Turkey's economic/political forecast 2005-2006
The Economist Intelligence Unit believes that the Justice and Development Party (AKP) government, led by Recep Tayyip Erdogan, will stay in power in 2005-06. Although there are still some obstacles to overcome, we expect the EU to start accession negotiations in October 2005, but there is a strong risk of rejection at the end of the process. Driven by domestic demand, GDP growth will average about 5.5% in 2005. In 2006 we expect a fall in the value of the lira to contribute to slightly higher inflation and slower GDP growth of 4%. A slowdown should help to reduce the current-account deficit from an annual average of 5% of GDP in 2004-05 to a more sustainable 3.4% in 2006.
Political outlook
The Turkish Cypriot presidential election held on April 17th was won by Mehmet Ali Talat. Mr Talat strongly favours a settlement along the lines of the UN-proposed plan that was overwhelmingly supported by Turkish Cypriots and rejected by the Greek Cypriots in April 2004. Mr Talat and Mr Erdogan have both been calling for new settlement talks. Although these are likely to be resumed soon, there is only a small chance in the next two years of a solution of the Cyprus issue, which remains one of the main stumbling blocks to Turkey's hopes of eventually joining the EU.
Economic policy outlook
After months of delays and uncertainty, which almost certainly exacerbated a bout of financial volatility in March, the Turkish authorities are now close to meeting the IMF's preconditions for the final approval of a new three-year stand-by credit facility for 2005-07. We expect the IMF to approve the agreement in May.
Economic forecast
On the basis of upward revisions to third-quarter GDP data, stronger than expected final-quarter data, and an acceleration in industrial output growth in January-February, we have revised our 2005 GDP forecast up to 5.4% (previously 5%) but we also expect the current-account deficit to be slightly higher at 4.9% of GDP (4.7% of GDP previously).
Outlook for 2005-06: Domestic politics
The Economist Intelligence Unit expects the government of the conservative Justice and Development Party (AKP), led by Recep Tayyip Erdogan, to remain in power throughout the outlook period. Constitutionally, a general election will not be obligatory until November 2007. The government may decide to call an election in 2006 if it considers the economic and political conditions to be right. We believe that its massive majority in parliament should be sufficient to shield it against the sporadic defections and backbench rebellions to which most Turkish political parties are susceptible. In recent months the AKP has lost several deputies, reducing its number of seats in parliament to 357 out of a possible 550, but Mr Erdogan retains substantial public support. His government has restored economic growth, dramatically reduced inflation and widened civil liberties.
However, Mr Erdogan faces several major challenges during the forecast period. He must overcome the remaining obstacles to the start of EU accession negotiations on October 3rd, as agreed at the European Council meeting in December 2004, and continue the IMF-backed economic reform programme, without leaving himself open to accusations from increasingly vociferous nationalists of making too many concessions on matters of Turkish interest.
Another possible problem for the government could be tensions with the country's secularist establishment, some of whom believe that the AKP's commitment to secularist principles is only skin-deep and that it is actually pursuing a hidden Islamist agenda. So far, Mr Erdogan and his government have generally been careful to avoid a head-on collision with the pro-secularist camp on issues such as ending the existing ban on the wearing of Islamic-style headscarves in universities and other state institutions. Equally, the military is unlikely to make overt moves to undermine Mr Erdogan, given that his public support still appears strong, and there is no viable alternative on the horizon.
We expect the AKP still to be the largest party after the next election, but its current majority may be cut back sharply, or even eliminated, if, as seems likely, one or more of its rivals on the centre-right were to succeed in surmounting the 10% threshold for parliamentary representation. Mr Erdogan might then have to seek a coalition with one or more of the elected parties. Against this, the left-of-centre Republican People's Party (CHP), the main party in opposition, is currently in a state of total disarray and faces the serious risk of falling apart. With three or more parties competing on the centre-left for a limited share of the electoral market, they might all fall short of the 10% threshold. This would help the AKP to win again, but would hardly strengthen Turkish democracy as a whole.
