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WorldOctober 1 2014

Turkey's finance minister pushes on with reform agenda

Turkey’s finance minister talks about the challenges facing the country's newly formed government after its first presidential elections, and the challenges posed by Turkey’s high current account deficit and inflation.
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Turkey's finance minister pushes on with reform agenda

Q: The Turkish population has, for the first time ever, elected its president – the former prime minister Recep Tayyip Erdoğan – and a new government has been formed. How has your strategy changed with the new government?

A: With [former] prime minister Mr Erdoğan becoming president, there were questions as to how the ruling party would manage the transition. Within a week or two we were able to elect a new president, a new chairman of the party, a new prime minister and cabinet, and push the government programme through parliament. Now we are back to business as usual. That was by any standard very smooth and very swift.

Our current prime minister, Ahmet Davutoğlu, is the former foreign minister, so he is not new. There is no fundamental shift in the course. We are working on more reforms and are preparing the ground for the next four to five years. We still have parliamentary elections scheduled for June 2015 but if you look at current opinion polls, they suggest that AK Party, the ruling party since 2002, will likely secure a comfortable parliamentary majority and the chances are that reforms will accelerate.

I am even optimistic that some of the reforms [we are working on now] will be pushed through parliament by March or April next year.

We are currently working on broadening and deepening our structural reform agenda. The next government will have a full four years with no elections, which implies stability and limited political noise. It is therefore very important to have the second generation of reforms ready to be pushed through in the early stages of the next government so that the ground is prepared for Turkey to go back to strong growth and to achieve its 2023 targets, which are very ambitious.

Q: What are your 2023 targets?

A: The Turkish republic was founded in 1923, so 2023 is the centenary. In the past, governments couldn’t look beyond 15 months, or two or three years. Now we are planning decades ahead and even beyond, thanks to political stability and good performance.

By 2023, Turkey aims to have a gross domestic product [GDP] of $2000bn, which would imply $25,000 per capita income, $500bn of exports, an unemployment rate of about 5% [September’s rate was 9.1%] and low single-digit inflation.

Considering Turkey's performance in recent years, these targets look ambitious. But these are extraordinary times. We had the global financial crisis, the eurozone crisis, which matters to us because Europe is Turkey’s largest trading partner. We had the Arab Spring, which turned into the Arab Winter, which was a huge disruption for Turkey and remains a disruption, and Europe remains sluggish.

But we have shown that between 2002 and 2007 political stability, reforms and a neutral global backdrop can imply a very strong performance for Turkey. The size of Turkey's GDP at the current exchange rate, for instance, was about $230bn in 2002 and we increased it to $820bn last year.

Q: You mentioned the export target of $500bn – in July, Turkey was exporting $13.4bn and related to that posted a high current account deficit. How are you aiming to boost exports?

A: Our public finances are in a good shape, the banking sector is healthy and households are doing well. That leaves us with an external vulnerability: a relatively large current account deficit and rising inflation.

My government has taken measures to moderate domestic demand and rebalance growth. If you go back to 2010/11, the average GDP growth rate was about 9%, but if you were to break down growth you would notice that domestic demand was expanding at almost 14%, with net exports being a drag to the tune of 5 percentage points of GDP.

Over the past year, we have introduced a number of macroprudential measures aimed at slowing excessive credit growth. We have encouraged banks to lend to corporates, mostly exporters, while on consumer loans we are trying to slow things down to have more moderate growth.

And we are making progress. Our current account deficit this year is likely to trend down to about 5.8% of GDP. Admittedly, this still is a high number but compared with a couple of years ago, when the deficit was almost at 10%, this shows that we are on the right track despite disruption in key markets such as Iran, Libya and Europe.

Prior to the turmoil in Iraq, we almost had $11bn to $12bn in trade surplus with the country, but unfortunately there has been a disruption. We hope that over the next few years we can bring the current account deficit to a more manageable level below 5%, with some foreign direct investment – non-debt creating inflows – covering a chunk of the deficit and therefore, in terms of the external debt-to-GDP ratio, there should be no concerns in terms of sustainability.

Q: High inflation is another challenge. The Turkish central bank hiked the benchmark one-week repo interest rate from 4.5% to 10% in January but since decreased it to 8.25% in July. The bank now expects inflation to rise even more, to 10%, by the end of the year. How are you trying to tackle inflation apart from through central bank measures?

A: Turkey experienced double- and triple-digit inflation for almost 40 years prior to our government. My government has been able to reduce inflation to single digits but unfortunately not to low single digits yet. Inflation this year has edged up to about 9.5% at the moment. The key driver has been food prices, largely reflecting droughts in Turkey and geopolitics. In response to sanctions from Europe, Russia has decided not to buy foodstuff from Europe, so all eyes are now on Turkey. Of course that pushes domestic food prices up and food prices make up about one-quarter of the Turkish consumer price index inflation. Prices have been moving very fast, which is pushing up headline inflation.

Price stability and making sure that the current upward trend of inflation is reversed are our top priorities. Thanks to all these macroprudential measures, there is a sizeable output gap. Technically speaking, if you put aside inflation driven by food prices, the output gap suggests that inflation should reverse. We are also looking at eliminating barriers in the food sector to enhance competition.

We are not just relying on what the central bank does but we have to help it through micro-level reforms. In addition to that, we have to make sure that credit growth remains at a more manageable level. We would like to bring inflation back to the 5% to 7% range over the next couple of years and then bring it down over the medium to longer term to low single digits.

Q: You mentioned that structural reform plans were key during the old government under Mr Erdoğan and remain important for the new government. What has to be tackled and where do your priorities lie?

A: Our top priority in government spending is education and we spend almost one-quarter of our tax revenues on that. Access to education has increased dramatically. We have hired 450,000 new teachers over the past decade. We have built nearly 210,000 new classrooms and the number of universities has doubled.

Across the board there is a big push into education because in the long run, if Turkey wants to be competitive and wants to move up the value chain, it has to enhance the human capital stock. Healthcare spending also remains a huge item and amounts to almost 21% of tax revenues.

The other priority area is infrastructure. Over the past decade there has been a big push to enhance the country’s physical infrastructure. Now we are building high-speed rail networks and have doubled the number of airports. From the deregulation of telecommunications, to roads, railways, ports and airports, there has been huge progress but there are still large ongoing infrastructure projects, so this remains one of the key areas.

Over the past few years, we have also introduced a very generous incentive of private pensions to increase savings, which has been really successful. And combating the shadow economy remains another priority. We are working on a draft income tax reform and I am still optimistic that we might be able to push this through prior to [parliamentary] elections [in June].

The reform is aimed at broadening the tax base, simplifying corporate income tax legislation and enhancing compliance, as well as getting more people to file tax returns.

The government is working on moving Turkey up the value chain, increasing savings, improving education and infrastructure, and reducing dependency on energy imports. We have a very long reform agenda and that is largely aimed at making sure that Turkey is moving towards a more sustainable external balance.

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