Turkey’s disinflation program has positive impact, including fall in interest rates, gains in equities

• Pages: 236-237

Page 236

Turkey introduced a disinflation program in December 1999, supported by an IMF Stand-By Arrangement of about $3.9 billion. The following description of Turkey’s program is based on a report included in the May 2000 World Economic Outlook and updated to reflect more recent developments.

Macroeconomic instability—characterized by chronic inflation, wide swings in output, volatile interest rates, and persistent fiscal imbalances—has been the norm for the Turkish economy during the past two decades. The country launched five disinflation programs during the 1990s, but these were ineffective in lowering the inflation rate, which averaged over 80 percent over the period. As a result, Turkey has been a striking exception to the disinflation trends observed worldwide since the 1970s.

The ultimate cause of chronic high inflation in Turkey has been the existence of deep structural weaknesses in public sector finances. Opaque indirect agricultural support policies, other nontransparent fiscal and nonfiscal activities by budgetary and non-budgetary funds and state enterprises, and credit subsidies through state banks have contributed to substantial primary deficits. These deficits have persisted since the 1970s and have been consistently monetized to alleviate the government’s budget constraint. As the inflation tax base eroded, however, the same level of money creation extracted lower amounts of seigniorage and provided further upward pressure on prices. Inflation was also sustained by a strong expectational component, which impeded the success of the disinflation programs of the 1990s. In particular, in the programs implemented in 1994–95 and 1998, the fiscal primary position strengthened significantly, and inflation performance also improved, but nominal interest rates failed to come down as envisaged. This was partly because financial markets remained worried about the sustainability of the situation, especially in the light of the crises in Asia and many other emerging market countries in 1997–98. The end result was sizable increases in real interest rates from already very high levels, thus undermining the authorities’ resolve to continue disinflation.

Design of program

The new disinflation program supported by the Stand-By Arrangement approved by the IMF Board on December 22, 1999 (see IMF Survey, January 10, page 14) was designed to address up front the credibility of the...