REPUBLIC
OF TURKEY
PRIME
MINISTRY
THE
UNDERSECRETARIAT OF TREASURY
Ankara,
July 31, 2001
Mr. Horst
Köhler
Managing
Director
International
Monetary Fund
Washington,
D.C., 20431
U.S.A.
Dear
Mr. Köhler:
1.
We have continued to implement forcefully our ambitious economic reform
program. The applicable quantitative performance criteria for end-May
and end-June were observed, and we have taken further important steps
in banking and other structural areas (Annexes A and B). On this basis,
we request completion of the ninth review under the stand-by arrangement.
We also request modification of the ceilings for the performance criterion
on the cumulative primary expenditure of the central government for
the remainder of 2001, consistent with our revised annual inflation
projections. Moreover, we request modifying the indicative ceilings
on base money, and thereby the performance criteria on the net domestic
assets of the Central Bank of Turkey, for the remainder of the year
in line with our updated macroeconomic framework. All other performance
criteria and indicative targets remain unchanged.
2. After a difficult first half, the economy is beginning to show
a positive response to the strengthened program. GNP fell in the first
quarter of 2001 by 4.2 percent year on year, and is expected to have
fallen further in the second quarter. Moreover, the persistence of
very high real interest rates and the contraction of domestic demand
are burdening bank and corporate balance sheets and putting pressure
on the enterprise sector, especially on the small and medium enterprises
that account for the bulk of employment. On the other hand, signs
of an incipient recovery are emerging: capacity utilization edged
up by more than three percentage points from April to June, and the
central bank’s business surveys show increased confidence among respondents,
partly because of surging exports and a boom in tourism. Moreover,
the inflationary impact of the large February depreciation seems to
have largely played itself out, and the inflation slowdown, which
began in May, continued in June with 3 percent CPI inflation during
the month. Finally, the slowdown and the depreciation of the Turkish
lira have led to a marked turnaround in the external current account.
3. Looking ahead, we believe that further progress under the program,
together with continued international financial support, will rebuild
confidence, help lower interest rates, and facilitate the economic
recovery. The May 3 letter, updated by the letter of June 26, remains
the main document describing our policies for 2001–02, and is further
updated in this letter in several areas. The major financial support
from the IMF (some US$19 billion committed for 1999–2002) and the
World Bank (US$6.2 billion committed for 2001–03) provides assurances
of adequate official financing. Regarding private sector involvement,
following the June 12–13 meetings with foreign commercial banks, we
have sent letters to the participants, seeking their commitment to
maintain their exposures to Turkey at mid-June levels, with a view
to restoring December 11, 2000 exposures as the program is implemented.
We have already received responses, and are following up with foreign
banks that have had difficulties in maintaining their exposure. We
believe that the policies and measures described in this letter are
adequate to achieve the objectives of the program, but we stand ready
to take additional measures if necessary to keep the program on track,
consulting regularly with the Fund.
Communications
policy
4. We
are making strong efforts to explain our economic strategy and achievements
under the program. In recent months, we have already taken a number
of steps, including outreach efforts by the State Minister for Economic
Affairs and other senior officials in Turkey, meetings with international
investors abroad, the issuance of statements and the publication on
official websites of material explaining the program, and the revamping
of the Treasury’s media relations unit to facilitate a more pro-active
approach to explaining economic policies and developments under the
program. We have also continued to publish the letters of intent,
and agreed to the publication of the IMF staff reports. In the period
ahead, we will hold regular domestic press conferences; seek to better
explain economic policies; and hold additional road shows in major
international financial centers and Turkey. Moreover, building on
our already active contacts with international investors, we are exploring
the scope for setting up a more formal investor council, as has been
done in other major emerging markets countries. Such a council would
help to further improve investor sentiment, reduce the volatility
in capital flows, and strengthen our ability to monitor shifts in
market perceptions.
Macroeconomic
framework
5.
