turkey experienced an enormous inflow of short-term capital in the years 1976-77, followed by a massive rescheduling involving both official source debt and commercial borrowings. As a result, short-term debt as a percentage of total debt outstanding fell from about 49 percent in 1978 to 12 percent in 1981. Turkey's prospects for future borrowing appear good although it is unlikely that the level and composition of concessional medium and long-term commitments realized in 1980 will be repeated. The Bank's medium-term projections envisage a feasible growth path which, from a creditworthiness point of view, does not overextend Turkey's capacity to borrow externally. Moreover, given the anticipated hump in debt repayments during the mid-1980s, Turkey will, in addition to obtaining a significant amount of commercial bank credit, need to diversify its bilateral aid arrangements. The recent major improvement in the balance of payments should enable Turkey to begin again to borrow medium to long-term in international markets. However, the payment difficulties afflicting developing countries have severely affected the syndicated loan market. Thus, it would seem important that donors continue to show support for the Turkish development effort through the provision of adequate official or officially-guaranteed loans until a greater volume of financing from other sources can be assured. Unemployment 45. A modest decrease in the population growth rate, and fertility rate, increased worker emigration, and resumption of GDP growth have not prevented unemployment from rising. Large idle capacity and low productivity have allowed GDP to grow with little impact on employment. Unemployment is expected to increase from 2.3 million in 1981 to 2.6 million in 1982, which corresponds to an unemployment rate of around 15-16 percent in 1982. 46. This is a longer term issue that requires serious study and has not been addressed in this report. Over the medium-term, the unemployment problem will be reduced if there is substantial economic growth resulting from increased private investment and exports. Success in pursuing the new development strategy hinges upon the maintenance of the policy of real positive interest rates and encouragement of exports, both of which should reduce the bias in favor of high capital-intensive investments and promote employment. - xii - Private Manufacturing Investment Outlook 47. The private sector is expected to play a key role in the Government's new development strategy in supporting export growth and employment. In order to generate the Base Case medium-term projections, this report assumes not only a revival of private sector investment in manufacturing after stabilization, but: also a dynamic leading sector role. 48. Given the financial difficulties associated with high real interest rates for non-preferential lborrowing, the lack of availability of adequate medium and long-term credits, inadequate functioning of the capital market, and inefficient banking sector and poor quality bank supervision, the outlook for a strong revival of private investment in manufacturing is not too encouraging unless appropriate policies are undertaken. These policies must include the implementation of a reform package for the financial and banking sectors along the broad lines discussed earlier, as well as SEE reforms. These would be in addition Ito the reform measures introduced since January 1980. 49. Turkey's industrialists have so far responded well to the changes in economic policies introduced since 1980. Costs are being cut, inefficient operations are being curtailed, and exports have greatly increased. If interest rates are now gradually eased, if export incentives remain strong, and domestic demand revives, then there is every possibility of a revival of the private manufaLcturing sector. Turkey's industrial plants, work force, and managers must now be induced to grow in quality--to increase their efficiency and productivity through greater price competition and gradual increase in competition with imports. New Role of Agriculture 50. The overall GDP growth projected in the medium-term crucially depends on the maintainence of an agricultural value-added growth rate of 3.1 percent per annum during the period 1983-1990 compared with 3.3 percent average annual growth during the period 1972-1979 and 1.0 percent during 1980-1981. Hence, the challenges for the agricultural sector over the medium-term are considerable. In particular, the export orientation would include modifying rigid self-sufficiency in all products as a goal and increasing agricultural exports while allowing for food imports as necessary. In pursuing this policy, the Government will ensure that the objectives of its self-sufficiency policies are not endangered. 51. There is an urgent need for policy and institutional reforms in the agricultural credit system. Currently the system suffers from a serious waste of resources and inefficiency. The negative real rate of interest on agricultural credit encourages its misuse, and little is actually reaching the small and medium-scale farmers. Lack of competition in the provision of agricultural credit has fostered inefficiency in the Agricultural Bank (TCZB) - xiii - and the failure to hold the sales cooperatives financially accountable for their support purchase activities has led to the build-up of huge arrears with TCZB. In order to increase the availability of agricultural credit and encourage its more efficient use, there needs to be a reform of the credit system, a reduction of subsidy on short-term lending, an improvement of the administration and accountability of the sales cooperatives and an examination of the possible way3 to promote village level banking. Additional Policy Concerns in the Medium-Term 52. As Turkey pursues its new development strategy, a number of issues that have been neglected, given the necessary preoccupation with short-run problems in the last few years, will need to be included in a policy agenda for the medium-term. These include; (i) Productivity Growth. There is evidence from cross-country comparisons that the pursuit of an open development strategy is associated with more rapid growth in total factor productivity. Turkey starts on this new path with a large and sophisticated industrial sector which has proven capable of responding to the shift in incentives and playing a leading role in the growth of exports. The development of the industrial base and especially of technologically advanced sectors has long been a major goal of Turkish economic policy. Given the current industrial base, the shift to an outward-looking development strategy is entirely consistent with this emphasis. The opening up of export markets and the liberalization of imports provides opportunities for transfers of new technologies that have clearly benefitted countries which have pursued this strategy. However, the links to increased productivity growth are not necessarily automatic and it is important for policymakers to consider the mechanisms involved. (ii) Regional Development. The issue of regional development is to reaffirm the importance of the social costs associated with the austerity program, the stabilization effort and the major change in the development strategy from import substitution to export expansion. However, this is a medium-term issue to be addressed in the mid to late 1980s, on the assumption that a return to a "normal" growth path capable of absorbing the unemployed will also give the Government the necessary latitude to develop regional policies designed to mitigate, in the later years, the social hardships incurred in the early 1980s. Conclusion 53. The Base Case medium-term projections outlined in the report are derived on the assumptions of export sustainability and a revival in private manufacturing investment accompanied by fiscal and monetary discipline in the - xiv - public sector. Besides a continuation of the policies introduced since January 1980, this implies a very significant and immediate progress in key areas of structural adjustment such as SEE reforms, financial and banking reforms, import liberalization, and further rationalization of public sector investment. Without these adjustments, it would seem difficult to envisage a rapid development of an efficient private sector, on which the new development strategy essentially hinges. 54. The combination of exchange rate and import liberalization policies together with an appropriate incomes policy and further price liberalization should ensure continued progress towards expanded trade and outward orientation in the Turkish economy. Together with the proposed reforms in the financial system, they wouLd also help in promoting private investment and increase the scope of efficient operation of market forces. 55. Given an appropriate policy framework, therefore, and given reasonable support from the international capital markets, there are grounds for optimism in that the most pronounced disequilibria in the economy could be eased before 1985, thereby laying a firm basis for a more rapid growth path. In order to restore price and exchange stability, it would be desirable to let the initial demand stimulus come from the export sector, as has been the Government's policy in the last three years rather than from domestic demand; in particular this is likely to imply continued tight monetary and fiscal controls and an appropriate incomes policy through 1984. The continued commitment by Turkey to this policy framework and its implementation can be expected to induce the international markets to maintain the flow of resources that will help the economy to achieve higher capacity levels while proceeding with its structural adjustment policies. INTRODUCTION The purpose of this report is to present an analysis of the medium-term prospects (1983-1990) and overall creditworthiness of the Turkish economy taking into account past performance particularly in the last two years. It emphasizes the economic and policy achievements since the inception of the January 1980 reform program and focuses on the developments to come should the structural adjustment process continue at the current pace. Finally, it identifies the major medium-term issues to be considered if Turkey is to achieve the change in development strategy it seeks. This report follows the last economic memorandum entitled "Turkey: Policies and Prospects for Growth" distributed in December 1979. Since then, the updating of economic developments and the general assessment of economic prospects have been undertaken through the continuing work on structural adjustment lending to Turkey, as well as through special economic missions. 1/ In addition to analyzing Turkey's medium-term prospects, the report also attempts to synthesize the special reports mentioned above. 1/ The report of the November/December 1980 special economic mission to evaluate the investment program and entitled "Turkey: Public Sector Investment Review" (Report No. 3472-TU) was distributed in December 1981. The report of the second special economic mission of May/June 1981, to review Turkey's industrialization and trade strategy entitled "Turkey: Industrialization and Trade Strategy" (Report No. 3641-TU) was published in February 1982. A separate report dealt with energy entitled "Turkey: Issues and Options in the Energy Sector" which was published in March 1983. Parallel to this exercise, a Bank mission undertook a review of the agriculture sector to assess the potential of Turkish agriculture in terms of production, exports and employment. This report is expected to be distributed in June 1983. A Bank mission visited Turkey in November 1982 to review the short-run and structural problems of the Turkish financial sector. It's report is to be discussed with the Government in June 1983. CHAPTER I - RECENT ECONOMIC DEVELOPMENTS A. The Legacy of the 1970's: Emerging Problems 1.1 Turkey's economic structure and growth process proved to be exceedingly vulnerable to the various exogenous shocks of the 1970's, including the rises in world oil prices, stagflation in the OECD economies, and the consequent deterioration in the terms of (external) trade. After attaining a favorable growth record throughout the First and Second Plan periods (of about 6.6 percent real GNP growth per year from 1963-72) with moderate reliance on external resources, Turkey opted to maintain its growth momentum in the Third Plan (1973-77) by financing its growing investment and import requirements through rapid reserve decumulation and heavy short-term borrowing. This externally financed GNP growth, while averaging around 7.7 percent per year in 1973-76, came to an abrupt halt in mid-1977, as the massive external debt burden led to a sharp deterioration in creditworthiness, severe shortages of imports and disruptions in industrial production, with a consequent rise in urban unemployment. GNP growth steadily declined from 4.0 percent in 1977 and to a negative figure in 1979, whereas domestic inflation accelerated from 24 percent in 1977 to 64 percent in 1979 (as measured by the Wholesale Price Index). 1.2 In external trade, merchandise imports in current prices declined from the level of $5.8 billion in 1977 to $4.6 and $5.1 billion in 1978 and 1979 respectively, while merchandise exports registered an encouraging increase from $1.8 billion in 1977 to about $2.3 billion in 1978, but remained approximately at that level in 1979. The corresponding contraction in the trade gap was instrumental in reducing the current account deficit from a staggering $3.6 billion in 1977 to $1.7 billion in 1978. The substantial rise in workers' remittances in 1979, following the April devaluation contributed to arrest any increase in the current deficit for the year. A notable characteristic of the external accounts in 1977-79 was the large share of oil imports in the total import bill causing severe financing and procurement problems. 1.3 By the end of 1979, domestic inflation had become an issue of critical importance. Although the international price increases, domestic cost-push factors and commodity imbalances influenced the inflationary process, a large monetary expansion was a prominent causal factor as well. These monetary imbalances originated mainly from the Government's budget deficits and the huge financing requirements of the State Economic Enterprises (SEEs). 1.4 A damaging feature of the accelerating inflation was that it generated severe distortions in the relative price structure. The rapid erosion of the real values of the interest rate and the exchange rate sharply reduced real incentives for financial savings and foreign exchange generating activities. The domestic marginal savings to GDP ratio accordingly declined from 26 percent in the Second Plan (1968-72) to 12 percent in the Third Plan (1973-77), becoming negative in 1977-79. Under such inflationary conditions, and with negative real interest rates, private savings were diverted to speculative investments while limited public savings were thinly spread over a large number of ongoing projects thereby prolonging the gestation periods of major investments. The resulting misallocation of scarce resources therefore aggravated the inflationary process from both the demand and supply sides. Consequently, the foreign exchange bottleneck, hyper-inflation znd rising unemployment were inter-related problems faced concurrently in Turkey in the late 1970s. To make things worse, political and social unrest aggravated the economic difficulties. It was in these exceptional circumstances that the January 1980 reform measures were adopted. B. Launching the Structural Adjustment Process - 1980 1/ 1.5 In response to the continuing foreign exchange shortages and disruptions of the economy, the Turkish authorities initiated a major shift in development strategy. The basic outline of the new strategy which evolved during 1977-80, was set forth in the economic program announced in January 1980 and included: (i) greater reliance on market forces and incentives, rather than on quantitative controls, to allow the private sector to operate efficiently under market forces; and (ii) policies designed to encourage exports and to achieve high export growth rates that could be sustained over the medium run. 1.6 The transition from an industrial strategy based on import substitution to one moving towards outward-orientation was to be achieved through an adjustment program designed to stabilize the economy while concurrently layjing the foundation for a sustainable medium-term growth path. The program included: (i) the adoption of a realistic and flexible exchange rate; (ii) incentives to encourage producers to export; (iii) t:ight monetary conditions to restrain domestic demand and cut inflation; (iv) imnproved external debt management policies and information systems; (v) sl:eps to improve institutional efficiency in key sectors; (vi) a rationalization of the public investment program; and (vii) the initiation of SEE reforms so as to reduce their burden on the budget and to improve their efficiency. 1/ The details of the 1980 policy reforms are given in "Turkey: Industrialization and Trade Strategy", IBRD (Report No. 3641-TU), February 1982, Volume II, Chapter I. - 3 - 1.7 The January 1980 reforms had some immediate effects. The premium on the lira in the parallel exchange market, which had averaged about 50 percent in 1979, declined to between 2 and 3 percent. The liberalization of SEE prices reduced the deficit of the SEEs significantly. Nevertheless, it was only after the military intervention in September 1980 that the beneficial economic effects of the reforms began to materialize. Prior to this, violence and increased strike activity had resulted in the loss of 7.7 million workdays in the first eight months of 1980, compared to only 1.1 million workdays in all of 1979. The immediate impact of the restoration of law and order was to arrest the decline in production and to expand exports. The dollar value of exports, which had stagnated in the first eight months of 1980, soared in the remainder of the year, reaching a level 63 percent higher than those for the same period in 1979. Also, increases occurred in the issuance of domestic investment licenses, indicating a build-up of confidence in the business community. 