Assessment and recommendations
Over the past two decades Turkey has successfully shifted to a growth strategy based on open and competitive markets. However, recurrent macroeconomic instabilities slowed down trend growth. The recovery from the 2001 crisis has brought an unprecedented period of high growth and the first palpable signs of sustained catch-up and convergence. Currently Turkey is in the difficult transition period from a successful exit from "post-crisis recovery" to a path of sustainable high growth.
New challenges facing the Turkish economy
Over the past two decades Turkey has successfully implemented a growth strategy based on competitive markets. The strategy nurtured a highly dynamic and vibrant private business sector, which started to make much more effective use of global capital, technology and market resources. However, this new growth trajectory remained vulnerable to deep and recurrent macroeconomic shocks. After the most severe of a succession of "boom and bust" cycles in 2001, a far-reaching fiscal, monetary and institutional reform package was put in place. A steady acceleration in economic growth followed, with an average growth rate of nearly 7% per year over the period 2002-07, confirmed by the latest GDP revisions. Large numbers of new jobs were created in industry and services, together with a spectacular decline in inflation. Fiscal balances improved remarkably and the public debt ratio was put on a steadily declining path.
Shifting to a pro-growth fiscal strategy
Following six years of very tight fiscal policies, which contributed to the restoration of macroeconomic stability, debt sustainability and investor confidence after the 2001 crisis, Turkey is faced with a fiscal policy challenge: how to: i) preserve a rigorous fiscal policy stance; while ii) both improving the quality and cost-efficiency of key public services and developing the country’s infrastructure; and iii) simultaneously reducing the most distortive aspects of the Turkish tax system. In response to this challenge the government is trying to develop a new pro-growth fiscal strategy. As the Stand-By Arrangement with the IMF – which formed a decisive anchor for fiscal policy since 2001 – expired in mid-2008, Turkey faces the task of putting in place a suitable macroeconomic and institutional framework which would preserve the credibility gained under IMF surveillance, while delivering the needed changes in revenue and public expenditure structures.
Monetary policy: facing the challenges
Monetary policy has been one of the main pillars of the post-2001 stabilisation programme. The Central Bank was made an operationally independent institution with a legal mandate to achieve price stability. Fiscal consolidation backed monetary policy, reducing fiscal dominance and reinforcing the independence (the capacity to adjust interest rates independently in order to meet policy objectives) of the Central Bank. Improved fundamentals coupled with a benign global environment have led to a reduction in the risk premium, attracting strong capital inflows and triggering currency appreciation, which also helped with disinflation. Headline inflation fell from around 70% at the end of 2001 to 7.7% by the end of 2005.
Enhancing competitiveness by fostering the growth of the formal sector
The Turkish business sector’s successful post-crisis performance has come under strain. Mounting competition from low-cost countries and strong real currency appreciation – until the early months of 2008 – have together undermined the performance of the trade-exposed sector, in particular of the segments dependent on low-skilled labour and domestic inputs. The resulting competitive squeeze gradually spilled-over to trade-sheltered activities, slowing down GDP growth.
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