We have revised our macroeconomic projections for 2001 in light of
recent data. While the fall in output in the first quarter was somewhat
greater than forecast, leading indicators of activity and export developments
suggest an output recovery starting in the third quarter. Taking into
account the decline in activity that has taken place so far, we now
project a fall in real GNP for 2001 as a whole of 5½ percent, compared
with the original program projection of a decline of 3 percent. Although
the increase in inflation in the second quarter resulting from the
initial depreciation of the lira was slightly above original projections,
the recent decline in inflation indicates that our target of 2 percent
monthly inflation by end-2001 is within reach. For the whole year,
we now expect CPI inflation (December over December) to be 58 percent,
compared with the originally projected 52.5 percent. For the next
twelve months (June over June) we expect CPI inflation to fall to
the 30–35 percent range. The external current account balance is expected
to show a US$5 billion (3 percent of GNP) surplus for the year (compared
with the originally projected broad balance), given continued strong
tourism performance, the rebound in exports (especially in the automobile
sector), and the fall in imports.
Fiscal
policy and debt management
6.
Fiscal policy has remained on track. Through end-May, the primary
surplus of the consolidated government sector reached 3.4 percent
of annual GNP, comfortably exceeding the program target by 1.7 percent
of GNP. This was underpinned by overperformance of income taxes (especially
the withholding tax on interest); delays in investment by extrabudgetary
funds; and lower-than-projected expenditures in state enterprises,
especially in the agricultural area. For the consolidated central
government budget, we kept primary expenditures within the end-May
ceiling, and for end-June, our cumulative primary balance remains
above program projections by 0.2 percent of GNP. On the policy side,
we expect the revenue impact of the recent overruling of the proposed
VAT rate increase on telephones to be offset by departure levies for
residents, and a fee on savings deposits.
7. We remain on track to meet our primary surplus target of 5.5 percent
of GNP in 2001, as revenue overperformance is expected to continue
and as state enterprise finances are better than expected. We expect
higher inflation to more than offset the impact of lower growth on
revenues, leading to an additional 0.2 percent of GNP in revenue during
the second half of the year. Combined with the overperformance already
realized during the first half (0.2 percent of GNP), and higher-than-expected
rate increases realized at Türk Telekom in June (yielding 0.1 percent
of GNP for the year), this provides room to offset the weakening in
real public expenditures implied by the revision to the macro economic
framework. In any case, should deviations emerge later in the year,
we would reduce discretionary noninterest expenditures, and take revenue
measures as needed to ensure attainment of the primary surplus target.
8. The increases in primary expenditures consistent with the
new macroeconomic framework and the primary surplus target are intended
either to maintain the original path for real public spending or to
alleviate the impact of the crisis on the most affected. Some 0.4
percent of GNP of the increase will be reflected in the consolidated
central government budget, and is due to inflation indexation of pension
payments and civil servants’ salaries and additional transfers to
social security institutions to help them maintain health expenditures
constant in real terms. The revised performance criteria on the ceilings
on the primary expenditure of the consolidated central government
reflecting this increase are shown in Annex C. While the more depreciated
exchange rate could raise our utility and agricultural subsidy costs
(which are defined in U.S. dollars), we expect to be able to contain
the possible additional costs within the budget appropriations. Spending
will also increase in the broader public sector by 0.1 percent of
GNP, accommodating outlays financed by an expected World Bank loan
to support the Social Risk Mitigation Project. This loan is aimed
at increasing education, health, and other social spending on the
poorest members of society. This reflects our continued emphasis on
supporting and strengthening the social safety net, given recent economic
difficulties. For all other spending items, we will adhere to existing
budget ceilings.