1.8 Despite these positive developments in the last three months of the year, 1980 was the second consecutive year of GDP decline. Buffeted by restrictive monetary policies and stagnant demand, domestic private investment decreased in real terms. The current account deficit increased markedly to $3.2 billion or 6 percent of GDP. The $3.9 billion oil import bill alone was bigger than total commodity exports of $2.9 billion. Inflation surpassed 100 percent mainly on account of one round of price increases for most SEE products. C. The Reform Program in Action - An Evaluation of 1981 Performance 1.9 Throughout 1981, the reform program was strictly adhered to and at times was even expanded. Aided also by restored social and political stability, economic performance in 1981 indicated a remarkable success in the implementation of the new strategy. Most fiscal and monetary targets in the stabilization program were met or exceeded. Major structural reforms in the tax system, the import and export regimes, the SEE pricing mechanism, as well as the liberalization of interest rates and the adoption of a daily fluctuating exchange rate, all contributed to substantial short-term progress with longer term implications. 1.10 Specifically, the annual rate of inflation as measured by the GDP deflator decreased from around 100 percent to 40 percent. Public finances also improved substantially with the budget deficit/GNP ratio falling from 4.6 percent in FY80 to 1.6 percent in FY81 (year ending February 1982). This remarkable improvement was in part due to the lower financing requirement of the SEEs (9.4 percent of GNP in 1981 as compared with 10.3 percent in 1980). In addition, the public sector investment program was partly rationalized and the growth of public investment: in real terms was 9.4 percent in 1981 (Table 1.1). 1.11 Although there occurxed significant progress on most fronts, export performance was the most noteworthy. Exports reached $4.7 billion, for a 62 percent growth rate in dollar value. Manufacturing exports more than doubled in virtually all categories with a total of $2.3 billion thus surpassing agricultural exports for the first time. The main increases were registered in textiles and clothing, food products, cement, glass and - 4 - ceramics, iron and steel, and motor vehicles (trucks and buses). The Middle East and North Africa emerged as an increasingly important market for Turkish exports with a 41 percent share. In contrast, the share of the EEC market dropped from a peak of 50 percent in 1977 to 32 percent in 1981. On the other hand, imports increased only moderately due to the slow recovery of domestic demand, thus helping to decrease the current account deficit from approximately 6 percent of GNP in 1980 to 3.7 percent in 1981. The export upturn and the strengthening in the real foreign balance contributed to an upturn in domestic production with a growth in GNP of 4.1 percent in 1981, after two consecutive years of negative growth. Table 1.1 below summarizes the national accounts for 1980, 1981 and 1982 (estimate). Table 1.1: TURKEY - NATIONAL ACCOUNTS 1/ 1980 Level 1980 1981 1982 In billions In ----Actual---- Estimate of Turkish Percent Percentage change from lira of GNP previous year (At 1981 prices) Consumption 5345.4 84.9 -3.4 0.6 4.0 Public 694.2 11.0 8.8 0.8 3.2 Private 4651.2 73.9 -5.1 0.5 4.2 Fixed Capital Investment 1221.1 19.4 -10.0 1.7 2.6 Public 700.9 11.1 -3.7 9.4 0.8 Private 520.2 8.3 -17.3 -8.8 5.4 Stockbuilding 115.3 1.8 (3.9) (0.8) (-1.2) Total domestic demand 6681.8 106.1 -1.2 1.5 2.5 Foreign balance -386.2 -6.1 (-0.2) (-2.5) (-2.0) GNP 6295.6 100.0 -1.1 4.1 4.6 (At current prices) Consumption 3731.4 84.1 102.4 44.1 32.9 Public 544.1 12.3 85.1 28.7 35.7 Private 3187.3 71.8 105.6 46.7 32.5 Fixed Capital Investment 863.6 19.5 92.2 43.8 31.6 Public 484.9 11.0 105.9 58.2 29.3 Private 378.7 8.5 77.1 25.3 35.2 Stockbuilding 2/ 84.3 1.9 (4.1) (0.7) (-1.3) Total domestic demand 4679.3 105.5 108.3 45.0 31.0 Foreign balance 2/ -244.1 -5.5 (3.4) (-2.0) (-1.6) GNP 4435.2 100.0 101.7 47.8 33.0 1/ Official revised estimates. 2/ Contribution in percentage points to growth in GNP. Source: SPO - 5 - 1.12 Along with these successes, however, there was a deep concern about the slow recovery of domestic demand, particularly that of private investment, which declined by 8.8 percent in 1981. The 1980 level was already depressed, as it was about 30 percent lower than the level reached in 1978. This raised concerns particularly for Turkey's export growth potential in the medium and long run as well as for improving the employment situation. External Debt Situation as of end 1981 1/ 1.13 Turkey's overall external indebtedness in 1981 increased only marginally in dollar terms ($17.6 billion in 1981 as against $17.5 billion in 1980) helped by the marked strengthening of the dollar against all major European currencies throughout 1981. 2/ Short-term debt, which declined 65 percent between 1978-80 dropped a further 15 percent in 1981. A summary of the evolution of external indebtedness since 1977 is given in Table 1.2 below. Table 1.2: LEVEL AND DISTRIBUTION OF EXTERNAL DEBT 1977-1981 a/b/ ($ billion) 1977 1978 1979 1980 1981 Short-term Credits 6.1(54) 7.2(49) 3.6(23) 2.5(14) 2.1(12) Medium- and Long-term 4.8(42) 6.9(47) 11.6(73) 13.9(80) 14.2(81) Debt of which private non-guaranteed 0.5 0.6 0.6 0.5 0.4 IMF 0.4(4) 0.6(4) 0.6(4) 1.1(6) 1.3(7) Total 11.3 14.7 15.8 17.5 17.6 a/ For details see Annex III. b/ Numbers in parentheses are percentage shares. Source: Ministry of Finance. 1.14 Both disbursements and commitments of medium and long-term capital fell sharply in 1981, signalling an end to the high levels of emergency aid and program assistance extended by the OECD countries. There was an almost 50 percent decline in commitments extended by the OECD countries, which was only marginally offset by a shift to grant aid on the part of the USA. Overall commitments declined 30 percent from their 1980 level of $3.0 billion to $2.0 billion. The multilateral institutions, primarily the World Bank, partially offset the fall in OECD lending. 1/ For details on external debt see Annex II. 2/ Of the 56 percent of Turkey's outstanding medium-term obligations payable in currencies other than dollars, the downward valuation adjustment was almost $1.1 billion. -6- D. Developments in 1982 1.15 While the 1981 economic performance was impressive, it presents too short a period to serve as a firm basis for establishing medium-term trends. Therefore it was crucial to scrutinize the latest developments in Turkish economic performance during 1982 before proceeding to assess the medium-term prospects. This is particularly important in assessing the success in lowering the rate of inflation, since this would influence whether the austerity measures associated with continued stabilization policies would further affect output growth as well as the revival of domestic demand. The latter would in turn affect the level of private investment and eventually the sustainability of the export: drive. General Considerations 1.16 On the basis of economic performance in 1982, there emerge two significant points of importance for both the short-term (1983) and the medium-term prospects (1984-1990). These are: (i) the 1981 export upsurge has continued, albeit at a lower rate, into 1982, with industrial exports leading the way. Industrial exports grew by about 50 percent in dollar terms in 1982 as compared to 1981; and (ii) progress on the stabilization program seems to have slowed down with some slippages in the monetary and fiscal areas on account of unanticipated shortfall in government task revenues, financing of a bumper harvest and more favorable developments on the external front. This was further aggravated by the failure of the so-called bankers (money lenders) that accepted deposits and provided loans at even higher interest rates to firms which were unable to obtain sufficient funds from commercial banks. The situation culminated in the collapse of the largest brokerage firm (Kastelli) in June 1982. 1.17 The continued excellent performance of exports--especially industrial exports--lends credence to the view that the higher export levels achieved since September 1980 need not be a short-term phenomenon. The Government has clearly stated its intention to continue to promote exports, and it remains important for the medium-term prospects that it does so. The private sector, judging by its response, seems to be taking the new development strategy seriously. The export drive must have time to take root, both in the mentality of Turkish industrialists and in foreign markets. Incentives to export must be rationalized and strengthened as suggested in paras. 3.25 to 3.29. 1.18 In the short-term, the continuing upsurge in exports led to a drop in the current account deficit in 1982, from $1.8 billion originally forecast to about $1.0 billion, with a c:onsiderable reserve accumulation ($500 million). This favorable performance implies a greater ability to reach a viable current - 7 - account balance before the large debt repayments in the 1984-87 period. It thus renders feasible a possible growth scenario (of 6 percent or more) concurrently'with significant debt repayments. 1.19 On the other hand, the acceleration in the year-on-year growth in broad liquidity (M2), a shortfall in 1982 tax revenues implying a higher than expected budget deficit/GNP ratio in 1982, an expected shortfall of SEE surplus from the original estimate along with the Government's inability to check stock accumulation and their financing, implied that progress in the 1982 stabilization program was slower than initially envisaged. The inflationary problem could be compounded by the foreign exchange reserve accumulation, unless proper measures are taken to absorb or offset the resulting increase in domestic liquidity. Thus, in the short-term these slippages in the financial program could mean that the stabilization effort should continue into 1984, constrain private sector investment, for which there is no clear sign of recovery yet, by severe restrictions on Central Bank credit expansion, continuing high interest rates and the need to finance Treasury deficits. This could in'turn defer achievement of sustained high growth (of 6 percent or more) for the second half of the Fifth Plan (1984-88). 1.20 Below is a summary of recent developments in the key areas of the economy. National Accounts 1.21 The latest estimates for 1982 GNP assume a 4.6 percent growth. Yet the sectoral production performance was not altogether favorable. A bumper crop due to favorable rainfall conditions contributed to a 6.7 percent growth in value-added for agriculture (3.2 programmed). This was counterbalanced by a lower than expected growth rate in the value-added of industry, namely 4.6 percent versus the 6.4 percent originally in the program. The rest of the economy was more or less on target. Nevertheless, there was some concern that the growth rate of manufacturing was being hindered by the private sector's perception that a revival of domestic demand would be slower to manifest itself than originally anticipated. Public Sector Investment 1.22 Of importance to medium-term prospects is restraining the continuing high rate of growth in public sector investment. This is to further the Government policy, endorsed by the Bank, of relying more on private initiatives since 1980. The currently depressed levels of private investment should not be a reason to change the policy. The low investment can be considered a rational response to low levels of demand and very high financing costs, both the result of the stabilization program. The estimated real growth in public fixed investment expenditures in 1982 was 0.8 percent as against the earlier forecast of 7.0 percent. This has been achieved through strict control over public expenditures and, unlike previous years, no additional allocations have been made during the course of the year. 1.23 A continuing concern for medium-term prospects is the ongoing financing of part of public sector investment by the private sector and the disturbing differences during 1980 and 1981 between program and realized saving-investment gaps for the public sector (Table 1.3). The outcome of 1982 is favorable in this regard since there is only a small increase in the savings investment: gap from the level programmed. Table 1.3: SAVINGS AND INVESTMENT TARGETS AND REALIZATION (Percent of GNP at current prices) 1980 1981 1982 Prog. Real. Prog. Real. Prog. Real. Public Sector Investment 10.19 15.49 13.48 14.63 12.18 12.60 Savings 6.21 5.17 10.21 8.50 9.10 8.32 Gap -3.98 -10.32 -3.27 -6.13 -3.08 -4.28 Private Sector Investment 9.57 10.24 8.58 9.75 9.72 8.94 Savings 10.31 15.06 6.67 12.37 10.86 11.88 Gap 0.74 4.82 -1.91 2.62 1.14 2.94 External ResourcesE 3,24 5.50 5.18 3.51 1.94 1.34 (positive denotes inflow) Source: SPO Prices and Wages 1.24 A central. part of l:he stabilization program has been the reduction in the rate of inflation. The increase in the wholesale price index for the 12-month period ending December 1982 was about 25 percent, as against 27 percent for the same period in 1981, but the slowdown in wholesale prices does not seem to have been Eully passed through at the retail level and the consumer price inflation feLl only marginally in 1982. The unweighted mean of the three major consumer price indexes rose by 29 percent over the 12-month period ending November 1982; the comparable rate of increase was 31 percent in the preceding year. 1.25 In the wake of several years' cuts in real wages, in 1982 the change in nominal wages appears to have been broadly in line with the rate of price inflation. Between January and October 1982, nominal wages increased by about 23 percent, resulting in a 2 percent reduction in real terms (deflated by the average of consumeer price indexes for the same period). 1.26 For the year as a whole, the implicit GNP deflator is estimated to have risen at an annual average rate of about 27 percent, which compares favorably with both the mid-year program target of 32-33 percent and the 1981 increase in the deflator of 42 percent. -9- Budget Estimates 1.27 In the fiscal area, progress is in the right direction although the indicators show a slight slippage in comparison with the program targets mainly because of tax collection problems in the consolidated budget. The shortfall in the revenue (an increase of only 26 percent against 39 percent) is estimated to have been partly offset by continued expenditure restraint and partly by a smaller-than-programmed reduction in net budgetary arrears. Government expenditures as a percentage of GNP declined from 22.6 percent in 1981 to an estimated 21.5 percent in 1982. The net result was to leave the budget deficit as a percentage of GNP at 1.2 percent as against the mid-year target of 1.0 percent and 1.4 percent achieved in 1981. Notwithstanding the slippage in the government accounts compared with mid-year expectations, the public sector borrowing requirement showed a significant improvement in relation to GNP in 1982 compared with 1981, declining to 5.5 percent (mid-year target of 5 percent) from 6.3 percent. The public sector domestic borrowing requirement increased to 5.2 percent of GNP (mid-1982 target of 3.5 percent) as against 4.3 percent in 1981. This would imply some slowdown in the fiscal program, and further imply that the 1983-84 period might be needed to restore the necessary equilibrium to the consolidated public sector accounts (including the SEE financing requirements) which would be compatible with both an easing of tight monetary policies and a steady increase of private sector investment. SEE Accounts 1.28 For 1982, a radical new strategy had been adopted for the operation of SEEs. First, it has been decided to give priority to operational results; second, managers have been given almost full autonomy to manage and adjust prices; third, transfers to SEEs have been limited and, in the case of nonpayment by SEEs of taxes, social security contributions, or amortization of foreign debt, such arrears are deducted before payments are made from the budget; and, finally, borrowing from the Central Bank has been limited to one SEE, the Soil Products Office, for financing of its grain purchases. This new strategy produced encouraging results. Profits of SEEs for 1982 are now expected to be higher than the estimate at mid-year and are, in relation to GNP, expected to go up to 0.5 percent compared with 0.1 percent in 1981. Estimated total investment of SEEs, although somewhat higher than expected at mid-year because of slightly larger stockbuilding, is at 6.8 percent of GNP substantially below the 9.4 percent recorded in 1981. 1.29 Of prime importance for the medium-term prospects is that the Government has been empowered by the National Security Council to overhaul the whole administrative structure. This would include both the SEEs and the agricultural cooperatives, whose reorganization had to be completed within 18 months of the recent decree (early June 1982). 1/ Thus, by the end of 1983, it was expected that the SEE burden on the public finances would be limited to the so-called duty losses of SEEs (government subsidies). The commercial-type SEEs would operate, and receive to a great extent the same advantages as the private sector. While of little impact on the 1982 expected results, the implementation of SEE reforms can alter the medium-term fiscal picture and reduce the crowding out factor. A rapid pace of reforms will affect the time horizon of the stabilization effort by reducing the public sector's claims on Central Bank credits at an early date. In addition, and presumably, increasing the efficiency of the SEEs through reforms could decrease their short-term borrowing requirements. 