REPUBLIC OF TURKEY
PRIME MINISTRY
THE UNDERSECRETARIAT OF TREASURY
General Directorate of Foreign Economic Relations
Ref : B.02.1.HM.0.DEİ.02.00/500/ Ankara, June 22 , 2000
22.06.00*50985
Mr. Horst Köhler
The Managing Director
International Monetary Fund
Washington, D.C.
Dear Mr. Köhler,
1. Just a few months after its inception, the disinflation and fiscal adjustment program initiated by the government of Turkey in late 1999—and supported by a stand-by arrangement (SBA) with the International Monetary Fund—is having clear and beneficial effects on the economy: inflation in the first five months of 2000 has dropped to the lowest level in 14 years, the public debt-to-GNP ratio is falling, interest rates have declined rapidly, and output growth is resuming. These results have been achieved through the strict implementation of our policies, which have garnered credibility in both domestic and international financial markets, as also reflected in upgrades by major credit rating agencies.
2. In spite of these positive results, the work remains unfinished. There is a need to further the disinflation process—so as to ensure the attainment of the 25 percent CPI inflation target for end-2000 and prepare the grounds for its decline to 10–12 percent by end-2001—while at the same time protecting external balance and growth prospects. This letter outlines the progress made thus far, confirms our key policy goals, and sets out new macroeconomic and structural policy steps to sustain the momentum of the adjustment process.
3. Significant progress has been made towards achieving the program’s goals. In spite of some unfavorable external developments, such as the sharp rise in international oil prices, inflation in the first five months of 2000 fell to the lowest level since 1986. This result shows that the government’s program is sharply affecting price dynamics, and strengthens our resolve to continue to gear macroeconomic policies to the attainment of the 2000 inflation target (25 percent December 2000/December 1999). Moreover, industrial production accelerated sharply in the first four months of 2000, an encouraging result with respect to the program’s GNP growth projection of 5–5½ percent in 2000.
4. The unexpected increase in international oil prices and the accelerated restocking of raw materials and unfinished products have led to a pick-up of imports in early 2000. As a result, the external current account deficit is expected to widen. However, we expect that it will remain at a level that, in the context of the strong policy environment brought about by our program, is sustainable.
5. Against this background of positive developments, we intend to continue implementing the program strictly, and, in fact, to bolster some aspects of the program’s policies, so as to minimize the risks to both inflation and the balance of payments.
6. Fiscal performance in the first quarter of 2000 has been strong. The floor on the primary surplus of the consolidated government sector was met by a good margin (Annexes A and B). The indicative targets for the primary surplus inclusive of privatization receipts (Annex B) and for the overall deficit (Annex C) have also been met. Moreover, developments in April suggest that the fiscal program will remain on track during the second quarter.
7. This performance has been underpinned by the budgetary measures envisaged in the program. In addition to the measures enacted in December 1999, the quarterly advanced payment of the personal and corporate income taxes was reintroduced in April, and administrative measures were introduced in May to contain overruns in health expenditure of Bag Kur (one of the social security institutions), meeting one of the program’s structural benchmarks. Another structural benchmark (submitting to Parliament the law to improve the administration of Bag Kur, including the increase in health premia and co‑payments) was also met. This law, together with a package of other laws strengthening the pension system, is expected to be passed by end-October.
8. The fiscal performance, however, was not equally strong for all components of the consolidated government sector. The central government budget did considerably better than expected, owing primarily to strong revenue performance. But the performance of key state enterprises has been weakened by the hike in international oil prices, as well as rising personnel costs. To allay these pressures, we will continue the strict implementation of the employment policy involving a replacement ratio of retiring employees not exceeding 15 percent.
9. There is also a need to ensure that any excess of revenues of the central government budget that may arise with respect to the program figures is saved. This policy is needed to limit the risks to the external current account, support disinflation, and offset the weakening in the state enterprise sector. To this end, tax rates will remain at least at the current level (and the petroleum consumption tax will be adjusted in line with the WPI) and primary expenditure of the central government will be kept equal to or below the original program projections. More specifically, primary expenditure of the central government will not exceed TL 16,720 trillion for the first three quarters of 2000 and TL 24,690 trillion for the whole year (net of earthquake-related expenses). Finally, should it be necessary to achieve our macroeconomic targets, we will introduce additional fiscal measures.
10. Fiscal policy will continue to play an important role in 2001. The preparation of the 2001 budget is now starting, and public expenditure guidelines will be defined soon and incorporated in the Prime Minister’s budget call and in the Ministry of Finance’s budget guidelines. In this respect, we intend to keep primary expenditure of the central government (net of earthquake-related outlays) constant in real terms in the 2001 budget with respect to the 2000 program figures.