Outlook for 2005-06: International relations
We expect Turkey to start negotiations with the EU on October 3rd 2005, as agreed by the European Council in December 2004. At the end of March the government moved closer to signing the protocol extending Turkey's 1995 customs union agreement with the EU to the ten new member states that joined the Union in May 2004, including Cyprus, although it still insists that signing will not constitute full recognition of the Greek Cypriot government of Cyprus. Slower progress has been made on the political reforms that are required. In particular, the government must implement the new penal code, which was to have taken effect in April but was delayed because of complaints that it could be used to limit the media’s freedom of expression. Legislation allowing the establishment of property rights of the religious and educational institutions of the non-Muslim minorities is also required, but at the time of writing the bill had not yet been presented to parliament. Based on past experience, we believe the government will do what is required, but it may be left to the last hour.
Outlook for 2005-06: In focus
Turkey's EU bid
Assuming EU accession negotiations start in December 2005, they are likely to be long and difficult, and membership will not be until 2015 at the earliest. The European Council insisted on stating in the December 2004 summit conclusions that a successful end to negotiations was not guaranteed (this applies to all candidate countries, not just Turkey, but Turkey's bid is the most likely to encounter obstacles). Members of the governing parties of some EU countries, notably France and Austria, and the majority of voters in some EU countries have serious doubts whether Turkey should ever be allowed to join the EU, for reasons including Turkey's geographical location, its size, its relative poverty, and the fact that it is predominantly Muslim. France and Austria have said that they may hold referendums on Turkish accession at the end of the negotiations. Given the high level of popular opposition at present, the outcome would almost certainly be negative if such referendums were held now. In Turkey, the overwhelming majority of the population supports the membership bid, but the experiences of other EU candidate countries (notably Poland) have shown that support for membership tends to wane during the accession negotiation process. The same may well happen in Turkey.
Although the main focus of Turkish foreign policy during the outlook period will be on integration with the EU, relations with the US will continue to be crucial. These have been difficult as a result of fierce criticism in Turkey of the US's policy in Iraq and the failure of the US forces there to remove the remaining bases of the militant Kurdistan Workers' Party (PKK/Kongra-Gel) from the north of the country, which are used to launch attacks against Turkish security forces in the south-east of Turkey. Both governments seem to recognise that, like it or not, they need to co-operate, but tensions are likely to re-emerge from time to time, given Turkey's increasingly independent policy in the region. Relations with Iraq's Kurds have improved, and Turkey now seems to be prepared to accept a federal structure for Iraq, recognising that it is in no position to tell the Iraqi people what sort of constitution they should adopt.
Outlook for 2005-06: Policy trends
The wide-ranging economic reforms introduced under Turkey's IMF stand-by agreements have helped to restore investor confidence since the 2001 financial crisis. Economic growth has been strong, inflation has continued to fall and fiscal policy has remained tight. As a result, the Turkish economy is more robust and resilient to shocks. However, much still remains to be done and external conditions will not be as supportive as in 2004. As shown by bouts of financial instability in May and September 2004 and in March-April 2005, Turkey is still vulnerable to volatility and sharp changes in investor sentiment, given its burgeoning current-account deficit and large government debt. Delays in signing the new three-year IMF stand-by credit facility, which had been agreed in principle in mid-December almost certainly exacerbated the exchange-rate volatility and sharp fall in the stockmarket triggered in the first half of March by the prospect of higher US interest rates and tighter international liquidity. By mid-April, however, the Turkish authorities were close to meeting the IMF's pre-conditions—the introduction of legislation to strengthen the tax administration, reduce the cost of the state pension system and further strengthen the banking sector—and agreement had been reached on the letter of intent containing the policies and targets that Turkey intends to implement in exchange for financial support. We expect the IMF executive to give its final approval in May. The Fund will lend Turkey up to US$10bn in 2005-07. The Turkish authorities have also requested the postponement of some repayments worth about US$3.7bn from 2006 to 2007. The prospect of a start to EU membership negotiations in October 2005 should also help to sustain investor confidence.
