TURKEY ECONOMIC MONITOR DECEMBER 2018 STEADYING THE SHIP World Bank Group TURKEY ECONOMIC MONITOR, DECEMBER 2018: STEADYING THE SHIP I TEM, December 2018: Steadying the ship © 2018 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org Standard Disclaimer: This volume is a product of the staff of the International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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II World Bank Group Contents EXECUTIVE SUMMARY...............................................................................................................................................1 I. TAKING STOCK.........................................................................................................................................................3 Uneven global growth and increased headwinds for Emerging Markets.........................................................................3 Declining capital inflows and high external vulnerability in Turkey...............................................................................4 Price pressures forcing supply side corrections in non-tradable sectors.........................................................................12 Financial shock in 2018 has caused a rise in corporate stress.......................................................................................20 Banks face volatility with strong buffers but cracks begin to appear.............................................................................26 Complex economic situation with acute policy trade-offs............................................................................................32 II. LOOKING AHEAD.................................................................................................................................................35 Downward correction to economic growth.................................................................................................................35 Inflation and slower growth will substantially impact households................................................................................36 A good foundation in the New Economic Program.....................................................................................................39 Consistent and credible package of reforms to ensure orderly adjustment...................................................................41 Appendix: Corporate financial distress and the Altman Z-score.......................................................................................45 Annex 1: Medium-Term Outlook...................................................................................................................................46 Annex 2: Medium-Term Outlook...................................................................................................................................47 Annex 3: Gross Domestic Product...................................................................................................................................48 Annex 4: Gross Domestic Product...................................................................................................................................49 Annex 5: Prices................................................................................................................................................................50 Annex 6: Balance of Payments.........................................................................................................................................51 Annex 7: Monetary Policy...............................................................................................................................................52 Annex 8: Monetary Policy...............................................................................................................................................53 Annex 9: Fiscal Operations..............................................................................................................................................54 Annex 10: Banking Sector Balance Sheet.........................................................................................................................55 Annex 11: Banking Sector Ratios....................................................................................................................................56 Annex 12: Doing Business Index (2019).........................................................................................................................57 Annex 13: Logistics Performance Index (2016)...............................................................................................................62 Annex 14: Health Statistics (2016)..................................................................................................................................63 Annex 15: Education Statistics (2015).............................................................................................................................64 References.......................................................................................................................................................................65 List of Figures Figure 1: Slowdown in portfolio flows to EMDEs.............................................................................................................4 Figure 2: Increased bond yields over the summer...............................................................................................................4 Figure 3: Sharp contraction in capital inflows....................................................................................................................5 Figure 4: Driven by outflow of portfolio debt....................................................................................................................5 Figure 5: Significant slowdown in capital flows but not a sudden stop...............................................................................5 Figure 6: High external vulnerability relative to other EMDEs..........................................................................................6 Figure 7: REER declining with free float...........................................................................................................................8 Figure 8: Rapid recovery in Lira........................................................................................................................................8 Figure 9: Equity markets contracted sharply......................................................................................................................8 Figure 10: Big drop in gross reserves..................................................................................................................................8 Figure 11: Increase in ST debt/reserves..............................................................................................................................8 Figure 12: Current account adjustment.............................................................................................................................8 Figure 13: Gross reserves decline due to RR policy............................................................................................................9 III TEM, December 2018: Steadying the ship Figure 14: Exchange rate volatility high in Turkey.............................................................................................................9 Figure 15: Reserves have started to recover........................................................................................................................9 Figure 16: Market perceptions of risk high in Turkey........................................................................................................9 Figure 17: Drivers of the current account balance in Turkey............................................................................................10 Figure 18: Jump in inflation after market volatility..........................................................................................................12 Figure 19: Broad-based increase in prices.........................................................................................................................12 Figure 20: Large divergence between PPI and CPI..........................................................................................................13 Figure 21: Due to declining consumer demand...............................................................................................................13 Figure 22: With contracting retail sales............................................................................................................................13 Figure 23: Precipitated by falling real wages.....................................................................................................................13 Figure 24: Composite output indicator already negative in run up to 2008-2009............................................................14 Figure 25: PMI is showing some signs of improvement in 2018......................................................................................14 Figure 26: Capacity utilization adjusting down from a period of overheating..................................................................14 Figure 27: Unemployment levels rising gradually, though from a higher base than 2008-2009........................................14 Figure 28: Real turnover contracting in non-tradable sectors...........................................................................................15 Figure 29: GVA and employment growth negative in non-tradable sectors......................................................................15 Figure 30: House price correction in Turkey....................................................................................................................16 Figure 31: House price changes linked to construction permit application......................................................................16 Figure 32: Demand falling below trend...........................................................................................................................17 Figure 33: House prices in line with income....................................................................................................................17 Figure 34: Change in house price-to-rent ratio................................................................................................................17 Figure 35: Low global rental yields..................................................................................................................................17 Figure 36: Housing is a big source of savings...................................................................................................................17 Figure 37: With high propensity for reinvestment...........................................................................................................17 Figure 38: Government incentives provide short-term boost to house sales......................................................................18 Figure 39: Divergence between construction costs and house prices................................................................................19 Figure 40: Developments in the construction sector have strong spillover effects.............................................................19 Figure 41: Increase in financial leverage of corporates......................................................................................................20 Figure 42: ICR drops below critical threshold.................................................................................................................20 Figure 43: Share of DAR above 2009 peak......................................................................................................................21 Figure 44: DAR associated with finance cost and REER..................................................................................................21 Figure 45: Financial distress peaks in 2018 Q3................................................................................................................22 Figure 46: Financial distress indicator below threshold....................................................................................................22 Figure 47: More corporates in distressed zone..................................................................................................................22 Figure 48: Daily index shows rise in corp. vulnerability...................................................................................................22 Figure 49: Sources of FX debt for Turkish corporates......................................................................................................23 Figure 50: Lower cost of FX debt....................................................................................................................................24 Figure 51: Large external debt service obligations............................................................................................................24 Figure 52: FX leverage vs. export ratios across sectors......................................................................................................25 Figure 53: FX leverage vs. export ratios within manufacturing.........................................................................................25 Figure 54: Banks dominate financial sector in Turkey......................................................................................................26 Figure 55: Sharp deceleration in credit growth................................................................................................................26 Figure 56: Banks’ external borrowing risen sharply..........................................................................................................27 Figure 57: Use of swaps to close short FX positions.........................................................................................................27 Figure 58: Widening liquidity gap...................................................................................................................................27 Figure 59: LT loans funded out of ST deposits................................................................................................................27 Figure 60: Declining FX deposits in Turkish banks..........................................................................................................28 Figure 61: Banks’ rollovers have fallen to 70 percent........................................................................................................28 Figure 62: Rising TRY Loan to Deposit ratio..................................................................................................................29 Figure 63: Liquidity cov. ratio within prudential norm....................................................................................................29 Figure 64: Breakdown of NPLs by borrower types...........................................................................................................30 Figure 65: Rising sale of NPLs.........................................................................................................................................30 Figure 66: Banks’ exposure to construction Co’s..............................................................................................................30 Figure 67: Construction NPLs declining slightly.............................................................................................................30 Figure 68: Consumer loans/GDP relatively low...............................................................................................................31 IV World Bank Group Figure 69: Small mortgage market...................................................................................................................................31 Figure 70: Limited NPLs in mortgage market.................................................................................................................31 Figure 71: Mortgages relatively short-term tenor.............................................................................................................31 Figure 72: Two episodes of monetary tightening..............................................................................................................32 Figure 73: Declining FX deposits....................................................................................................................................32 Figure 74: Liquidity boost to financial sector...................................................................................................................33 Figure 75: Aug-Sept spike in M3 expansion....................................................................................................................33 Figure 76: Moderate increase in budget deficit................................................................................................................34 