1/ The SEE reforms decree has recently been approved by the Government. - 10 - Balance of Payments 1.30 The current account deficit is estimated to be well below the 1982 program target of $1.8 billion or its mid-year revision to $1.4 billion. It is currently projected at about $1.0 billion. As a percentage of GNP it fell from 4 percent in 1981 to about 2 percent in 1982. The value of exports, estimated at $5.7 billion, was more or less in line with the program target, despite a greater-than-expected decline in export prices, mainly of agricultural products. As in the previous year, manufactured exports were the major source of expansion, as exporters continued to make inroads in Middle Eastern markets. Imports are estimated to have declined in dollar terms by 2.3 percent compared with 1981, and were significantly below the revised program target for 1982. The decline in oil prices and a slower than expected expansion in real domestic expenditure contributed to this development. Also, increasing confidence in the Turkish economy is believed to have resulted in a reduction in import prices through elimination of risk premiums charged by foreign suppliers. The better-than-expected performance on the trade balance more than offset the shortfall in the surplus on the services account. The latter reflected lower receipts from workers' remittances and tourism and interest payments larger than envisaged. Industrial exports continued to lead the way, accounting for about 60 percent of total exports. Processed food, textile exports and other manufacturing exports made steady gains (Table 1.4). Table 1.4: MERCHANDISE EXPORTS 1/ ($ million) 1980 1981 1982 1982/81 (percent) I. Agricultural products 1672(57.5) 2219(47.2) 2141(37.3) -3.5 A. Crops 1541(53.0) 1934(41.1) 1727(30.0) -10.7 B. Livestock and sea products 131(4.5) 285(6.1) 414(7.3) 45.3 II. Mining 191(6.5) 194(4.1) 175(3.0) -9.8 III. Manufacturing 1047(36.0) 2290(48.7) 3430(59.7) 49.8 A. Processed food 209(7.2) 412(8.8) 568(9.9) 37.9 B. Textiles 424(14.6) 803(17.1) 1056(18.4) 31.5 C. Other manufacturing 414(14.2) 1075(22.9) 1806(31.4) 68.0 TOTAL 2910(100.0) 4703(100.0) 5746(100.0) 22.0 1/ Numbers in parentheses are percentage shares. Source: SPO - 11 - 1.31 While exports increased to both areas, the share of Middle Eastern countries grew while that of the EEC countries diminished. Turkish exports to the four major markets in the Middle East--Iraq, Iran, Libya and Saudi Arabia--accounted for 34.7 percent of total exports, as compared to 30.3 percent in 1981 and only 11.1 percent in 1980, while those to the EEC dropped to 30.5 percent of total exports from 31.9 percent in 1981 and 42.7 percent in 1980 (see Table 1.5 below). Exports to Iraq quintupled from $113 million in 1979 to $559 million in 1981. In 1982, Iran emerged as the most important market for Turkish exports, surpassing Germany. Table 1.5: EXPORTS BY DESTINATION ($ million) 1980 1981 1982 1982/81 (percent) OECD Countries 1680(57.7) 2264(48.1) 2556(44.5) 12.8 EEC Countries 1242(42.7) 1503(31.9) 1755(30.5) 16.8 Germany 604(20.7) 643(13.7) 707(12.3) 10.0 Other 638(22.0) 860(18.2) 1048(18.2) 21.9 Other OECD 438(15.0) 761(16.2) 801(14.0) 5.3 Middle East 654(22.5) 1943(41.3) 2689(46.8) 38.4 & North Africa Iraq 135(4.6) 559(11.9) 610(10.6) 9.9 Iran 85(2.9) 234(5.0) 791(13.8) 238.0 Libya 60(2.1) 442(9.4) 235(4.1) -46.8 Saudi Arabia 44(1.5) 187(4.0) 358(6.2) 91.4 Others 330(11.4) 521(11.0) 695(12.1) 33.4 Other Countries 576(19.8) 496(10.6) 501(8.7) -1.0 TOTAL 2910(100.0) 4703(100.0) 5746(100.0) 22.2 Source; SPO 1.32 The continued excellent performance in exports in the face of a world recession in which even the proven export performers (e.g. Taiwan, Hong Kong, Singapore, and Korea) could achieve at best only 5-6 percent growth in exports in nominal terms in the first half of 1982 is due to a combination of exogenous and policy-related factors. The single most important factor behind Turkey's success has been the flexible exchange rate policy that has maintained the profitability of exports on the one hand and encouraged private entrepreneurs to bring about structural changes on the other. The other important factor was the weakness of domestic demand that has prevailed in recent years. Under these circumstances, it was natural for private manufacturers to turn their attention abroad for commercial success. In - 12 - addition, the Government provided timely and significant incentives for exports. The relevant question for the medium-term is what will happen to exports when domestic demand begins to pick up. Or, stated differently, what will be the best policy mix for the country to sustain the export growth at acceptable levels, to maintain a healthy balance of payments, and at the same time to return to a high GDP growth path without inflation? 1.33 Workers' remittances from the EEC countries, which are dominated by Germany, do not show any significant nominal increase over 1981 levels. The slowdown of the German economy in recent months contributed to the lower than expected remittance inflow. However, the flow of savings into the Dresdner Bank Scheme tripled to DM 50 million per month in the first quarter of 1982 compared with only DM 18 million monthly in 1981. The Turkish Government introduced the scheme in 1978 in order to allow Turkish workers in Germany to save in DM at high interest rates. The amount of savings under this scheme now totals around $500 million. Based on this trend, and the future prospects of the German economy, it is expected that workers' remittances from the EEC countries will remain near their current nominal level of $1.8 billion yearly for the next few years. 1.34 Remittances from the Middle East became sizable only in recent years. Although a few firms have started to work abroad since 1968, it was not until 1979 that Turkish contractors were seriously involved in the Middle East. Total outstanding contracts by end 1979 was $2.7 billion, but close to $8 billion worth of contracts were signed in 1981 alone mainly with Libya. Total contracts signed by end 1981 amounted to about $10 billion, out of which $2 billion worth were already completed. Table 1.6 summarizes construction activities in the Middle East with country breakdown and value of contracts. Table 1.6: CONSTRUCTION ACTIVITIES IN THE MIDDLE EAST (end 1981) Value of Tenders Country Number of Firms ($ million) Libya 88 8,000 Saudi Arabia 22 1,140 Iraq 17 772 Jordan 3 43 Abu-Dhabi 2 48 Kuwait 5 12 Egypt and Yemen 2 - TOTAL 139 10,015 Sources: Izmir Foreign Trade Corp., "Development in Turkish Economy Performance and Prospects"; January 1982; Turkish Contractors Association; Mission Estimates. - 13 - 1.35 With an estimated 180,000 workers in the Middle East, workers' resittances from the Middle East in 1981 amounted to around *640 million, about one quarter of total workers' remittances. In addition, contractors repatriated about *160 million in 1981 to cover overhead costs at home. In total, contracting firing in the Middle East contributed to the balance of payments about *800 million in 1981 in transfers apart from exports generated by them. Ini 1982, it is estimated that their total contribution to the balance of payments iill be about S1 billion, assuming that the total worth of jroject completion vill be around $2.5 billion. OECD Pledges 1.36 The OECD Special Action Programme for Turkey was implemented in 1979. Total pledges for the years 1979-81 amounted to $3.1 billion, including some $540 million in the form of grants (largely from the United States). Nearly 65 percent of all pledges constituted program aid, both tied and untied, with the remaining 35 percent being composed of loans for specific projects and more general export credit arrangements. 1.37 By the end of 1981, disbursements under the Special Action Programe totalled around *2.2 billion, of which 75 percent has been against program loans, 5 percent in project loans and the remaining in export credits. Contrary to earlier indications from Turkey and the OECD countries of a discontinuation of further special assistance, agreement was reached at the June 1982 Working Party meeting on a final round of pledges. Disbursements for 1982 are estimated at $856 million with $400 million of this in program aid. 1.38 This is likely to aid Turkey's debt management program which aims at: (i) an optimal accumulation of reserves in line with inflation targets in the short run (i.e. 1982 and 1983); and (ii) a growth rate of 6 percent or higher in GDP beyond the stabilization period that is compatible with the larger debt repayments (resulting from rescheduling) and which are due during the 1985-88 period. Table 1.7: STRUCTURE OF OECD PLEDGES ($ million) 1979 1980 1981 1982 1/ Total pledge (all countries) 989.3 1160.5 973.8 850.0 of which: Program 625.1 705.0 659.4 425.0 Project 46.2 230.0 124.1 200.0 Export credit 318.0 225.5 190.3 225.0 1/ Estimated Source: OECD Secretariat - 14 - E. Concluding Remarks 1.39 The evidence of performance under the structural adjustment program from 1980-82 supports a growing optimism about Turkey's medium-term prospects as well as its return to international creditworthiness. Progress on the export front is especially remarkable, but there have been some slippages in the fiscal and monetary areas. Of particular concern is the absence of a medium-term framework that would outline the adjustment policies and within which the year-to-year adjustments can be gauged so as to better define the rate of progress and the time element involved in achieving the restructuring of the Turkish economy. The objective would be a sustained growth path based on a dynamic and competitive export sector and on increased productivity of the domestic sector, both guided as far as possible by the interplay of market forces. To help fill this gap, Chapter II starts from the 1982 performance and attempts to quantify the medium-term outlook based on a continuation of the structural adjustment process, while Chapter III identifies the basic issues which will need to be considered if Turkey is to achieve its stated goals. - 15 - CHAPTER II - THE MEDIUM-TERM FRAMEWORK: 1983-1990 A. Introduction 2.1 After years of experience with an "inward-looking" development strategy associated with an ever expanding public sector, Turkey in January of 1980 changed direction. The aims of the new program were to: (i) place greater reliance on the interplay of market forces; (ii) to shift from an inward looking to an outward oriented strategy; (iii) to reduce the share of the public sector in GNP; and (iv) to mitigate the "crowding out" of the private sector from the credit markets by ensuring a better balance between public resources and public expenditures. The shift in development strategy implies a change in the doctrine of planning suggesting a move from direct controls towards use of incentives that work through markets. Thus, the implications of the new economic policy direction for planning can be expected to emphasize a move from prescriptive to indicative planning which allows private firms to freely make their decisions with the incentive system ensuring that private and social profitability coincide. Indicative planning is more consistent with the basic policy thrust of the 1980 reforms and their evolution since then. The idea is to use the price mechanism to further economic development. This would be in line with a development strategy increasingly based on an efficient partnership between the public and private sectors and on giving an increased role to market forces. 2.2 The Government, intent on correcting the more immediate balance of payments disequilibrium and the dislocating inflationary situation, set aside the Fourth Five-Year Development Plan (1979-1983) and concentrated on the shorter term stablization measures. These have been implemented on a year-to-year basis concentrating on targets set within the announced annual programs. The urgency of the situation required "crisis management" rather than pursuing a medium-term plan. With the crisis under reasonable control, the focus is again beginning to shift to the medium-term. 2.3 Further progress in structural adjustment requires a well defined picture of where the reform process might eventually lead the economy, of what resources (domestic and foreign) can be available for the growth process and of what roles are to be ascribed to the public and private sectors. The establishment of a medium-term framework is also essential to the evaluation of the key issues in formulating a coherent development strategy. It will provide clear signals to the various economic agents, of where the economy is intended to go and thus allow the private and public sectors to make investment, production and trade decisions within the framework of a stable policy context. - 16 - B. Medium-Term Projections 2.4 There is as yet no official medium-term framework for economic development. The Government is expected to issue the draft Fifth Five Year Plan (1984-88) in June 1983. The medium-term projections presented in this section are obtained with the aid of two Bank models--Revised Minimum Standard Model (RMSM) 1/ and Computable General Equilibrium Model (CGE) 2/--and based on a specific policy package discussed with the Government and highlighted in Chapter III. In projecting the consequences of alternative development strategies, it is important to remember that all model results are conditional on the specific policy packages and projections of exogenous variables that are being used. The selection of one scenario as representing the Base Case is made on the assumptions that the policies underlying the scenario, and which essentially represent a continuation and evolution of the policies of the 1980 Program, would be pursued by the Government in the 1980s and that the export environment will remain favorable. C. The Base Case 2.5 The results of the Base to be used in analyzing Turkey's medium-term prospects and creditworthiness are presented in summary form in Tables 2.1 through 2.4 below. The detailed assumptions and results for the Base Case, as well as the results under various more pessimistic and one more optimistic assumptions as to the exogenous variables, are to be found in full detail in Annex III. Guiding Considerations for the Base Case 2.6 The Base Case projections are predicated on the assumption that the 1981-82 upsurge in exports will not be a temporary phenomenon and that it will continue to grow in real terms at a decreasing rate, from 22 percent in 1982 to 9.6 percent per annum during 1983-1985 and 9.5 percent per annum during 1985-1990. Secondly, it is assumed that the monetary and fiscal policy slippages observed in 1982 will not disrupt the basic shift in development strategy. Consequently, for the medium-term we anticipate a continuation of stabilization and austerity through the 1983-84 period with a pick-up in GDP growth beginning in 1984 and rising to an average of 6.1 percent (Table 2.2) for the 1985-90 period. Binding Constraint 2.7 Turkey will have to face larger than usual debt repayments beginning in 1985 and continuing throughout the decade because of the large debt reschedulings that have taken place in recent years. These payments will no 1/ For details see Annex III. The results presented in this Chapter are in the RMSM framework. 2/ For details see Annex IV. To compensate for the behavioral weaknesses inherent within the RMSM framework, the CGE Model was used to generate a set of behaviorally consistent production and investment levels as well as import and export flows, with capital flows exogenously supplied. The policy mechanisms of mutually consistent trade policies, supply side policies, and relative prices are elaborated in Annex IV. - 17 - doubt act as constraints on Turkey's growth performance, but will be mitigated if the export drive does not falter. Hence, from the point of view of the model structure, an equilibrium scenario is defined as, ceteris paribus, a growth path which is deemed feasible within the projection horizon, and which, from a creditworthiness point of view, does not overextend Turkey's capacity to borrow externally. In other words, the trade gap model is constrained by the ability of Turkey to maintain its external debt structure at a level compatible with a feasible debt service capability over the medium-term. The Base Case cannot consider as feasible a growth scenario which leads to excessive external borrowing through the year 1990. It was assumed that, given the projected commitments, foreign loans (medium and long-term) would lead to an approximately $2.5 billion in disbursements in 1990. This would leave a gap of about $3.0 billion of yet unidentified sources to fill the total requirements for foreign exchange in 1990. These figures in turn imply a debt service ratio of about 18 percent in the terminal year, a figure which could conceivably be increased along with the growth of GDP. Yet, given the dynamic nature of the problem and the fact that this year's borrowing affects the next ten years at least, prudent external debt management requires, in the Turkish context, the maintenance of debt service ratios in the 16 - 20 percent range which the Base Case opts for as a binding constraint on the growth path. - 18 - The Results 1/ 2.8 Balance of Payments. Table 2.1 shows the summary balance of payments projections for the period 1983-90. BASE CASE Table 2.1: SUMMARY OF BALANCE OF PAYMENTS PROJECTION (Millions of uS$) Actual Estimate Projection 1981 1982 1983 1985 1990 Export of goods &t NFS 6416 7620 8894 12523 26681 Import of goods & NFS 9892 9641 10853 14293 30080 Workers' remittance 2490 2187 2350 2622 3508 Current account balance -2089 -1035 -870 -485 -1757 Memorandum items Capital required /2 3303 2401 2002 2555 5979 Total debt service -1231 -2385 -2316 -3120 -5616 Total debt outstanding and disbursed 16355 16818 17238 18347 25688 Debt service ratio /3 13.8 24.2 20.6 20.6 18.1 Current account deficit/ GDP (%) -3.7 -1.7 -1.5 -0.8 -1.8 Real Growth Rates (2) 1983-85 1985-90 Export of goods 4703 5746 9.6 9.5 Import of goods 8933 8734 7.7 9.1 1/ The Base Case projections do not reflect the recent decrease in oil prices. The beneficial effects of real oil price declines lead to potentially higher GDP growth rates in 1984-85 as well as lower external borrowing requirements. However, this has to be balanced against possible lower exports to the oil producing countries. The Government's 1983 growth targelt is likely to remain unaffected by the new situation since there is a lag in translating improvements in the current account balance into a higher growth rate. 2/ Current Account Balance + Total Amortization + Change in Reserves. 