IMF Praises Program to Deal With Turkey’s 60-Percent-Plus Inflation (But Puts a Hold on Support)

By Colin MacKinnon

The first time I went to Turkey—this was in the mid-1960s—the currency exchange rate was 12 lira to the dollar and you could buy a good meal for 20 lira or so. If you were feeling expansive and wanted a real blow-out, you could spend 30 or 40 lira. When I went there again at the end of the summer of 1995, the exchange rate had become something like 49,000 lira to the dollar, an inflation of over 4,000 percent, and a decent meal might cost 600,000 lira.

The exchange rate changed every day, invariably upward, as did prices. At the beginning of the trip I was getting around 48,500 lira for a dollar. When I left, three weeks later, I was getting close to 50,000. The country’s annual rate of inflation that year, 1995, was 88.1 percent.

This was my first practical acquaintance, close up and personal, with hyperinflation, and I found the experience odd, even unsettling, though Turks seemed to deal with it coolly enough. As well they might. Inflation on this scale has been a fact of Turkish life for years.

The current rate of exchange, grabbed on the fly as it were in mid-summer 1999, is about 430,000 lira to the dollar, almost ten times what it was in 1995. By the end of this year, it will be well over 500,000.

Here, let us note, we are discussing two separate but related concepts: exchange rates and inflation rates. The exchange rate reflects the decline in value of Turkey’s currency on international markets, which is what tourists notice.

But the fall in the value of the lira internationally has been mostly, though not entirely, a result of the country’s domestic inflation problem, the worst in the Middle East.

Since the beginning of this decade Turkey’s annual inflation has dipped below 60 percent only once (in 1990, to 58.6 percent). It has often been in the high 80s. In 1994 it was 106.3 percent. If you’re wondering how Turks live with prices that ratchet constantly and rapidly upward, you’re not alone.

But they do. Some cope by holding relatively stable foreign currencies in bank accounts; some do business in dollars or deutsche marks; some have their salaries indexed to the inflation rate; some hold gold, though that has been a bad mistake in recent years. All watch prices of goods and services churn upward on an almost daily basis.

Hard as this makes life for ordinary individuals, the macroeconomic effects can be even more devastating: inflation on such a scale unbalances everybody’s economic calculations (you can’t tell what anything really costs or what price you’ll get for any item in the future).

Inflation on such a scale unbalances everybody’s economic calculations.

Turkey’s inflation has driven interest rates sky high (they are over 100 percent currently), which has discouraged investment and has sent Turkish money overseas looking for safe havens. Foreign investors have to think twice before coming into such a milieu.

In short, Turkey’s high inflation rate is terrible for economic growth and makes everyone in the country poorer, beyond the day-to-day problems it creates by shrinking the currency’s value.

What on earth causes such inflation? Simply put, it’s because the government spends more—a lot more—than it takes in and prints money to make up the difference. The budget deficit will be 11 percent of GDP this year.

Major expenses for the Turkish government are the country’s social security system, agricultural subsidies, money-losing state-owned enterprises, and the Kurdish war. This last is costing something like $7 billion a year and seems endless.

Turkey also has $100 billion of foreign debt, which it must service, another drain on the budget.

The biggest problem, everyone has come to realize, is the social security system, which is hypergenerous. Turkish women, for example, can “retire” and start drawing pensions, indexed to inflation of course, at age 38, men at age 42. The social security deficit this year will be 3 percent of GNP.

IMF Team Arrives

At the end of June a team from the International Monetary Fund came to Turkey for its annual Article IV discussions with local authorities. Inflation was the principle topic. The team, headed by Carlo Cottarelli, spent two weeks in Turkey talking to business people and government officials, an unusually long period.

The term “Article IV” refers to a section in the Fund’s Articles of Agreement, which members of the Fund recognize as binding when they join, that gives Fund economists the right to put members’ exchange rate policies under “strong surveillance.”

From this small starting point the Fund over the years has acquired the power to put all aspects of a member country’s economic and fiscal policies under “strong surveillance” and, when it finds something it doesn’t like, recommend corrective measures.

These are usually unpleasant. Fund economists typically demand that governments cut subsidies, raise taxes, sell off state-owned firms, and lower tariffs. Though the Fund cannot actually dictate policy to governments or force them to act in any particular way, it can withhold badly needed financial aid and doesn’t hesitate to do so.

Last summer the Turkish government, with advice from the Fund, launched a program that, despite some slippage, has brought inflation down to about 50 percent, winning IMF praises.

New Pledges by Turkey

This year Turkey has promised a new program. Under it, the government will pass a social security reform bill, one of whose features would raise the retirement age to 62 for both men and women.

Turkey has also promised to amend the constitution to allow foreign arbitration of investment disputes, a move that would encourage foreign investment, especially in the key power and transportation industries. The system of agricultural price supports is to be abandoned, too, probably in favor of a system guaranteeing farmers’ incomes.

This is all fine with the IMF. If carried out, says the Fund, the program should bring inflation down to 25 percent a year by the end of the year 2000 and 10 percent by the end of 2001. It would also drastically cut the budget deficits.

In return, the Fund is understood to have offered a total of $7 billion in what it calls a “stand-by arrangement,” that is, a line of credit that will allow Turkey to pay down its foreign debts and give the country additional time to reform its finances and restructure its economy.

But support is contingent on Turkey carrying out the program. The IMF will release no funds until it sees Turkey has done so, probably close to year’s end.

Can Turkey Stick with It?

After parliamentary elections in April, Prime Minister Bulent Ecevit of the DSP (the Democratic Left Party) formed a coalition government consisting of his party, the center-right ANAP (Motherland Party), and far-right MHP (Nationalist Movement Party).

The coalition’s large parliamentary majority, 330 of 550 seats, may allow it to pass much-needed legislation. That ANAP, the center-right party, holds the ministries of finance, labor and social security, all of them important for economic reform, is one indicator of the government’s intentions. Another is the passage in June of an important banking reform bill.

Much depends, though, on whether the coalition can stick together. Three-party coalitions are inherently difficult and major ideological differences separate the parties. Recent Turkish political history, which has seen a string of unstable coalitions come and go, isn’t encouraging either. So it’s not yet clear whether the government can pass the program it has promised, but the stakes are very high. As high as the difference between 10 percent and 100 percent inflation.

Colin MacKinnon is contributing editor to the Washington-based Middle East Executive Reports.