Turkey Economy: New Lira

The recent climate of stability and optimism will be put to the test in 2005. The Justice and Development Party (AKP) government maintained both its hold on power and its grip on public finances in 2004. The budget deficit fell below 10% of GNP and the gross central government debt appeared to stabilise at around 75% of GNP. Although the government tightened its belt, household, export and investment spending surged. In particular, tumbling interest rates linked to the lowest inflation for three decades encouraged the growth of credit and unleashed pent-up appetite for automobiles and other durable goods. GDP rose by 8.7% year on year in the first three quarters. Aided by high oil prices, strong domestic demand sent the current-account deficit soaring to over 4% of GDP, notwithstanding ever-rising tourism revenue. However, the gap was fully covered by capital inflows, including private lending to companies and banks and purchases of government debt. Official gross foreign-exchange reserves edged up to about US$35bn.

This climate was underpinned by financial and business optimism related to the prospects for EU membership talks -- particularly after Turkish Cypriots voted in favour of the Annan Plan for a Cyprus settlement in an April 24th referendum. Excitement peaked with the release of the EU Commission's recommendation on October 6th and the decision of the EU heads of government on December 17th. But leaving the EU issue aside, domestic demand is tiring, and exports are threatened by the possibility of slower world economic activity as well as the global abolition of textiles quotas. If the official 5% GNP growth target proves optimistic, fiscal targets will be harder to achieve, and issues of public and private sector solvency may arise. If growth holds up, the current-account deficit may go on causing nervousness.

Watch for

+ New Turkish lira. Turkey adopts a new currency as of January 1st 2005. Each New Turkish lira (YTL) will be worth 1m old liras. The redenomination will simplify calculations and spare Turkey the embarrassment of an exchange rate in the region of TL1,900,000 to the euro.

+ Inflation. Three years of rapidly falling inflation have created an ideal opportunity for the adoption of the YTL. In 2004 consumer price inflation fell from 18.4% to about 10%. But further price hikes related to the oil price, indirect tax increases or a weaker exchange rate could endanger the 8% target set for the end of 2005. The Central Bank of Turkey may opt to keep short-term interest rates high even at the expense of economic activity.

+ New stand-by. The government and the IMF are about to finalise a follow-up stand-by accord. The deal will effectively ease the schedule for the repayment of the US$20bn owed to the Fund. This is essential to maintain external balances and support the lira, the relative strength of which has been an intrinsic element of recent economic stability. Continuing IMF tutelage also acts as a guarantee of government commitment to tight fiscal policy, Central Bank independence and structural reforms.

+ Privatisation. Deals worth over US$1bn were concluded in 2004, including the sale of the Tekel alcoholic drinks unit in February and a 23% share offering for Turkish Airlines in December. Larger deals are still to come. Potential buyers of a 55% stake in Turk Telekom have until January 11th to apply for pre-qualification and until May 31st to place their bids. Also due to be sold are the Tekel cigarette enterprise, regional power distribution networks, the state's controlling stake in iron and steel mill Erdemir, the National Lottery, the state refinery company, Tupras, and petrochemicals company, Petkim.

Risk factors