11. Public debt management succeeded in financing large amounts of domestic public debt coming to maturity in early 2000, while maintaining the average maturity of public debt broadly unchanged with respect to end-1999. Owing to improved macroeconomic conditions, the interest rate on new domestic borrowing fell dramatically, with large expected savings in interest payments in the months ahead. Borrowing conditions have also improved on international markets, with the share of external borrowing in total borrowing rising to 17 percent in the first quarter, from 5 percent in the average of 1999. Nevertheless, contracting of public external debt has remained within the program ceilings (Annex A). These results bode well for future fiscal developments, as they will facilitate a faster decline in the public debt‑to‑GNP ratio than initially anticipated.
12. With the goal of enhancing the liquidity of government paper, and thereby reducing the cost to the government (and taxpayers) of its funding operations, we have put in place a system of primary dealers for government debt (a structural benchmark). The primary dealers were selected in late April, and the system started operating on May 8.
13. Price and incomes policies are an integral part of our disinflation program. In the second half of 2000, a number of actions will take place in this area.
· In line with the budget law, civil servants’ salaries were adjusted in June by the difference between inflation in the first five months of 2000 and 15 percent, plus a 2 percent compensation for the erosion of wages that took place until June. Civil servants’ salaries will be raised by 10 percent in the second half of 2000.
· In the area of private sector wages and prices, the Economic and Social Council will be reconvened as early as possible in June with the goal of reaching an agreement among the social partners on a formal joint declaration in support of the government’s disinflation targets, as well as on price and wage guidelines for 2000 and 2001 consistent with noninflationary growth, the protection of the purchasing power of employees, and the fiscal adjustment process.
· To remove the backward-looking elements in the formation of personnel costs in the private sector, parliament has approved a law to switch from backward-looking to forward-looking indexation in the determination of the minimum premium base on social security contributions for 2000–01. The resulting losses to social security institutions will be offset by raising the ceiling on contributions to four times the minimum level, as well as through the savings arising from the administrative and legal measures related to Bag Kur mentioned above.
· Regarding public sector wages, it is our intention that all wage increases in 2001‑2002 be fully in line with the government’s inflation targets.
14. Monetary and exchange rate policies have been rigorously implemented in the first few months of 2000. The end-March performance criteria for net domestic assets (NDA) and net international reserves (NIR) of the central bank were met (Annex A). Moreover, the no-sterilization policy has been consistently followed, with NDA always remaining in the program’s corridor (with the allowed exception of the predetermined periods including religious holidays). For the future, we remain committed to implementing the monetary and exchange rate policy framework described in the December 9, 1999 LoI, as well as to the performance criteria for NDA, NIR, and the contracting or guaranteeing of new external debt as reported in Annexes D, E, F, and G.
Structural reform
15. Considerable progress has been made in furthering structural reform during the first months of 2000. While there have been delays, important results have been achieved in all key areas, and an Economic Reform Loan (ERL) has recently been extended by the World Bank in support of our structural reform agenda.
16. In addition to the sale of 51 percent of Petrol Ofisi A.S., already mentioned in the March 10 LoI, two other key operations have taken place so far: the public offering of 31½ percent of Tupras; and the sale of one GSM license. The receipts from the latter operation will amount to about US$2½ billion (excluding VAT). Altogether these operations amount to US$ 5 billion, most of which is expected to be cashed this year. So far the total receipts cashed from these operations amount to almost US$1¼ billion. The receipts from the sale of the GSM license are expected to be cashed during the third quarter.
17. As to other operations, the tender of 20 percent of Turk Telecom was announced on June 13, but the sale may not be finalized before end-September (one month later than envisaged in one of the program’s structural benchmarks). Nevertheless, the target of privatization receipts of US$7.6 billion for 2000 remains within reach. Privatization operations will continue in 2001, and to this end, we have identified a new portfolio of enterprises that will be transferred to the Privatization Agency by end-August (a structural benchmark). This portfolio includes factories from TSFAS (sugar), CAYKUR (tea), MKEK (machinery and chemicals), and ETI holding. In addition, we intend to privatize parts of TEKEL (see below), the thermal generation plants and distribution companies which remain under state management after 2000, and plan further disinvesture of enterprises that started being privatized in 2000.