Figure 77: Driven by capex and revenue slowdown..........................................................................................................34 Figure 78: Slowdown in tax collections............................................................................................................................34 Figure 79: Sharp rise in lending and capex.......................................................................................................................34 Figure 80: Sharp slowdown in 2019................................................................................................................................36 Figure 81: Consensus forecast is negative for 2019..........................................................................................................36 Figure 82: Household debt low and falling......................................................................................................................38 Figure 83: Household deposits rising faster than loans.....................................................................................................38 Figure 84: Unemployment projected to rise.....................................................................................................................38 Figure 85: Most employment growth in services..............................................................................................................38 Figure 86: Growth-led poverty reduction is expected to slow in the baseline....................................................................39 Figure 87: NEP projects negative output gap over medium-term....................................................................................40 Figure 88: NEP assumes adjustment in public consumption and investment..................................................................40 Figure 89: Projected recovery in tax revenue is ambitious................................................................................................40 Figure 90: Turkey lags most on labor markets, innovation, financial sector, human capital..............................................43 Figure 91: Gaps between Turkey and EU average greatest for human capital and labor market........................................43 List of Tables Table 1: Breakdown of distressed assets............................................................................................................................27 Table 2: Expenditure shares by decile of per capita expenditure distribution....................................................................35 Table 3: Simulated poverty impacts of inflation...............................................................................................................35 Table 4: NEP fiscal consolidation....................................................................................................................................39 List of Boxes Box 1: Drivers of the current account balance in Turkey..................................................................................................10 Box 2 Real estate sector developments.............................................................................................................................15 Box 3: Corporate debt in Turkey.....................................................................................................................................21 Box 4: Financial sector vulnerabilities from the construction sector.................................................................................28 V TEM, December 2018: Steadying the ship The Turkey Economic Monitor (TEM) periodically analyzes economic developments, policies and prospects in Turkey. The TEM was prepared under the guidance of Johannes Zutt (WB Country Director, Turkey), John Panzer (Acting Senior Director, Macroeconomics Trade and Investment) and Lalita M. Moorty (Practice Manager, MTI GP) by Habib Rab (Program Leader, EFI Turkey), David Knight (Senior Country Economist, MTI GP), Pinar Yasar (Country Economist, MTI GP), Erdem Atas (Research Analyst, MTI GP), and Alper Ahmet Oguz (Senior Financial Sector Specialist, Finance, Competitiveness and Innovation GP). The team is very grateful to the following colleagues (in alphabetical order): (i) Alexander Pankov (Lead Financial Sector Specialist, FCI GP), Karlis Bauze (Senior Financial Sector Specialist, FCI GP), and Mario Guadamillas (Practice Manager, FCI GP) for their inputs and guidance on the financial sector; (ii) Aysenur Acar (WB Consultant), Efsan Ozen (WB Consultant), Facundo Cuevas (Senior Economist, Poverty GP), Metin Nebiler (Research Analyst, POV GP), Sirma Demir Seker (Economist, Social Protection and Jobs GP) and Ximena Del Carpio (Program Leader, Social Inclusion) for their inputs and guidance on poverty and the labor market; and (iii) the WBG Global Economic Prospects team for discussions on economic prospects. The team is very grateful to: Ivailo Izvorski (Lead Economist, MTI GP) and William G. Battaile (Lead Economist, MTI GP) for peer review comments and advice; colleagues from the IMF Turkey team for their comments; Pinar Baydar (Senior Program Assistant, WB) and Selma Karaman (Program Assistant, WB) for administrative support; and Tunya Celasin (Senior Communications Officer) on external communication. The team is very grateful to colleagues from the Central Bank of the Republic of Turkey, the Ministry of Treasury and Finance, and the Presidency of Strategy and Budget for very helpful discussions on economic developments and policy priorities. The team greatly appreciates insights provided by business associations and the private sector during the preparation of the TEM. The TEM is a product of the staff of the World Bank Group. The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the Executive Directors of the World Bank (or the governments they represent), or the Government of the Republic of Turkey. VI World Bank Group EXECUTIVE SUMMARY TAKING STOCK Mid-2018 was a period of intense market volatility Supply side corrections combined with elevated and rising economic stress in Turkey that was corporate debt, including FX exposure, have raised precipitated by existing macroeconomic imbalances corporate solvency and liquidity concerns in Turkey. and elevated political tensions with the US. An analysis of the balance sheets of listed corporates in A confluence of burgeoning domestic economic Turkey points to a rapid increase in financial leverage imbalances and a more challenging external environment in 2018 Q2-Q3, even relative to other EMDEs. In led to a dent in investor confidence in Turkish assets and addition, starting 2018 Q3, corporates have come under a sharp slowdown in capital flows to Turkey in 2018 increased liquidity pressures, including stress on debt Q2-Q3. Though this did not technically amount to a servicing capacity. A combination of the above has led to a sudden stop, Turkey was particularly badly affected by general increase in corporate vulnerabilities as measured a general move away from emerging markets (EMDE) by the share of debt-at-risk. Energy, telecommunication due to its accumulated macro imbalances (high current and real estate investment trust corporates are under most pressure. A composite measure of financial distress account deficit, high inflation, overheating economy) further indicates a deterioration in the overall financial and perceived policy weaknesses. conditions of listed non-financial corporates in 2018. Market volatility in Turkey has subsided since the Though the financial sector entered the recent turbulence in August, but the economic situation period of turbulence with adequate buffers, cracks remains fragile. Turkey’s large external exposure leaves are beginning to appear because of real sector it vulnerable to further market jitters and external developments and tighter international finance. monetary tightening. The external shock in the summer Structural imbalances including maturity and currency of 2018 also translated into significant real sector mismatches persist and expose Turkish banks to external impacts, including a sharp acceleration in inflation market volatility risks. Exchange rate and interest rate from already elevated levels. The gap between consumer developments have further dented banks’ balance sheets and producer price inflation widened significantly through recalculation of risk-weighted assets, mark to since July, reflecting suppliers’ inability to pass on price market security portfolios and on-balance sheet open increases to consumers due to declining demand. High positions. Banks to date have been able to weather production costs together with slowing demand have liquidity pressures thanks in part to Central Bank prompted supply side adjustments. liquidity injection and continued access to external Supply side indicators suggest that the correction in loans. The growing challenge, however, is with the 2018 Q2-Q3 is more gradual compared to the run up deterioration in asset quality, which goes beyond the to the last major recession in Turkey (2008-2009), reported Non-Performing Loans; NPLs are around 3.7 when output fell much more sharply. This does not percent of outstanding loans whereas distressed assets preclude a more serious supply correction in 2018- are closer to 13 percent. 2019, particularly as corporates exhibit increased stress Fiscal policy has been mildly expansionary with from falling demand and credit, though an important automatic stabilizers helping to cushion some of difference with the 2008-2009 crisis is the role of the economic slowdown. Early indications are that external demand. In 2008-2009, both domestic and social insurance outlays will increase in late 2018 as external demand had collapsed. In 2018, employment more people have become eligible for unemployment and turnover numbers point to a rebalancing towards insurance, whilst the seasonally adjusted unemployment tradable sectors as exchange rate depreciation has rate has risen to 11.2 percent in the third quarter from boosted external competitiveness. Non-tradable sectors, 10.7 percent in 2018Q2. Central government debt particularly construction and energy, on the other hand outstanding as a ratio to GDP jumped up by nearly are highly vulnerable. three percentage points in the third quarter of 2018, 1 TEM, December 2018: Steadying the ship driven by the revaluation effects of FX-denominated forecasts. Growth-led poverty reduction is expected to debt. At 31.4 percent or US$56bn equivalent, central slow in the baseline, and there is a risk of higher poverty government debt remains manageable though the should downside risks materialize. realization of contingent liabilities, the full extent of which is difficult to estimate, could dent this fiscal space. The authorities’ New Economic Program released in September provides a good foundation for gradually LOOKING AHEAD restoring macro stability. The NEP’s headline growth projections are at the upper end of the range of forecasts, The economic outlook is subject to higher levels though also the most conservative ever presented in an of uncertainty than usual given high domestic and NEP/Medium-Term Program. That said, the demand external vulnerabilities. Growth is projected to slow side drivers of medium-term projections in the NEP to a 10-year low of 1.6 percent in 2019 followed by assume that much of the downward correction to a medium-term recovery. Private domestic demand growth arises from the public sector, whereas given is projected to drop sharply in 2019, offset in part the outlook for the economy, countercyclical fiscal by public consumption and external demand. Most policy is expected to play a big role. This is particularly analysts project a sharper correction for 2019 with a important as a big challenge for policy makers in 2019 consensus mean of -0.1 percent (Consensus Economics is the prospect of stagflation – a combination of high Inc., November 2018). Investment is projected to unemployment and high inflation. contract, though a significantly higher budget deficit is expected. Monetary tightening and commitments in Building on the NEP, a consistent package the New Economic Program (NEP) signal important of economic policies could ensure an orderly policy adjustment, though any uncertainty or inaction adjustment for the Turkish economy. Monetary could tip the economy into a more difficult situation. policy should remain tight while inflation is well- The lack of progress on an orderly deleveraging in the above the target and inflation expectations are elevated. private sector could precipitate this tipping point. Continuation of an appropriate monetary policy should be complemented by a financial sector response The projected economic slowdown poses multiple that supports gradual deleveraging and enhances challenges for households. Food inflation, at close to financial risk monitoring and management. Critical 30 percent compared to a year ago, has a far greater to supporting the deleveraging process is a strong negative incidence for the poor than the non-poor. The corporate debt restructuring framework, the absence poverty rate is very sensitive to such price increases, of which could spell the difference between an orderly although the net effect may be offset by nominal adjustment for the economy and a hard landing. An wage or income growth. Neither household debt nor upwards fiscal adjustment led by automatic stabilizers net financial equity are expected to be significant and essential support for households will be necessary stress factors for most households. Minimum wage to help the economy tide over the period ahead, while adjustment in early 2019 and government employment also laying the ground for a gradual fiscal consolidation support programs may help to stem the decline in real as a recovery becomes entrenched to maintain a strong wages but overall the outlook suggests that both wages fiscal anchor across the cycle. Clear communication of and employment will be depressed, and unemployment such a package of economic and fiscal policies is central is expected to rise over the next three years based on to avoiding a short-term challenge becoming a longer- estimated employment elasticities and sectoral growth term problem. 2 World Bank Group I. TAKING STOCK Over the past six months Emerging Markets and Developing Economies (EMDEs) have faced headwinds from declining capital flows, slowing global trade, and commodity price volatility. In Turkey, these factors combined with macro imbalances, perceived policy weaknesses, and international tensions to trigger a Lira sell-off and capital outflows. Market volatility has subsided since August; the Lira has rebounded and external imbalances have narrowed. But Turkey’s external financial situation remains fragile and market perceptions of risks are high. Market volatility has also affected the real sector through high inflation, falling demand, and a big supply side correction. Supply side adjustments combined with elevated corporate debt, including FX exposure, has raised corporate solvency and liquidity concerns. Impacts vary across sectors; non-tradable sectors are the worst affected whilst outward oriented manufacturing sectors remain buoyant. Rising corporate stress has exacerbated banking sector vulnerabilities. Timely policy actions including liquidity management, a tightening of monetary policy, and addressing corporate debt vulnerabilities have helped prevent a sharper correction. Uneven global growth and increased 2). These developments were linked to US monetary tightening (June saw the 7th increase in policy rates since headwinds for Emerging Markets1 December 2015) and higher Treasury yields from the 1. Global growth in the first three quarters of 2018 fiscal stimulus in the US, a combination of which led to has remained strong though more uneven across a general appreciation of the US dollar. Nevertheless, regions compared to 2017. The US economy has been other investment flows to EMDEs have held up and expanding rapidly thanks to procyclical fiscal policy; portfolio flow reversals did not amount to a sudden adding an average of 200,000 jobs per month, which stop. contributed to unemployment falling to 3.7 percent in 3. Rising trade policy uncertainty and a slowdown September, its lowest level since 1969. Growth in the in global trade further contributed to rising risk Euro area on the other hand moderated in 2018 Q3, premia in EMDEs and a sell-off in EMDE equity coming in at 0.2 percent (q/q, sa), its slowest pace since markets over the summer. International trade 2014 Q2. The Japanese economy contracted in two tensions have been mounting with the United States out of three quarters in 2018, whilst China and many imposing tariffs on around $300 billion of its imports, other Emerging Market and Developing Economies and other countries retaliating with tariffs on similar (EMDEs) are exhibiting signs of slowdown. 