Turkey's leaders may lack the pluck to deal with much-needed reform of public finances

EIGHT MONTHS into loan negotiations with the International Monetary Fund (IMF), Turkey is increasingly looking the odd man out among developing economies, apparently determined to go it alone while other emerging markets beg the IMF for money.

But Turkish analysts say speculation about a new IMF deal masks a more crucial concern: regardless of the IMF, do Turkish politicians have the political will to ensure that Turkey retains the international trust that made it a number one destination for foreign investment in the early years of this millenium?

“Turkey may be able to roll over debt this year, but that is not the issue,” says Elif Bilgi, managing director of EFG Securities, an Istanbul brokerage. “The issue is whether Turkey is going to continue with the fiscal prudence . . . that led foreign investors to talk of a paradigm shift in the Turkish economy until 2007.”

After years of boom and bust that culminated in a massive banking crisis in 2001, Turkey pulled itself together under the current AK Party government, pushing through reforms and privatisation that brought in up to €14 billion in foreign direct investment annually, more than Turkey pulled in in two decades before 2000.

This year, though, huge spending rises have dug a deep hole in Turkey’s budget, whose deficit is expected to reach €35 billion by year’s end.

Turkey’s leaders say the results reflect its efforts to stimulate a slowing economy, and insist there is no need for concern.

After six years in which it maintained budget surpluses averaging 4 per cent, Turkey does have a little money to spend on a rainy day. Increasing financing pressures look likely to be offset by a current account deficit that is expected to plummet from €29 billion last year to €7 billion this year on the back of lower petrol prices and slower trade.

But their argument is also a touch disingenuous. Turkey began loosening fiscal policies in the run up to general elections in 2007, before the start of the global crisis.

Today’s budget deficit is as much the result of Turkey’s failure to put off crucial structural reforms while the global going was good as it is of more recent efforts to stimulate a domestic economy in crisis, analysts add.

“The whole Turkish fiscal adjustment story was good, but over-rated: a lot of tweaking of indirect taxes – on alcohol, for instance – and little effort to attack structural weakness in the budgetary system,” says Murat Ucer, an analyst for the New York economic intelligence company GlobalSource.

For Ucer, Turkey’s key problem is a tax system, both opaque and subject to political manipulation, that depends for 70 per cent of revenue on indirect taxation like sales taxes. The imbalance leaves the country’s finances extremely sensitive to economic downturn.

IMF officials overseeing the €7 billion stand-by arrangement Turkey completed in 2008 talked constantly about the need to reduce an unregistered economy analysts believe to amount to a third of total Turkish GDP.

On May 20th, treasury minister Mehmet Simsek highlighted the urgent need to “up the fight against the unrecorded economy” and “collect income tax” from a broader base. Putting words into action now looks set to be tough, though.

The IMF expects Turkey’s GDP to shrink by 5.1 per cent in 2009, hardly an ideal environment for zealous tax inspection.

But there are also political reasons for the Turkish leader’s apparent unwillingness to tackle budget and tax reform: general elections in 2011.

The head of a party which won 47 per cent of votes at general elections in 2007, Prime Minister Recep Tayyip Erdogan was clearly stunned when AK Party garnered only 39 per cent of ballots at local elections this March.

“The 2011 polls will define all of Erdogan’s actions from now on,” says Murat Yetkin, Ankara bureau chief for the liberal secular daily Radikal.

“If he thinks [a new policy] will cost him votes, he will take all risks and not sign along the dotted line.”

The tax issue is made especially sensitive for Mr Erdogan by the fact that tax evasion is most widespread among the SMEs and Anatolian businessmen who form the bedrock of AK Party support.

Few analysts foresee Turkey facing major economic problems in the short-term, with or without a new IMF deal.

For Murat Ucer, though, the government’s on-going failure to agree on the need for a fiscal rule bodes ill for the middle-term. “Turkey is losing sustainability of public finances,” he says.

“For the past three years, we have been at a crossroads: are we going to tackle structural reforms, or are we going to basically risk going back to the 1990s, with unsustainable debt and high inflation? We haven’t started that game yet, but the trend is in that direction.”