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  Assessment and Recommendations

  A severe banking and currency crisis in late 2000 and early 2001 caused the collapse of the three-year exchangerate based stabilisation programme only 14 months after its launch. The crawling peg was abandoned and the currency floated on 22 February 2001. It immediately fell by about one-third, and ultimately by almost two-thirds, against both the dollar and the euro. A new programme was presented initially in May 2001 and was further elaborated and refined during the course of the year and into 2002. It gained IMF support, with a commitment of new funding in Autumn 2001, followed by a substantial disbursement in February 2002. The new programme represents a deeper attempt than previous ones to address the fundamental weaknesses in the economy. Hence, key structural reforms placed a strong focus on public sector reform, building a sound banking sector, and liberalising markets for private sector–led growth. Because of the large fiscal costs for the banking sector clean–up, and the resulting jump in the public debt stock, the fiscal targets were tightened. And with the need for a new nominal anchor, monetary policy was foreseen as evolving toward a regime of formal inflation targeting by an independent Central Bank...

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  Macroeconomic Developments

  After a severe financial crisis and deep recession in 2001, Turkey’s policy goal is to enter a sustained recovery while taking measures to address the root causes of the crisis. The underlying reasons for the crisis had been building over the previous decade, notably a fragile banking system, weaknesses in the structural fiscal adjustment, as well as contagion effects from financial crises elsewhere. Against this background, a political dispute with a swelling current account deficit triggered the collapse of the three-year exchange-rate based stabilisation programme in February 2001, only 14 months after its launch. The crawling peg for the Turkish lira was abandoned and real interest rates skyrocketed, precipitating a banking crisis, which was followed by a deep recession accompanied by higher inflation and rising unemployment. A strengthened programme, backed by substantial international financial support, is intended to permit a gradual return of confidence, a sounder banking system and easing in financial market conditions, while the deep recession and a newly independent Central Bank have facilitated a rapid return to the disinflation path. Early signs of an inventory and export led recovery appeared in 2002. However, renewed political tensions in mid-2002 sparked a brief turmoil in financial markets, and may have interrupted the improving trend, while persisting market concerns about the continuity of the programme because of early elections have subsequently kept the sovereign risk premium at high levels. On the other hand, appropriate economic policies remain in place while recent political developments represent not only risks but also opportunities to show that ownership of the programme is shared by all the political parties garnering public support and that newly established institutional structures for economic management are robust to changes in government...

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  Macroeconomic Policies

  In recent decades, the Turkish economy has been marked by short spurts of growth followed by financial crises, then by stabilisation policies attempting to restore growth. Average growth rates have been on a downward trend, and year-toyear rates have become increasingly volatile. Furthermore, Turkey is now the only major emerging country which has failed to bring inflation firmly under control. This poor performance has reflected pervasive structural rigidities, weak public finances and low policy credibility, combined with a poorly supervised and weak banking sector suffering from both low capital adequacy and uncovered shortterm exchange rate positions...

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  Banking System Restructuring in the Context of Macroeconomic Stabilisation

  A weak banking system was a root cause of the crisis that ended the December 1999 stabilisation programme and led to a new series of IMF packages. The quasi-currency board rules supporting the exchange rate-based disinflation attempt exacerbated problems of currency and maturity mismatch in the banking system, leaving it highly vulnerable to the shifts in international investor sentiment that occurred after mid-2000. The success of the new programme and sustained recovery are unlikely without significant reform of the banking system, difficult though that may be in a crisis. Central Bank inflation targeting cannot work well if a risk-exposed, fragile banking system constrains interest rate policy adjustments in either direction. Conversely, a healthy banking system requires macro stability, as high inflation and a large public debt currently distort banking incentives. Achieving durably low inflation would moreover allow Turkish agents to issue more debt denominated in their own currency and at longer maturities, greatly enhancing stability of the financial system. Disinflation and banking reform thus go hand in hand, an important strength of the current programme...

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  Structural Reforms for a New Role of the Public Sector in the Market Economy

  During the past two decades, Turkey has worked hard to open its economy to international competition and to integrate its product and financial sectors in international markets. However, a similarly deep reform of its institutions has been missing. The public sector has continued to exert a direct and strong influence on the economy mainly through its control of State Economic Enterprises (SEEs) and State Banks. These institutions had been required to carry out redistributive activities mostly unfunded by the State budget, thereby endangering their competitiveness in increasingly open markets. At the same time, the State has kept using extra-budgetary funds, revolving funds and contingent liabilities leading to an unsustainable position for the public sector finances. Despite this intensive use of resources, public intervention has failed to achieve fundamental policy objectives like ensuring a wider participation in the labour market, achieving full employment and reinforcing social cohesion through a reduction in poverty and inequality...

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