3/ Total Debt Service including debt relief, excluding short-term exports of gds + NFS + workers' remittance. Source: SPO, IBRD projections 1983-1990. - 19 - Merchandise exports are projected to continue to grow at 9.5 percent in real terms into the late 1980s based on assumed continuation of present policies designed to adjust exchange rates for differential inflation, to encourage formally and materially private sector exports and to develop further Middle Eastern markets in which Turkey has advantage due to cultural and geographical proximity. Such a scenario would of necessity require a reduction in the level of protection in order to promote efficiency among domestic producers and to reduce the profit bias against exports. 2.9 Imports are projected to grow slowly in real terms during the initial period--continuation of stabilization 1982-84--and then to pick up from their 7-8 percent level to an average of a little over 9 percent for the 1985-90 period. This is in line with the attempts to regain the normal growth path as soon as inflation has been brought under control as well as the pursuance of policies towards import liberalization. Higher growth means higher imports as reflected in the 1985-90 import projections with an average import elasticity of approximately 1.4. 2.10 The current account balance, under these assumptions, would show a decreasing negative trend for 1982-85 as stabilization curtails imports while encouraging exports. As growth sets in, the trend is reversed for the 1985-90 period and Turkey's current account deficit is seen to increase again. The terminal year 1990 would show a deficit of $1.8 billion as compared to a 1985 deficit of $484 billion. 2.11 The capital account remains in equilibrium throughout the projection period as reflected by the projected debt service ratio. The latter is seen to decrease from a high of 24.2 percent in 1982 to 20.6 percent in 1985 and finally to 18.1 percent in 1990. This scenario suggests that if the underlying assumptions are realized, the projected growth of the economy would be at an average rate of 6.1 percent per annum during 1985-1990. It will also permit Turkey to meet the amortization and interest payments arising from the $9.2 billion of rescheduled debts during the 1978-82 period and maintain an exchange reserve equivalent to two months' imports. 2.12 A conservative estimate of medium and long-term capital inflows from known commitments is $2.4 billion in 1990 with an extra $0.5 billion due to short-term credits. Required capital, however, would amount to $6.0 billion implying that approximately $3.0 billion would have to be borrowed from as yet unidentified sources. Yet, even with these capital requirements, the debt service ratio will only be 18.1 percent and exchange reserves at 2 months imports implying a complete restoration of Turkey's creditworthiness. 2.13 National Accounts. Table 2.2 presents the summary of the projected national accounts in billion TL at constant 1980 prices. The Base Case indicates a GDP growth of 5 percent per annum for 1982-85 (stabilization period), and a higher figure of 6.1 percent per annum for 1985-90. Achievement of these growth rates will depend essentially on the growth of the productive sectors, namely agriculture and industry, and within the industrial sector, particularly manufacturing. A key assumption is the assumed ability of agriculture to reach an average 3.1 percent real growth per annum, 1/ and 1/ The policy requirements to achieve the agricultural value-added growth are mentioned in IBRD: Agriculture Sector Report expected to be published in June 1983. - 20 - of manufacturing to achieve an 8.9 percent real annual growth rate in value-added. The services sector is expected, as in the past, to follow the growth of GDP rather than lead. 2.14 In order to reach these overall and sectoral growth rates, it is assumed that improvements are made in the productivity of capital through decreasing the ICORls and that total fixed investment would rise from 20.1 percent of GDIP in 1982 to a 22 percent in 1990. BASE CASE Table 2.2: SUMMARY OF PROJECTED NATIONAL ACCOUNTS (Billion of TL at constant 1980 prices) Percentage Share of GDP Actual at Market Price (%) Average Annual Growth Rate (C 1981 1982 1985 1990 1982 1982-85 1985-90 GDP at market price 4518 100.0 100.0 100.0 4.6 5.0 6.1 Agriculture 928 21.6 19.6 16.9 6.7 3.2 3.1 Industry 1103 20.5 25.7 29.6 4.6 7.0 9.2 Mining 73 1.6 1.5 1.7 -16.0 7.8 9.5 Manufacturing 941 16.9 21.9 24.9 6.0 6.7 8.9 Energy 89 2.0 2.4 3.0 14.2 9.9 11.3 Other 2225 49.5 48.7 47.7 4.1 4.9 5.7 Consumption 3611 79.7 79.0 77.8 4.0 4.7 5.8 Fixed investment 898 19.6 20.7 22.0 2.6 6.9 7.4 Public 516 11.9 11.9 11.0 0.8 5.0 4.5 Private 382 7.7 8.8 11.0 5.4 9.6 11.0 Gross domestic savings 854 19.0 20.7 21.9 5.1 7.9 7.4 SOURCE: SPO, Missioin Projections 1983-1990. Consumption by contrast would have to decrease from an observed high of 79.7 percent of GDP in 1982 (81.9 percent in 1980) to a projected 77.8 percent for 1990. While the share of consumption in GDP would decrease over the projection horizon, consumption would still grow at an average annual rate of 4.7 percent or about 1.5 percent per capita in the stabilization period and a more comfortable 5.8 percent (3 percent per capita) in 1985-90. While public consumption is to grow faster during the austerity program years 1982-85, private consumption growth will surpass that of the public sector in the - 21 - latter years of the decade. The growth period is seen to bring with it increasing improvements in the standard of living as measured by private consumption expenditures. 2.15 Investment and Savings. The Base Case assumes an increasingly important role for private sector investment in line with the policy of rationalizing public sector investments and curtailing them in the manufacturing sector. Private sector investments are seen to fill the gap in this area. Table 2.2 shows the growth rates in public and private investment necessary to finance a 6.1 percent per annum medium-term growth path. 1/ 2.16 The overall result of such a policy is to slow down the real growth of public investment to 5 percent for 1982-85 and eventually 4.5 percent for 1985-90, recognizing that such a growth would constitute an upper limit. In terms of GDP percentages, this would mean a drop from about 12 percent in the first part of the decade on average to 11 percent in the latter part. A corollary of this policy is to limit the growth of manufacturing SEEs. Thus, public fixed investment in manufacturing is assumed to drop from 15.2 percent of the total in 1981 to 11.1 percent in 1985 and finally 9.7 percent in 1990. By contrast, private manufacturing investment as a share of total investment increases from 9.8 percent in 1981 to 15.9 percent in 1985 and finally to 20 percent in 1990. 1/ The Base Case printout in Annex III indicates the results of a conscious government policy objective of retrenching public sector investments to 50 percent of total fixed investments by 1990 (as against 60 percent in 1982). - 22 - BASE CASE Table 2.3: PUBLIC SECTOR PROJECTIONS (Billion of TL, Constant 1980 Prices) 1981 1982 1983 1985 1990 Consolidated budget Revenue 971 943 1068 1158 1479 Expenditure 1045 1022 1132 1178 1410 Current 693 636 749 812 1037 Fixed investment 201 234 251 270 337 Transfers of SEEs 151 152 132 95 37 Budget balance -73 -79 -64 -20 68 Change accounts payable 47 - - - - Financing balance -27 -79 -64 -20 68 SEE accounts Sales Revenue 1245 1385 1529 1602 2545 Expenditure 1243 1360 1499 1562 2418 Gross Profit/Loss 2 25 31 40 127 Investment 431 318 319 403 509 Fixed investment 282 269 276 330 411 Stock changes 1/ 149 49 43 73 98 Depreciation alLowance 20 25 27 66 82 Financing requirements -409 -268 -261 -297 -300 Public sector borrowing requirements -314 -234 -233 -270 -271 Financing balance -27 -79 -64 -20 68 Transfers of SEE 151 152 132 95 37 Taxes of SEE -29 -39 -40 -48 -76 Financing requirement of SEE -409 -268 -261 -297 -300 Public sector borrowing/ GDP (%) -6.9 -5.0 -4.7 -4.9 -3.7 1/ Stock changes are not strictly a policy variable and hence the projections are indicative of the recent performance. Source: SPO, IBRD Projections 1983-1990. - 23 - BASE CASE Table 2.4: SAVINGS & INVESTMENT FLOW OF FUNDS (Billions of TL, Constant 1980 Prices) Actual Estimate Projected 1981- 1982 1983 1985 1990 Public sector Investment 696 609 632 722 906 Savings 271 271 336 404 575 Gap -425 -425 -296 -318 -332 Private sector Investment 421 441 464 516 857 Savings 583 581 620 724 1035 Gap 162 140 156 208 177 External resources -263 -152 -140 -111 -154 Percentage of GNP (X) Public sector Investment 15.0 12.7 12.6 13.0 12.2 Savings 5.9 6.6 6.7 7.3 7.7 Gap -9.2 -6.1 -5.9 -5.7 -4.5 Private sector Investment 9.1 9.2 9.2 9.3 11.5 Savings 12.6 12.1 12.2 13.1 13.9 Gap 3.5 2.9 3.1 3.7 2.4 External Resources 5.7 3.2 2.8 2.0 2.1 (positive denotes inflow) Source: SPO, IBRD Projections 1983-1990. Moreover, the public investment share of agriculture remains more or less stable, while that of services decreases gradually, the slack being taken up by private sector investments, presumably in housing, banking, tourism and other services. - 24 - 2.17 Thus, the projections assume not only a revival of private sector investment, partic:ularly after stabilization, but also a dynamic leading sector role based on policies geared towards efficiency in production at home and towards exports growth. Thus, the onus of the continuation of structural adjustments, and the taking root irreversibly of these adjustments, rests in the initial periodi on the public sector as it strives to curb inflation and to create an economic climate conducive to private sector exports and investments. However in the second period, on the assumption of healthy trends in the public sector, as shown in the Base Case results, the onus of performance must per force shift to the private sector if Turkey is to achieve once again its historical growth rates of 6 percent or more per annum. Table 2.2 indicates that to sustain this growth path, private sector investments must grow in real terms at an annual rate of 9.6 percent during the period 1982-85 and at 11 percent during 1985-90. The former is likely to be less difficult since the 1979-82 period saw a significant retrenchment in private investment and therefore the 1982 base would look unusually low. The second period, 1985-90, will certainly imply greater difficulties for the private sector, since the medium-term framework suggested here implies an 68 percent increase in (real terms) in private investment, or a 11 percent growth rate per annum from its 1985 base. 2.18 Table 2.3 presents the Base Case results for the public sector block consistent with thte balance of payments, national accounts and fixed investment projections. The basic policy thrust implicit in these results is to restore financial balance to the public sector while trying to mitigate if not eliminate the "crowding out factor". The Base Case suggests: (i) a continued improvement, albeit slow, in the financing balance of the consolidated budget; (ii) a gradual elimination of transfers to SEE's; (iii) an improvement in the profit/loss accounts of the SEE's; and (iv) a bottom line decrease in the Public Sector Borrowing Requirements from a high of 6.9 percent of GDP in 1981 to 4.9 percent in 1985 and finally to a target 3.7 percent in 1990. 2.19 With a decreasing Public Sector Borrowing Requirement (PSBR) projected over the period, the Base Case implications for the "crowding out" of private investment are clear. Table 2.4 shows the Savings Investment Flow of Funds between the private and public sectors. The public sector savings-investment gap as a percentage of GNP would decrease from -9.2 percent in 1981 (actual) to -5.7 percent in 1985 and eventually to -4.5 percent in 1990. The private sector savings-investment gap, being positive at 3.5 percent in 1981, increases to 3.7 percent in 1985 and then decreases to 2.4 percent in 1990. Thus, during the stabilization period where private investment remains weak, we note a shift in the financing of the PSBR from external resources to domestic savings. In the second period (1985-90), by contrast, the shift would be reversed, as the ever decreasing public sector financing gap is filled by external resources rather than domestic ones, since the private sector's investment requirements would have to rise substantially in order to support the 6.1 percent average growth rate of GDP over the period in question. The process would be accompanied by a rise in Gross Domestic Savings as shown in Table 2.2, and as growth rises over the 6 percent threshold, the chronic unemployment problem will begin to be alleviated. An upcoming employment mission will be able to shed some greater light on the impact of this Base Case medium-term projection on the employment prospects. -25 - D. Sensitivity Analysis 2.20 The realization of the Base Case projections is subject to a number of major uncertainties. The model framework is therefore used to develop alternative scenarios to assess the possible impact of changes in the main assumptions on the Base Case results. The following sensitivity runs were undertaken: (i) Sensitivity 1 - Lower Oil Price Scenario. 1/ Variations in the international oil price, by virtue of the importance of petroleum imports to Turkey, are highly influential to the eventual results. Consequently Table 2.5 indicates the data used in an alternative lower oil price scenario. The Base Case data is the same as that provided by the Bank Commodity Price Forecast, while the low is substantially below the base. This choice reflects the present stagnant demand for world oil. Table 2.5: OIL PRICE ASSUMPTIONS: BASE AND SENSITIVITY 1 ($/barrel) Base Case Low Price (1) 1980 30.5 30.5 1981 34.3 34.3 1982 33.6 33.6 1983 34.6 33.6 1984 36.3 33.6 1985 38.5 33.6 1986 41.4 35.3 1987 44.5 37.0 1988 47.9 38.9 1989 51.4 40.8 1990 55.2 42.9 (ii) Sensitivity 2 - Export Growth Scenarios. Since much of the future growth achievements for Turkey are dependent on export sustainability, a lower export growth scenario than the Base Case was envisioned as important in the downside risk analysis. Thus, Sensitivity 2 consists of an 7.4 percent export growth per annum rather than 9.5 percent over the 1985-90 period. 1/ Since the report was prepared, there has been a marked downward movement in oil prices in 1983 which resulted in the price of crude oil being lower than presented even under this scenario ($29-$30 per barrel as against $33.6 per barrel). However, the above scenario assumes overall a lower than expected price movement over the medium-term (1984-90) and hence could still be regarded as a lower oil price variant. The favorable price developments in 1983 may translate into an improvement in the current account deficit by about $400 million as compared to the above scenario, bringing down the deficit to about $300 million as against $700 million. - 26 - 2.21 These sensitivity runs, although by no means exhaustive, are meant to pinpoint some of the key areas of possible gain and shortfall. Of basic concern to the analysis is the retrenchment of the public sector generally and more specifically its progressive withdrawal from manufacturing activities. Rather than test the impact of such a change in policy on ceteris paribus assumptions, it was felt more useful to introduce such a policy slippage condition in the I)ownside Risk Case where a confluence of factors would act together to dislodge Turkey from its Base Case medium-term prospects. Sensitivity 1 - Lower Oil Price Scenario 2.22 Turkey, as an oil importing middle income country, is highly dependent on the world price of petroleum and petroleum products for its medium-term prospects. This is because such a large proportion of imports (estimated at 42 percent in 1982) is made up in value terms of petroleum and petroleum products. Consequently, no assessment of Turkey's medium-term prospects and creditworthiness can possibly leave out an assessment of the impact of variations in the international price of oil on the possible growth scenarios for the medium-term. The results are shown in Table 2.7. LEDWER OIL PRICE SCENARIO Table 2.6: PROJECTIONS OF SELECTED ECONOMIC INDICATORS 1982 1985 1990 (Current $ mil) Import of goods 8734 12259 26665 Current account balance -1035 98 -591 Capital required 2401 1690 4226 Total debt outstanding and disbursed 16818 17221 19158 Ratios (Z) Debt service ratio 24.2 20.4 14.2 Fixed investment/GDP 19.6 20.7 22.0 Savings/GDP 19.0 21.3 22.2 Export of goodsi'GDP 10.5 11.5 12.7 Import of goods/'GDP 13.6 14.7 16.9 Current account balance/GDP -1.7 0.2 -0.6 1982-85 1985-90 Average annual reasl growth (%) GDP at market price 5.2 7.2 Import of goods 7.8 10.4 Source; SPO and IBRD projections. The growth path has been adjusted bearing in mind the foreign exchange constraints and the dictates of prudent debt management. 