ICEA The Turkish EconomyPresentation 14February200

The Turkish Economy: EU Accession and Future Economic Prospects: 

The Turkish Economy: EU Accession and Future Economic Prospects The International Economic Consultants’ Association 14 February 2006 Fadi Hakura, Turkey Specialist, Chatham House and Founder of Conkura

Order of Presentation: 

Order of Presentation Brief Economic History Recent Economic Policies EU Accession Process Economic Achievements Economic Impact of EU Accession Future Prospects for Turkish Economy

Slide3: 

Brief Economic History

Brief Economic History : 

Brief Economic History Turkey enjoyed regular boom-and-bust economic cycles since the 1950s. Excessive budgetary expenditures and inflationary pressures were the norm. Major economic crises in 1994, 1998 and 2000-2001. 2000-2001 crisis devastated all sectors of Turkish economy and society.

Slide5: 

Recent Economic Policies

Recent Economic Policies: 

Recent Economic Policies Since 2001, successive Turkish governments implemented a tough IMF programme. Undercapitalised banks seized, shut down or privatised. Number of banks slashed from 80 in 2000 to 48 in 2005. Energy and telecommunications’ markets liberalised. Independent banking regulator created in 2001.

Slide7: 

Foreign investment and employment laws streamlined. Primary fiscal surplus target of 6.5% of GDP. Inflation-targeting since January 2006: 5% in 2006 and 3% in 2007. Turkish Lira free-floating. Privatisation radically accelerated: $20,000 million of state assets sold to private sector in 2005.

Slide8: 

Vodafone purchased Telsim – the second largest mobile operator – for $4,550 million in December 2005. Top rate of income tax cut from 40 to 35% in 2004. Corporate tax rate reduced from 30% to 20% in 2005.

Slide9: 

EU Accession Process

EU Accession Process: 

EU Accession Process Accession negotiations commenced on 3 October 2005. Accession process expected to take 10-15 years. Speed of accession conditioned upon pace of implementation of EU rules and standards. 100,000 pages of EU law and policy must be adopted and implemented.

Slide11: 

EU-Turkey Customs Union since 1996 ensuring free circulation of goods and a harmonised competition policy. Reuters’s survey of 30 emerging market strategists (7-9 February 2006): Median forecast of Turkey joining EU in 2016. 20% chance of Turkey pulling out of negotiations – range between 0 and 70.

Slide12: 

20% chance that the EU may suspend negotiations due to human rights or Cyprus issue.

Slide13: 

Economic Achievements

Economic Achievements: 

Economic Achievements Economic growth has expanded dramatically: 7.5% per year on average in 2002-2004 and over 5% in 2005.

Turkey settles into stable growth: 

Turkey settles into stable growth Source: PNC Financial Services

Slide16: 

Inflation rates decreased from 73% in early 2002 to 8.1% in October 2005. Total central government deficit has shrunk from 15% of GNP in 2001 to 5% in 2005. Public debt has declined from 90% of GNP in 2001 to 70% in 2005.

Kicking the habit of high inflation: 

Kicking the habit of high inflation Source: IMF

A happy economic picture: High economic growth and low inflation: 

A happy economic picture: High economic growth and low inflation Source: OECD

Slide19: 

Domestic interest rates have slumped from 75% in 2002 to 15% in October 2005. Net FDI static at $800 – 1,000 million during the 1990s. Reached $4,000 million in 2005. According to the World Investment Report 2005, Turkey climbed from 57th to 35th position in terms of FDI inflows.

Effect: appreciating Lira moderated by productivity improvements: 

Effect: appreciating Lira moderated by productivity improvements Source: Central Bank and BNP Paribas

Slide21: 

Economic Impact of Accession

Likely Impact of Accession : 

Likely Impact of Accession Enhanced FDI inflows: e.g. BNP Paribas purchased 50% of TEB Bank; Fortis merged with Disbank; GE bought 25.5% stake in Guaranti Bank. European Commission granted Turkey “market economy” status, a key criteria for EU membership. Lower risk premiums on Turkish government securities:

Impact of EU Accession on Risk PremiumsTurkey’s Euro EMBIG subindex, spread over Bunds, bps: 

Impact of EU Accession on Risk Premiums Turkey’s Euro EMBIG subindex, spread over Bunds, bps Source: JP Morgan Chase

Slide24: 

Extensive deep restructuring of Turkish economy and public sector. Prescriptive EU rules and standards on public procurement, sectoral liberalisation, employment laws, environment, public procurement, State aid (public subsidies) and many other areas.