Outlook for 2005-06: Fiscal policy
The government must keep fiscal policy tight for several years to come if it is to continue to reduce Turkey's large government debt burden (73.5% of GDP at end-2004) and maintain investor confidence. Under the new IMF-backed programme the government has committed itself to maintaining ambitious fiscal targets, particularly the public-sector primary surplus (the broad public-sector balance less interest payments on government debt). The primary surplus target of 6.5% of GNP was achieved in 2004, thanks to strong growth and indirect tax increases, but the task will be more difficult in 2005-06, when we expect economic growth to be weaker and political pressure on the budget to mount ahead of the next general election.
Even with substantial primary surpluses, the overall deficit will still be quite large, reflecting the high cost of servicing Turkey's government debt, although a combination of lower interest rates, declining debt and the strength of the lira should continue to reduce the interest/GDP ratio to about 11% in 2005, compared with about 23% in 2001. A slight increase is expected in 2006, reflecting our forecast that interest rates will edge up. As a result, we expect the central government deficit to be 6-7% in 2005-06, compared with 7% of GDP in 2004 and 16.1% in 2001. Although well down from the 100% peak reached in 2001, the government debt/GDP ratio is forecast to remain at about 70% in 2005-06. Besides the size of the debt burden, its structure leaves Turkey vulnerable to interest rate and exchange-rate shocks. At end-2004 about 45% of the government debt was tied to foreign currencies, and the average maturity of the domestic debt was just 21 months, down from 25 months at end-2003.
Outlook for 2005-06: Monetary policy
In recent years the Central Bank of Turkey's monetary policy has been cautious, enhancing the credibility of its recently established independence. It has cut interest rates drastically, in line with reductions in inflation and steady progress in the area of fiscal consolidation, but has resisted occasional pressure from various sectors for potentially premature rate reductions. Since the beginning of 2005 the bank has cut rates four times, reducing the overnight borrowing rate to 15% (compared with 44% at end-2002), and the lending rate to 19% (compared with 51% at end-2002). Assuming that in 2005 the exchange rate is stable and inflation remains under control, we expect further cuts of about 200 basis points during this year. However, there will be limited scope for large reductions to continue in 2006 if, as we expect, there is another fall in the value of the lira and inflation starts to edge up again. At the start of 2006 the Central Bank plans to move from "implicit" inflation-targeting to a fully fledged policy of inflation targeting (at present its policy focuses on monetary base targets). The redenomination of the Turkish currency by removing six zeros from the lira at the beginning of 2005 went smoothly and is not expected to have inflationary effects.
Political outlook
The Turkish Cypriot presidential election held on April 17th was won by Mehmet Ali Talat. Mr Talat strongly favours a settlement along the lines of the UN-proposed plan that was overwhelmingly supported by Turkish Cypriots and rejected by the Greek Cypriots in April 2004. Mr Talat and Mr Erdogan have both been calling for new settlement talks. Although these are likely to be resumed soon, there is only a small chance in the next two years of a solution of the Cyprus issue, which remains one of the main stumbling blocks to Turkey's hopes of eventually joining the EU.
Economic policy outlook
After months of delays and uncertainty, which almost certainly exacerbated a bout of financial volatility in March, the Turkish authorities are now close to meeting the IMF's preconditions for the final approval of a new three-year stand-by credit facility for 2005-07. We expect the IMF to approve the agreement in May.
Economic forecast
On the basis of upward revisions to third-quarter GDP data, stronger than expected final-quarter data, and an acceleration in industrial output growth in January-February, we have revised our 2005 GDP forecast up to 5.4% (previously 5%) but we also expect the current-account deficit to be slightly higher at 4.9% of GDP (4.7% of GDP previously).
Outlook for 2005-06: Domestic politics
The Economist Intelligence Unit expects the government of the conservative Justice and Development Party (AKP), led by Recep Tayyip Erdogan, to remain in power throughout the outlook period. Constitutionally, a general election will not be obligatory until November 2007. The government may decide to call an election in 2006 if it considers the economic and political conditions to be right. We believe that its massive majority in parliament should be sufficient to shield it against the sporadic defections and backbench rebellions to which most Turkish political parties are susceptible. In recent months the AKP has lost several deputies, reducing its number of seats in parliament to 357 out of a possible 550, but Mr Erdogan retains substantial public support. His government has restored economic growth, dramatically reduced inflation and widened civil liberties.