9. We are taking further steps to strengthen the overall fiscal position
and to improve overall budgetary management. We are preparing the
2002 fiscal strategy with a view to further increasing the public
sector’s primary surplus to 6.5 percent of GNP. This will require
tight expenditure restraint, and in our budget call we have asked
agencies to limit their spending requests to a level consistent with
no real increase. We expect to finalize the central government budget
proposal in October. While spending will be restrained next fiscal
year, we hope to see an increase in the efficiency of spending through
the implementation of a new public procurement law. We expect to submit
this law to parliament by October 15, 2001 (a structural benchmark),
after consulting with the World Bank and EU. To further support our
budgetary restraint and our cash planning, we will begin regularly
monitoring expenditure commitments. Until our new computerized accounting
system is operational (at the end of 2001), and extended to include
reporting of commitments, we will use quarterly surveys as monitoring
devices, beginning at the end of the third quarter of 2001. To minimize
the burden of taxation necessitated by our expenditure plans, we will
also seek to broaden the tax base. In this context, last year we received
technical assistance from the IMF on tax policy and administration.
We are now working jointly with the World Bank to adopt a medium-term
strategy for improving the tax system in Turkey by end-2001. Finally,
we continue to make progress on the extension of tax identification
numbers to financial transactions, expected to commence on September
1, and we will intensify our efforts at collecting arrears by setting
strict performance standards for tax offices.
10. We are taking a number of steps to reduce the government’s borrowing
needs and costs so as to ensure the orderly rollover of government
debt:
-
The government will maintain a strong primary budget position. Together
with the use of external resources, this will keep the Treasury’s
domestic borrowing need well below redemptions during the remainder
of 2001.
- On
July 26, we announced a package of measures to further reduce the
rollover risk. To encourage a move toward longer maturities for bank
liabilities, we will differentiate withholding tax rates on deposits,
applying lower rates for longer maturity deposits and higher rates
for shorter maturities with the intention of keeping this measure
broadly revenue neutral. To encourage more direct holdings of treasury
bills by households, we propose to raise the income tax exemption
for buyers of government paper from the equivalent of TL 4.9 billion
to TL 50 billion until end-2002 (when a broader reform of the system
is planned). To reduce the cost of banking sector intermediation the
CBT will begin paying interest on Turkish lira required reserves.
Finally, to remove barriers to import financing, we will lower the
tax on foreign import credits from 6 to 3 percent. These measures
will not have a significant fiscal impact. Should deviations emerge,
we will take additional measures to achieve our fiscal targets.
- In
addition, Treasury’s gross borrowing from private banks will be reduced
substantially through the participation of state banks and the CBT
in the rollover of Treasury obligations. Nearly one third of the scheduled
redemptions in the coming months are owed to state banks and the CBT.
As anticipated in the original program, the liquidity provided through
these redemptions should correspondingly increase demand for Treasury
paper, either directly through the participation of state banks in
Treasury’s rollover, or indirectly to the extent that redemptions
financed a move of depositors toward private banks. Following the
recapitalization in May, the financial position of state banks has
been strengthened considerably, and the rate at which deposits have
moved to other banks has not been as rapid as anticipated. As such,
these institutions are expected to have the capacity to participate
directly in the debt rollover for some time. To this end, the portion
of Treasury’s redemptions that is not needed to cover state banks’
liquidity needs will be redeemed in the form of new Treasury paper
bearing market interest rates and quarterly coupons. This measure
will ensure that state banks’ balance sheets remain strong, while
these banks are being prepared for sale in line with our original
strategy, and in the meantime should reduce rollover risk by ensuring
the borrowing from private banks remains below their redemptions.
Should the state banks face unexpected liquidity needs because of
deposit withdrawals, such liquidity will be provided promptly by the
Treasury. Also, in line with our original strategy to reduce balance
sheets of intervened banks, the Treasury will continue to service
all obligations to SDIF banks in cash.
-
The new Law on Public Finance and Debt Management has been presented
to Parliament (meeting a structural benchmark under the program),
and will provide the necessary legal framework for strengthened
debt management. We expect that the new framework will be in place
by end-November 2001.
- With
the recent passage of legislation to establish private pension and
insurance funds, we expect nonbank institutions to increase their
participation in Treasury bill auctions over time.