1 levels of US exports. There was some reduction in 2. EMDEs experienced financial pressure in uncertainty with the announcement of a new trade 2018 Q2-Q3 though, apart from a few countries agreement with Mexico and Canada on October 1st including Turkey, not as severe as other recent and a temporary agreement between the US and China episodes of global financial tightening. Portfolio to deescalate the ongoing trade war on December 2nd. flows to EMDEs in the first 8 months of 2018 Nevertheless, global goods trade stagnated for the first dropped by 40 percent compared to the same period time in two years in 2018 Q2, reflecting weakening trade in 2017, turning negative in Q2 (Figure 1) and Q3. in and out of Asia and decelerating imports from some From June to August, EMDE issuances of sovereign major advanced economies. Moreover, by September and corporate debt were down 65 percent from the global new export orders has declined for 8 consecutive same period in 2017. Bond yields in EMDEs increased months, falling just below the threshold that indicates over the summer, reflecting higher risk premia (Figure contraction. 1 This section draws on WBG, “Global Economic Monitor,” May-November 2018. 3 TEM, December 2018: Steadying the ship Figure 1: Slowdown in portfolio flows to EMDEs Figure 2: Increased bond yields over the summer Sources: International Finance Statistics, WB Staff estimates Source: Haver Analytics Note: Emerging Market countries according to MSCI classification; OI: Other Investment 4. Volatility in commodity markets has further Declining capital inflows and high exacerbated economic uncertainties around EMDEs. Crude oil prices reached a 4-year high in external vulnerability in Turkey October, hitting $86 per barrel amid reports that Iranian 5. A difficult external environment together with oil exports had fallen ahead of the reintroduction of domestic economic challenges combined into a US sanctions and rising international tensions with sharp slowdown in portfolio and other investment Saudi Arabia. Since then, however, oil prices have flows to Turkey in 2018 Q2-Q3. In the first three been declining rapidly, averaging $70 per barrel in quarters of 2018, portfolio and other investment flows November compared to $80 in October with reports averaged a third of inflows over the same period in the of increased production in Russia and Saudi Arabia. previous 5 years, turning negative in Q3 for the first Metal prices on the other hand have been on a steady time since 2016 Q3 (Figure 3). A very small part of this decline throughout 2018, reflecting concerns over trade contraction was driven by a sell-off in portfolio equity, tensions and growth prospects in China. Economic in line with a rebalancing away from emerging markets activity across several commodity-exporting EMDEs more generally. Most of the contraction in capital has stalled, with more severe stress among metal flows however was due to an outflow of portfolio debt exporters. Turkey, whose energy imports amount to the (Figure 4), linked to repayment of securitized debt, equivalent of 6 percent of GDP, stands to benefit from particularly as some banks and corporates chose not to the recent fall in oil prices and is particularly sensitive refinance due to escalating interest rate and currency to oil price volatility. pressures. FDI inflows remained stable whilst net errors and omissions increased sharply, amounting to nearly twice the level of portfolio and other investment flows in 2018 Q1-Q3. 4 World Bank Group Figure 3: Contraction in capital inflows Figure 4: Driven by outflow of portfolio debt Sources: International Finance Statistics, WB Staff estimates Sources: International Finance Statistics, WB Staff estimates Note: Excludes FDI, Net Errors and Omissions Note: Excludes currency and deposits 6. Whilst the slowdown in capital flows to Turkey was significant, it did not technically amount to a sudden stop.2 Turkey experienced two sudden stop episodes in the past 20 years, namely during the 2000-2001 and 2008-2009 crises (Figure 5).3 The decline in capital inflows in 2018 was milder than those earlier episodes and the capital flow shocks in 2014 and 2016. Moreover, non-residents’ portfolio flows in October and November turned positive,4 and large Turkish banks’ rollover of more than $5 billion in external debt, albeit at higher costs, Figure 5: Significant slowdown in capital flows but not a sudden stop Sources: IFS, WB Staff estimates 2 The sudden stop analysis in this section is based on the framework in Eichengreen, B, and Gupta P. “Managing Sudden Stops,” WBG Policy Research Working Paper (April 2016). 3 Eichengreen and Gupta classify an episode as a sudden stop when: (i) non-resident portfolio and other investment inflows decline below the average in the previous 20 quarters by at least one standard deviation; (ii) when the decline lasts for more than one quarter; (iii) and when flows are two standard deviations below their prior average in at least one quarter. Episodes end when capital flows recover to the prior mean minus one standard deviation. 4 See CBRT: Securities Portfolio of Non-Residents (Market Value, Stock, Flow, Million USD). 5 TEM, December 2018: Steadying the ship Figure 6: High external vulnerability relative to other EMDEs Sources: International Finance Statistics, WB Quarterly External Debt Statistics, Haver Analytics, WB Staff estimates between September and November, signals recovery in 8. The situation came to a head in August other investments. when rising international tensions combined with Turkey’s macro imbalances and perceived policy 7. Nevertheless, the slowdown in capital flows weaknesses to trigger a Lira sell-off and capital happened when Turkey was already facing high outflows. The severity of the shock and the potential external vulnerability, indicating weaker defenses adjustment path are benchmarked below (Figure 7 to against the effects of market volatility. As discussed Figure 12) against a range of financial effects (i.e. on in the previous TEM,5 Turkey’s external buffers against exchange rate, reserves, capital markets, short-term tightening financial conditions had declined relative debt) from 28 sudden stop episodes in emerging to 2007 (before the onset of the Global Financial markets between 1990 and 2016.6 A few points are Crisis) and 2012 (before the Taper Tantrum following worth noting: announcement of US monetary policy normalization). Turkey’s external vulnerability was also high compared (i) The recovery of the Lira since August has been to other emerging markets, as reflected by its relatively sharper and more rapid relative to the sample of large current account deficit; considerable dependence sudden stops (Figure 7, Figure 8).7 Most currencies in on volatile, debt-creating flows; and elevated short- the sample had some form of exchange rate peg, unlike term debt to reserve ratio (Figure 6). the Lira which is a free float, making their drop more akin to traditional currency crises including adjustment of exchange rate to a much lower equilibrium. 5 WBG, “Turkey Economic Monitor: Minding the External Gap,” May 2018. 6 Countries in the sample include Argentina, Brazil, Chile, Czech Republic, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Philippines, Poland, Russia, South Africa, Thailand, Turkey and Ukraine. Quarterly capital flow data includes non-resident portfolio and other investment flows accessed from the IMF’s International Financial Statistics. Data period is 1990-2018. Sudden stop classification is based on Eichengreen and Gupta (2016). 7 The precipitous drop in August likely reflects overshooting linked to a rapid deterioration in international relations. 6 World Bank Group The degree of downward adjustment in the falling domestic consumption and investment have currency directly affects pressures on the real and contributed to a sharp deceleration in import demand, financial sectors, which are discussed in the next whilst exports have accelerated. These developments sections. In Turkey, prolonged currency weakness after helped shift the current account deficit to surplus in the August shock would have been even more troubling August, September and October 2018, reducing to for the economy given the high exposure of corporates some extent pressures on external financing needs. to forex debt, dependence on imports of energy and A detailed analysis of the drivers of current intermediate inputs, and exchange rate pass through to account balances (Box 1) finds that credit to the inflation. private sector has contributed most in recent years to (ii) The impact of the 2018 Q3 capital flow shocks on Turkey’s current account deficit. The sharp drop in the Turkish stock market valuation seems in line with credit growth therefore should help to contain current the impact during sudden stop episodes (Figure 9). account imbalances going forward. However, equity markets in Turkey are generally quite 9. Market volatility in Turkey has subsided since shallow, and portfolio equity (hot money) is less than the turbulence in August. The Lira has recovered a quarter of external financial inflows. Therefore, the and stabilized for now (Figure 14), averaging TRY 5.4/ real sector impacts of this are likely to be more limited. USD in November, after bottoming out in August (iii) The impact on reserves and short-term debt to at TRY 7.2/USD. Though reserves remain slightly reserves has been more severe and closer to the upper below prudential threholds (5.6 months of imports in bound of sudden stop episodes (Figure 10, Figure 11). November), they are starting to pick up; the Central Gross international reserves declined by just over 20 Bank’s net international reserves have risen from a percent between 2018 Q1 and Q4. Given Turkey’s large 2018 low of $25 billion in October to $28 billion in external financing requirements on the one hand (see November, whereas gross reserves have increased from below) and tightening capital flows on the other, the big $86 billion to $91 billion over the same period (Figure drop in reserves prompted concerns from some about 15). external financing gaps and a balance of payments 10. Nevertheless, Turkey’s external financial crisis. situation remains fragile whilst market perceptions But a big part of the decline in reserves was of risks are high. CDS spreads have declined from 560 driven by the Central Bank’s decision to lower forex bp in August to 370 bp in November (only Argentina reserve requirements of banks, including under the is higher among emerging/frontier markets) (Figure Reserve Options Mechanism (ROM) (Figure 13); this 16). Short-term treasury bond yields have come down was introduced to provide greater forex liquidity to from a high of 27 percent in August though remain banks at a time of tightening external finance and forex elevated at 20 percent in November. At the same time, liabilities coming due. The increase in short-term debt Turkey has close to $40 billion in external debt service to reserves is linked to the decline in gross reserves due between December and June 2019. Though it has rather than an increase in short-term debt. successfully covered a spike in refinancing requirements in October and reduced its current account financing (iv) Current account imbalances have started to need, its ability to raise external finances will depend on shrink, in line with the adjustment in past sudden stop global monetary conditions and soundness of domestic episodes (Figure 12). Exchange rate depreciation and policies. 7 TEM, December 2018: Steadying the ship Figure 7: REER declining with free float Figure 8: Rapid recovery in Lira Figure 9: Equity markets contracted sharply Figure 10: Big drop in gross reserves Figure 11: Increase in ST debt/reserves Figure 12: Current account adjustment Sources: International Financial Statistics, WB Quarterly External Debt Statistics, Haver Analytics, WB Staff estimates Notes: t = quarter in which sudden stop started (for Turkey it is 2018 Q3 when capital flows turned negative). 8 World Bank Group Figure 13: Gross reserves decline due to RR policy Figure 14: Exchange rate volatility high in Turkey Sources: CBRT, WB Staff estimates Sources: Haver Analytics, WB Staff estimates Notes: Annualized volatility estimate. EDMEs in range include Argentina, Brazil, Russia, RSA, Malaysia, Indonesia, India, Mexico Figure 15: Reserves have started to recover Figure 16: Market perceptions of risk high in Turkey Sources: CBRT, WB Staff estimates Source: Bloomberg Terminal 9 TEM, December 2018: Steadying the ship Box 1: Drivers of the current account balance in Turkey Turkey over the past 20 years has experienced large and persistent current account deficits relative to its peers. Ongoing World Bank research looks to econometrically assess the drivers of current account imbalances in Turkey. The results aim to inform policy discussions on external sustainability, an issue that has come into focus with recent external shocks. Drivers of current account imbalances in Turkey Large and persistent CAD: Increased domestic investment and consumption in Turkey post 2000s contributed to a widening current account deficit (CAD). This was further accelerated by FDI-related imports (Figure 17). Ongoing analysis finds that Turkey’s CAB has a low level of persistence by comparison with other countries, which suggests that the CAB in Turkey adjusts more quickly in response to shocks. Figure 17: Drivers of the current account balance in Turkey Sources: International Finance Statistics, Haver Analytics, WB Staff estimates Credit expansion and CAD: The biggest single driver of Turkey’s CAD post 2001 was a rapid expansion of credit to households. Private credit accelerated further between 2007 and 2012 with global monetary easing though this time led by corporates. Between 2013 and 2017, compensating factors came into play to lower the CAD, most notably the pull-back in credit to households. But the deficit persisted due to continued expansion of credit to corporates, while a deterioration in openness relative to other countries also contributed more substantively to the CAD in this period. Large negative Net Foreign Assets (NFA) perpetuated CAD: The hangover from successive CADs began to be felt in earnest as the servicing costs of foreign liabilities exerted a larger negative pull on the current account. NFA reached 50 percent of GDP at the end of 2017, a threshold level which has been found to be associated with a higher risk of external crisis.8 8 Catao, L. and G.M. Milesi-Ferretti (2014), “External Liabilities and Crises”, Journal of International Economics, Volume 94, Issue 1. 10 World Bank Group Policy implications Link between growth and CAD: Strong macro fundamentals in the early 2000s resulted in domestic investment expanding more rapidly than domestic savings. The resulting gap was financed by foreign sources, which led to a negative NFA position. A high CAD and growing exposure to volatile capital flows implies that Turkey would need to move to a growth model that breaks the link between growth and the CAD through higher domestic savings. Depth of financial markets and credit booms: Credit to corporates more than doubled over the past 10 years, growing from a relatively low base. Turkey has a strong suite of macro-prudential regulations to maintain financial stability and rapid credit growth does not necessarily imply risks to sustainability. But capital inflows and private credit have been highly procyclical in recent years, including an elevated credit-to- GDP gap. These trends can exacerbate external risks. Openness and CAD: CAD expansion is linked to some decline in openness relative to other countries. Agricultural trade is subject to restrictive tariff quotas and price regulation, though import barriers on grains, cereals, pulses and meat have been reduced in the past two years. Protectionist and localization hurdles have also arisen in sectors such as pharmaceuticals, medical devices, apparel and e-commerce. But openness varies across sectors, with some sectors more open than in other countries. This will be discussed further in the upcoming paper on drivers of CA imbalances. Foreign Direct Investment: While FDI inflows had a negative effect in the past, FDI is generally associated with increased productivity in the domestic economy, increased diversification and sophistication of the production and export bundles, thus reducing vulnerabilities associated with current account deficits, as well as benefiting the economy beyond its impact on the current account balance. 