However, Mr Erdogan faces several major challenges during the forecast period. He must overcome the remaining obstacles to the start of EU accession negotiations on October 3rd, as agreed at the European Council meeting in December 2004, and continue the IMF-backed economic reform programme, without leaving himself open to accusations from increasingly vociferous nationalists of making too many concessions on matters of Turkish interest.
Another possible problem for the government could be tensions with the country's secularist establishment, some of whom believe that the AKP's commitment to secularist principles is only skin-deep and that it is actually pursuing a hidden Islamist agenda. So far, Mr Erdogan and his government have generally been careful to avoid a head-on collision with the pro-secularist camp on issues such as ending the existing ban on the wearing of Islamic-style headscarves in universities and other state institutions. Equally, the military is unlikely to make overt moves to undermine Mr Erdogan, given that his public support still appears strong, and there is no viable alternative on the horizon.
We expect the AKP still to be the largest party after the next election, but its current majority may be cut back sharply, or even eliminated, if, as seems likely, one or more of its rivals on the centre-right were to succeed in surmounting the 10% threshold for parliamentary representation. Mr Erdogan might then have to seek a coalition with one or more of the elected parties. Against this, the left-of-centre Republican People's Party (CHP), the main party in opposition, is currently in a state of total disarray and faces the serious risk of falling apart. With three or more parties competing on the centre-left for a limited share of the electoral market, they might all fall short of the 10% threshold. This would help the AKP to win again, but would hardly strengthen Turkish democracy as a whole.
Outlook for 2005-06: International relations
We expect Turkey to start negotiations with the EU on October 3rd 2005, as agreed by the European Council in December 2004. At the end of March the government moved closer to signing the protocol extending Turkey's 1995 customs union agreement with the EU to the ten new member states that joined the Union in May 2004, including Cyprus, although it still insists that signing will not constitute full recognition of the Greek Cypriot government of Cyprus. Slower progress has been made on the political reforms that are required. In particular, the government must implement the new penal code, which was to have taken effect in April but was delayed because of complaints that it could be used to limit the media’s freedom of expression. Legislation allowing the establishment of property rights of the religious and educational institutions of the non-Muslim minorities is also required, but at the time of writing the bill had not yet been presented to parliament. Based on past experience, we believe the government will do what is required, but it may be left to the last hour.
Outlook for 2005-06: In focus
Turkey's EU bid
Assuming EU accession negotiations start in December 2005, they are likely to be long and difficult, and membership will not be until 2015 at the earliest. The European Council insisted on stating in the December 2004 summit conclusions that a successful end to negotiations was not guaranteed (this applies to all candidate countries, not just Turkey, but Turkey's bid is the most likely to encounter obstacles). Members of the governing parties of some EU countries, notably France and Austria, and the majority of voters in some EU countries have serious doubts whether Turkey should ever be allowed to join the EU, for reasons including Turkey's geographical location, its size, its relative poverty, and the fact that it is predominantly Muslim. France and Austria have said that they may hold referendums on Turkish accession at the end of the negotiations. Given the high level of popular opposition at present, the outcome would almost certainly be negative if such referendums were held now. In Turkey, the overwhelming majority of the population supports the membership bid, but the experiences of other EU candidate countries (notably Poland) have shown that support for membership tends to wane during the accession negotiation process. The same may well happen in Turkey.
Although the main focus of Turkish foreign policy during the outlook period will be on integration with the EU, relations with the US will continue to be crucial. These have been difficult as a result of fierce criticism in Turkey of the US's policy in Iraq and the failure of the US forces there to remove the remaining bases of the militant Kurdistan Workers' Party (PKK/Kongra-Gel) from the north of the country, which are used to launch attacks against Turkish security forces in the south-east of Turkey. Both governments seem to recognise that, like it or not, they need to co-operate, but tensions are likely to re-emerge from time to time, given Turkey's increasingly independent policy in the region. Relations with Iraq's Kurds have improved, and Turkey now seems to be prepared to accept a federal structure for Iraq, recognising that it is in no position to tell the Iraqi people what sort of constitution they should adopt.