18. Tax policy measures in preparation of the 2001 budget will be discussed during the third review of the program, with the goal of further improving the efficiency and equity of the tax system. In order to improve tax administration, a fully computerized system has started operating this year, contributing to the strong revenue performance observed so far. In addition, we have begun implementing a quarterly monitoring system of tax arrears in April (meeting one of the program’s structural benchmarks), and remain committed to reducing the stock of tax arrears—which stood at about 4¾ percent of GNP in March 2000 (of which a large share within the public sector)—by enforcing the provisions of the tax law (and without any tax amnesty).
19. In the area of fiscal transparency, 25 budgetary funds and 2 extrabudgetary funds have been closed between February and May (meeting with some delay another structural benchmark of the program). We will close another 20 budgetary funds by end-August (a structural benchmark). In addition to the 2 extrabudgetary funds already closed, 3 will be closed in July 2000 (a structural benchmark) and 2 more by February 2001, leaving only 6 extrabudgetary funds. The need for maintaining these remaining extrabudgetary funds will be further reviewed on the basis of the Public Expenditure and Institutional Review prepared in collaboration with the World Bank.
20. A fiscal transparency review from the International Monetary Fund took place in April, following the practice instituted in 1999, which has covered so far several industrial and emerging economies. We intend to publish the report of this mission by end-August 2000. Taking into account the report’s recommendations, as well as the recommendations of the committee on Restructuring Public Financial Management and Fiscal Transparency, the government agencies involved in fiscal management will enhance the contents of the Annual Program to be submitted to parliament in November together with the budget to state the government’s fiscal policies and commitments. As of 2001, this document will be complemented by a mid-year Economic and Fiscal Update. We will also submit to parliament before the end of the year a law on public finance and debt management that will: (i) define clear borrowing rules and limits for the public sector; (ii) widen the coverage of the budget by incorporating quasi-fiscal activities of the treasury, including on-lending operations; and (iii) set rules, limits, and accounting standards for the issuing of debt guarantees. Moreover, we intend to identify during the third review additional steps (to be taken in 2001–02) to implement the reports’ recommendations. This will include an overhauling of the relation between the central government, the state enterprises, and the social security institutions, including the issues of tax and social security contributions payments, and the resolution of the outstanding stocks of duty losses and tax arrears. As regards the identification of the government’s contingent liabilities, we will continue improving transparency by publishing the maturity structure of government guarantees and the terms of other contingent liabilities.
21. Outside the central government sector, the central bank has for several years published its balance sheet weekly. By June 2001 we will start publishing annually the annual financial statement of the central bank, audited by an external auditor according to internationally accepted standards.
22. Some key structural changes have already taken place under the program in this area, the most important one being the removal of credit subsidies from state banks. The effects of this removal have been cushioned by the sharp decline in market bank lending rates, including those on agricultural credit, caused by the improved macroeconomic framework.
23. Support prices have been raised broadly in line with targeted inflation. The support price for wheat was raised according to the mechanism specified in the December 9 LoI (a mark-up of 35 percent over international prices); this involved an increase close to targeted inflation (27½ percent). A major reform has taken place with the parliamentary approval on June 1 of a law granting autonomy to agricultural sales cooperatives and their unions (ASCUs, a structural benchmark). As a transitional arrangement to facilitate the restructuring of these cooperatives, the law allows the use of some of the budget allocation for support to cooperatives to be used this year to finance support purchases of industrial crops. However, in order to contain the cost of this transitional arrangement, and to encourage efficient, market-driven restructuring, the ASCUs will only be granted budgetary funds upon acceptance by the restructuring board (or, until the board becomes operational, the Treasury and the Ministry of Industry and Trade acting on its behalf) of a business plan based on realistic market-determined prices, and purchased volumes no greater than what can be expected to be sold, within a total operating and investment budget not exceeding their own funds (including any funds borrowed on their own account) plus the 2000 budget allocation from the government.
24. Three new laws necessary to phase out the support price mechanism for tobacco and for reforming TEKEL will be enacted in 2000. The first law will separate TEKEL’s support purchasing unit from its other commercial units and will introduce an auction mechanism for the sale of tobacco, whereby the support purchasing unit of TEKEL will buy the unsold tobacco at a discount of at least 15 percent from the lowest auction price for comparable qualities. The second law will de-monopolize the production of alcoholic spirits thereby allowing private sector entry into the industry. The third law will enable the privatization of TEKEL’s production facilities for spirit, salt, and tobacco products. The divestiture of TEKEL’s commercial assets will start in 2001 and will be completed by end-2002.
