Turkey - Challenges for adjustment (Vol. 2 of 3) : Annexes

Report No. 15076-TU Turkey Challenges for Adjustment (In Three VlIuLMIs) Voluic 11: Annexes April 1, 1996 COuntrv Operations Division Cou ntrv Departniunt I Europe and Central Asia Region Document of the World Bank  CURRENCY EQUIVALENTS Currency Unit = Turkish Lira (TL) Turkish Lira per US dollar 1992 (average) 6,872 1993 (average) 10,984 1994 (average) 29,608 1995 (average) 45,731 December 31, 1995 61,054 FISCAL YEAR January 1 - December 31  TURKEY: COUNTRY ECONOMIC MEMORANDUM ANNEXES TABLE OF CONTENTS Page ANNEX I: HoW DESTRUCTIVE IS HIGH INFLATION? ......................................1 ANNEX fl-A: IS TURKEY'S CURRENT FISCAL STANCE SUSTAINABLE? USING THE FINANCEABLE DEFICIT APPROACH ................................................. 3 A. Financeable Deficits And Core Inflation ..................................................... 3 B. Brief On Theory And Model .....................................................3 C. Current Fiscal Stance: More Adjustment is Needed ......................... ...............4 D. The Cost Of Delays ..........6..........................................6 E. Financial Sector Liberalization .....................................................7 F. Macroeconomic Impact Of Foreign Exchange Deposits ..................................7 G. Conclusion .....................................................9 ANNEX 11-B: FISCAL POLICY, INFLATION, AND FINANCIAL SECTOR REFORM: A QUANTITATIVE APPROACH To FISCAL POLICY ........................................... 10 A. INTRODUCTION .................................................... 10 B. ANALYTICAL FRAMEWORK .................................................... 10 Fiscal Deficits, Money Creation And Debt .................................................... 10 Revenue from Monetarization and the Structure of the Financial Sector .................................................... 13 Creditworthiness and the Limits on Foreign Debt Issue ................................. 14 Putting It All Together: On The Design Of Consistent Fiscal Policies .................................................... 15 C. ESTIMATION OF BASE MONEY DEMAND .................................................... 16 D. PARAMETERIZATION OF THE BASE RUN ..................................................... 18 ANNEX r-A: ECONOMIC UIPLICATIONS FOR TURKEY OF A CUSTOMS UNION WIT THE EUROPEAN UNION: A QUANTITATIVE BASED POLICY ANALYSIS ............ 22 A. RESULTS FOR THE CUSTOMS UNION ..................................................... 22 B. REVENUE REPLACEMENT .................................................... 26 C. ADDmTIONAL UNILATERAL MEASURES .................................................... 27 Reduction In Agricultural Tariffs .......................... .......................... 27 Removal Of Export Subsidies To Third Countries ......................... ............... 27 Removal Of All Subsidies Except The VAT .................................................. 28  Page ANNEX i-B: DOCUMENTATION OF CGE MODEL DEVELOPED TO ANALYZE EFFECTS OF CUSTOMS UNION ............................ 31 A. GENERAL MODEL STRUCTURE ............................................. 31 B. EMPIRICAL IMLEMENTATION FOR TURKEY ............................................. 32 Systematic Sensitivity Analysis ............................................ 39 REFERENCES ............................................ 46 TABLES AND FIGURES ANNEX I: Figure 1: Inflation and Per Capita Growth: 1962-92 ............................................ 1 Table 1: Inflation Crisis: Growth Recovers After Stabilization ............................. 2 ANNEXH1-A: Table 1: Summary of Model Results: Financeable Fiscal Balances Core Inflation ............................................ 5 Table 2: Reserve Requirement (RR) on FX and Time Deposits ............................ 7 Table 3: Macroeconomic Impact of FX Deposits ............................................ 8 Figure 1: Cost of Delayed Adustment ............................................ 6 ANNEX II-B: Table 1: The Estimates of the Financial Sector Portfolio Model for Turkey . 17 Table 2: Implied Long Run Coefficients of the Portfolio Model for Turkey . 18 Table 3: Money Stock Data .18 Table 4: Domestic Debt of the Public Sector, 1986-94 .20 Table 5: Net Foreign Exchange Liabilities of Public Sector .21 ANNEX rn-A: Table 1: Impact of the Customs Union with the European Union on Turkey Full and Decomposed Effects .29 Table 2: Impact of Unilateral Turkish Policy Choices to Optimize Customs Union Implementation .30 ANNEX rn-B: Table 1: Production Sectors .33 Table 2: Factors of Production .34 Table 3: Percentage Tax and Subsidy Rates in the Base Model (Net Basis) . 35 Table 4: Base Model Elasticities for Each Sector .38 Table 5: Results of Sensitivity Analysis .40 Table 6: The cost Structure of Domestic Production .41 Table 7: Production and Trade .42 Table 8: Imports Volumes, Shares, and Rates of Production .43 Table 9: Export Volumes, Shares, and Rates of Production .44 Table 10: The Composition of Domestic Demand . .45  ANNEX I How DESTRUCTIVE Is HIGH INFIATION?l 'as inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery. 'John Maynard Keynes. 1. After two decades of world-wide inflation amid lower growth, the industrial world along with most developing countries have come to appreciate that Keynes' nightmarish image of inflation out of control was not far from reality and low inflation is again becoming the primary objective of policy makers worldwide. The transition from high inflation to relative price stability, while not universal, has been widespread and dramatic. Brazil, one of the last bastions of very high inflation in Latin America, has recently joined the region's other successful stabilizers (Bolivia, Chile, Mexico, Argentine and Peru), and the number of countries in Eastern and Central Europe stabilizing from the post-collapse, hyperinflation explosion is gradually increasing. This widespread move towards relative price stability leaves behind a number of interesting questions: Why is it that the prevailing view in 1950s and 1960s, that the growth costs of inflation are not serious and, indeed, that some inflation is good for growth, has today been discarded? At what level does inflation become detrimental to growth ? Why worry about low or moderate inflation if the growth costs are not apparent? Even if high inflation is bad for growth, doesn't inflation stabilization itself lead to severe and yigure 1 prolonged recession? Inflation and Per Capita Gsrwtb 1960-92 (pooled annuaI observations, 127 coumtries) 2. A recent 4/ World Bank study 4 T-M a (cit.) of inflation and I 0c/o]U- H *_ growth in 127 j -2%- l countries, from 1960 r, 4%- to 1992 shows a _____ close association _ a