Outlook for 2005-06: Policy trends
The wide-ranging economic reforms introduced under Turkey's IMF stand-by agreements have helped to restore investor confidence since the 2001 financial crisis. Economic growth has been strong, inflation has continued to fall and fiscal policy has remained tight. As a result, the Turkish economy is more robust and resilient to shocks. However, much still remains to be done and external conditions will not be as supportive as in 2004. As shown by bouts of financial instability in May and September 2004 and in March-April 2005, Turkey is still vulnerable to volatility and sharp changes in investor sentiment, given its burgeoning current-account deficit and large government debt. Delays in signing the new three-year IMF stand-by credit facility, which had been agreed in principle in mid-December almost certainly exacerbated the exchange-rate volatility and sharp fall in the stockmarket triggered in the first half of March by the prospect of higher US interest rates and tighter international liquidity. By mid-April, however, the Turkish authorities were close to meeting the IMF's pre-conditions—the introduction of legislation to strengthen the tax administration, reduce the cost of the state pension system and further strengthen the banking sector—and agreement had been reached on the letter of intent containing the policies and targets that Turkey intends to implement in exchange for financial support. We expect the IMF executive to give its final approval in May. The Fund will lend Turkey up to US$10bn in 2005-07. The Turkish authorities have also requested the postponement of some repayments worth about US$3.7bn from 2006 to 2007. The prospect of a start to EU membership negotiations in October 2005 should also help to sustain investor confidence.
Outlook for 2005-06: Fiscal policy
The government must keep fiscal policy tight for several years to come if it is to continue to reduce Turkey's large government debt burden (73.5% of GDP at end-2004) and maintain investor confidence. Under the new IMF-backed programme the government has committed itself to maintaining ambitious fiscal targets, particularly the public-sector primary surplus (the broad public-sector balance less interest payments on government debt). The primary surplus target of 6.5% of GNP was achieved in 2004, thanks to strong growth and indirect tax increases, but the task will be more difficult in 2005-06, when we expect economic growth to be weaker and political pressure on the budget to mount ahead of the next general election.
Even with substantial primary surpluses, the overall deficit will still be quite large, reflecting the high cost of servicing Turkey's government debt, although a combination of lower interest rates, declining debt and the strength of the lira should continue to reduce the interest/GDP ratio to about 11% in 2005, compared with about 23% in 2001. A slight increase is expected in 2006, reflecting our forecast that interest rates will edge up. As a result, we expect the central government deficit to be 6-7% in 2005-06, compared with 7% of GDP in 2004 and 16.1% in 2001. Although well down from the 100% peak reached in 2001, the government debt/GDP ratio is forecast to remain at about 70% in 2005-06. Besides the size of the debt burden, its structure leaves Turkey vulnerable to interest rate and exchange-rate shocks. At end-2004 about 45% of the government debt was tied to foreign currencies, and the average maturity of the domestic debt was just 21 months, down from 25 months at end-2003.
Outlook for 2005-06: Monetary policy
In recent years the Central Bank of Turkey's monetary policy has been cautious, enhancing the credibility of its recently established independence. It has cut interest rates drastically, in line with reductions in inflation and steady progress in the area of fiscal consolidation, but has resisted occasional pressure from various sectors for potentially premature rate reductions. Since the beginning of 2005 the bank has cut rates four times, reducing the overnight borrowing rate to 15% (compared with 44% at end-2002), and the lending rate to 19% (compared with 51% at end-2002). Assuming that in 2005 the exchange rate is stable and inflation remains under control, we expect further cuts of about 200 basis points during this year. However, there will be limited scope for large reductions to continue in 2006 if, as we expect, there is another fall in the value of the lira and inflation starts to edge up again. At the start of 2006 the Central Bank plans to move from "implicit" inflation-targeting to a fully fledged policy of inflation targeting (at present its policy focuses on monetary base targets). The redenomination of the Turkish currency by removing six zeros from the lira at the beginning of 2005 went smoothly and is not expected to have inflationary effects.
posted by Marko at 11/21/2005 02:47:00 PM
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