25. The reform of bank supervision structures and regulations has continued in early 2000. The Board of the Bank Regulation and Supervision Agency (BRSA) was appointed at end-March, meeting one structural performance criterion. The board is actively at work and all efforts will be made to have the BRSA fully operational ahead of the program’s deadline (end-August, an action which remains a structural performance criterion).
26. In the area of bank regulation:
· All regulations needed to implement by end-June 2000 the consolidated capital adequacy and foreign exchange exposure limits specified in paragraphs 54 and 61 of the December 9 LoI have been introduced, meeting a structural performance criterion.
· The central bank introduced in early May a 100 percent reserve requirement on foreign exchange positions in excess of the prudential limits (a structural performance criterion for end-June).
· Progress is also being made in issuing regulations on internal risk management systems and in amending capital adequacy rules to take into account market risk; we expect these regulations to be introduced according to the original schedule set out in the December 9 LoI (end-June, a structural benchmark).
· The securities valuation regulation was issued on May 18, 2000 (a structural benchmark).
· The reporting of quarterly consolidated accounting (originally expected by end-April; a structural benchmark) has been delayed. We now expect to issue the circular needed to require quarterly reporting on a consolidated basis to be issued by end-June (a structural benchmark). The World Bank is providing technical assistance to improve further the accounting rules during the second half of 2000.
27. Regarding state banks, the interest rates paid by the treasury on the stock of its liabilities towards the state banks (the so called duty losses) had to be adjusted, with respect to the figures indicated in the December 9, 1999 LoI, owing to the sharp change in the structure and level of interest rates. Accordingly, the spread over treasury bill rates used to compute the interest rates on the duty losses (see paragraph 58 of the December 9 LoI) has been lowered from 35 percent to at most 26 percent for Ziraat, and raised from 21 percent to at most 26 percent for Halk Bank. In addition, Ziraat Bank and Halk Bank will be allowed to adjust their lending rates freely as long as these rates are kept at least 5 percent higher than treasury bill rates. As part of the medium-term program to restructure the state-owned bank sector, we intend to send to parliament legislation that would allow the commercialization and eventual privatization of all state banks (including their transformation into joint-stock companies). We are also in the process of preparing an action plan to resolve the stock of duty losses on the books of the state banks. We expect that these reforms will be supported by a Financial Sector Adjustment Loan from the World Bank.
28. As regards the resolution of the eight banks currently owned by the Saving Deposit Insurance Fund (SDIF), on May 31 we have selected a financial consultant firm to assist us in the implementation of the financial restructuring plans worked out by the SDIF in April. The consultant is expected to prepare the appropriate strategy for completing the resolution of these banks while addressing the government’s objectives of least cost to taxpayers, systemic stability and maximum asset recovery. We expect the consultant’s report to be completed and delivered to us by July 31, 2000. By August 15, based on the consultant’s report, we will decide on the specific approach to restructuring the above banks. Specific deadlines for implementing the restructuring strategy will be agreed during the third review of the program. In the meantime, the staff of the SDIF is in the process of setting up a special unit that will be in charge of the recovery of the bad loans currently in the portfolio of the banks. This asset management unit will be operational by end-June 2000, with the aim of completing the transfer of bad assets by August 15, 2000.
29. Over the medium term, the Turkish banking system will have to adapt to an environment of lower inflation, real interest rates, and bank spreads. The size of the bank loan market, which is small at present, will likely rise, and with it the challenges and opportunities that could be potentially faced by banks. The increase in consumers’ credit in the last few months, in a market characterized by more intense competition, is a first sign of this development. The changes in bank regulation mentioned above, together with the strengthening in the implementation of bank supervision that will follow the setting up of the BRSA, are necessary steps to facilitate this evolution. Changes in the area of reserve requirements and of the taxation of banks could also be helpful. In this respect, we intend to lower as of January 1, 2001 the reserve requirement coefficient, so as to reduce the burden of reserve requirements, which is above that of other banking systems competing with Turkish banks. Moreover, the deductibility of loan loss provisioning will be examined with a view to phasing it in starting in 2001. This issue will be discussed during the third review, as part of the discussions on the 2001 policy package.
30. Finally, we intend to improve the availability of statistics on developments in the monetary and banking area. As of end-July 2000, we will enhance our system of collection and publication of aggregate statistics on bank lending rates, by requesting from commercial banks information on volume-weighted interest rates used in their credit operations, for the main types of credit facilities and currencies. The delay in the publication of monetary survey data, which now exceeds three or four months, will be reduced to no more than two months.
Sincerely yours,
Mr. Recep Önal Mr. Gazi Erçel
Minister of State for Economic Affairs Governor of the Central Bank