TRANSITION REPORT 2014 Innovation in Transition

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Highlights

  • Growth has been slowing since the first half of 2014. The depreciation of the lira at the turn of the year, combined with necessary monetary tightening in January 2014 and the banking watchdog’s (BDDK) measures to slow credit growth, shifted growth drivers away from domestic demand towards net exports, which helped trim the large current account deficit. Inflation, however, remains well above the central bank’s target of 5 per cent for the third consecutive year.
  • Structural reforms continued at a mixed pace amid the ongoing electoral cycle. While there have been recent improvements in liberalising the energy, transport and infrastructure sectors, progress was mixed in improving the business climate and increasing labour market flexibility.
  • Liberalisation of the energy sector has progressed and the renewable energy sector has grown, although challenges still remain. Electricity distribution companies and some power plants were recently privatised, but progress towards liberalising the natural gas market has been slow. The renewable energy sector has attracted investor interest, although some of it is due to legal and financial incentives.

Key priorities for 2015

  • Regional development and inclusion efforts should be accelerated. Discrepancies between rural and urban regions remain significant in areas such as education, employment and local services, despite European Union (EU) funds being used extensively to foster rural development. Inclusive reforms should be accelerated to achieve more balanced growth.
  • Liberalisation of the energy sector should continue. The electricity and renewable energy sectors have recently moved towards more liberalisation. The electricity distribution grids are now fully privatised, but the public sector still has a share of 33.4 per cent in electricity generation. The authorities plan to privatise the remaining public sector power plants, with the exception of big hydroelectric power plants, in the coming years. The upstream oil and most of the natural gas sector activities, excluding distribution, remain largely monopolised and publicly owned.
  • Inflation should be tamed and the current account rebalanced. Inflation de-anchoring risks should be minimised, and regulatory independence fostered and preserved. Policies should be structured in a way that would help consolidate and continue the recent rebalancing of the current account, with a view to reducing external vulnerabilities and ensuring sustainable economic growth.

GROWTH HAS BEEN SLOWING SINCE THE FIRST HALF OF 2014

STRUCTURAL REFORMS CONTINUED AT A MIXED PACE AMID THE ONGOING ELECTORAL CYCLE

LIBERALISATION OF THE ENERGY SECTOR HAS PROGRESSED AND THE RENEWABLE ENERGY SECTOR HAS GROWN, ALTHOUGH CHALLENGES STILL REMAIN

2014 sector transition indicators
Corporate Energy Infrastructure FI

Source: EBRD.
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.


Main macroeconomic indicators %

  2010 2011 2012 2013 2014
          proj.
GDP growth 9.2 8.8 2.1 4.0 3.0
Inflation (average) 8.6 6.5 8.9 7.5 9.0
Government balance/GDP -3.4 -0.7 -1.8 -1.5 -2.0
Current account balance/GDP -6.2 -9.7 -6.1 -7.9 -5.8
Net FDI/GDP 1.0 1.8 1.2 1.2 1.1
External debt/GDP 39.8 39.2 42.8 47.3 n.a.
Gross reserves/GDP 10.8 9.9 12.4 13.3 n.a.
Credit to private sector/GDP 43.6 49.3 53.9 65.1 n.a.

Macroeconomic performance

After growing 4.1 per cent in 2013, the economy slowed somewhat in the first half of 2014, with inflation remaining well above target. Private consumption, government spending and strong credit growth spurred economic growth in 2013, but also created a large current account deficit. Together with macroprudential measures taken in the last quarter of 2013, the sharp depreciation of the lira at the turn of the year shifted growth drivers favourably away from domestic demand towards net exports, thereby helping to rebalance the current account. At the same time, year-on-year growth slowed to 2.1 per cent in the second quarter of 2014. Meanwhile, inflation accelerated in 2014 and remains persistently high at 8.9 per cent as of September 2014, well above the target of 5 per cent, for the third consecutive year.

Since April 2014 the lira has stabilised, depreciation has somewhat reversed and the country’s risk premium indicators have dropped. Amid elevated domestic political uncertainty and the US Federal Reserve tapering its quantitative easing programme, the lira depreciated by about 20 per cent in 2013, and in early 2014 it appeared to be more susceptible to shifts in global sentiment compared with other emerging-market currencies. This led to a pronounced increase in the risk premium, which in turn resulted in the central bank hiking policy rates to 10 per cent in January 2014 in an effort to bolster the currency. A more stable political backdrop following the March elections, along with increased global liquidity and foreign funds being diverted from Russia to Turkey in the wake of the Ukraine crisis, resulted in a partial recovery of the currency and risk premiums, and prompted the central bank to lower the interest rate to 8.25 per cent as of August 2014.