2.23 The lower oil price scenario Sensitivity 1, provides a great deal of financial breathing space for the Turkish economy;in the medium-term. It results in a balance of payments surplus of $98 million in 1985, even with the average growth path being raised from 6.1 percent per annum to 7.2 percent per annum (1985-90) as shown in Table 2.7, the debt service ratio by 1990 is only 14.2 percent. Total outstanding debt by 1990 is seen to be only $19.2 billion versus the comparable $25.7 billion in the Base Case. In other words the Turkish medium-term prospects appear to be highly sensitive to changes in the international oil price, as revealed by Sensitivity 1. Sensitivity 2 - Lower Export Growth Scenario 2.24 With Turkey's medium-term prospects highly dependent on export sustainability, a sensitivity run was made on the assumption that export growth would be significantly lower in the 1983-1990 period. The lower export growth scenario assumes that exports will only grow at 7.4 percent per annum as opposed to 9.5 percent in the Base Case in the 1983-1990 period. Table 2.7: LOWER EXPORT GROWTH SCENARIO PROJECTIONS OF SELECTED ECONOMIC INDICATORS 1982 1985 1990 (Current S mil) Export of goods 5746 9749 19428 Import of goods 8734 12763 25863 Current account balance -1035 -484 -2233 Capital required 240' 2545 6402 Total debt outstanding and disbursed 16818 18357 26647 Ratios (Z) Debt service ratio 24.2 20.7 19.8 Fixed investment/GDP 19.6 20.7 22.0 Savings/GDP 19.0 20.7 21.6 Export of goods/GDP 10.5 11.5 12.7 Import of goods/GDP 13.6 14.7 16.6 Current account balance/GDP -1.7 -0.8 -2.3 1982-85 1985-90 Average annual real growth (Z) GDP at market prices 4.9 5.3 Fixed investment 6.8 6.6 Export of goods 8.4 7.4 Import of goods 7.4 7.9 Source: SPO and IBRD projections. - 28 - Table 2.7 shows the movement of the key indicators. As can be noted from the results, a lower export growth scenario, even 'with identical 1982 performances for both alternat:ives, leads to a more difficult balance of payments situation, more external borrowing, a lower growth path and a higher debt service ratio. The growth path 1985-90 is lowered as a result from 6.1 percent per annum to 5.3 percent per annum in order to bring the current account balance into a manageable position. Nevertheless, borrowing over the period needs to be higher and thus with 0.8 percent lower growth the outstanding debt :in 1990 is $1.0 billion higher and the debt service ratio is 1.7 percentage po:ints higher than in the Base Case. This indicates that Turkey's medium-term prospects will be rather dependent on export sustainability and industrial sector growth. Moreover, the better the performance in the medium-term, the more comfortable Turkey will be as it enters the 1990s. Higher export growth under prudent external debt management assumptions reinforces Turkey's creditworthiness. This is not to say that the lower export scenario shown in Table 2.8 is unfeasible. Rather it is to point out that if 1990 :is the chosen horizon, the years beyond count also, and they count more and more the closer one gets to that horizon. E. The Downside Risk Case 2.25 The downside risk case represents a confluence of negative factors which would seem to put a lower floor on the possible growth performance of Turkey over the mediumrterm. Since Turkey's avowed policy, in the medium to long-term, is a restoration and maintenance of creditworthiness in the international marlket, and especially among the commercial banks, the downside risk case was iterated on the assumption that the debt service ratio in the terminal year (1990) would not significantly exceed the 16 - 20 percent used in the Base Case. The downside risk case assumptions were as follows: (i) export sustainability in the medium-term was assumed to be less optimistic with export growth in 1983-85 to be 8.2 percent versus 9.6 percent in the Base Case, and in 1985-90 6.8 percent versus 9.5 percent; (ii) oil prices in the downside risk case are assumed to change in the medium-term according to a moderately more rapid rate of price increase from 1985 onwards; 1/ (iii) the downside risk case assumes less progress in the public investment area with the Government being unable or unwilling to cut back on the role of the public sector in the economy. Thiis has been translated into a situation where the public/private investment shares reach a 55 percent - 45 percent level in 1990; and (iv) SEE transfers remain constant in real terms throughout the period 1984-1990. 1/ The assumptionis ($ per barrel) are: 1985 1986 1987 1988 1989 1990 39.4 43.0 46.9 51.1 55.7 60.7 2.26 There are, of course, a myriad of other downside assumptions that can be sade for some of the other relevant parameters. Notable are upward revisions in import elasticities, higher than expected interest payments as concessionary financing becomes scarce, higher international inflation for imported capital goods, lower elasticity of government revenue to GDP, lower than expected improvements in the profit/loss account of the SEE's and the inability to control the stocking policies of the SEE's. These were not introduced in the downside risk case presented here, as it was felt that it would be improbable to have such excessive negativeness confronting Turkey in the projection period under consideration. The present indications are that there is cause for optimism for Turkey's medium-term prospects and therefore the downside risk case should try to realistically adjust the Base Case for events that could conceivably act together to temper that optimism. 2.27 The results of the downside risk case are presented in Table 2.8. As with previous runs, the negative impact of some of the assumptions on the balance of payments have inevitably led to a downward iteration of the growth path as measured by the real growth rate of GDP. The feasible relatively optimal growth scenario was accepted to be compatible with a 20.6 percent debt service ratio in the terminal year. This contrasts with the Base Case equivalent of 18.1 percent and the general framework of the study which had argued for an upper limitation of 20 percent or so. In this case, however, the lower growth scenario in conjunction with unemployment argued for greater indebtedness. DOWNSIDE RISK CASE Table 2.8: PROJECTIONS OF SELECTED ECONOMIC INDICATORS 1982 1983 1985 1990 (Current * mil) Export of goods 5746 6800 9717 18938 Import of goods 8734 9697 12785 25857 Current account balance -1035 -870 -533 -2720 Capital required 2401 2002 2594 6932 Total debt outstanding and disbursed 16818 17238 18423 27840 Ratios (X) Debt service ratio 24.2 20.6 20.8 20.6 Fixed investment/GDP 19.6 19.8 20.7 22.0 Savings/GDP 19.0 19.4 20.6 21.3 Export of goods/GDP 10.5 10.6 11.6 12.8 Import of goods/GDP 13.6 14.0 14.6 16.5 Current account balance/GDP -1.7 -1.5 -0.8 -2.9 1982-85 1985-90 Average annual real growth (X) GDP at market price 4.7 4.8 Fixed investment 6.6 6.1 Export of goods 8.2 6.8 Import of goods 7.2 7.3 Source: SPO and IBRD projections. - 30 - 2.28 It is clear that Turkey's external debt exposure is much higher in the downside risk case with a total debt outstanding in 1990 of nearly $28 billion as opposed to the Base Case $25.6 billion. Interest payments on the debt are higher and although exports and imports are lower, the current account shows a greater deficit through the period. Required external capital in 1990 to cover the current account deficit, the capital account deficit and the changes in reserves is higher by $1 billion. There is therefore a much greater need for concessionary financing, even after a downward adjustment in the growth path which is reflected in a real import growth rate of 7.2 percent per year for 1983-85 and 7.3 percent per year in 1985-90 as opposed to the Base Case respective figures of 7.7 and 9.1 percent. 2.29 The downslide growth path is constrained by the foreign exchange limitations to an average annual real growth rate in GDP of 4.7 to 4.8 percent as compared to the! Base Case 6.1 percent. The leading sectors, namely agriculture and industry, have substantially lower contributions to make and fixed investment is seen to grow at a much slower rate especially in the second period (1985-90). In a sense the downside risk case, rather than projecting a stabilization period followed by a return to the normal growth path, suggests that stabilization growth rates will continue throughout the period, but with aL pick up in private investment. Under these conditions there is no chance of absorbing the unemployed and therefore the downside risk case is compatible! with medium-term prospects that can be characterized as low growth with unemployment. 2.30 The public sector block projections for the downside risk case clearly show, on the assumed changes, a deterioration of anticipated results. 1/ Thus, the financing balance in 1990 of the consolidated budget is lower than in the Base Case, the profit and loss account of the SEE's show a lower profit, the SEE financing requirements are higher, all leading to a PSBR of TL 356 billion (constant 1980 prices) as against the Base Case equivalent of TL 271 billion. The results are even worse on a percentage of GDP basis as the PSBR in 1990 rises to 5.2 percent in the downside risk case from its Base Case level of 3.7 percent. 2.31 The projected savings and investment flow of funds between the private and public sectors display a marked deterioration in the public sector's ability to finance its own investments and therefore a much stronger crowding out factor. The improvements in public sector retrenchment are in the early years, but are not followed through as in the Base Case and the public sector continues to encroach on the private sector throughout the projection period. What this illustrates is the necessity of restoring a balance between public sector investments and public sector savings so as to allow the private sector to fulfill its potential. 1/ Details in Annex III. - 31 - F. Concluding Remarks 2.32 From today's perspective the medium-term prospects delineated in the Base Case seem reasonable. Its realization would depend to a large degree on the Government's determination to render the public sector more efficient and to create an investment climate for the private sector which will allow the latter to play the heavy role being given to it. It would seem that a 6-7 percent range in annual real GDP growth following stabilization is much more likely if the issues highlighted in Chapter III are satisfactorily resolved by the Government, and that the downside risk to this scenario, given the progress of the last few years, would be a 4-5 percent range in GDP annual real growth. The former would be conducive to an absorption of unemployment and a very positive rating in the international credit markets,.while the latter would fail to achieve the employment objectives and at the same time strain Turkey's external borrowing capabilities. - 32 - CHAPTER III - DEVELOPMENT ISSUES AND STRATEGY A. Introduction 3.1 The basic thrust of policy changes which changed the inward-oriented development strategy Turkey followed in the previous decades, appears sound. The new strategy combines stabilization measures aiming at reducing the rate of inflation and improving the balance of payments, with reform measures designed to turn ithe Turkish economy in an outward direction and to give an increased role to market forces. The medium-term strategy should be a continuation of the same policies. The basic development issues which will need to be dealt with in formulating policies to achieve the medium-term projections outlined in Chapter II include: (i) resource mobilization and efficiency, especially in the SEEs and the financial sector; (ii) rationalization of the public sector investment program, both with respect to size and sectoral strategies; (iii) external trade issues, particularly policies to sustain export growth and the need for import liberalization; (iv) restoring creditworthiness and access to commercial markets; (v) unemployment; (vi) reviving private investment in manufacturing; (vii) new role of agriculture; and (viii) regional development and productivity growth. 3.2 These are the issues which will have a direct bearing on the economic performance of Turkey in the medium-term. These should not, however, be considered exhaustive, since the report did not analyze the distributional and the employment implications of the recently adopted policies. The policies required to deal with these issues, and an evaluation of their effects need to be placed within a medium-term framework to help policymakers determine the speed and monitor the rate of progress involved in getting the Turkish economy towards a sustained growth 'path. B. Resource Mobilization and Efficiency in Resource Use 3.3 Sustainec1 growth in the mid-to-late 1980s would largely depend upon a greater reliance on domestic resources in light of the anticipated decline of concessional external borrowing and the modest prospects of obtaining significant commercial money. Domestic resources will not be adequate without reforms in the financial sector and a more efficient functioning of the SEEs both of which are discussed below. Other areas needing attention were - 33 - discussed fully in an earlier Bank report. 1/ These cover tax reform, measures affecting foreign direct investment, appropriate incentives for new investment and a policy for technological growth. SEE Reforms 3.4 The SEEs are significant entities (in terms of the share of investment, value-added and employment) in manufacturing as well as in traditional public utilities, transport, and agricultural marketing. Since the late 1970s, their operating losses and growing investment demands have put intolerable burdens on the budget and added to inflationary pressures. The sources of these difficulties are well known. They include price controls, uneconomic and excessive investments, overstaffing, lack of autonomy and over-centralization of decisionmaking, frequent changes of management, inadequate salaries to attract appropriate managerial and technical staff, and a confusion between economic, social, and political goals. 3.5 The reduction of the financial burden of the SEEs through improvements in their efficiency is a major issue to be resolved by the Government's structural adjustment program. The success of the reform has been assumed in the Base Case projections, which show a gradual elimination of transfers to the SEEs, an improvement in their profit and loss accounts accompanied with greater efficiency, and therefore a decreasing financing burden on the budget. 3.6 The Government is committed to ensuring that the SEEs' prime objectives should be profitability and productivity, that their operations should be under professional, not political management, and that their investments should be primarily in infrastructure, agriculture and energy, with manufacturing increasingly left to the private sector. The Government will have to implement a number of interim measures to improve short-term financial performance of SEEs, redirect their investment programs and finance them increasingly from non-budget sources, while at the same time undertake legal reforms to institutionalize these changes. The first step, in early 1980, was to liberalize prices with a view to generating additional financial resources. This was followed, in 1981 and 1982, by several additional measures designed to begin to improve efficiency, reduce costs and constrain investment. 3.7 The core of the Government's program for SEEs is a wide-ranging reform law. 2/ While the Government recognizes that the basic challenge is to change deep-rooted attitudes not laws, the new law should have considerable impact in the long-term by formally signalling the new official attitude towards 1/ Turkey: Industrialization and Trade Strategy; IBRD; February 1982. 2/ This law has recently been approved by the Government. - 34 - SEEs. The SEE reforms when implemented are likely to fundamentally alter the fiscal picture in the medium-term and alleviate the tendency to crowd out the private sector in the allocation of credit. The pace of reforms would affect the time horizon of the stabilization effort by reducing the public sector's claims on Central Bank credits. Moreover, the increasing efficiency of the SEEs would decrease their short-term borrowing requirements. 3.8 The ultimate challenge for the Government in implementing the reforms will be to fully integrate the SEEs in the market economy where they will survive or flourish while competing with private sector firms on an equal footing, especialLy with regard to their prices of output, cost of factor inputs, and credit: facilities. Financial Sector Reforms 1/ 3.9 An imporl:ant determinant of the success of the domestic resource mobilization effort as well as the revival of private investment will be the restructuring of ithe financial system. The present structure and the working of the financial sector is not conducive to enhanced efficiency in either domestic resource mobilization or allocation of resources. The cost of credit is very high. Two-thirds of credits from the Central Bank are allocated at heavily subsidized rates. The capital market is underdeveloped, enterprises are undercapitalized, and the large industrial groups are integrated with the banking system to the detriment of new entrepreneurs. The recent collapse of the unorganized and unregulated money market has further aggravated the situation. 3.10 In view of the importance of the financial sector in the overall structural adjustment process, the Government's strategy and objectives should be to continue thie process of financial deepening, reduce the cost of credit, improve the efficiency of credit allocation, allow more competition in the financial system, strengthen the institutions which supervise the financial system and revitalize the capital market. These problems faced by the financial sector in Turkey are of a structural nature which will need to be resolved in the medium-term. There are also short-term problems. The most pressing one appears to be the high level of the real costs of credits currently at 30 percent on average. This has created acute problems of liquidity and solvency for banks and firms alike and requires immediate action. The mission endorses the following major recommendations made by the recent Financial Sector Mission: 2/ 1/ This section is largely based on the interim draft report of the Financial Sector Mission (April 18, 1983) which visited Turkey during November 1-18, 1982. Its report is to be discussed with the Turkish Government in June 1983. 2/ Some of the measures mentioned here have already been introduced by the Government while others are under consideration for incorporation in the new Banking Law. The recommendations related to the development of capital markets are also being reviewed by the Government in the context of implementation of the Capital Market Law introduced in 1981. - 35 - (i) reducing non-concessional interest rates by lowering the deposit rates and gradually eliminating the transactions tax. This will give the private sector better access to working capital at reasonable cost; (ii) streamlining selective credit policies to ensure a rational allocation of resources by reducing the dispersion of interest rates applied to preferential credits and raising them to the rate of inflation; (iii) in line with the development of the capital market structure, revitalizing the bond market by issues of treasury bills and bonds at competitive rates and by encouraging bond issues by development banks and SEEs; (iv) formulating an action plan for the development of the bills and notes market; (v) improving the system of monitoring bad debts in the banking system and revising the tax regulations in order to enlarge the possibilities of deducting the losses from such loans from taxable income; (vi) introducing a legislation to permit industrial firms to revalue their fixed assets and accumulated depreciation. 