11 TEM, December 2018: Steadying the ship Price pressures forcing supply side in part by the effects of exchange rate depreciation on imported intermediates. Private consumption in Q3 corrections in non-tradable sectors moderated (1.1 percent yoy growth) whilst investment 11. The financial effects of market volatility contracted (-3.8 percent yoy growth). Retail sales, which in Turkey translated into significant real sector map closely to private consumption developments, impacts, including a sharp acceleration in inflation contracted in 2018 Q3 for the first time since 2016 from already elevated levels. Year-on-year consumer Q3, whilst consumer confidence was its lowest level prices increased by 25 percent in September (Figure 18), since end 2008. Rising inflation has contributed to a following a 6 percent jump that month, levels not seen broad-based decline in real wages in 2018 Q3, further since the 2001 crisis in Turkey. Despite the big jump in depressing demand (Figure 21, Figure 21, Figure 23).9 food and energy prices, there is little divergence between headline and core inflation, pointing to a broad-based 13. Declining demand, among other factors, increase in prices across all major components of the contributed to the first monthly deflation in CPI basket. This is further illustrated by the distribution November since June 2017. Consumer prices in of price increases across the CPI basket (Figure 19); November fell by 1.5 percent, whilst year-on-year whilst in January 2017, prices across 70 percent of the inflation fell by 3.62 percentage points in November to CPI basket rose in the 0-10 percent range, in September 21.6 percent – the first time it has fallen since March and a 2018, 70 percent of the basket rose in the 20-40 percent better-than-expected outturn. The biggest contribution range.8 to declining CPI stemmed from the durable goods, falling by 15 percentage points in one month thanks to 12. The gap between consumer and producer recent tax cuts on vehicles, furniture and white goods. price inflation widened significantly since July, The domestic PPI also fell in November, from 45 to reflecting suppliers’ inability to pass on price 38.5 percent last month. Aside from declining demand increases to consumers due to declining demand and tax cuts, a partial rebound in the Lira and softer oil and more direct exposure of producer prices prices helped reduce inflation. to exchange rate shocks. Producer price inflation peaked at 46 percent in September (Figure 20), driven Figure 18: Jump in inflation after market volatility Figure 19: Broad-based increase in prices Sources: Haver Analytics, WB Staff estimates Sources: Haver Analytics, WB Staff estimates 8 9 All sectors have seen declining real wages in Q3, but construction stands out the worst hit. Construction sector real wages (SWDA, q-o-q) contracted by 7.8 percent in Q3 while manufacturing and retail trade sectors recorded 4.6 percent and 5.0 percent contractions, respectively. 12 World Bank Group 14. High production costs together with slowing which in part reflects a correction from rapid growth demand have prompted supply side adjustments. in the last two quarters of 2017. This is consistent Output growth over Q3 steadily decelerated, with the with sustained easing in the manufacturing purchasing composite leading indicator reaching 1 percent (yoy) by managers’ index (PMI) since May, albeit with some September. The industrial production index (calendar signs of bottoming out in September. adjusted) contracted by 5.7 percent in October (yoy), Figure 20: Large divergence between PPI and CPI Figure 21: Due to declining consumer demand Figure 22: With contracting retail sales Figure 23: Precipitated by falling real wages Sources: Haver Analytics, TURKSTAT, WB Staff estimates 13 TEM, December 2018: Steadying the ship 15. Supply side indicators point to a big correction territory (Figure 24) before the economy collapsed into in 2018 Q2-Q3 compared to the six months four consecutive quarters of contraction. In addition: preceding the last economic contraction in 2016 Q3, the PMI experienced a sustained drop from 51 to 41 in albeit a more gradual correction compared to the the run up to the 2008-2009 recession, before collapsing run up to the last major recession in Turkey (2008- to 32, though is showing some signs of improvement in 2009). The severity of the adjustment relative to 2016 2018 (Figure 25); capacity utilization declined from 81 Q3 in part reflects the economy coming down from a to 73 percent in 2008-2009, compared to a drop from period of overheating in 2017-2018. On the other hand, 78 to 74 percent in 2018 (Figure 26). Unemployment in the four months preceding the 2008-2009 recession, rates increased more rapidly in 2008-2009, though also the composite leading indicator was already in negative started from a lower base (Figure 27). Figure 24: Composite output indicator already Figure 25: PMI is showing some signs of negative in run up to 2008-2009 improvement in 2018 Figure 26: Capacity utilization adjusting down Figure 27: Unemployment levels rising gradually, from a period of overheating though from a higher base than 2008-2009 Sources: Haver Analytics, TURKSTAT, WB Staff estimates 14 World Bank Group Figure 28: Real turnover contracting in Figure 29: GVA and employment growth negative non-tradable sectors in non-tradable sectors Sources: Haver Analytics, WB Staff estimates 16. These developments do not preclude a more rate. Agriculture too has seen continued job losses in serious supply correction in 2018-2019, particularly Q3. Both services and industry sustained growth in Q2 as corporates exhibit increased stress from falling and continued to create jobs in Q3, though in services demand and credit (see next two sections), though the bulk seems to be in non-tradable public services. In an important difference with the 2008-2009 crisis is manufacturing, the PMI shows a much stronger outlook the role of external demand. Real turnover growth in for new export orders compared to domestic orders. the year to September has contracted in non-tradable Within industrial sub-sectors, motor vehicle and other sectors (Figure 28). Higher costs and credit rationing transportation equipment exhibit growth in Q3, adding are forcing corporates to cut costs. Tradable sectors, on 1.2 percent to total industrial production y-o-y, driving the other hand, have seen an over 20 percent increase overall growth for the quarter. This sub-sector was in real turnover. This strong growth has been aided by primarily led by exports, with motor vehicles exports in the mid-year deprecation of the Lira, with Lira-priced US$ growing 1.2 percent over the same period. exports increasing in value with depreciation and sustained external demand. Not only exports of goods 18. Developments in the housing market signal but also exports of services contributed to growth in risks for housing developers, banks, suppliers 2018, thanks to a strong rebound in tourism sector. In and households (Box 2). A combination of FX 2008-2009, both domestic and external demand had indebtedness, increased cost of construction, excess collapsed. Without the compensating effect of tradable supply, and lack of price adjustment explain housing sectors, the economy is likely to have already dipped developers’ recent financial stress. This is important into recession. given the real estate sector’s linkages across the economy. Although households are not significantly 17. The rebalancing towards tradable sectors leveraged and most of the newly sold houses were is also evident in employment numbers. Both non-mortgaged sales, negative wealth effect might construction and agriculture, primarily non-tradable further lower consumption. The wealth effect is likely sectors, are contracting, whilst the more outward- to hit through high inflation (lower yield of housing oriented manufacturing, and to some extent services, investments), higher borrowing costs, lower asset prices sectors are still growing, albeit at a slower pace (Figure (lower collateral values) and therefore a lower wealth 29). Employment in construction fell sharply in Q2, level. and has continued to fall in Q3, although at a slower 15 TEM, December 2018: Steadying the ship Box 2: Real estate sector developments Conditions in the real estate sector can influence the real and financial sector impacts of recent market volatility in Turkey. Changes to real estate asset prices and returns affect household wealth and consumption; housing developers’ and suppliers’ profits and solvency; and the health of the financial sector. Sharp corrections can exacerbate economic stress and trigger crisis. This section reviews real estate sector developments in Turkey and economic vulnerabilities that may arise. House price developments in Turkey: After a period of rapid house price inflation in Turkey between 2013 and 2015, price increases started to decelerate, eventually deflating in real terms, starting in early 2018 (Figure 30). House price inflation in September 2018 fell to 10.5 percent (yoy) from a peak of 19 percent in May 2015, whilst in Istanbul it fell from a peak of 29 percent to 4.1 percent over the same period. In real terms, house prices in Turkey declined by 8 percent (yoy, deflated with CPI) while Istanbul’s real house prices declined by 14.2 percent in August. This in part reflects a sharp correction in the buy-to-let market particularly in large metropolitan areas. Buy- to-let investments increased rapidly in the last 8 years with construction of high-rise buildings and increased mortgage lending. The availability of ‘sell-build model’ also enabled housing developers to sell their units before construction, which also impacted on prices (Figure 31). Until recently, these investments offered high returns; but an oversupply of rental housing has led to declining rental yields (see below). Combined with rising cost of finance, the demand for housing has fallen below trend (Figure 32) and prices have started to decline. Alignment of house prices and income: Turkey’s house price-to-income ratio on the other hand has been low (and declining) relative to other OECD economies and MICs (Figure 33).10 This signals that house prices in Turkey are in line with income relative to OECD countries and MICs. This means that income growth has been greater than house price inflation, though it does not automatically imply that housing in Turkey is affordable. This would require more detailed analysis of affordability across markets and households within the country. Figure 30: House price correction in Turkey Figure 31: House price changes linked to construction permit application Source: CBRT Sources: TURKSTAT, CBRT 10 The price to income ratio is the nominal house price divided by the nominal disposable income per head. 16 World Bank Group Figure 32: Demand falling below trend Figure 33: House prices in line with income Sources: TURKSTAT, WB Staff calculations Sources: Towngate Insurance, WDI Figure 34: Change in house price-to-rent ratio Figure 35: Low global rental yields Source: Global Housing Watch Source: Global Property Guide Figure 36: Housing is a big source of savings Figure 37: With high propensity for reinvestment Source: Turkey Capital Markets Board Survey Source: Turkey Capital Markets Board Survey 17 TEM, December 2018: Steadying the ship Returns on housing investment: Data on price-to-rent ratio11 shows that house prices increased faster than rental prices in Turkey since 2010, amounting to lower returns from housing investment in Turkey compared to other OECD economies (Figure 34); among a selected group of metropolitan cities, Istanbul in 2018 in had one of the lowest rental yields (Figure 35). This potentially signals some overvaluation in housing, a correction to which seems to be underway. This has important implications for households given that real estate is an important saving/investment instrument in Turkey; there is also high propensity for reinvestment in housing (Figure 36, Figure 37). Policies to stimulate house sales: In response to falling demand, the government has in recent years tried to incentivize house purchase. Policies measures include increasing the Loan-To-Value ratio from 75 percent to 80 percent in 2016; temporary reduction in housing VAT rates in 2013, 2016 and 2018; reduction in mortgage lending rates; allowing housing developers to receive 20 percent in advance amount in instalments. These have provided short-term boosts to demand but not reversed the trend (Figure 38). Though stimulus measures include relaxation of macro-prudential regulations or reduction in mortgage rates, mortgage-backed sales are a small and declining share of total sales, falling from 45 percent in 2013 June to 5.5 percent in 2018 October. Cash purchases and purchases through financing packages offered by housing developers make up the bulk of total sales. Figure 38: Government incentives provide short-term boost to house sales Sources: TURKSTAT, CBRT, WB Staff estimates Investment by foreigners: The share of houses sold to foreigners in total house sales has been stable around 1.5-2 percent until 2018, increasing recently to 4.3 percent in October 2018. The government lowered the minimum housing investment requirement for Turkish citizenship from $1million to $250,000 to boost foreign investment in real estate. Developments in the construction sector: Falling demand for housing is impacting the construction sector, which has expanded very rapidly in the last 10 years. The shares of construction in gross value added and employment as of 2018Q3 are high at 8.4 and 7.1 percent respectively. In 2017, the sector contributed to around a quarter of GDP growth. But as discussed elsewhere in the TEM, there has been a marked deceleration in 2018. 11 The price to rent ratio is the nominal house price divided by the rent price. 18 World Bank Group Figure 39: Divergence between construction costs Figure 40: Developments in the construction and house prices sector have strong spillover effects Source: Turkey Capital Markets Board Survey Source: Turkey Capital Markets Board Survey The acceleration in costs of construction has outpaced house price inflation since November 2016, with a rapid divergence since January 2018. The annual change difference between cost of construction and house prices is more than 29 percent as of September 2018, reflecting housing developers’ inability to pass on costs to buyers given the slowdown in demand (Figure 39). This has prompted supply side adjustments, which have significant spillover effects across other parts of the real economy. Input-output analysis show that construction sector is the second largest in terms of value added creation in other sectors. Construction and real estate activities together form more than 18 percent of total backward linkage share of value added with the other sectors (Figure 40). 19 TEM, December 2018: Steadying the ship Financial shock in 2018 has caused a as measured by corporates’ debt-to-equity ratios.12 Turkish corporates’ financial leverage has been on an rise in corporate stress upward trajectory over the past five years, diverging 19. Supply side corrections combined with from other EMDEs (Figure 41) (consistent with elevated corporate debt, including FX exposure, findings in Box 3). The spread between the debt to has raised corporate solvency and liquidity equity index of corporates trading on MSCI Emerging concerns in Turkey. Corporate debt in Turkey has Markets Index13 and on Turkey’s BIST Istanbul 100 risen sharply since the Global Financial Crisis, driven Index hit the highest level in 2018 Q3 amid the financial in big part by foreign exchange (FX) debt including in turbulence in Turkey over the summer. non-tradable sectors that are vulnerable to the recent 21. In terms of liquidity, listed corporates currency shock (Box 3). The situation is exacerbated experienced a sharp drop in their interest coverage by credit rationing, making it more difficult for ratio (ICR)14 in 2018 Q3, signaling increased corporates to access finance for rising working capital pressure on debt servicing capacity. In 2017, rapid needs (see next section). This has resulted in a rapid economic expansion helped improve the ICR for most rise in corporate debt restructuring demands in the corporates despite an increase in financial expenses. past months, including under the newly established But in 2018, a combination of declining corporate Concordat process. earnings and rising borrowing costs caused the ICR 20. Consistent with this, an analysis of the balance to deteriorate sharply, falling to 0.90, significantly sheets of listed corporates in Turkey points to a below the critical threshold of 1.5 (Figure 42). These rapid increase in financial leverage in 2018 Q2-Q3 developments are not reflected in non-performing loan Figure 41: Increase in financial leverage of corporates Figure 42: ICR drops below critical threshold Source: Bloomberg Terminal Sources: WB Staff estimates based on RASYONET *4-quarter rolling Notes: While BIST 100 index includes both financial and non-financial corporates, financial corporates and the corporates having zero financial expenses or not having value for financial expenses, are excluded from all listed corporates 12 This section uses data of corporates listed on the Istanbul Stock Exchange to quantify the amount of debt which is at risk and the financial stress of corporates up to 2018 Q3. Financial companies (banks, factoring, insurance, venture capital trusts, financial leasing, investment securities and trusts) are excluded from the listed corporates. The Altman Z-score is estimated to measure the financial distress of corporates by employing several corporate income and balance sheet indicators. Although the analyses do not cover all the non-financial corporates in the economy and do not reflect all corporates’ situation, the financial analysis of listed companies, which are relatively well-performing, can provide some up to date insight information about the general trend. 