Turkey

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Highlights

• Economic activity picked up in early 2013. This followed a sharp slow-down in 2012. A continued surge in public consumption and public fixed investment also helped to stimulate demand, but export conditions for Turkey deteriorated. Meanwhile, inflation has risen in 2013, and inflationary pressures have remained high, on the back of a weakening currency.
  
• Large macroeconomic imbalances remain. Capital outflows have increased the risks faced by the economy, especially given its large external financing requirements, heavy reliance on short-term foreign borrowing and volatile portfolio inflows.
  
• Some measures have been undertaken to liberalise the energy sector. A new Electricity Market Law was passed in March 2013, which aims to increase competitiveness and transparency in the electricity market.

Key priorities for 2014

• Cross-cutting reform priorities should raise labour market efficiency and reduce energy dependence. Excessive labour market regulation and tax procedures discourage formal employment and the formal economy in general. The widening current account deficit has led policy-makers to raise concerns about competitiveness and Turkey’s energy dependence.
• Infrastructure reforms should focus on greater efficiency in the energy sectors and improved regional and rural infrastructure. The renewable energy sector has attracted foreign and domestic investor interest, as has the ongoing privatisation of electricity distribution grids. Policy dialogue is still at an early stage, but is under way, especially in the context of public-private partnerships (PPPs).
• Access to finance and business support for enterprises should be enhanced. This is especially needed in more remote regions. Other policy priorities include support for the deepening of financial intermediation and the development of local currency capital markets.

Macroeconomic performance

Economic activity picked up during the first half of 2013, following a sharp slow-down in 2012. Real GDP grew by a stronger-than-expected 4.4 per cent, year-on-year, in the second quarter of 2013, bringing the growth rate in the first half of 2013 to 3.7 per cent, up from 3 per cent during the same period last year. The main driver of growth was private consumption, supported by a large boost in public spending, especially in investments. However, private investment remains weak, contracting in the second quarter. Net exports also continue to be a drag on growth, as strong domestic demand fuels imports.

Large macroeconomic imbalances remain. The current account deficit remains large, at above 6 per cent of GDP, leaving Turkey vulnerable to sudden shifts in global market sentiment. Turkey continues to have persistently large external financing requirements (estimated at about 23 per cent of GDP) and is heavily reliant on short-term foreign borrowing and volatile portfolio inflows to meet those requirements. The prospect of quantitative easing by the US Federal Reserve System has led to a reversal of capital flows since May 2013, with the currency weakening to record lows against the US dollar, and bond yields in double digits.

Monetary policy continues to be reactive to global liquidity conditions. Strong domestic demand and a weaker currency have contributed to persistently high inflation, which reached 8.2 per cent in August 2013, compared with the Central Bank of the Republic of Turkey’s target of 5.0 per cent by the end of 2013. However, the Central Bank remains focused on containing the pressure on the currency. In early June 2013 it tightened lira liquidity and reintroduced daily foreign exchange selling auctions, leading to a rapid drawdown on foreign exchange reserves. These measures were followed by hikes in the overnight lending rate by 125 basis points in two steps, in late June, and more liquidity tightening in August, which pushed the average lira funding rate towards the 7.75 per cent ceiling. The Central Bank has reiterated its commitment to keeping the effective funding rate in the 6.75-7.75 per cent range as of September 2013 until the end of the year, and to prioritise interest rate stability over foreign exchange volatility.

Risks to the outlook are tilted to the downside. Output growth is likely to slow in the near term if higher lending rates materialise and the lira depreciates further, thus constraining domestic demand. While a weaker currency could help reduce the current account deficit, it is likely to keep inflation above the Central Bank’s target. Lastly, the US Federal Reserve’s decisions, and geopolitical risks surrounding Syria, represent uncertainties, with sustained capital outflows potentially leading the authorities to tighten policy more than anticipated.