1/ Depreciation charged to the income accounts should be based on the revalued gross fixed assets value. The surplus on revaluation should be credited to a revaluation reserve exempt from the capital gains tax; (vii) improving the accounting and auditing standards and practices in private enterprises and SEEs as well as a standardized accounting system for the banks; and (viii) introducing a system of floating interest rates for medium and long-term credits. 3.11 In view of the large role which the private sector will need to play in the medium-term, the measures mentioned above would need to be urgently undertaken to encourage private investment by increasing the availability, lowering the cost of non-preferential credit to the private sector, and establishing a more efficient banking sector. 1/ The Government has enacted this law early this year and has begun implementing it for the 1982 accounts. - 36 - C. Rationalization of Public Sector Investment: Size and Sectoral Strategies 1/ 3.12 The rationalization of public sector investment is critical to the success of Turkey's medium-term development strategy. Implied is an investment strategy that: (i) restrains the growth of public investment thus allowing the expansion of private investment without creating excessive pressures on domestic and external resources. The aim would be to restore the share of public to total fixed investment to its historical level of 50 percent by 1990 as against 60 percent in 1982; (ii) focuses public sector investments on high priority projects in infrastructure, agriculture and energy, with manufacturing increasingly left to the private sector; (iii) establishes rates of return criteria for all new investments while improving project evaluation methods; (iv) completes projects more quickly and makes provisions to concentrate the public investment program on a smaller number of projects; and (v) progressively raise the share of SEE investments out of their owm resources. 3.13 It must, however, be recognized that these objectives can only be attained over a number of years. The sheer size of the present program (including over 6000 projects), means it can only be modified to a limited extent in any single year. This problem is aggravated by the overhang of a large number of projects, many of uncertain merit, which cannot be fully funded given current resources. Despite recent efforts to trim the program, considerable work remains to be done. It is therefore most important that progressive annual targets be established with the framework of a medium-term strategy. Size of the Program 3.14 Public sector investments in 1982 registered a real growth of 0.8 percent as against an increase of 9.4 percent in 1981. Though an improvement over the previous years, this increase in public investment is still financed to some extent by private savings. Although the public investment-savings gap has declined from 10 percent in 1980 to about 4.3 percent of GNI' in 1982, it is still more than programmed. The target referred to in Chapter II calling for a reduction in the share of public investment to total investment to 50 percent in 1990, is essential for the full implementation of the outward-oriented strategy. The rationale behind avoidance of immediate drastic reductions in public investment is given below: 1/ This topic was the main focus of "Turkey: Public Sector Investment Review"; 3 Volumes, IBRD Report No. 3472-TU; December 7, 1981. - 37 - (i) the need to rehabilitate the transport (and others) infrastructure in order to support the export drive; (ii) an urgent need to remove bottlenecks in energy production; and (iii) the need to maintain the overall level of investment in the economy in view of the sluggishness in aggregate private investment. 3.15 The overriding concern would be to avoid "crowding out" the private sector. This implies that a greater proportion of public sector investments should be financed by public savings and that SEE investments in turn are not to be financed through subsidized credits. Sectoral Strategies 3.16 Behind the issue of public sector investment as a whole lies the question of sectoral strategies. An objective of the new structural adjustment policy is that the public sector should reduce its share in manufacturing and concentrate its investments in agriculture, energy and infrastructure. Thus for example, the rapid development of indigenous energy sources, solving the shortage of bulk transport facilities, and the infrastructure required for industries and agriculture, will continue to be a heavy burden on the Government's financial and managerial resources. D. External Trade Issues 3.17 Efficient exports along the lines of comparative advantage and encouraged by the application of a flexible exchange rate policy are essential prerequisites for the medium-term prospects delineated in the Base Case. Export Sustainability 1/ 3.18 Sustaining the growth of exports is central to the new development strategy. The 1981 export upsurge, albeit at a lower rate, seems to be continuing into 1982. Estimated data for 1982 show that exports were about 22 percent higher in dollar terms than those in 1981. In virtually all categories, exports continue to grow rapidly with industrial exports leading the way. The current incentive and exchange rate policies have worked well and may reflect a permanent change in the orientation of the Turkish economy. Exports of goods and nonfactor services as a percentage of GDP jumped from 7 percent in 1980 to 10 percent in 1981 (Table 3.1). Should this trend continue, the ratio should reach 16.8 percent by 1990. This would require an annual real growth rate of over 9.0 percent for 1983-90. In light of other countries' experiences, the projections appear feasible given the implementation of appropriate policies referred to in paras. 3.25 and 3.26. Turkey's manufacturing sector, which is expected to play a major role in expanding exports, is still very much domestically oriented. Also, manufactured exports should grow more rapidly than manufacturing output in order to exploit Turkey's comparative advantage, to attain economies of scale, and to participate in the international division of the production process through the manufacture of parts, components and accessories for assembly elsewhere. 1/ For a fuller discussion see Annex I. - 38 - 3.19 Some Turkish manufacturers have been exporting for years. They rely mostly on domestic sales, but like to export part of their production so as to maintain market contacts that are becoming more important to them when domestic demand is weak. This is a classic strategy of reducing risk by diversifying one's portfolio. The export boom of 1980 and 1981, however, clearly went beyond such considerations. For the most part, these new exports are not seen as a response to new opportunities for profit--rather, exporters say that they have been a necessary condition for survival in the face of weak domestic demand and intolerably high cost of credit for non-exporters. 3.20 The weak demand is confirmed by low capacity utilization rates, discussed in paras. 6 and 7 of Annex I. Difficulties and expenses entailed in laying off unneeded workers mean that almost all costs except commodity and energy inputs are fixed to the firm. In many sectors (textiles is a good example) domestic competition has depressed product prices. But even worse, the full cost of working capital credits (as of June 1982) is about 40 percent per year in real terms. (Nominal rates plus fees are about 75 percent to 80 percent, taking compensating balances into account). Few businesses can bear such charges for very long. So tht -availability of credit for exporters at around 40 percent nominal--about zero in real terms--is a crucial factor behind the export boom. 3.21 Even though the primary cause of the export boom is the "export or die" dilemma caused by weak domestic demand and very high financial costs for non-exporters, exporters are keenly aware that their profitability is increased considerably through a set of additional incentives. In addition to the cheaper working capital credits just mentioned, exporters consider the most important incentives to be (in order): (a) those affecting revenue: the exchange rate and tax rebates; (b) duty-free access to imported inputs, which is important to a minority of exporters; and (c) export requirements in exchange for cheap credit for investments. Simplification of procedures has also helped exporters. Table 3.1: EXPORTS FROM TURKEY AND COMPARATOR COUNTRIES Manufactures Manufacturing Exports of Goods share in Exports/ and Non-factor Merchandise Manufacturing Services/GDP Country GNP/Capita Exports Value Added (Dollars) ----------- (Percent)-------------------- 1980 1979 1979 1980 Philippines 690 35 23 20 Turkey 1,470 28 5 7 Brazil 2,050 39 10 9 Portugal 2,370 76 38 28 Turkish Data 1980 29 5 7 1981 40 16 10 Sources: Table 5 of Annex I; World Development Report, 1982. NOTE: Food, beverages, and tobacco products are excluded from manufactured export figures in all cases. - 39 - 3.22 In 1982, the Government's target of $3 billion of manufactured exports has been exceeded ($3.4 billion). Most enterprises interviewed by the mission in June expected such an outcome. The target was surpassed on account of weak domestic demand, continued high financial costs of non-exporters and no weakening of the export incentives. 3.23 As co longer-run export prospects, however, it is not clear how far an "export mentality" has spread and taken root in Turkish manufacturing, nor whether the present incentive structure is strong enough to continue to motivate exports when domestic demand revives. Even among the companies interviewed by the mission (which included many successful exporters), a significant minority said that they would reduce their exports (some to zero) if domestic demand revived and the interest rate differential were reduced. Many others intend to continue to export indefinitely, however, as insurance against future fluctuations in domestic demand. Nevertheless, these businessmen, and even more the bankers, officials of export trading companies, and officials of manufacturers' associations, were virtually unanimous in the view that more than half of Turkey's manufactured exports were not profitable enough to be worth the trouble in normal conditions. 3.24 Unfortunately, most of the information gathered by the mission on the relative profitability of export sales vs. domestic sales supports this view. In interviews, the mission obtained this information on 23 product lines. In six cases profits were higher on export sales, in six more there was no significant difference, and in 11 cases profits were higher on domestic sales. These estimates included all export incentives, and--again--it must be noted that they come from a set of firms that tend to be successful and important exporters. Of the 12 cases where export profits were said to be as high as or higher than on domestic sales, 4 interviewees mentioned that domestic prices were abnormally depressed. Managers of two export trading companies said that in general their clients made lower profits on exports than on domestic sales. Other information, from TSKB surveys and studies, shows that for four textile products, export profits (again, including incentives) were about equal to profits on domestic sales for three and higher for one; for five manufacturers of engineering goods, export profits were higher in two cases, about equal in one, and lower in two. 3.25 As local conditions become more prosperous, the time will come when incentives must be designed more carefully, if manufactured exports are to continue at the desired level. Under more normal conditions, the two "incentives" that are now the most important will lose much of their force: domestic demand will revive, and interest rates for non-exporters will fall. The indirect tax rebate will also weaken to some extent; the Government has already announced changes that will relate rebate amounts to value-added and (more closely) to taxes actually paid; this will reduce the amount of the rebate. Thus, in an environment where potential exporters enjoy stronger domestic demand and therefore will require reasonable profit margins on exports, Turkey will need to strengthen its incentive structure if exports are to continue. Such a structure would consist of: (i) continued lower-interest loans to exporters, perhaps for longer terms (e.g. 12 to 18 months). A separate program of multi-year credits for exporters of capital goods will also be necessary for Turkey to develop her considerable potential in that sector; - 40 - (ii) continued rebate of all indirect taxes; (iii) continued free access to imported inputs, free of duty; (iv) more clear and stable changes in policies, with changes not only less frequently, but also only after prior consultation and a period for industry to adjust; (v) continued progress in streamlining Government administrative procedures in dealing with private companies; (vi) strengthening supporting infrastructure including in telecommunications and financial institutions. An export promotion center could also be useful; (vii) implementing a system of export credit insurance; (viii) introducing a system of providing credits for indirect exporters; and (ix) most important of all, a foreign trade regime including a tariff policy that removes the bias, in incentive favoring the domestic market against exports. This depends on import protection and the exchange rate, as well as on explicit export incentives. 3.26 Management of a flexible exchange rate during the last two years has been a major incentive to exports. But the bias favoring the domestic market over exports is still too strong. This is reflected in a level of protection that is still too high. Since explicit export subsidies cannot be increased beyond present levels (because of their financial burden and because they may provoke retaliation), the practical solution would be a reduction in protection of domestically produced goods that compete with exports. 3.27 Transition to an incentive structure that will work in the long run should be undertak;en over the next two or three years, as domestic demand picks up. Assistance is restructuring should also be undertaken; firms need to acquire efficient technology, increase productivity, and continue to improve export marketing. 3.28 As regards markets and comparative advantage, it appears that Turkey's advantages in exporting manufactured products seem to be based on characteristics such as: (a) moderate to high weight or volume-to-value ratios; (b) competitive production costs based either on domestic agriculture, livestock, or minerals, or on moderately skilled but low-wage labor; (c) custom-made products or those produced in small batches; (d) moderately fast speed of delivery and communication; and (e) cultural or political affinity with the purchasing country. The mission's interviews thus confirm the Industrialization and Trade Strategy Report's conclusions on comparative advantage (paras. 5.55-5.87). 1/ 1/ Turkey: Industrialization and Trade Strategy. IBRD (Report No. 3641-TU). February 1982. - 41 - 3.29 In order to meet the target of industrial exports, promotion of research and product development is a priority task. This would permit, in particular, the exploitation of Turkey's long-term comparative advantages in the electrical and non-electrical machinery, machine tool, and electronics industries. The promotion of R&D could best be accomplished in the framework of a medium-term plan of science and technology that would also provide for the improved training of engineers and technicians. Apart from public programs, incentives for research and training by private industry would be necessary for this purpose. The Process of Import Liberalization 3.30 In order to reduce the existing bias favoring the domestic market against exports and to promote efficient investments in line with Turkey's comparative advantage, a policy of lowering import protection assumes greater importance. Nevertheless, from a desire to prevent any arbitrary disruption of scarce foreign exchange reserves as well as because of entrenched domestic forces dependent on protection and international trade restrictions, the Government's aim is to gradually liberalize imports. Hence, such a process should be carefully conceived and should draw upon the results of the ongoing protection studies in order to: (i) rationalize the existing tariff system; and (ii) gradually shift from a licensing system of import control to one relying on tariffs. 3.31 Import liberalization is a priority issue. The eventual pick-up of domestic demand will increase the profitability of production for the highly-protected domestic market at the expense of exports. Further, present levels of protection are not compatible with an outward orientation, and competition from imports is necessary to promote adjustment in domestic industry. 