13 The MSCI Emerging Markets is an international equity index, which tracks stocks from 24 emerging market countries, including Turkey. All corporates both financial and non-financial are presented to compare with the other emerging market economies. 14 ICR reflects the ability of corporates to cover their interest and financial expenses with their operating earnings. 20 World Bank Group Figure 43: Share of DAR above 2009 peak Figure 44: DAR associated with finance cost and REER Sources: WB Staff estimates based on RASYONET, CBRT ratios. This is partly because the analysis only covers several corporate income and balance sheet indicators listed companies, and partly because of the acceleration to measure financial distress of corporates.16 Calculated in debt restructuring. It nevertheless signals risks for Altman Z-scores for listed non-financial corporates the banking sector (see next section). display a downward trend since 201317 (Figure 45, Figure 46) falling below a critical threshold in 2018, 22. A combination of the above has led to a reaching its lowest level in 2018 Q3. general increase in corporate vulnerabilities as measured by the share of debt-at-risk (DAR). The 24. This is mostly driven by the deterioration in share of DAR is measured by the ratio of the debt of the interest coverage ratio and drops in liquidity, corporates15 that have ICR of less than 1.5 over total profitability and loss in market value 18. Rapid lira debt. Based on this, the share of risky debt among listed depreciation caused an increase in financial expenses corporates in Turkey has more than doubled since 2013, and a decline in net margin and put pressure on working surpassing the peak reached in 2009 (Figure 43). The capital. This is exacerbated by increased uncertainty in share of DAR was at around 42 percent in 2018Q3. market values. The number of corporates going into The share of DAR is directly associated with cost of the distressed zone increased significantly (Figure 47). borrowing, and even more so with REER depreciation (Figure 44). Energy, telecommunication and real estate 25. At sector level, large energy corporates and investment trust corporates are under most pressure, real estate investment trusts seem to experience contributing significantly to the rise in DAR. the biggest deterioration in Z- scores. As they have large asset size, their poor performance drags down the 23. A composite measure of financial distress weighted average Z-score. The outlook for corporate further indicates a deterioration in the overall earnings in 2019 is not promising amid the expectations financial conditions of listed non-financial of a slowdown in the economy and of a decline in corporates in 2018. The Altman Z-score combines profit margins pressured by inflation. 15 All listed corporates except financial ones are included in the sample. The real estate investment trust corporates are not excluded as they are not pure financial entities and are actively working on real estate sector.  16 See Appendix for details on Altman Z-score. 17 While the unweighted Altman Z-score is trending down from mid-2010, the weighted equivalent remains stable until 2013. 18 Market value is the price of the company in the stock exchange market. 21 TEM, December 2018: Steadying the ship 26. High frequency corporate vulnerability index index 1-year return) and Turkish Interbank 3-Month data confirm the elevated pressure on corporates. (short-term risk-free rate) are used as macro financial A daily corporate vulnerability index is calculated by factors in the estimation. According to the index (Figure the Credit Research Initiative (CRI) to estimate the 48), corporate vulnerability has been on an increasing probability of default (PD) of individual publicly listed trend since March 2018. It peaked in August, surpassing corporates.19 Macro financial risk factors and firm 2009 levels. There has been a decline in vulnerability specific attributes (distance to default, balance sheet in the recent months and the value-weighted index indicators) are used as inputs to the model. For Turkey, retreated to the level in May 2018. However, the Istanbul Stock Exchange National 100 Index (stock vulnerability is still high compared to early 2018. Figure 45: Financial distress peaks in 2018 Q3 Figure 46: Financial distress indicator below threshold Sources: WB Staff estimates based on RASYONET and CBRT Notes: Both currents assets and total assets are used in calculating the weighted Z-scores Figure 47: More corporates in distressed zone Figure 48: Daily index shows rise in corp. vulnerability Sources: WB Staff estimates based on RASYONET and CBRT Source: The Credit Research Initiative 19 The Credit Research Initiative (CRI), launched in 2009, is a non-profit undertaking at the Risk Management Institute (RMI) of the National University of Singapore. The corporate vulnerability index is estimated based on the intensity model developed by Duan et al. (2012). The equally-weighted CVI is the average value of the individual PDs in a group. The value-weighted CVI sums up the individual PDs with their market capitalizations as weights. The tail CVI is the top 5th percentile of the individual PDs in a group, focusing on the riskiness of the most vulnerable firms in a group. For detailed information, https://www.rmicri.org/en/view_cvi/8503/. 22 World Bank Group Box 3: Corporate Debt in Turkey Corporate indebtedness in Turkey: Corporate debt in EMDEs rose sharply since the Global Financial Crisis, from around $9 trillion to $31 trillion dollars (108 percent of GDP).20 Among EMDEs, Turkey has one of the highest corporate debt to GDP ratios, rising from 56 percent of GDP at the end of 2014 to an estimated 77 percent in 2018 Q3. FX debt of Turkish corporates: Around 90 percent of the increase in Turkey’s corporate debt over this period stemmed from a rise in FX debt, driven by post-GFC global monetary easing and Turkey’s strong economic performance. By 2018, around 65 percent of corporate debt to GDP is FX denominated. Lira depreciation had a substantial impact on the recent increase through a reduction in the dollar denominated GDP. The rise in FX leverage has caused a large and negative net open FX position for corporates (net sum of all FX assets and liabilities), reaching 215.3 billion dollars (26 percent of GDP) in August. Source of FX debt: The corporate sector’s FX borrowing comes largely from (Figure 49): (i) FX lending by domestic banks to Turkish corporates; (ii) direct lending by foreign banks or investors to Turkish corporates; and/or (iii) securitized debt (e.g. bond issuances by corporates). Around 60 percent of total FX loans are through domestic banks. The amendment of Decree 32 in June 2009 allowed firms with no FX income to borrow in FX from on-shore bank branches provided the loan amount was greater than $5 million with minimum maturity of one year. Firms that collateralized FX loans with FX deposits and securities were exempt from these conditions. Regulations however were tightened in May 201821 given rising concerns about increased forex exposure of some companies that have no forex earnings or other form of hedge. Figure 49: Sources of FX debt for Turkish corporates FX debt costs and maturities: FX debt is available at lower cost and longer maturity compared to TRY debt, reflecting low levels and short-term nature of TRY deposits in the banking system. The weighted average interest rate for TRY loans have exceeded that of FX loans by on average 10-15 percentage points, rising to 25 percentage points in the most recent months due to monetary tightening (Figure 50). 20 2122 Most of the $150 billion external debt of corporates22 (iii in Figure 50) has medium to long-term maturity (4.9 years average) and only 1.5 percent of the total, excluding import credits ($41.3 billion), is short-term. Around 12.5 percent of long-term external corporate debt is maturing in one year or less (Figure 51). 20 BIS Database 21 Official Gazette No. 30312, January 25, 2018: (i) Decree No. 2018/11185 amending the Decree No. 32 on the Protection of the Value of the Turkish Currency; (ii) Communiqué No. 2018-32/46 amending the Communiqué on the Decree No. 32 on the Protection of the Value of the Turkish Currency. The government introduced new measures to restrict on new FX borrowing by SMEs by introducing new limits for FX debt to FX income ratio and banning new FX-indexed corporate loans in May 2018. 22 I.e., excluding domestic FX loans A relatively smaller amount – around 6 percent of external debt – is Lira denominated. 23 TEM, December 2018: Steadying the ship Figure 50: Lower cost of FX debt Figure 51: Large external debt service obligations Source: CBRT Sources: CBRT, BRSA FX debt servicing obligations of corporates and concentration by size of corporates: Corporates face increased debt servicing costs (around $5 billion) in the last quarter of 2018. Long-term refinancing rates of the corporates are still over 100 percent, reaching 141 percent (12-month rolling) in September. Around 85 percent of FX loans (and half of TRY loans) are held by large corporates. SMEs on the other hand benefited from an acceleration in TRY credit through the extension of government guarantees in 2017 and early 2018. FX debt concentration across sectors:23 The highest concentration of FX loans is in the manufacturing sector (29 percent of total FX loans), though its share has been declining in the last decade. There is also high concentration in the energy sector (12 percent of external FX loans, 17 percent of domestic FX loans), and the transportation and storage sector. In more recent years, FX lending to the construction sector has risen sharply (10 percent of external FX loans, 13 percent of domestic FX loans). FX debt leverage and currency risk across sectors:24 FX leverage of a sector is defined as total FX liabilities divided by total non-equity liabilities. Comparing FX leverage of a sector to that sector’s tradability, measured by the ratio of export receipts to total sales, gives a sense of potential currency risk; in other words, export revenue can provide a natural hedge against currency depreciation. High leverage versus low tradability signals currency mismatch and vulnerability to currency shock. Manufacturing, transport and storage, and mining have relatively high FX leverage, but also relatively high export to sales ratios, which provides a hedge against currency risk (Figure 52). Within manufacturing, motor vehicles, transport equipment, electrical machinery have relatively high FX but also high export receipts (Figure 53). There are sub-sectors within manufacturing however that may face higher currency risk. These include chemicals, pharmaceuticals, coke refined petroleum sectors; all have weak export to sales relative to their FX leverage. These sectors also rely quite heavily on intermediate imports. The food sector, one of the largest but most 23unproductive 24 25 26 sub-sectors,25 is highly leveraged with a low export to sales ratio. 23 The breakdown of corporate FX loans at sectoral disaggregation is not publicly available for the domestic FX loans which constitute the bulk of FX exposure of corporates. Therefore, the figures are obtained from the CBRT Financial Stability Report, November 2018. 24 FX leverage data and exports receipts to total sales data obtained from CBRT sectoral accounts (2015-2016 averages) which is the latest data available. The significant developments in FX market since that time may have led to a change in the sectorial position. The results should be interpreted with this in mind. 25 WBG 2018, “Firm productivity and economic growth,” (forthcoming). 26 In the energy sector, around 80 percent of the loans are FX-denominated. 24 World Bank Group Outside of manufacturing, there are several non-tradable sectors with high FX leverage. The real estate sector significantly increased its FX exposure in the last decade without strong natural hedge. The real estate sector’s FX leverage is greater than 50 percent whilst almost all its sales are domestic. Similarly, in the energy sector, FX exposure is around 45 percent26, even though sales are almost all domestic. The sector however is buffered against currency risk through indexation of energy prices to exchange rate developments. Despite its FX denominated pricing, the restrictions on domestic energy price adjustments might put pressure on debt servicing capability. Figure 52: FX leverage vs. export ratios across sectors Figure 53: FX leverage vs. export ratios within manufacturing Sources: CBRT Sectoral Accounts 2015-2016 average, WB Staff estimates 25 TEM, December 2018: Steadying the ship Figure 54: Banks dominate financial sector in Turkey Figure 55: Sharp deceleration in credit growth Sources: World Bank, Global Financial Development Database Sources: CBRT, BRSA Banks face volatility with strong as of October 2018, despite regulatory forbearance measures introduced by BRSA. Loan growth has buffers but cracks begin to appear decelerated sharply in recent months (Figure 55), due 27. The Turkish financial sector’s buffers were to the phaseout of the credit guarantee scheme, interest relatively strong ahead of recent market volatility. rate hike, and tightened liquidity conditions. Banks account for around 90 percent of total assets in the financial sector, growing rapidly over the past 29. Additionally, structural imbalances including decade with assets reaching 101 percent of GDP at maturity and currency mismatches persist and the end of 2017. Strong capital buffers, strengthened expose Turkish banks to external market volatility banking regulation and supervision, and effective risks. Rapid credit growth over the past decade has macro-prudential regulation set a strong foundation been fueled by external capital flows (Figure 56). for weathering the 2008-2009 crisis. On the other Share of foreign liabilities in total liabilities recorded a hand, capital markets and the non-bank financial sector sharp increase from 10 percent to 22 percent between remain relatively small and underdeveloped in Turkey 2009 and 2013 as banks took advantage of cheap compared to more advanced economies in the OECD international funding conditions. Between 2013 and (Figure 54). 2017 share of foreign liabilities followed a relatively flat trend and fluctuated between 22 and 23 percent levels 28. The banking sector still exhibits sound before surpassing 24 percent in October 2018 after the financial metrics despite recent market pressures, August FX volatility. Large FX positions generated by but cracks are beginning to appear on the asset banks’ FX funding have been closed through derivatives quality side due to rising corporate stress discussed above. Banks’ capital adequacy ratio – available capital transacted with foreign counterparties (Figure 57). as a share of banks’ risk weighted assets, which Most balance-sheet hedging of FX exposures is provides a measure of banks’ ability to absorb losses – achieved through conventional cross-currency and is high at 18.19; though part of this is also because CAR interest rate swaps with international banks. With calculation has benefited from temporary forbearance tightened regulations, the on-balance-sheet short measures introduced by the BRSA in August 2018, position decreased to 30 percent of regulatory capital adding around 160 basis points to CAR. Profitability in in October after peaking at 50 percent in June 2018. the banking system remains strong with return on assets Hedging allows banks to reduce exposure to market at 1.23 percent and return on equity at 12.60 percent. At (exchange rate) risk although given their short tenor the same time, Non-Performing Loans have been on an relative to the banks’ lending terms, rollover risks and upward trend in recent months, reaching 3.47 percent maturity mismatches remain high. 26 World Bank Group Figure 56: Banks’ external borrowing risen sharply Figure 57: Use of swaps to close short FX positions Sources: CBRT, BRSA 30. Maturity transformation has become more wholesale funding remains short-term, i.e., below one prominent in the banks’ balance sheets during year according to date to maturity (Figure 59). the last 15 years as they have been moving from 31. Recent exchange and interest rates government securities to private credit, whilst developments impact banks’ balance sheets extending loan maturities. High TL loan premia have through recalculation of risk weighted assets, mark also incentivized rising maturity transformation and to market security portfolios and on-balance sheet increasing balance-sheet maturity mismatches while open positions, ultimately impacting on solvency. liquidity risk management has become more challenging The regulator introduced some forbearance measures (Figure 58). Deposit maturities are very short with 95 to mitigate the immediate impact of the currency percent of the deposits below 1 year and 90 percent depreciation on bank balance sheets including on mark below 3 months maturity. It is important to note that to market security portfolio and risk weighted assets. banks have managed to increase the share of wholesale At the same time, the longer-term impact of worsening external funding in medium term maturity buckets macro-financial environment on banks’ liquidity asset over the last six years. However, more than half of the quality, profitability, and solvency is yet to be felt. Figure 58: Widening liquidity gap Figure 59: LT loans funded out of ST deposits Sources: CBRT, BRSA 27 TEM, December 2018: Steadying the ship Figure 60: Declining FX deposits in Turkish banks Figure 61: Banks’ rollovers have fallen to 70 percent Source: CBRT Note: Bank rollovers are on a 6-month total basis. 