11. Confidence
that Turkey’s public debt burden is sustainable is a critical element
of the program’s success. Taking into account the more conservative
assumptions on growth and inflation in 2001, Turkey’s debt burden
remains sustainable even if ex-ante interest rates were to remain
close to the high averages of the past decade. To achieve sustained
rapid growth—a basic objective of our program—a significant decline
in real interest rates is required. In this regard, we believe that
continued progress in implementing the program will further strengthen
market sentiment and facilitate the convergence of interest rates
and other macroeconomic variables to program objectives.
Monetary
and exchange rate policy
12. We are moving ahead swiftly with our plans to introduce inflation
targeting. To this end, the CBT has made considerable progress in
strengthening its information base and accelerating its modeling and
research efforts. Monetary policy decisions are already being increasingly
guided by the inflation outlook. Since under this monetary framework
communication with the public and markets will be important, we will
also accelerate our efforts to establish mechanisms, including regular
issuance of inflation reports, to ensure transparency and the effectiveness
of monetary policy. The next inflation report will be issued by early
October. In view of the expected improvements in the fiscal situation,
the rapid progress on banking reforms, and the completion of the pass-through
from the initial depreciation to prices, we intend to formally make
an inflation target the nominal anchor of monetary policy beginning
in the last quarter in 2001. At that time, we will announce an inflation
target for 2002, supported by an indicative quarterly inflation path.
In the meantime, the CBT will regularly assess the inflation developments
and outlook and, based on this assessment, will adjust interest rates
consistent with the disinflation objective. As the program is implemented
and inflation continues to decline, we expect short-term interest
rates to be on a declining trend, although the CBT stands ready to
raise rates as needed to support a continued fall in inflation.
13.
During the transition to inflation targeting, base money will remain
the nominal anchor for the disinflation effort. In line with the updated
macroeconomic framework, and more closely reflecting the seasonal
behavior of currency demand, we have prepared revised targets for
the monetary base (Annex D). To help achieve the base money target,
the CBT will sell foreign exchange (see next paragraph) and adjust
money market rates as needed.
14. Discretionary foreign exchange intervention will be limited to
smoothing operations. Consistent with the program strategy, the CBT
will continue to conduct two types of foreign exchange operations.
First, the CBT will sell foreign exchange in the market to offset
the impact on domestic liquidity of the use of external borrowing
for the budget for domestic payments. To this end, the CBT will place
all such external support in a special account. The portion of these
funds which is used for domestic payments will be sold in pre-announced
auctions. Second, the CBT may also intervene from time to time to
smooth temporary exchange rate fluctuations. However, to avoid taking
bets against the market, such intervention will be infrequent and
in both directions, consistent with the floating exchange rate regime.
Banking
sector reforms
15.
We have continued to make rapid progress on banking sector reform.
Commitment letters with plans to raise banks’ capital to adequate
levels by end-2001 have been signed with private banks identified
as financially weak. Five banks that were unable to commit to credible
recapitalization plans were intervened on July 10. Three of the four
SDIF banks (Etibank, Interbank, and Esbank) for which no interest
had been shown by potential investors were merged into a second transition
bank (under Etibank) on July 2. Moreover, Bank Ekspres has been sold
to a local group, and an international bank (HSBC) won the bid to
further negotiate the sales and purchase agreement of Demirbank until
September 20. Negotiations on the sale of Sümerbank are still ongoing.
If no agreement can be reached about the sale, liquidation procedures
will be initiated before end-September. We revoked the license of
Emlak bank on July 9, and its banking assets and liabilities have
been transferred to Ziraat, which has been adequately capitalized
to absorb those assets. A monitoring system has been introduced to
monitor profits/losses, liquidity, and interest rate margins of the
state banks. The independent audit of the state banks has been completed,
and outside advisors have been appointed to guide the operational
restructuring of state banks. An omnibus law to facilitate the restructuring
of the state banks as well as mergers of banks and their subsidiaries
has also been passed.