3.32 Parallel with the abolition of import licensing, existing excessively high tariffs need to be lowered. This may involve establishing a tariff ceiling, to be reached in annual installments over a transitional period of five years, and reducing inter-industry differences in tariff rates. Additional incentives may be granted to infant industries on a temporary basis. In addition, the administrative procedures for import liberalization should be streamlined. At present, there are too many independent agencies (Ministries of Commerce, Customs, Finance, and SPO) involved with the process. Foreign Exchange Reserve Policy 3.33 The favorable capital account developments in 1982 have led to some build-up of foreign exchange reserves. During the phase of structural adjustment, it may be prudent to accept a higher level of reserves to generate international confidence and security, particularly in view of the lump in debt repayments during the mid-1980s and of the uncertainties with regard to oil prices and the world economic outlook. The mission endorses this view with the following reservations: (i) the inflationary impact should be counteracted by appropriate monetary policies; - 42 - (ii) no postponement of import liberalization efforts, but a more systematic alternative to ad hoc, haphazard import liberalization; and (iii) the reserve level should be a function of debt management and the need to restore international confidence. Hence, a reserve build-up equivalent to finance about two to three months of imports would be appropriate and is assumed in the medium-term projections. Debt Management, Creditworthiness, and Access to Commercial Markets 3.34 Debt Management Issue. The level of past borrowings and the medium-term growth prospects underlying the Base Case indicate that: (i) Turkish debt servicing obligations will rise significantly in the mid to late 1980s, largely on account of the repayments of rescheduled debt (on an average of over $1 billion a year); and (ii) in light of anticipated reductions in concessional aid, Turkey would need greater access to medium and long-term credits from commercial sources starting in 1983-84. This will be dependent upon Turkey establishing her creditworthiness. 3.35 For these reasons, there is a need to formulate a set of clearly defined debt management policies. Short of this, the recent excellent performance on the external front may not restore adequate confidence among the international lenders. An essential prerequisite for debt management is establishing an up-to-date and accurate record of Turkey's total external debt. The rapid upsurge in borrowing from 1973 onward brought about a marked deterioration in the quality and coverage of debt statistics. This was exacerbated by the arrears build-up and subsequent implementation of successive rescheduling arrangements. The Ministry of Finance and State Economic Enterprises (SEEs) method of recording debt service payments i.e., at the time of transfer of Turkish lira counterpart funds worked well during periods of timely external payment but broke down completely when the appropriate foreign exchange transfers were not being made. 3.36 As the size and complexity of the loan file increased, the Turkish authorities recognized that the major obstacle faced in performing any meaningful debt analysis and in turn, formulating on overall debt management policy was the inability to compile and manipulate the available data rapidly and accurately. It was felt that this difficulty could be alleviated through the introduction of computerized data processing, techniques. Currently the computerized system is projected to go into operation by 1983-84. 3.37 From an institutional point of view, the coordination of all external borrowing needs to be systematically conducted. An initiation of a serious review of the external debt outstanding and its future servicing implications, as well as a continuous review of all applications from Turkish entities for external borrowing, are considered priority tasks for enabling the pursuance of a sound debt management policy. Even after reschedulings of public and publicly-guaranteed debt, a massive one of short-term commercial bank debts, the burden is very significant, given the hard terms offered to Turkey. This - 43 - burden may deter creditors from lending, unless Turkey develops and implements a responsible external debt management policy, to prevent new arrears and limit the volume and type of new obligations. These self-imposed limitations must be reconciled with further substantial capital inflows needed to resume viable growth. Borrowing Prospects and Access to Commercial Markets 3.38 Turkey's prospects for future borrowing appear good although it is unlikely that the level and composition of concessional medium and long-term (M<) commitments realized in 1980 will be repeated. The analysis of medium-term projections envisages a feasible growth path, which, from a creditworthiness point of view, does not overextend Turkey's capacity to borrow externally. Consequently, it was assumed that, given a conservative projected commitments on M< borrowing, disbursement of about $2.8 billion would be available by 1990. Turkey could turn to another $3.0 billion of yet unidentified sources to fulfill its foreign exchange requirements in 1990. However, medium-term private capital inflows, such as Eurocurrency loans, supplier credits and possibly foreign investment, will be contingent upon actual improvements in economic performance rather than promises. If Turkey vigorously diversifies its bilateral aid arrangements, and seeks larger contributions to match the scale of needs, a larger proportion of requirements can be met from this source. It is equally important that there be no net increase in short-term debt. Turkey will also have to cultivate and rely on commercial banks as much as on new official debt. Hence, prudent external debt management and a favorable response to it by the international financial community are critical for medium-term financial viability. 3.39 However, there is as yet little evidence to suggest large scale lending to Turkey by the commercial banks in the near future. Turkey's present borrowing strategy is designed to expand its banking relationships world-wide and to approach international markets in an orderly fashion when borrowing opportunities arise on terms and conditions considered attractive. Currently Turkey is expanding its banking ralations in the Middle East, where banks have shown interest in providing funds to f:.nance trade, covering the importation of oil and the export of agriculttral -ommodities and minerals. The Central Bank of Turkey signed a one-year agreement in July 1981 for $100 million at 1 percent over LIBOR with a syndication led by the Libyan Arab Bank for tobacco prefinancing. In January 1982, a six-month $70 million facility, again at 1 percent over LIBOR, for importation of Iraq oil was arranged by the Central Bank with the Kuwait Foreign Trading Contracting and Investment Company and the National Bank of Kuwait. Recently Turkey concluded a prefinancing of $200 million for the agricultural cooperatives through a syndicated loan with 27 banks participating. In addition, about $100 million is expected to be raised in March 1983 for Ipras to prefinance import of oil from Iraq (1 year loan at 1 percent over LIBOR). 3.40 Turkey's efforts to encourage commercial banks to provide financial support for specific projects, such as in the energy sector or to secure fresh financial credits of a medium-term nature have not yet resulted in any significant capital inflow from commercial banks, although some success is evident from the recent decision to borrow $200 million medium-term credit for balance of payments purposes from a syndicated loan under the coordination of Morgan Guaranty Trust Company. The only medium-term loan that Turkey has been - 44 - able to raise in the Euro-market since 1979 was the $76.5 million loan on behalf of the Turkish Airlines (TU,V) syndicated in early 1982. As mentioned earlier, very recently Morgan Guaranty has received a mandate from the Government to raise medium-term finance of about $200 million at 1 1/2 percent over LIBOR (maturity of 5 years with 3 years grace) for a loan to the Central Bank for balance of payments purposes. Given Turkey's recent economic performance and its potential medium-term prospects, Turkey should be in a position to tap more commercial loans. The medium-term projections in the Base Case assume commitments from commercial banks of about $120 million per year during 1984-85 and about $200 million per year during 1986-90. Moreover, the projections inidicate that Turkey would require an additional amount of as yet unidentified annual gross capital inflows of about $1.0-$2.8 billion during 1985-90 in order to close the anticipated balance of payments gap. Since we have been rather conservative in our projections of future loan commitments which show no appreciable increase in nominal terms from the 1981 level (around $2.0-$2.5 billion as against $2.0 billion in 1981) and a drastic reduction from the annual average level of $3.3 billion during 1975-77, some portions of the unidentified capital inflow will need to come from non-commercial bank sources, though at somewhere close to commercial terms. Still a significantL proportion of it will have to be borrowed from commercial banks. Hence, Turkey will need to borrow about $500 million - $1.0 billion a year from commercial banks during 1985-90. This is dependent upon Turkey pursuing not only sound economic management to reach its economic potential, but her ability to engender confidence among the commercial banks through timely and better reporting of external debt statistics and pursuing appropriate debt management policies. This would suggest that Turkey makes significant inroad into commercial markets for medium-term loans beginning 1983 which would ensure Turkey receiving the amount specified above during the 1983-90 period when sustained growth is resumed. Creditworthiness 3.41 Developments in Turkey's external borrowing over the past few years have probably been as dramatic as her export performance. Enormous inflows of short-term capital in the years 1976-77 ($6.1 billion in 1977, $7.2 billion in 1978) was followed by a massive rescheduling and restructuring operation involving both official source debt and commercial borrowings with high levels of "emergency aid" and other medium and long-term assistance from 1978 onwards. 3.42 Following the resolution of the 1978 debt crisis, Turkey pursued a very conservative policy of external borrowing which was restricted almost entirely to long-term borrowing. Much of this was arranged through the OECD Consortium for Turkey and was extended on concessional terms. Also between 1978-1980 Turkey rescheduled some $9.2 billion outstanding obligations through a series of reschedluling arrangements concluded with official and commercial creditors. Approximately $6.0 billion of short-term debt, including $2.6 billion in convertible Turkish lira deposits and bankers credits and $1.2 billion of non-guaranteed suppliers credits were consolidated into medium-term loans or partially converted into Turkish lira obligations. As a result of such a mELjor restructuring, short-term debt as a percentage of total debt outstanding fell from 51 percent in 1978 to 12.5 percent in 1981. Inflows were mostly from official sources: major creditors being the OECD countries, the World Bank and the IMF. Of the total debt outstanding at end 1981, 87 percent constituted medium and long-term debt. - 45 - 3.43 As shown in Table 3.2, in the Base Case, debt outstanding and disbursed as a percent of GDP is projected to rise to 31.0 percent in 1982 and fall to 29.2 percent in 1985 and 26.4 percent in 1990, from 28.0 percent in 1981. 3.44 In order to avoid history repeating itself, the binding constraint imposed on the Base Case projections allows for a range of manageable debt service ratio between 18 percent - 20 percent during 1984-1990. Accordingly, the debt service ratio is projected to decrease from about 24 percent in 1982 largely as a result of a large repayment of previously rescheduled debt under the earlier OECD agreements which became due and payable, 19 percent in 1984, and then increase to 20.6 percent in 1985 (again on account of repayments of rescheduled debt) before falling to about 18 percent in 1990. Table 3.2: INTERNATIONAL LIQUIDITY AND DEBT PROFILE, 1978-1990 BASE CASE (In millions of US dollars) Actual Est. Projected 1978 1979 1980 1981 1982 1985 1990 Debt outstanding & disbursed 1/ 14078 16064 16431 16324 16818 18347 25688 Official 6322 10942 8328 9354 10103 10930 10687 Private 2/ 557 630 4852 4859 4604 5395 11390 Short-Term 7199 4492 2480 2111 2111 2111 3611 Debt outstanding/GDP (%) 26.8 26.8 29.0 28.0 31.0 29.2 26.4 Reserve level 874 800 1209 1876 2076 2138 4573 (number of months' imports) (2) (2) (3) (2) (2) (2) (2) Reserve level/total debt outstanding (%) 6.2 5.0 7.4 11.5 12.0 12.0 18.0 Percent growth in: Exports of goods 32.1 -20.4 0.6 79.0 23.0 9.0 9.7 Total debt outstanding 28.4 14.1 2.3 -0.5 3.0 4.0 9.0 Total debt service 27.3 29.5 3.3 17.3 93.7 23.0 13.0 Ratios: Debt service ratio (%) 3/ 13.0 13.9 17.0 13.8 24.2 20.6 18.1 Debt service/GDP (%) 1.0 1.1 1.3 2.1 4.4 5.0 5.6 1/ Medium and long-term debt and short-term, excluding IMF. 2/ Including private guaranteed and nonguaranteed gap fill for the projected years. _/ Total debt service as % of export of goods & NFS + workers' remittances. Source: Ministry of Finance, Central Bank of Turkey and IBRD projections. - 46 - 3.45 Although the projected debt service would be relatively high as compared to past Levels (5.0 percent of GDP in 1985 as against 1.3 percent of GDP in 1980), the debt service ratio is manageable on account of the sustainability of export earnings and maintenance of workers' remittances at the present level. The projections underline the sensitivity of Turkish prospects to the continued growth of exports. The conclusions from the model runs highlight thes breathing space given by the debt rescheduling and the need to implement borrowing policies which will enable the financing of the external accounts when the debt payments which have been rescheduled start to fall due in the mid to late 1980s. They also confirm the continued importance of constraining the growth of the energy bill through development of domestic resources and reasonable pricing policies. Hence, the debt burden should remain manageable, provided current policies are successfully implemented, the export drive is sustained, and Turkey manages to stage a significant re-entry into the medium-tesrm commercial markets. Given sound economic and financial management, Turkey is expected to build up its creditworthiness through and beyond the 1983-1'390 period. 3.46 Turkey's creditworthiness is assumed to be maintained even in the "Downside Risk" case as discussed in Chapter II. On the assumption of adherence to prudent debt policies, the impact of negative influences would mainly affect GDP growth which in that case is assumed to be 4.7 percent during 1982-1990. The debt service would rise to a level of 20.8 percent in 1985 and fall to 20.6 percent in 1990 (as against 20.6 percent and 18.1 percent in the corresponding years of the Base Case). Turkey's external debt outstanding by 1990 is expected to reach $27.8 billion ($25.7 billion in the Base Case). The required capital to finance the current deficit would be higher by $1.0 bi:Llion in 1990 as compared to the Base Case. Hence, in the "Downside Risk" case there is a much greater need for concessionary financing, even after allowing for a downward adjustment in the growth path. In other words, in the "Downside Risk" case, Turkey's creditworthiness will be maintained if the Government allows for no pick up of growth from the present level. Launching a high growth strategy in such a situation would call for an unmanageable debt burden, and the situation could be a repeat of the late 1970s. E. Unemployment L/ 3.47 A modest decrease in the population growth rate, and fertility rate, increased worker emigration, and resumption of GDP growth have not prevented unemployment from rising. Large idle capacity and low productivity have allowed GDP to grow with little impact on employment is expected to increase from 2.3 million in 1981 to 2.6 million in 1982, which corresponds to an unemployment rate of around 15-16 percent. 3.48 The unemployment issue can be tackled on a derived demand basis in the short run, as the stabilization program requires limiting public employment additions and moreover is not likely to lead to an upsurge in employment opportunities through private sector investments in industry and housing. 1/ This issue wiLl be the focus of a forthcoming Bank mission. - 47 - 3.49 This is a longer term issue that requires serious study and has not been addressed in this report. Over the medium term, the unemployment problem will be reduced if there is a substantial economic growth resulting from increased private investment and exports. Success in pursuing the new development strategy hinges upon the maintenance of the policy of real positive interest rates and encouragement of exports, both of which should reduce the bias in favor of high capital-intensive investments and promote employment. In this sense, unemployment must be tackled largely through increasing opportunities in the private sector (e.g., export industries, tourism, housing, contractors' activities abroad, workers emigrating to foreign countries, and increasing opportunities in industries aiming to meet domestic demand once the economy reaches a sustained growth path). F. Private Manufacturing Investment Outlook 1/ 3.50 The private sector is expected to play a key role in the Government's new development strategy in supporting export growth and employment. In order to generate the Base Case medium-term projections, the mission assumes not only a revival of private sector investment in manufacturing after stabilization, but also a dynamic leading sector role. In fact, a growth of private investment in manufacturing of about 10.5 percent per annum during 1983-1990 is a sine qua non for achieving the growth targets for not only manufactured exports but also the resumption of the growth process. 3.51 The economic and political environment prevailing in Turkey since 1977, has had an adverse impact on private manufacturing investments which declined by over 33 percent in real terms during 1978-1981, and are now below the level attained in 1973. While in the previous years the key constraints were low capacity utilZzation due to shortages of imported inputs, power ailures and labor disputes. At present, the major difficulties affecting the private manufacturing sector include high real cost of credit, weak domestic demand, scarcity of funds, and low utilization of capacity. Reported capacity utilization rates are currently in the 55-65 percent range. Even allowing for alleged overstatement of capacities by some 10 percent, the present situation is clearly not conducive to investment. This compares to reported utilization above 80 percent, from the same sources, in the late 1970s. 3.52 The stated policy of the Turkish Government is to reduce the role of the public enterprises, and to rely more on the private manufacturing sector. It would be a mistake to interpret the present low levels of private investment as a reason to reverse this policy. The private sector's behavior is the predictable and rational response to the effects of the anti-inflationary program in effect since January 1980. If and when demand picks up, and if credit is available at reasonable rates, investment will revive. Private manufacturers' successful performance in export markets, which are especially difficult during an almost world-wide recession, is ample evidence of the capabilities of Turkish private industry. 