32. Banks were able to absorb liquidity pressures (124 percent), reflecting FX loan deleveraging and in the aftermath of the August volatility thanks to robust quarterly growth in TL deposits. The Liquidity the timely actions of the Central Bank (see next Coverage Ratio of the banking sector is well above the section). Deposit outflows observed during the few minimum legal ratio27 while the share of liquid assets weeks of high volatility in August stopped, and funds to total assets has been fluctuating between 20 and 23 partially returned to the system (Figure 60). However, since the beginning of 2015. Turkish banks can access in total, there has been around US$ 12 billion net sufficient FX liquidity – primarily foreign currency withdrawal in resident’s FX deposits as of October placed with the central bank, and short-term currency since the beginning of the year. swaps with foreign counterparties – to service short- term wholesale debt in the event of a loss of market 33. Banks also generally been able to rollover access. their foreign syndicated loans, starting with first- tier banks in September (Figure 61). However, the 35. Though officially reported asset quality cost of refinancing almost doubled compared to the indicators show only a slight downward trend, beginning of the year, standing at around 275 bps level continuing exchange rate and interest rate in October. The downward trend in rollover ratios could pressures as well as the anticipated economic be associated with slowing loan demand due to falling downturn negatively affect asset quality. The level investment and increasing cost of borrowing. It is of distressed assets in the financial system is much worth noting that Turkish banks historically had access higher than official NPL levels. Loans under close to international borrowing even in times of liquidity monitoring (Category 2) have continued rising and crunch such as during the GFC in 2008, when banks in fact are almost three times higher than officially were able to rollover 80 percent of their FX loans. reported NPL levels (Categories 3, 4 and 5 combined). It is worth noting that loans under close monitoring 34. Turkish banks maintain substantial liquidity have also increased due to implementation of internal especially in FX. Public preference for FX deposits credit rating models under TFRS 9 standard since coupled with the strong demand for TL loans resulted the beginning of 2018 and banks’ prudent attitude in a widening in the gap between TL and FX Loan to which is reflecting a more comprehensive approach in Deposit (LTD) ratios. The banks’ average LTD ratio identifying risks. An analysis of the loan portfolio of remains high (end-Q3: 121 percent) (Figure 62) but the seven largest Turkish banks shows that while NPLs it has slightly improved compared with June 2018 27 The minimum liquidity coverage ratio should be 90 percent for total and 70 percent for FX assets. 28 World Bank Group Figure 62: Rising TRY Loan to Deposit ratio Figure 63: Liquidity cov. ratio within prudential norm Sources: CBRT, BRSA Table 1: Breakdown of distressed assets June 2017 June 2018 October 2018 Standard loans (Group 1) 93.8 89.4 87.5 Loans under close monitoring (Group 2) 3,1 7,7 9,3 Loans with limited collectability (Group 3) 0.3 0.5 0.6 Loans with doubtful collectability (Group 4) 0.6 0.5 0.7 Uncollectable loans (Group 5) 2.1 2.0 1.9 Sources: Independent audit reports of the largest 7 Turkish banks for 2017-2018. remain at TL 59.8 billion or on average 3.3 percent of 37. To understand the overall picture of distressed total loans, Category 2 loans have reached TL 170,8 assets, it is important to consider restructured billion or on average 9.3 percent of total loans as of loans and sold NPLs. Restructured loans included in September 2018 (Table 1). Categories 1 and 2 have increased sharply; often these loans have been restructured more than once. The 36. Category 2 loans are a relevant proxy for analysis of the top 7 banks shows that restructured financial distress because banks in Turkey tend to loans where payment plan extensions have been restructure problematic loans as soon as possible adopted have reached (i) TL 26 billion or 1.6 percent before the loan becomes 90 days overdue, thereby of total loans in Category 1, and (ii) TL 51 billion or 31 benefitting from laxer provisioning requirements. percent of total loans in Category 2. The aggregate amount of loans included in Categories 2-5 is TRY 230.7 billion or on average 12.5 percent of 38. Private Turkish banks have been selling NPLs total loans, which might be a better representation of since 2008 following the introduction of legal current NPL levels in Turkey (Table 1). This is a rapid framework for Asset Management Companies in increase from 10.0 percent in June 2018 but due to the 2006. In 2017 the procedure for NPL sales by state typical time lag does not reflect the full impact of the banks was simplified. Between 2008 and 2017 Turkish large depreciation in June-August 2018. The situation banks sold a total amount of TL 38 billion NPL with Category 2 loans has deteriorated substantially portfolios consisting of retail and corporate portfolios compared to June 2017, when Category 2 loans were (Figure 64). Since its start, NPL portfolio sales growth only 3.1 percent of all loans (Table 1). has been 20 percent per annum. Historically, retail NPL 29 TEM, December 2018: Steadying the ship Figure 64: Breakdown of NPLs by borrower types Figure 65: Rising sale of NPLs Source: BRSA sales have made up the majority (58 percent) of total financial institutions; and (iii) the moral hazard problem sales. This has been mostly due to; (i) lower average for financial institutions (i.e. granting favorable terms ticket size requiring a systematic approach to collection to some borrowers may lead to a moral hazard amongst for financial institutions; (ii) the higher share of performing borrowers). unsecured loans, hence lower recovery expectations of Box 4: Financial sector vulnerabilities from the construction sector Banks’ exposure to construction sector: The construction sector accounted for 11.7 percent of total corporate loans in 2017, the second largest exposure for the banking sector (Figure 66). NPLs in the construction sector have declined since September 2016 (currently at 3 percent) (Figure 67). This is likely due to debt restructuring and loans extended under the Credit Guarantee Fund. Figure 66: Banks’ exposure to construction Co’s Figure 67: Construction NPLs declining slightly Source: BRSA Source: BRSA 30 World Bank Group Figure 68: Consumer loans/GDP relatively low Figure 69: Small mortgage market Source: Haver Analytics Source: CBRT Risks in the Turkish mortgage market: Household indebtedness is generally low at around 15-17 percent of GDP. Household mortgage loans total between 5-6 percent of GDP. Macroprudential regulations for mortgage lending have generally been tight. Turkish banks have been quite careful to select high credit worthy customers for mortgage loans, and there are no sub-prime mortgages. Mortgages are only available in Turkish Lira with a fixed rate. Risks in the housing portfolio: The share of non-performing mortgage loans peaked at 2 percent during the 2009 financial crisis and declined afterwards to 0.5 percent (Figure 71). Turkish households have been borrowing at between 5-10 years’ maturity for housing loans. Since late 2012, maturity composition has slightly shifted from 10-15 years to 5-10 years which increased from 57 percent to 73 percent of total housing loans (Figure 72). Due to the existing level of mortgage loans as a share of GDP and shorter maturity profile, the mortgage market in Turkey can be classified as a burgeoning market relative to advanced economies. In the medium and long run, improvement in macro-financial conditions with lower cost of mortgage credits and longer maturities may help deepening in mortgage market and shape the future of the Turkish housing market. Figure 70: Limited NPLs in mortgage market Figure 71: Mortgages relatively short-term tenor Source: CBRT Source: CBRT 31 TEM, December 2018: Steadying the ship Complex economic situation with the one-week repo rate as the central policy rate of the Central Bank. A second round of tightening was acute policy trade-offs implemented in September with a 625 b.p. hike in the 39. The above developments have compounded policy rate, which currently stands at 24 percent.29 Some into a complex economic situation with acute expressed concerns that the decision to raise interest policy trade-offs. The orthodox response to a large rates came late; moreover, credit rationing had already currency sell-off, capital outflows and market volatility started from August with sharply rising commercial as experienced by Turkey in recent months would be to lending rates. Nevertheless, the policy rate adjustment tighten monetary and fiscal policies to contain macro in September provided a boost to market confidence. imbalances and halt the currency slide. In most sudden 41. At the same time, the Central Bank had to stop episodes of recent years, policy makers in other respond to rising concerns over liquidity in the countries have opted for fiscal tightening but monetary financial sector. Those concerns stemmed firstly from easing to offset tighter external finances, and thereby the risks of deposit withdrawals triggered by concerns avert too sharp an economic correction.28 For those over the health of the banking system; between May countries, this also meant sharp currency depreciation and September, FX deposits declined from $195 (Figures 7, 8) and an eventual move to a more flexible billion to $170 billion, associated with debt repayment exchange rate. This was a viable policy mix in those rather than conversion into TRY deposits (Figure 73). countries given relatively low inflation and forex The second source of concern was the large FX debt liabilities at the onset of their sudden stop episodes. rollover needs of the banking sector, with nine banks 40. In Turkey, however, high inflation and forex requiring annual loan syndications by the end of 2018. liabilities together with a flexible exchange rate, The third source of concern was pressures on TRY called for Central Bank to tighten monetary policy. liquidity in the financial system. The loan to deposit A first round of tightening was implemented in June ratio for FX is around 95 percent, but for TRY it is close with a 300 b.p. hike in interest rates (Figure 72); this to 150 percent, requiring banks to use FX borrowing to followed a decision in May to improve the transparency finance TRY lending. of the monetary policy framework by reverting to Figure 72: Two episodes of monetary tightening Figure 73: Declining FX deposits Sources: Haver Analytics, CBRT Sources: CBRT, WB Staff estimates 28 Eichengreen, B, and Gupta P. “Managing Sudden Stops,” WBG Policy Research Working Paper (April 2016). 29 In August, the Central Bank implicitly tightened monetary policy following the sharp increase in FX volatility by temporarily reverting back to the O/N lending rate (19.25) instead of policy rate (17.75). 32 World Bank Group Figure 74: Liquidity boost to financial sector Figure 75: Aug-Sept spike in M3 expansion Sources: Haver Analytics, CBRT Sources: Haver Analytics, CBRT, WB Staff estimates 42. The authorities successfully implemented the same period last year (contraction in real terms), measures to relieve liquidity pressures, which with indirect tax collections slowing most sharply due on the other hand expanded broad money and to declining consumption and imports (Figure 78). contracted forex reserves. To provide FX liquidity, Subsidy to gasoline prices and temporary tax cuts on the Central Bank lowered the Reserve Options durable goods also contributed to the slowdown in Mechanism for FX reserves of domestic banks from revenue collection. 55 to 40 percent of banks’ total FX reserves with the CBRT, which as discussed earlier led to a drop in gross 44. Interest payments, wages and salaries and reserves. To relieve pressures on TRY deposits and public transfers have driven spending growth. the currency, the Banking Regulation and Supervision Central government interest costs peaked in July Agency (BRSA) in August restricted Turkish banks’ FX and August, and continue to rise faster than overall Swap transactions (i.e. where Turkish banks pay TRY spending (Figure 79). Personnel and current transfer and receive FX) with foreign banks to 25 percent of the costs are also growing with the hiring of contract Turkish banks’ equity. In addition, CBRT net funding workers early in the year, and one-off payments to for commercial banks rose sharply in September pensioners in June and August. Government lending is (Figure 74); this fueled broad money growth (Figure 75) expanding rapidly year-on-year, standing at 60 percent but not credit expansion as discussed earlier. higher than at the same point last year. Following a spike early in the year, capital expenditure has slowed, 43. Fiscal policy has been mildly expansionary while goods and services nominal spending is running in 2018 to date, with a moderate increase in the far below inflation, standing at just 3.2 percent. In May central government budget deficit from 1.5 percent this year, net cash outlays began falling below accrued of GDP last year to 1.9 percent in 2018 (Figure expenditure, indicating a build-up of obligations which 76, Figure 77). The primary surplus has narrowed are likely to adversely affect the budget position at some from 0.3 to 0.1 percent over the same period. Central point in the future. By October, this annual differential government revenue in the first ten months of the year had reached its highest level – Lira 8.5bn – since August increased 19 percent in nominal terms compared to 2016. 33 TEM, December 2018: Steadying the ship Figure 76: Moderate increase in budget deficit Figure 77: Driven by capex and revenue slowdown Changing in buldget balance - 2018 ytd on 2017 ytd Increase Decrease Total Figure 78: Slowdown in tax collections Figure 79: Sharp rise in lending and capex Increase Decrease Total Sources: Haver Analytics, CBRT, WB Staff estimates 45. Automatic stabilizers are to some extent could dent fiscal space. Central government debt helping to cushion the economic slowdown. Early outstanding as a ratio to GDP jumped up by nearly indications are that social insurance outlays will increase three percentage points in the third quarter of 2018, in late 2018 as more people have become eligible for driven the revaluation effects of FX-denominated debt. unemployment insurance and with unemployment At 31.4 percent or US$56bn equivalent, total central rising (from 9.7 percent in 2018 Q2 to 11.4 percent in government debt remains manageable. Contingent 2018 Q3). Unemployment insurance payouts30 increased liabilities include Treasury guaranteed debt at US$14bn from TRY 369.1 m in January 2018 to TL488.9 million (end June). There are other potential liabilities (e.g. in November. Unemployment insurance payments US$17bn of unguaranteed debt contracted by public are expected to rise further, particularly since the institutions, mostly public banks and US$15bn in debt government announced a loosening of eligibility criteria assumption guarantees for PPP projects), in addition in its 100-day action plan. to demand guarantees provided for the PPP projects. At this stage it is difficult to estimate how much or 46. Government debt levels remain manageable, whether any of these liabilities are likely to be realized although the realization of contingent liabilities, though they pose risks that warrant close monitoring. the full extent of which is difficult to estimate, 30 Unemployment Fund payments are not part of the central government expenses discussed above. 