16. Several further steps are being taken to strengthen the financial
position of private banks:
-
For
the financially weak banks that have committed to capital strengthening
plans, we have established a framework to monitor closely banks’
compliance with the agreed plans. The BRSA will promptly impose
the sanctions prescribed in the Banking Law on any bank that does
not fully comply with the plan.
-
We will continue to monitor the financial condition of private banks,
and our strategy will remain to require banks identified as financially
weak to agree with the BRSA on capital strengthening plans. Whenever
such plans cannot be agreed, the banks in question will be resolved
promptly, by the time of the following program review.
-
A
strengthened regulatory framework will help reinforce the implementation
of banking reforms. In this context, an amended regulation on connected
lending has been issued.
17. We remain committed to resolving the banks taken over by
the SDIF by end-2001, and will in the meantime continue the operational
restructuring of these banks:
18. The work to prepare the state banks for privatization is
moving ahead:
-
Progress has been made with the operational restructuring (branch
and staff consolidation) of Ziraat and Halk. Criteria for branch
closures and reductions in employees are being worked out, with
rationalization to be completed over the next 18 months.
- Following
the transfer of Emlak’s assets and liabilities to Ziraat on July 9,
a shareholders’ meeting will be held on August 17 to appoint a liquidator.
Furthermore, while all of Emlak’s branches initially were transferred
to Ziraat, we are currently in the process of identifying branches
that will be transferred to Halk by end-August 2001.
-
The process of privatizing Vakif will resume as soon as market conditions
permit. Following passage of the law facilitating more flexible
sale methods, the implementing decree has been opened for signature
by cabinet ministers.
19. We will ensure that our strategy strengthens and consolidates
viable banks. To this end, we have established basic principles for
the resolution of the SDIF and undercapitalized private banks: (i)
any bank to be sold or merged must be properly recapitalized upfront;
(ii) the new owner must fully comply with the required “fit and proper”
criteria; (iii) the new owner must also be able to provide a convincing
business plan to ensure the bank’s future profitability; and (iv)
the recapitalized bank must be viable/profitable and be in compliance
upfront with all prudential regulations. We will ensure that these
principles are properly adhered to for all future bank sales or resolutions
involving the BRSA or SDIF.
20. We will ensure that the BRSA has the legal right and financial
resources to maintain and recruit qualified staff, with employment
conditions in line with the institutions under its supervision. We
realize that the soundness of the banking system to a large extent
depends on the way in which the BRSA carries out its responsibilities,
which in turn depends on the quality of its staff. Similarly, to maximize
its loan recoveries and to minimize the cost imposed on taxpayers,
the Collection Department within the SDIF will have the financial
resources to recruit experienced private sector banking experts.
Privatization,
business climate, and governance
21. The preparations for divestiture of large state-owned assets
are advancing as planned. While market conditions will continue to
guide the timing of asset sales, we are pushing ahead with the necessary
preparations:
-
The Privatization Administration (PA) is in the process of completing
the draft offers for TUPRAS (oil refinery) and POAS (petrol distribution),
and the public offerings are slated for the fourth quarter of 2001
as planned.
- The
government will resubmit the Tobacco Law that parliament approved
in June as soon as parliament reconvenes. The concerns expressed on
managing the transition period are being addressed through various
projects supported by the World Bank. The PA will prepare privatization
plans for TEKEL (tobacco and alcohol monopoly) and SEKER (sugar company),
consistent with the commitments under the World Bank Economic Reform
Loan, by end-2001.
- We
will immediately start preparations for the privatization of electricity
generation and distribution assets for which there are no pending
contracts for Transfer of Operating Rights. For those assets for which
such contracts are pending, we will conclude or otherwise resolve
the pending contracts before end-October 2001 (the new deadline in
the amended Electricity Markets Law), and then move ahead with the
privatization of the remaining assets as envisaged in our May 3 Memorandum
on Economic Policies. We are receiving assistance from the World Bank
in the implementation of the new Electricity Markets Law.
-
We are working with the Ministry of Energy to prepare for the transfer
of gas companies from BOTAS to the PA’s portfolio.