Large external imbalances remain, but public finances and the banking sector are still strong. The current account deficit, which reached 7.9 per cent of GDP in 2013, narrowed in the first half of 2014 owing to a strong export performance and weaker domestic demand pushing down imports, and it is expected to remain below 6 per cent of GDP for the rest of the year. However, Turkey continues to have persistently large external financing requirements and is heavily reliant on foreign borrowing and volatile portfolio inflows to meet those requirements, with foreign direct investment inflows financing only about 17 per cent of the current account. That said, government finances remain solid, with public debt below 40 per cent of GDP. Furthermore, the banking sector remains broadly healthy, with a low share of non-performing loans and comfortable capitalisation, which gives some room for manoeuvre if necessary.

Growth is expected to moderate to 3 per cent in 2014, with inflation remaining well above the 5 per cent target. Domestic demand has been constrained by slower household credit growth and tighter monetary policy (necessary to tame rising inflation), while net exports have been constrained by the turmoil in Iraq, Turkey’s second-largest export partner. With the current monetary stance, as well as higher food prices and a rise in utility prices in October, inflation is expected to remain well above the target, at an average of 9 per cent in 2014. Growth is expected to remain at around 3.2 per cent in 2015 and gradually recover in the following years towards an average of 4.5 to 5 per cent, reflecting a healthy long-term growth potential in Turkey. Nevertheless, sustaining these growth rates will require continued and increasingly sophisticated structural changes and institutional improvements. Key risks to the outlook are shifts in global and domestic sentiment. The economy is already vulnerable to shifts in global sentiment due to large external imbalances. Quantitative easing by the US Federal Reserve and geopolitical risks surrounding Iraq, Syria and Ukraine may reduce business confidence and investments, and increase financing costs and oil prices. In addition, renewed domestic political uncertainty and a perceived weakening of regulatory independence may also reduce business sentiment, thereby affecting investments and growth.


Major structural reform developments

Progress on improving the business climate across sectors has been mixed. In the World Bank Doing Business 2015 report Turkey improved its position, ranking 55th out of 189 countries, despite receiving low scores in dealing with construction permits and resolving insolvency procedures. An amendment to the Public Procurement Law, which would enforce a compulsory 15 per cent price advantage for medium and high-tech domestic products, has been criticised by the European Commission’s recent Progress Report. Nevertheless, some steps to improve the business climate have recently been taken. An omnibus bill, banning the reversal of privatisation transactions five years after the assets have been transferred to the private sector, has been adopted and should increase business confidence among foreign investors.

While the labour market still remains excessively regulated, some efforts to increase its flexibility have recently been made. Excessive labour market regulation continues to discourage formal employment, and little action has been taken to increase women’s participation rate in the labour force, which continues to constrain potential growth in Turkey. However, the government adopted the national employment strategy in May 2014, which aims to solve structural problems in the labour market and enhance employment, both of which should contribute to medium and long-term growth.

Measures to liberalise transport and infrastructure have been undertaken. New legislation has been prepared to liberalise the rail transport sector, which allows private companies to build their own railway infrastructure and to become designated operators. Legal arrangements to privatise highways and bridge crossings through public offerings have been finalised. Large public transport and infrastructure projects continue to be implemented, some under public-private partnership (PPP) structures, including new terminals at the larger airports, the Eurasia Tunnel Project and the Gebze-Izmir highway. A new clause allowing the Turkish Ministry of Health to amend suspended PPP project contracts has been added to the PPP Law, which is expected to accelerate projects in the health care sector.

Despite an impressive track record for implementing reforms in the energy sector, progress has been slow over the past year. Plans for the liberalisation of Turkey’s wholesale power market and the creation of the Energy Market Operation Joint Stock Company (EPIAS) – originally expected to be completed by early 2014 – are not likely to be finalised until mid-2015. Electricity distribution companies and a number of power plants were recently privatised, contributing to the liberalisation efforts, but progress towards liberalising the natural gas market has been slow. The renewable energy sector developed profitably in line with market prices (that is, without the use of feed-in tariffs). While financial incentives and price guarantees introduced by recent laws have boosted investments in the renewable energy sector, some of these incentives, such as bonus payments for locally sourced content, may distort the market.

Steps were taken to strengthen the financial sector. The Banking Regulation and Supervision Agency’s regulations to comply with Basel III standards, came into force in January 2014, and includes regulations on: equity of banks; measuring and evaluating capital adequacy, capital conservation and counter-cyclical capital buffers; and measuring and assessing leverage and liquidity ratios. The new regulations aim to strengthen the equity structure of the banking sector.

A bill on retail trade regulation was submitted to the National Assembly in August 2014. If adopted, the law should encourage competition in the retail sector, as well as protect consumers and reduce informal activities. The bureaucratic formalities to establish a new business and close an existing one should therefore be simplified, as applications would be handled from a centralised system.