34 World Bank Group II. LOOKING AHEAD The economic outlook is subject to high levels of uncertainty than usual given domestic and external vulnerabilities. Growth is projected to slow to a 10-year low of 1.6 percent in 2019 followed by a gradual medium-term recovery. Private domestic demand is projected to drop sharply in 2019, offset in part by public consumption and external demand. Monetary tightening and commitments in the New Economic Program (NEP) signal important policy adjustment, though any uncertainty or inac- tion could tip the economy into a more difficult situation. The lack of progress on an orderly deleveraging in the private sector could precipitate this tipping point. The projected economic slowdown poses multiple challenges for households, with the impact of inflation on household purchasing power likely to be the most acute. The authorities’ New Economic Program provides a solid foundation to tackle Turkey’s economic challenges, though a bigger role for countercyclical fiscal policy will be needed than envisaged under the NEP. This should be complemented with tight monetary policy, a financial sector response that supports gradual deleveraging of the private sector and enhances financial risk monitoring and management in the banking sector. Crit- ical to supporting the deleveraging process is a strong corporate debt restructuring framework, the absence of which could spell the difference between an orderly adjustment for the economy and a hard landing. Downward correction to economic moderate from 7.4 percent in 2017 to 3.5 percent in 2018 and down to 1.6 percent in 2019 before recovering growth to 3 percent in 2020. This assumes policy adjustment 47. The economic outlook for Turkey is subject (tight monetary policy, countercyclical fiscal policy, to higher levels of uncertainty than usual. The partial corporate debt restructuring) and a moderately economic situation remains fragile given high supportive external environment to help tide the domestic and external vulnerabilities discussed economy through a difficult period. above. The economy’s ability to avert a deep recession 49. Private domestic demand is projected to drop depends in part on sound policies, as discussed further sharply in 2019, offset in part by public consumption below. Monetary tightening and commitments in the and external demand. Private consumption, which New Economic Program (NEP) signal important accounts for two thirds of GDP growth, will be weighed policy adjustment. There are however exogenous down by falling real wages and credit, and is projected factors, namely the pace of monetary tightening in the to contract over 3 quarters starting in 2018 Q4. The US and the EU, global trade uncertainty, the path of outlook for private investment is severely negative commodity prices, and investor sentiments towards linked to corporate stress and credit rationing. To EMDEs, that will substantially affect the outlook for prevent the economy tipping over into deeper recession, Turkey. Upcoming local elections in Turkey, scheduled public consumption growth is projected to accelerate for March 2019, add another element of ambiguity (see below), whilst a slowdown in growth will lead to a around policy direction. deceleration in revenue collections, a combination of which will yield a larger fiscal deficit. Net exports are 48. Growth is projected to slow to a 10-year low of projected to make a positive contribution to growth, 1.6 percent in 2019 followed by a gradual medium- driven by a sharp contraction in imports and continued term recovery (Figure 80). Growth is estimated to growth in both goods and services exports. 35 TEM, December 2018: Steadying the ship Figure 80: Sharp slowdown in 2019 Figure 81: Consensus forecast is negative for 2019 Sources: Haver Analytics, CBRT Sources: Haver Analytics, CBRT, WB Staff estimates 50. Most analysts project a sharper correction even a partial assessment at this stage is important to for 2019; with a consensus mean of -0.1 percent, understand the potential implications for countercyclical although forecasts range from 3 to -5 percent growth fiscal policy to support households. (Figure 81).31 While the investment projection for 2019 is in-line with the mean of consensus forecasts, a higher 52. The impacts of high and rising inflation in budget deficit is assumed and, partly arising from that, Turkey varies across different types of households. higher private consumption growth. Implemantation The poorest decile of households spends 36 percent of of NEP policy commitments will be important to avert their budget on food (Table 2). This is almost double more challenging economic conditions. The lack of the share of the average household in the country. progress on an orderly deleveraging in the private sector Therefore, food inflation, at close to 30 percent could precipitate this tipping point. In this alternative compared to a year ago, has a far greater negative scenario, the economy is projected to go into a deep incidence for the poor than the non-poor. In general, recession with economic contraction in 4 consecutive too, the poor consume a larger share of their income quarters, a sharp increase in the fiscal deficit, currency than the non-poor, i.e. they save much less, so inflation depreciation, and current account surplus. acts as a regressive tax and has a greater incidence for the poor. Inflation and slower growth will 53. Simulations show that the poverty rate is very substantially impact households sensitive to such price increases, although the net 51. The above outlook for the Turkish economy effect may be offset by nominal wage or income will impact households through various channels, growth. To simulate the effects of inflation on poverty including the effects of: (i) price inflation on in Turkey, the value of the poverty line is inflated by disposable incomes, particularly of poorer households; the inflation rate and, using the latest household survey (ii) financial tightening on household debt; (iii) slower data on household per capita expenditure, different economic growth on employment and wages; and (iv) poverty indicators are calculated. The World Bank uses slower growth on poverty levels. The TEM tries to the Upper-Middle-Income Country (UMIC) poverty assess below the impact of each transmission channel, line to measure poverty in Turkey (320 TL per capita though in reality the net effect on households will be per month in 2017 prices), which leads to a baseline a combination of all these channels.32 Nevertheless, headcount poverty rate of 9.3 percent. 31 Consensus Economics Inc., November 2018. 32 Though each transmission channel has been looked at separately (partial equilibrium), in practice the net effect on households will be some combination of all these factors. 36 World Bank Group Table 2: Expenditure shares by decile of per capita expenditure distribution Overall D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 Food and non-alc. beverages 19.6 35.8 32.0 28.9 26.7 25.1 23.8 22.8 21.0 18.3 11.7 Alcoholic beverages and tobacco 4.4 6.1 6.9 6.8 6.7 6.0 5.9 5.4 4.6 4.0 2.6 Clothing and footwear 5.2 5.4 5.2 5.0 4.9 4.9 4.9 5.1 5.4 5.7 5.0 Housing and Utilities 25.3 29.0 28.5 29.8 29.2 29.9 28.1 27.4 25.5 25.2 21.1 Furnish, hh equipment, hh maint. 6.2 4.0 4.9 5.3 5.7 5.7 5.9 6.2 6.6 6.5 6.7 Health 2.0 1.5 1.7 1.6 1.5 1.6 1.5 1.8 2.0 2.1 2.3 Transport 17.9 6.6 7.8 8.3 9.6 11.0 12.9 14.3 16.0 17.8 27.0 Communications 3.7 2.7 3.1 3.0 3.9 3.9 4.1 4.2 4.0 4.0 3.3 Recreation and culture 2.8 1.1 1.2 1.5 1.6 1.7 2.2 2.0 2.6 3.1 4.0 Education 2.2 0.4 0.6 0.6 0.9 1.2 1.4 1.5 2.2 2.6 3.4 Hotels, cafes and restaurants 6.4 3.9 5.1 6.1 5.8 5.7 6.2 6.0 6.0 6.5 7.2 Miscellaneous goods and services 4.2 3.4 3.1 3.0 3.5 3.2 3.2 3.4 3.9 4.2 5.6 Source: World Bank Staff estimates using Household Budget Survey 2016 54. A simulation of possible impacts of inflation will be less than this estimate. Conversely, if there are shows that there would be severe effects on poverty significant job losses, household incomes will fall and in Turkey of this sharp increase in prices (Table 3). the net effect may be greater. Table 3 also presents A price increase of 24.52 percent (as of September smaller simulated price shocks to proxy for these net 2018)33, without any compensating increase in incomes effects. Even the most moderate of these still show or any substitution effects, would increase the poverty large poverty impacts. headcount from 9.3 percent to 15.4 percent, and the number of people in poverty would increase by 55. Household debt is low and well-insulated from 5.1 million. But this simulation models inflation as a external and monetary shocks in the short-term. ‘shock’ to the poverty line while maintaining income Household debt and net financial equity is not expected and expenditure patterns constant. In practice, the to be a significant stress factor for most households. impact will depend on changes in income and wages Household debt has been declining in relative terms as well. If wages increase, the net effect on poverty for the last five years (Figure 82). Household debt as a Table 3: Simulated poverty impacts of inflation Poverty Line (per capita per month) Poverty headcount Poverty gap (%) Poverty severity Number of Poor and simulated increases ratio (%) (million) 320 TL 9.3 2.5 0.9 7.6 320+5% = 336 TL 10.3 2.6 1 8.5 320+10% = 352 TL 11.5 3 1.2 9.5 320+15%= 368 TL 12.9 3.4 1.3 10.6 320+20%= 384 TL 14.1 3.8 1.5 11.6 320+24.52% =398 TL 15.4 4.2 1.7 12.7 Source: World Bank Staff estimates using Household Budget Survey 2016 33 The scenarios are prepared based on the latest available data in November 2018. 37 TEM, December 2018: Steadying the ship Figure 82: Household debt low and falling Figure 83: Household deposits rising faster than loans Source: CBRT proportion of GDP stands at 14 percent, while average 2019 and government employment support programs household debt per capita is just over TRY 5,000. At may help to stem the decline in real wages but overall the same time, household deposits in the domestic the outlook suggests that both wages and employment banking system have been rising relatively rapidly. Most will be depressed, and unemployment is expected household assets in Turkey (around two-thirds) are held to rise over the next three years based on estimated in deposits. The loan-to-deposit ratio for the household employment elasticities and sectoral growth forecasts sector is also low, and has fallen further, from 0.23 at (Figure 84). Under baseline assumptions, employment the beginning of 2014 to 0.20 in 2018 to date (Figure growth is expected to fall sharply in 2018 and remain at 83). only around 1 percent in that year and each of the next two years, much lower than recent years’ employment 56. As noted earlier, there has been a broad-based growth. Over this period, positive employment growth decline in real wages with the construction sector is almost entirely driven by the service sector, which is being the worst hit. Minimum wage adjustment in early estimated to be more resilient over the next two years Figure 84: Unemployment projected to rise Figure 85: Most employment growth in services Sources: TUIK and WB Staff estimates 38 World Bank Group Figure 86: Growth-led poverty reduction is expected to slow in the baseline Sources: TUIK and WB Staff estimates than agriculture and industry (Figure 85). Assuming a A good foundation in the New constant labor force participation rate, this would imply that the unemployment rate will grow steadily over the Economic Program forecast period, reaching 12.3 percent by 2020. 59. The authorities’ New Economic Program released on September 20 sets out a Medium-Term 57. Poverty has been significantly reduced in Fiscal Policy Statement to restore internal and Turkey in the last 15 years. The poverty headcount external macro balances. It is the clearest statement rate has decreased from 36.5 percent in 2003 to as on recent macro-financial challenges in Turkey and the estimated 9.3 percent in 2017. This poverty-reduction government’s proposed policy response. The NEP’s progress has been largely driven by economic growth. headline growth projections are at the upper end of the With Turkey’s economy now facing downside risks, range of forecasts, though also the most conservative slowing growth could have significant impacts on ever presented in an NEP/Medium-Term Program. poverty. The elasticity of poverty with respect to GDP The NEP projects the largest and most sustained in Turkey is estimated to be -1.2. These forecasts negative output gap for Turkey in at least ten years are based on the effect on poverty of GDP growth (Figure 87). only, and do not capture price effects and erosion of household purchasing power discussed in section one. 60. That said, the demand side drivers of medium-term projections in the NEP assume that 58. Growth-led poverty reduction is expected much of the adjustment to growth is likely to come to slow and there is a risk of higher poverty if from the public sector. However, a bigger drop off downside risks materialize. The projected trajectory in private consumption and investment than projected of the poverty headcount ratio is shown in Figure 87. is highly likely (Figure 88). A sharper than projected Poverty is expected to fall from 2017 to 2020 under slowdown in private demand would need to be offset central assumptions, but the rate of poverty reduction is by less ambitious fiscal consolidation projected in the much slower than in the recent past. It is also important NEP (see below). This may require frontloading of to note that this is solely based on impacts of GDP very targeted interventions to enable households to on poverty and does not include price-induced welfare tide over difficult times, and assuming some contingent erosion. The next 3 months will be crucial to resolve liabilities should there be a deeper shock to companies some of these uncertainties and achieve a clearer picture and banks. in terms of poverty reduction for the near future. 39 TEM, December 2018: Steadying the ship Figure 87: NEP projects negative output gap over Figure 88: NEP assumes adjustment in public medium-term consumption and investment Sources: NEP, TURKSTAT, WB Staff estimates 61. This is particularly important as a big points of GDP projected decline on average in 2019- challenge for policy makers in 2019 is the 2021 relative to the 2011-2016 annual average) (Table prospect of stagflation – a combination of high 4). The decline in revenue could likely be even sharper unemployment and high inflation. Whilst inflation when taking account of historical trends in revenue calls for fiscal tightening, rising unemployment and buoyancy (Figure 89). Though the NEP discusses falling demand calls for countercyclical fiscal policy. potential revenue reforms, these may prove overly The challenge is exacerbated by reduced revenue ambitious during a downturn. collection due to economic slowdown (2.2 percentage Figure 89: Projected recovery in tax revenue is ambitious Sources: NEP, Haver Analytics, WB Staff estimates 40 World Bank Group Table 4: NEP fiscal consolidation 2011-2016 2017-2018 2019-2021 Reference period Change from reference period (% of GDP) (percentage points) Revenue 33.7 -0.9 -2.2 Tax 18.2 -0.7 -0.5 Non-Tax 1.8 -0.1 -0.4 Factor incomes 4.9 -0.3 -0.9 Social Funds 8.8 0.1 -0.4 Expenditure 34.8 0.2 -1.4 Recurrent 31.5 -0.2 -0.4 Primary expenditure 28.8 0.5 -0.7 Interest expenditure 2.7 -0.6 0.3 Capital expenditure 3.4 0.3 -1.1 Overall balance -1.1 -1.1 -0.8 Primary balance 1.6 -1.7 -0.5 Recurrent balance 2.2 -0.7 -1.9 Memo items (annual change %) GDP growth 6.5 -0.9 -3.1 Inflation 8.3 8.1 2.3 Unemployment 10.4 0.7 1.2 Sources: NEP, WB Staff estimates - Note: General Government data 62. The authorities have accordingly adopted Consistent and credible package of a strong path for expenditure consolidation to set fiscal policy as an anchor for stabilization. reforms to ensure orderly adjustment The biggest consolidation is in capital spending (-1.1 64. Building on the NEP, a consistent package percentage points of GDP projected on average in of economic policies could ensure an orderly 2019-2021 relative to 2011-2016 annual average). But the adjustment for the Turkish economy. This would biggest driver is non-transfer related recurrent spending include tight monetary policy to close internal and – namely items such as wages and salaries, goods and external imbalances, complemented by a financial services. The projected changes in public transfers seem sector response that supports gradual deleveraging and in line with the projected changes in unemployment. enhances financial risk monitoring and management. The NEP envisages growing transfers both in 2019 and Critical to supporting the deleveraging process is a 2020, in line with changes in unemployment. Though as strong corporate debt restructuring framework, the noted above, projected unemployment is conservative, absence of which could spell the difference between an including given the projected drop in private demand. orderly adjustment for the economy and a hard landing. Fiscal adjustment will be necessary to help the economy 63. The marginal impact of transfers on growth tide over the difficult period ahead. could be relatively strong as we would assume a stronger fiscal multiplier than in 2017. The 65. Recent monetary tightening through interest estimated multiplier is between 0.9 and 1.3 assuming rate hikes are helping to gradually restore price low trade openness, low public debt, high labor market stability, exchange rate stability, and rebuilding rigidity, and most importantly a negative output gap. external buffers and should be maintained while Nevertheless, higher unemployment would also require inflation expectations remain elevated. Sustaining higher transfer expenditures and less consolidation. 