1/ This section draws heavily upon the work done by the members of the mission who reviewed the private manufacturing sector on the basis of firm-level interviews. Their views are put together in Annex I on "Private Manufacturing Sector". - 48 - Policy Requirements to Encourage Private Investment 3.53 The major issues to be resolved by the Government for a healthy growth of private investment in manufacturing are related to the reform of the financial sector which was discussed earlier in Section B. More specifically these are; (a) a reduction in the real interest rates for non-preferential borrowing; (b) the need to improve the availability of medium and long-term credits; (c) the need to develop Turkish capital markets in order to help firms to have access to new sources of equity; (d) the need to reform the banking system especially to introduce a review of loan portfolio of banks by the Ministry of Finance and the Central Bank, and satisfactory resolution of the foreign exchange risk of credits denominiated in foreign currencies; and (e) a proper revaluation of physical assets. The analysis of the medium-term framework in the report assumes that most of these issues will be satisfactorily resolved. These issues are discussed below. 3.54 Interest Rates: The cost of working capital for companies without access to preferential credits in June 1982 was about 80 percent per year, with an inflation running between 30 to 40 percent. Exporters have access to much cheaper credit, but companies that cannot export much of their production face an intolerable interest rate burden. The high costs of finance are compounded by weak demand and difficulty in laying off unnecessary employees, except in the areas where demand is buoyant--heavy electricals, transport equipment and food products. Continuation of the present high cost of working capital in conditions of depressed demand will inevitably lead to even-increasing baLnkruptcies and buy-outs of companies in financial difficulties. This, in turn, could lead to increased unemployment as well as increased industrial concentration. 3.55 The report recognizes that inflation had to be reduced in Turkey, and that this meant limiting growth of credits which, in turn, implies high interest rates. But it is certain that real rates as high as 30 percent on an average are neither needed nor sustainable. The Government wishes to let inefficient and poorly managed companies disappear, but such high interest costs will harm sound companies too. 3.56 As discussed in para. 3.10, the interest rates are high, in part, because of the hig;h costs of intermediation. The medium-term framework used in the report assumes that substantial reductions of some of these cost factors will be made. Other useful steps could include: (i) reallocation of some credit from SEEs to private borrowers; (ii) equalization of interest rates as between SEEs and private borrowers; and (iii) changing loan contracts to include monetary correction on the principal amount. - 49 - 3.57 Availability of Medium and Long-Term Credit: As mentioned earlier in the discussion of reforms in the financial sector, a second problem, which is more general and longer-run, is the need to improve the availability of medium and long-term credits and the whole system by which they are allocated. Medium and long-term credits are granted mostly by commercial banks and by development banks of which TSKB is the most important in the private sector. Commercial banks are generally dominated by industrial holding groups and, although they are required by law to allocate at least 20 percent of their portfolio to medium and long-term credits, most have been able to fulfill this obligation with credits to enterprises in their own holdings. Even the more independent commercial banks--including particularly Is Bank, the largest commercial bank--have acquired significant industrial holdings as a result of the current financial restructuring, which prejudices their ability to allocate credits impartially. Private sector development banks offer an alternative but their role is modest (TSKB and SYKB combined extend perhaps 10 percent of the medium and long-term credit to the private sector). Moreover, the usefulness of the development banks has been declining because of the growing aversion of investors to borrowing in foreign exchange (discussed later) and the difficulty they have had in mobilizing lira resources. Specific issues which require immediate government attention include: (i) ways of attracting more financial resources to investment and development banks by encouraging bond issues, and the general question of what role they should play in the future; (ii) the need for introduction of a system of floating interest rates on medium and long-term credits in accordance with changes in inflation rates; (iii) the elimination of subsidies from the Interest Rate Rebate Fund for commercial bank lending to SEEs. This will increase the efficiency of the financial markets and allow equal competition between the public and the private sector; and (iv) the reform of the complex system of selective credits to the private sector which imposes a burden on non-preferential borrowers through charges that directly or indirectly finance the subsidized credits and which may reduce competition among financial institutions, distort the allocation of resources, and may involve use of part of the subsidized credits for purposes for which they are not intended. This will involve phased reduction in the disparity of interest rates applied to preferential credits. 3.58 Development of Capital Markets and Revaluation of Physical Assets: A third, closely related longer-run problem is the need to develop Turkish capital markets. There is a stock exchange but it does almost no business; bonds and stocks that are traded are generally placed through securities dealers who until passage of the Capital Market Law in early 1982 were wholly unregulated. Fixed-income securities markets are weak and largely devoted to short-term paper. Improvement of the capital markets along the lines suggested earlier under Section B will help firms get access to additional sources of equity and thus help ameliorate the serious undercapitalization that now exists. - 50 - 3.59 The problem of undercapitalization would also be eased by allowing firms to revalue their assets in line with inflation, without suffering the present capital gains tax on the increase in book value. This would allow for more realistic depreciation allowances and profit figures. The Government most recently has considered measures to allow only a single revaluation to make up for past erosion, but no action has yet been taken. 1/ What is needed is to go beyond such a measure, and allow for future revaluation on a continuous basis in line with inflation that is actually experienced. Given the levels of inflation that are forecast in Turkey, the lack of such a mechanism, by failing to allow sufficient depreciation, amounts to a significant tax on capital. 3.60 Reform of the Banking System - Review of Loan Portfolio of Banks by the Ministry of Finance and the Central Bank: The recent developments point to the need for going further with the reform of the financial system. This is because the continued maintenance of high real interest rates creates liquidity problems and threatens the viability of a number of industrial enterprises and several banks. 3.61 High real interest rates are in part caused by credit demands owing to the refinancing of existing loans, with interest payments added. Since the banks have to add to their reserves as they increase their loans to existing borrowers in nominal (although not in real) terms, the availability of credit to new borrowers is reduced. At the same time, a number of these loans continue to be refinanced without expectations for repayments. 3.62 Unless action is taken, the situation is bound to deteriorate further, increasing liquidity problems in Turkey and eventually affecting the solvency of firms as their debt-equity ratio deteriorates. Hence there would be need for the long-promised reform of the banking system. Such a reform could include a review of the loan portfolio of banks by the Ministry of Finance and the Central Bank, with a view to establishing reserves for bad debts; strengthening banks through consolidation, and making a start in reducing ties between banks and industrial groupings. In turn, the banks could give help to enterprises that are in financial difficulties but are basically sound. 3.63 Foreign Exchange Risk: A final problem in the financial area is the very strong aversion of borrowers to credits denominated in foreign currencies. The removal of the foreign exchange risk insurance scheme in 1978 (initiated in 1977) and the substantial devaluation in 1980 are very fresh in borrowers' minds, and almost all industrialists told the mission of their dread of further borrowing in anything but lira. TSKB staff confirmed the prevalence of this attitude. The initial recommendation of the Financial Sector Mission calls for the creation of a Fund to provide exchange rate guarantees in foreign currency. Such a Fund would be financed by the commissions paid by the borrowers seeking the 1/ The Government has recently enacted such a law. - 51 - foreign exchange risk guarantee. The commissions should correspond to the difference between the interest rate of each foreign loan and the floating interest rate proposed by the mission, plus a spread to compensate for long maturities. However, there may be risks that such commissions would not be enough to ensure the solvency of the Fund. Prospects for Private Manufacturing Investment 3.64 Given the financial difficulties outlined above, the iimnediate outlook for a strong revival of private investment in manufacturing is not too encouraging, hence the mecdium-term prospects outlined in the report are clouded with uncertainties. The prospects of a strong revival of private manufacturing investment, however, is possible if appropriate policies discussed in the previous section are undertaken. These are in addition to the reform measures introcluced since January 1980 and the SEE reforms discussed in Section B. 3.65 Turkey's industri'alists--owners, managers, and workers--have so far responded well to the changes in economic policies introduced since 1980. Costs are being cut, inefficient operations are being curtailed, and exports have greatly increased. If interest rates are now gradually eased, if export incentives remain strong, and if a bit more import competition is allowed as domestic demand revives, l:hen there is every possibility of a revival of the private manufacturing secl:or. Turkey's industrial plants, work force, and managers must now be induced to grow in quality to increase their efficiency and productivity through greater price competition and gradual increase in competition with imports. G. New Role of Agriculture 1/ 3.66 The overall GDP growth projected in the medium-term crucially depends on the maintainence of an agricultural value-added growth rate of 3.1 percent per annum during the period 1983-1990 compared with 3.3 percent average annual growth during 1972-1979 and 1.0 percent during 1980-1981. Hence, the challenges for the agricultural sector over the medium-term are considerable. The Agricultural Sector Study indicated limited possibilities for growth through expansion of area or of livestock numbers since the latter was not associated with significant improvement in animal husbandry practices or productivity. Hence growth must now increasingly come from higher productivity and through a crop mix which better reflects Turkey's comparative advantage. The outward orientation would include modifying rigid self-sufficiency in all products as a goal, and increasing agricultural exports while allowing for food imports as necessary. In pursuing this policy, the Government will ensure that the objectives of its self-sufficiency policies are not endangered. 3.67 In line with the new development strategy, there is an urgent need for policy and institutional reforms in the agricultural credit system. Currently the system suffers from a serious waste of resources and inefficiency. The negative real rate of interest on agricultural credit encourages its misuse, and little is actually reaching the small and medium 1/ This is the main focus of IBRD: Agriculture Sector Study expected to be published in June 1983. - 52 - scale farmers. In order to increase the availability of agricultural credit and encourage its more efficient use, there should be a reform of the credit system, a reduction of subsidy on short-term lending, improving the administration and accountability of the sales cooperatives and segregate their financing from the Agricultural Bank (TCZB), making available agricultural credLit rediscount facilities to other financial institutions and examining ways to promote village level banking institutions. H. Additional Pclicy Concerns in the Medium-Term 3.68 As Turkey pursues its new development strategy, a number of issues that have been neglected, given the necessary preoccupation with short-run problems in the last few years, will need to be included in a policy agenda for the medium-term. These include: (i) Productivity Growth. There is evidence from cross-country comparisons that the pursuit of an open development strategy is associated with more rapid growth in total factor productivity. Turkey starts on this new path with a large and sophisticated industrial sector which has proven capable of responding to the shift in incentives and playing a leading role in the growth of exports. The development of the industrial base and especially of technologically advanced sectors has long been a major goal of Turkish economic policy. Given the current industrial base, the shift to an outward-looking development strategy is entirely consistent with this emphasis. The opening up of export markets and the liberalization of imports provides opportunities for transfers of new technologies that have clearly benefitted countries which have pursued this strategy. However, the links to increased productivity growth are not necessarily automatic and it is important for policymakers to consider the mechanisms involved. (ii) Regional Development. The issue of regional development is to reaffirm the importance of the social costs associated with the austerity program, the stabilization effort and the major change in the development strategy from import substitution to export expansion. This is a medium-term issue to be addressed in the mid to late 1980s, on the assumption that a return to a "normal" growth path capable of absorbing the unemployed will also give the Government the necessary latitude to develop regional policies designed to mitigate, in the later years, the social hardships incurred in the early 1980s. I. Concluding Reimarks 3.69 The optimistic but feasible medium-term prospects outlined in the report are derived on the assumptions of export sustainability and a revival in private manufacturing investment accompanied by fiscal and monetary - 53 - discipline. Besides a continuation of the policies introduced since January 1980, this implies a very significant and immediate progress in key areas of structural adjustment such as SEE reforms, financial and banking reforms, import liberalization and further rationalization of public sector investment. Without these adjustments, it would seem difficult to envisage a rapid development of an efficient private sector, on which the new development strategy essentially hinges. 3.70 The combination of exchange rate and import liberalization policies together with appropriate incomes policies and further price liberalization should ensure continued progress towards expanded trade and outward orientation in the Turkish economy. Together with the proposed reforms in the financial system, they would also help in promoting private investment and increasing the scope of efficient operation of market forces. 3.71 Given an appropriate policy framework, therefore, and given reasonable support from the international capital markets, there are grounds for optimism in that the most pronounced disequilibria in the economy could be eased before 1985, thereby laying a firm basis for faster growth and significant progress towards the process of structural change in the economy. It would be desirable to let the initial demand stimulus come from the export sector, as has been the qovernment's policy in the last three years rather than from domestic demand; in particular this is likely to imply continued tight monetary and fiscal controls and an appropriate incomes policy through 1984. The continued commitment by Turkey to this policy framework and its implementation can be expected to induce the international markets to maintain the flow of resources that will help the economy to achieve higher capacity and growth levels while proceeding with its structural adjustment policies. I I - I 25' 30- 35- 40 45' BULGARIA ,, -- , - ckSe r KIRKLARELI ,-.s R ~~*/ wJW- r ~~~~~~r Zonguldak KASTAMONU SSINOP /_ , <<,IS EKIRAG0STANBUL pyZONGULDAK /)t /)\ Artvin) ()j ~ ~ ~ ~ ~ ---Xv} ? 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Группа Всемирного банка · Pre-2003 Economic or Sector Report
Turkey - Country economic memorandum : recent economic development and medium-term prospects (Vol. 1 of 2) : Main report
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Pre-2003 Economic or Sector Report
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