Major structural reform developments

Progress on improving the business climate across sectors has been mixed. A new five-year development plan, containing measures to improve the competitiveness of the economy, was approved by parliament in July 2013, in addition to a series of laws in the energy sector (oil and electricity) designed to increase private sector participation (see below). However, discussions on an income tax reform bill and extensive amendments to the Consumer Protection Act were postponed until October 2013. The new consumer protection law aims to align consumer protection with European Union (EU) standards, and to strengthen the capacity of the regulator. Under the new income tax law it is proposed to merge the existing corporate income tax and personal income tax laws, simplify them, eliminate many exemptions and exceptions, and close loopholes, with a view to making taxes fairer, reducing informality and broadening the tax base.

The new Turkish Commercial Code (TCC) has come into force.  Adopted in July 2012, the new legislation aims to bring Turkey’s business environment into line with that of the EU, especially through improvements in corporate governance standards. The TCC removes the need for board members to be company shareholders and also states that shareholders cannot incur debt to the firm (this is only applicable to joint stock companies). Provisions on independent auditing became effective on 1 January 2013, while those requiring equity capital companies to make information available online entered into force on 1 July 2013. Some steps have also been taken to improve corporate governance. The Capital Markets Board (CMB) published a Corporate Governance Principles Guide, to which public companies are required to indicate adherence in their annual statements. The new TCC provides the CMB with the exclusive authority to regulate corporate governance.

Measures to liberalise the energy sector have been undertaken. In March 2013 the new Electricity Market Law was passed, which aims to increase competitiveness and transparency in the electricity market, and to establish an independent regulatory and auditing mechanism. In May 2013 the parliament also approved a law to liberalise the oil market, placing the private sector on an equal footing with the state-run, upstream firm, TPAO. The law aims to increase competitiveness in the oil market and to allow for more foreign participation in exploration and production projects in Turkey's oil sector. In the natural gas sector, the government is trying to reduce the market dominance of the state-owned gas company, BOTAS, via a gas release programme, whereby the incumbent must transfer 10 per cent of its gas and liquefied natural gas (LNG) contracts each year. Private operators are expected to take over the space created by the BOTAS opt-out, which could help to expedite the liberalisation process. Nevertheless, reducing the market dominance of BOTAS remains a key challenge. In September 2012 the Turkish government, with a view to improving the gas market’s operations and enhancing competition, introduced amendments to the country’s Gas Market Law that envisage splitting BOTAS into three separate entities –  oil and gas pipeline operations, LNG import facilities, and underground gas storage.

Despite some setbacks, the government’s privatisation programme is set to continue. However, the pace of progress will depend on market conditions and investor appetite. In October 2012 the Privatisation Administration invited bids for three regional electricity distribution firms and management rights for several toll motorways and bridges. Other scheduled privatisations include sugar refineries, the national lottery, operation rights for more bridges and toll roads, and gas distributors. A new round of electricity privatisation, which will include 2 GW of state-owned electricity generation capacity, is also underway. The government is also pushing ahead with several major infrastructure projects, with PPPs and Build-Operate-Transfer schemes likely to increase private sector participation. However, the privatisation drive has experienced some setbacks, with the introduction in 2012 of a new law stating that the prime minister must supervise the tender process. Since then, a large number of privatisation tenders have been scrutinised, resulting in the cancellation, in February 2013, of a US$ 5.7 billion infrastructure tender as a result of claims by the prime minister that it was being undersold. This has dampened investor confidence somewhat, with market participants claiming that the privatisation drive is likely to stall as a result of high government valuations ahead of the announcement of major infrastructure spending plans.

Parliament has passed the Terrorism Financing Prevention Law. This law is designed to cut the funding sources of terrorist groups. The new law will allow the Turkish authorities to freeze the accounts of suspected terrorists without a court order. The legislation was prompted by the recommendations of the Financial Action Task Force (FATF), after Turkey became at risk of being placed on the FATF’s list of non-compliant countries.

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