Turkey's Challenge

• Author: Prakash Kannan and André Meier
• Position: IMF European Department
• Pages: 85-95

Page 85

Turkey's economy has performed well since the 2001 crisis, but is now facing less favorable external conditions. Global developments are creating head-winds for growth, inflation, and external financing. The current environment poses a policy challenge for Turkey, as it does for many emerging markets.

Page 95

Turkey's economy has performed well since the 2001 crisis, but is now facing less favorable external conditions.

Thanks to good policies and a benign external environment, Turkey has experienced six years of strong and stable economic performance, including in comparison to its emerging market peers.

More recently, however, the global environment has turned decidedly less favorable.

The financial crisis that originated in the U.S. mortgage market has caused a broader tightening of credit conditions and dimmed prospects for world growth, while recordhigh commodity prices are fueling global inflationary pressures. These trends have also started affecting the Turkish economy.

Clouds on horizon

High global prices for energy and food, combined with the effects of a domestic drought, have recently pushed up Turkish consumer price inflation to 9¾ percent. The risk is that these shocks might cause broader-based price pressures, significantly delaying convergence to the official 4 percent inflation target.

The same adverse supply shocks have also slowed Turkey's economic growth in recent months. Growth is projected to slip to 4.0 percent in 2008 from 4.5 percent last year and 6.9 percent in 2006.

Near-term prospects are further clouded by the expected slowdown in global economic activity: IMF staff research suggests that a 1 percentage point reduction in industrial-country growth tends to reduce Turkey's growth by a cumulative 0.8 percentage points over two years. Under current conditions, however, this impact should be mitigated somewhat by the continued dynamism of other emerging markets, whose share in Turkey's total exports has risen from 20 percent to 26 percent over the past three years alone.

According to the IMF research, only about half of the total spillover from industrialcountry growth comes via the trade channel.

This points to an important role for financial transmission channels. Indeed, Turkish asset prices have tended to respond more strongly to global market fluctuations than any other large emerging market.

In this context, the...