-
Petkim (petrochemicals company) and Turkish Airlines are undergoing
operational restructuring (in the former case through plant closures,
in the latter through sales of aircraft and staff layoffs) to improve
their financial position in preparation for privatization. Also,
we are preparing for the privatization of ERDEMIR (steel company)
through a merger with ISDEMIR
-
Several steps will be taken toward the privatization of Türk Telekom:
the company will contract advisors by end-October 2001 (a structural
benchmark) to develop a corporatization plan acceptable to the World
Bank by end-2001, which will streamline the operations of the company
in preparation for its privatization; the Tender Committee for the
privatization of Türk Telekom will be appointed shortly, and the
PA will start the preparation of the privatization plan, which is
expected to be completed by end-2001 (a structural benchmark). We
are exploring the possibility of IFC assistance in the form of a
pre-privatization investment.
-
Two laws that will regulate the sale of government-owned land have
recently been enacted. These laws provide the basis for incentives
to facilitate land sales, such as payment in installments, exemption
from taxes and fees on sale transactions, and exemption from property
tax. To implement the land sales, a coordination committee has been
set up under the chairmanship of the Ministry of Finance with the
participation of the Land Registry Office, the Ministry of Tourism,
and other interested institutions. Moreover, the circulars
and directives defining the details of land sales, including assessment
procedures, have been adopted.
In
sum, we remain confident that the expected proceeds from privatization
of US$1 billion for the remainder of 2001 will be received as envisaged
under the program.
22. We are also implementing planned steps to improve the business
climate. The study on administrative barriers to investment by the
World Bank (FIAS) was completed in June as envisaged. The executive
summary of the report has been circulated to the relevant agencies
for comments in preparation for a September workshop. An action plan
will be presented to the Council of Ministers by end-September 2001.
23. We
are also implementing our strategy to improve governance in the public
sector:
-
In early July, we held a World Bank-supported workshop on ways to
fight corruption. Based on these findings, a working group is now
preparing an action plan, in advance of the anti-corruption conference
scheduled for September. The Prime Minister has sent a circular
to all government agencies relating to the initiative to strengthen
transparency, requesting recommendations and setting up special
committees to tackle this issue; this is expected to help involve
the agencies more directly in this effort.
-
On government expenditure management, the Public Expenditure and
Institutional Review (prepared in collaboration with the World Bank)
has been finalized, and the strategy for improvements in expenditure
management is now being implemented. As first steps, a High Planning
Council resolution on the rationalization of public sector investments
has been adopted, and line agencies have been instructed through
the 2002 budget call to prepare their budgets in line with the macroeconomic
targets. As part of the implementation of this strategy, we are
now preparing a conference on expenditure management scheduled for
November 2001.
24.
We are taking steps to alleviate the impact of the temporary contraction
of activity on viable private sector companies. We are channeling
some of the long-term credits secured from the European Investment
Bank and other sources to the small and medium enterprise sector.
We are also protecting the funding of the Turkish Eximbank within
the limits of our fiscal constraints.
Social
dialogue and incomes policy
25. Our economic program respects the need for social consensus and
social dialogue. To that end, we expect that the first meeting of
the Economic and Social Council since its legal status was established
will be held in August 2001. Moreover, to guide wage and price expectations,
we have raised the minimum wage by 19.8 percent from July, consistent
with projected inflation for the remainder of the year.
26. Finally, we are carrying out a number of enhanced social
policies with the support of the World Bank. These include: (i) strengthened
monitoring of the social impact of the crisis; (ii) preparations for
the introduction of the unemployment insurance scheme from the middle
of next year; (iii) strengthening the social safety net for the most
vulnerable groups, especially children; (iv) providing cash benefits
and re-insertion programs for workers displaced as a result of privatization;
(v) protecting public expenditure on health, education and social
protection at levels above the average of the last three years (as
a share of GNP); and (vi) introducing direct income support to farmers
during the remainder of 2001.
Very truly yours,
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