EU accession maybe a significant driver for underlying economic growth: 

EU accession maybe a significant driver for underlying economic growth Source: Deutsche Bank Research

… and income per capita: 

… and income per capita Source: Deutsche Bank Research

In fact 1996 EU-Turkey Customs Union experience demonstrates impressive Turkish export potential: 

In fact 1996 EU-Turkey Customs Union experience demonstrates impressive Turkish export potential Source: State Institute of Statistics

Slide28: 

Daniel Gros and Kemal Dervis estimate long-term annual economic growth could be 3-6 percentage points per year ahead of that in Western Europe and 1-3 percentage points ahead of that in Central/Eastern European countries. World Bank finds that Turkey’s per capita income will increase by 1.5% per year with EU accession. Turkey could converge to per capita income of today’s Poland by 2020 (Deutsche Bank research).

But there are significant environmental costs…: 

But there are significant environmental costs… EU environmental rules: Anil Markandya (World Bank) forecasts total compliance costs of €28,000 million (“fast reform” scenario) to €49,000 million (“slow reform” scenario). Expenditures to be spread over approximately 17 years. OECD indicates that Turkey currently spends 0.5% of GDP on the environment. So, levels need to triple or quadruple. Appropriate policy mix could cut compliance costs by about half.

… and agricultural changes : 

… and agricultural changes Agricultural reform: World Bank predicts budgetary costs of €3,000 million (without EU compensation) and €1,200 million (with EU compensation). Agricultural value-added at €2,145 million (with EU subsidies) and €341 million (with 35% of EU subsidies). EU policies will lead to 1.87% increase in real household incomes in the medium-to-long term.

Slide31: 

Accurate projections highly dependent on developments in CAP reforms.

Slide32: 

Future Prospects for Turkish Economy

Future Prospects of Turkish Economy: 

Future Prospects of Turkish Economy Future of Turkish economy is strongly positive subject to a number of issues. Absolute necessity to tackle corruption – 3.5 score by Transparency International 2005 [10= no corruption]. Turkish GDP would jump 5-6% if corruption cut to the level of Portugal enjoying a score of 6.5 by Transparency International 2005 (Netherlands Bureau for Economic Policy Analysis).

Slide34: 

Undertake radical public sector and institutional/governance reforms and improve quality of regulations/rule of law – public sector restructuring boosted productivity by 40% in 2000-2004 (Morgan Stanley) However, below Eastern/Central European standards (World Bank). Job-creation: Estimated Labour Force Participation Rate is only (approximately) 40% vs. 65% in Spain - 0.5 million new workers enter labour force each year.

Labour force participation and unemployment: 

Labour force participation and unemployment Source: State Institute of Statistics

Slide36: 

Capitalise on “demographic window of opportunity” – dependency ratio expected to decline from 60% in 2000 to around 45% in 2030 (UN) – Major cause of the East Asian economic “miracle” between 1960-1990s. Happens only once in a country’s lifetime.

Slide37: 

Deeper liberalisation of factor and product markets (European Commission) – e.g. 112 weeks of wages for firing a worker vs. 35 weeks in High Income OECD countries (World Bank): “Index of Economic Freedom” (Wall Street Journal / Heritage Foundation” rated Turkey’s economy as “Mostly Unfree”. Stimulate FDI inflows. Lower and simplify taxes further. Improve business environment - Cut red-tape even more.

Slide38: 

“Legalise” the informal economy – half the size of formal economy. Maintain primary fiscal surplus target of 6.5% of GDP after IMF programme ends in 2007. Debt “overhang”: Foreign currency sovereign debt rating of B1 (Moody’s), BB- (S&P) and Ba3 (Fitch-IBCA). Below “investment grade” of Baa3

Slide39: 

Maintaining expansion of trade: Exports at 30% of GDP in 2003 could 40% of GDP by 2010 (Deutsche Bank Research). Reorient education away from rote learning to critical thinking: 0.98 for South Korea, 0.91 for Bulgaria vs. 0.8 for Turkey [1= best] according to the World Bank Education Index.

Slide40: 

Current account deficit of 6.5% of GDP - 70% financed by “hot money” (ie. non-resident portfolio investments and non-resident deposits). Does not seem to be a major worry because: Private-sector investment-driven rather than consumption-centric. Rapid increase in productivity: total factor productivity growth was 5.2% in 2002-2004 vs. 0.5% during the 1990s (Morgan Stanley) – reflects institutional/structural efficiency improvements rather than just cyclical factors.

Slide41: 

Structural changes in Turkish economy: Shift from low productivity manufacturing (e.g. textiles) and agriculture to high-productivity manufacturing (e.g. automotive) and services. Primary budget surplus of 6.5% of GDP. (What will happen after end of IMF programme in 2007? Maastricht criteria ill-suited for Turkey. Leaves it too vulnerable to external shocks.) Turkish Lira is free-floating. Moderately overvalued based on productivity weighting.

Slide42: 

25% of current account deficit due to high oil prices. Privatisation proceeds could cover more than half of deficit over next two years. Average maturity of new domestic government borrowing increased from 10 months in 2004 to 34 months in 2005 (Turkish Undersecretariat of Treasury). … But high current account deficits unlikely to disappear in short-to-medium term.