41 TEM, December 2018: Steadying the ship the monetary policy framework rationalized in May 2018, containing risks in the financial sector, including including adoption of a central policy rate, is important those transmitted through volatile capital inflows. for monetary policy transparency. Operational and Demand shocks in recent years, however, led to some policy independence of the Central Bank is essential loosening of macroprudential regulations in 2016. for basing policy adjustments on strong economic Though this contributed to countercyclical finance, the judgement. This together with a credible inflation target policy mix should now be revisited. Macroprudential supported by a transparent and predictable adjustment instruments are central to the effectiveness of to policy rates, could help anchor inflation expectations. monetary policy targets.36 Macroprudential measures Premature loosening of monetary policy while inflation should be focused on financial stability (countercyclical and inflation expectations are elevated could lead to an buffers, mitigating systemic risks, liquidity). This means upward wage-price spiral. unwinding short-term relaxation of macroprudential policies aimed at accelerating consumption or expanding 66. Credit to the private sector has started to sector investments. adjust down very significantly. Evidence from past financial crises that were preceded by credit booms, as 69. Credible tightening of monetary policy, with in the case of Turkey, suggests that credit plays little consistent financial sector and macro-prudential role in supporting economic recovery after growth policies, will require careful adjustment to fiscal has bottomed out.34 Therefore, efforts to curtail policy. In the short-term, to ensure that tighter deleveraging (e.g. through credit guarantees, loosening financing does not lead to a sudden stop, supply side macroprudential regulations) are likely to be counter- subsidies (e.g. minimum wage support, tax relief) need productive. The focus should be on analyzing the to be withdrawn gradually (which is important too for impact of current conditions (i.e. weak Lira, economic longer-term productivity). There may also be scope to downturn, credit crunch) on banks’ credit risk, liquidity, adjust other inefficient expenditure to ease pressures on and capital. This would help target interventions, the supply side of the economy; this requires deeper including potential resolution of problem banks. analysis of public expenditures as proposed in the New Economic Program 2019-2021. 67. This analysis of the banking sector should provide details on the links between the financial 70. In general, fiscal policy will need to play system and corporate debt distress. This would an important countercyclical role, particularly provide the basis for a corporate debt resolution through public transfers given the projected decline framework. The Concordat system adopted earlier this in demand and rise in unemployment. Currently, year enables companies to negotiate debt restructuring Turkey’s social assistance spending is at 1.5 percent of through the courts with all creditors. The authorities GDP, while the average OECD country spends almost are also exploring out of court options like the Istanbul twice as much. Turkey’s social assistance programs Approach adopted in 2001, and there has been talk perform relatively well in terms of targeting the poor of setting up an Asset Management Company to and vulnerable households. In contrast, benefit levels (temporarily) absorb troubled assets. Whatever the as a share of household expenditure are significantly mechanism, corporate debt resolution is central to an lower than peer countries and are not adjusted for orderly adjustment; it can help provide much needed inflation. As a result, even though targeting performs breathing space for both corporates and banks, well, low adequacy yields a rather limited impact of without which there are heightened risks of corporate social assistance on reducing poverty headcount and insolvency, rapid deterioration of banks’ asset quality, poverty gap. debt overhang, and potential government bailout. 71. The counter-cyclical response needs to be 68. These processes can help further enhance short-term, finite and targeted to soften the impact Turkey’s already extensive macroprudential on the worst-affected. The authorities have already toolkit,35 which has played an important role in committed to a loosening of unemployment support 34 Takats, E. and Upper, C (July 2013) “Credit and growth after financial crises,” BIS Working Papers (No. 416). 35 Kara, H. (2016): “A brief assessment of Turkey’s macroprudential policy approach: 2011-2015”, Central Bank Review 16 (2016). 36 Chadwick, M.G. (2018): “Effectiveness of monetary and macroprudential shocks on consumer credit growth and volatility in Turkey,” Central Bank Review. 42 World Bank Group Figure 90: Turkey lags most on labor markets, Figure 91: Gaps between Turkey and EU average innovation, financial sector, human capital greatest for human capital and labor market Sources: : Economic Freedom Index (2018), OECD Product Market Regulations Sources: : Economic Freedom Index (2018), OECD Product Market Regulations (2013), World Bank Doing Business (2018), Global Competitiveness Index (2018) (2013), World Bank Doing Business (2018), Global Competitiveness Index (2018), Notes: Z scores derived for sub-indicators by survey, then grouped according to 8 Penn World Tables categories (labor market, innovation, financial sector, human capital, infrastructure, Notes: Indexes and rankings across the above indicators were normalized for EU and institutions and contracts, openness and trade, business regulations). Results are Turkey between 0 (bottom EU performer) and 1 (top EU performer). The size of averages of Z scores of sub-indicators under each category. each bar shows the gap between Turkey and the EU average. eligibility which is expected to substantially increase including through property tax and rationalization of coverage of those made unemployed from formal tax incentives, which can have positive impacts on employment. The expected uprating of the national domestic savings and labor formality; (ii) containing minimum wage, broadly in line with consumer price recurrent spending growth, and a slight rebalancing inflation, early next year should also help to relieve towards good quality public investments. hardship for working families. However, elevated levels of external and private sector debt, possible 73. The New Economic Program also highlights recapitalization needs of the banking sector and important structural reforms that are critical to other contractual government commitments have the productivity in the economy. One way of prioritizing potential to rapidly erode fiscal space, so measures need across the different areas is to look at Turkey’s to take these into account. biggest competitiveness gaps relative to countries that transitioned quickly out of Upper Middle Income 72. In addition to short-term fiscal measures, it is (UMIC) status (high performers), and others that have also important to maintain momentum medium- remained in the UMIC category for a more extended term fiscal policy reforms, some of which are period (trapped MICs).38 Based on this, Turkey’s highlighted in the New Economic Program biggest competitiveness gaps relative to high performer (2018-2021) that are critical to productivity in the comparators are in the areas of labor markets, economy. These could include among other things:37 (i) innovation, financial sector, and human capital (Figure a rebalancing of tax burden from labor towards capital, 90). Turkey even trails Trapped MICs in these policy 37 WB (May 20, 2014), “Turkey Public Finance Review: Time for a Fiscal Policy Pivot?”. 38 “High performer” countries include a sample that recently graduated from Upper Middle Income to High Income in less than 20 years: Chile; Czech Republic; Korea, Rep; Poland. The other, referred to as “trapped MICs,” includes countries that have remained in the Upper Middle Income category for more than 20 years: Argentina; Brazil; Malaysia; Mexico; and South Africa. The time series data on transition across income categories is based on World Bank data on per capita GNI and Felipe et. al (2012). 43 TEM, December 2018: Steadying the ship and institutional areas. Across all areas, high performer predictable, credible and transparent policy framework comparators do better than Turkey, with the slight is essential for market stability. This would provide a exception of openness to trade where Turkey performs clearer indication of how the authorities plan to manage better. Relative to the EU average, Turkey trails most a soft landing. This means protecting the integrity of on human capital, labor market efficiency and business macroeconomic institutions and policy anchors, which regulations (Figure 91). The financial sector indicator in Turkey has significantly strengthened over the past the EU assessment measures the narrower dimension decade and a half.39 Key among those institutions of credit market rigidity where the gap is not very and policy anchors are an independent Central Bank; significant. monetary policy framework based on inflation targeting; 74. Clear communication of such a package of strong bank supervision; transparency of public economic policies is central to avoiding a short- finances; a medium-term expenditure framework; and term challenge becoming a longer-term problem. A sound public debt management. 39 See IMF, “Structural Reforms and Macroeconomic Performance – Country Cases,” (November 2015); and WBG, “Turkey’s Transitions: Integration, Inclusion, Institutions,” (December 2014). 44 World Bank Group Appendix: Corporate financial distress and the Altman Z-score The Altman’s Z-Score method was developed by Edward Altman to predict the financial failure of companies and is extensively used to measure the financial distress of corporates by employing several corporate income and balance sheet indicators (Altman, 1968). It is a multivariate formula used to measure the financial health of a corporate and the likelihood that it will enter bankruptcy in the next two years. Although the Z-score methodology was improved over time (Altman 1978, 2000) and Altman et. al (2014)), the original model (Altman 1968) is the one that has been most extensively used in the literature (Yilmaz and Colak, 2017). The original model was found to be approximately 80-90 percent accurate in predicting the financial stress for the US corporates. The original Z-score formula is the weighted sum of five key financial ratios: Z-score = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 X1 = working capital / total assets (liquidity indicator) X2 = retained earnings / total assets (profitability indicator) X3 = earnings before interest and taxes / total assets (operating efficiency indicator) X4 = market value of equity / book value of total liabilities (market indicator) X5 = sales / total assets (asset turnover) Z= Overall Index The lower the score, the more likely the corporate is to declare bankruptcy. The coefficients and thresholds are determined based on listed corporate in New York Stock Exchange. Threshold for Altman Z-score Score Zones Z > 2.99 “Safe” Zone 1.81 < Z < 2.99 “Grey” Zone Z < 1.81 “Distress” Zone There are several studies applying the Z-score methodology for listed corporates in Turkey (Zeytinoglu and Akarim 2013, Muzir and Caglar 2009, Okay 2015). The predictive power of these models is found to be 80 percent or less. A recent research working paper by the Central Bank (Yilmaz and Colak, 2017) employs the original Altman Z-score model for listed corporates in Turkey and makes the performance testing of the Z-score with original coefficients and critical values. According to their findings, the Z-score performs well with accuracy of 70 percent when it comes to predicting financial stress in the coming period. Yilmaz and Colak (2017) argue that there is not a significant difference between the performance of the model estimated using the original Altman model coefficients and the performance of models using coefficients based on Turkish corporate data in previous studies. Based on this assessment, the TEM uses the original Altman model in assessing the financial stress of non- financial corporates listed in Turkey. 45 TEM, December 2018: Steadying the ship Annex 1: Medium-Term Outlook Key Macroeconomic Indicators 2015 2016 2017 2018 2019 2020 Population (mid-year, million) 78.2 79.3 80.3 81.3 82.4 83.4 GDP (current US$, billion) 861.9 862.7 851.5 771.8 746.9 746.0 GDP per capita (current US$) 11019 10883 10602 9488 9067 8945 Upper middle-income Poverty Rate 11.5 9.9 9.1 8.9 8.8 8.6 (US$5.5 in 2011 PPP) CPI (annual average, in percent) 7.7 7.8 11.1 16.3 19.0 11.0 Real Economy TL Billion, unless otherwise indicated Real GDP 1527.7 1576.4 1693.7 1753.8 1781.2 1834.2 Private Consumption 930.7 964.8 1023.7 1054.8 1067.9 1096.7 Government Consumption 200.4 219.5 230.5 244.1 257.9 263.7 Gross Fixed Capital Formation 455.5 465.8 502.1 486.7 459.5 471.7 Net Exports -14.2 -33.9 -31.9 24.2 52.0 58.2 Fiscal Accounts TL Billion, unless otherwise indicated Total Revenues 799.2 904.3 1028.2 1219.4 1435.4 1653.6 Total Expenditures 801.5 940.5 1085.5 1334.3 1618.3 1801.2 General Government Balance -2.3 -36.2 -57.3 -114.8 -182.8 -147.6 Government Debt Stock 646.5 738.5 877.9 1116.3 1432.9 1671.8 Primary Balance 52.6 16.6 3.0 -29.2 -56.4 26.6 Monetary Policy TL Billion, unless otherwise indicated Broad Money (M3) 1232.3 1451.8 1686.4 - - - Credit Growth (FX-adjusted, eop, y-o-y) 11.8 10.9 20.3 - - - Average Funding Rate (annual average, in percent) 8.4 8.4 11.5 - - - Gross Reserves (in US$ Billion) 110.5 106.1 107.6 - - - o/w Gold Reserves 17.6 14.1 23.5 - - - o/w Net Reserves 28.3 34.1 36.1 - - - External Sector US$ Billion, unless otherwise indicated Current Account balance -32.1 -33.1 -47.4 -25.4 -21.8 -28.8 Trade Balance -23.9 -25.6 -39.0 -17.5 -14.1 -21.5 Exports 152.0 150.1 166.2 176.9 186.4 193.0 Imports 200.1 191.1 225.1 218.4 220.5 228.9 Net Foreign Direct Investment 12.9 10.2 8.2 6.9 6.7 7.5 Sources: TURKSTAT, CBRT, Strategy and Budget Office, WB Staff Calculations 46 World Bank Group Annex 2: Medium-Term Outlook Key Macroeconomic Indicators   2015 2016 2017 2018 2019 2020 Real Economy Annual percentage change, unless otherwise indicated Real GDP 6.1 3.2 7.4 3.5 1.6 3.0 Private Consumption 5.4 3.7 6.1 3.0 1.2 2.7 Government Consumption 3.9 9.5 5.0 5.9 5.6 2.3 Gross Fixed Capital Formation 9.3 2.2 7.8 -3.1 -5.6 2.6 Exports 4.3 -1.9 11.9 7.8 8.0 6.0 Imports 1.7 3.7 10.3 -6.6 1.2 5.2 Fiscal Accounts Percent of GDP, unless otherwise indicated Total Revenues 34.2 34.7 33.1 32.6 32.2 32.6 Total Expenditures 34.3 36.1 34.9 35.6 36.3 35.5 General Government Balance -0.1 -1.4 -1.8 -3.1 -4.1 -2.9 Government Debt Stock 27.6 28.3 28.3 29.8 32.1 33.0 Primary Balance 2.2 0.6 0.1 -0.8 -1.3 0.5 Monetary Policy Percent of GDP, unless otherwise indicated CPI (annual average, in percent) 7.7 7.8 11.1 16.3 19.0 11.0 Broad Money (M3) 52.7 55.7 54.3 - - - Gross Reserves 12.9 12.3 12.7 - - - In months of merchandise imports c.i.f. 6.4 6.4 5.5 - - - Percent of short-term external debt 104.9 104.6 91.4 - - - External Sector Percent of GDP, unless otherwise indicated Current Account balance -3.7 -3.8 -5.6 -3.3 -2.9 -3.9 Trade Balance -2.8 -3.0 -4.6 -2.3 -1.9 -2.9 Exports 17.7 17.4 19.5 22.9 25.0 25.9 Imports 23.3 22.1 26.4 28.3 29.5 30.7 Net Foreign Direct Investment 1.5 1.2 1.0 0.9 0.9 1.0 Sources: TURKSTAT, CBRT, Strategy and Budget Office, WB Staff Calculations 47 TEM, December 2018: Steadying the ship Annex 3: Gross Domestic Product Gross Domestic Product: Production Approach   2013 2014 2015 2016 2017 GDP (current, TL billion) 1809.7 2044.5 2338.6 2608.5 3106.5 Agriculture 121.7 134.7 161.4 161.3 189.0 Industry 355.3 410.8 462.0 511.8 639.8 Construction 145.9 165.7 190.6 223.4 266.0 Services 962.4 1097.0 1246.7 1402.4 1657.8 GDP (constant prices, TL billion) 1369.3 1440.1 1527.7 1576.4 1693.7 Agriculture 94.6 95.2 104.1 101.4 106.3 Industry 268.9 284.0 298.4 311.0 339.4 Construction 101.3 106.4 111.6 117.6 128.2 Services 743.4 790.4 834.8 861.2 926.6 Real GDP Growth (%) 8.5 5.2 6.1 3.2 7.4 Agriculture 2.3 0.6 9.4 -2.6 4.9 Industry 9.0 5.6 5.1 4.2 9.1 Construction 14.0 5.0 4.9 5.4 9.0 Services 7.7 6.3 5.6 3.2 7.6 GDP (constant prices, % share) Agriculture 6.9 6.6 6.8 6.4 6.3 Industry 19.6 19.7 19.5 19.7 20.0 Construction 7.4 7.4 7.3 7.5 7.6 Services 54.3 54.9 54.6 54.6 54.7 Sources: TURKSTAT, WB Staff Calculations 48 World Bank Group Annex 4: Gross Domestic Product Gross Domestic Product: Expenditure Approach   2013 2014 2015 2016 2017 GDP (current, TL billion) 1809.7 2044.5 2338.6 2608.5 3106.5 Private Consumption 1120.4 1242.2 1411.8 1560.5 1834.2 Government Consumption 255.6 288.1 324.6 387.0 450.5 Gross Fixed Capital Formation 516.2 590.7 694.8 764.7 931.9 o/w Construction 291.4 338.4 380.2 424.5 535.3 o/w Machinery and Equipment 182.3 206.4 263.1 283.9 327.0 Net Exports -105.1 -79.4 -61.0 -75.3 -140.2 Change in Inventories 22.6 2.8 -31.5 -28.4 30.2 GDP (constant prices, TL billion) 1369.3 1440.1 1527.7 1576.4 1693.7 Private Consumption 857.2 882.8 930.7 964.8 1023.7 Government Consumption 187.0 192.8 200.4 219.5 230.5 Gross Fixed Capital Formation 396.6 416.8 455.5 465.8 502.1 o/w Construction 217.1 231.2 242.1 248.8 279.2 o/w Machinery and Equipment 148.2 153.9 182.4 184.5 186.0 Net Exports -48.1 -22.3 -14.2 -33.9 -31.9 Change in Inventories -23.4 -30.1 -44.7 -39.8 -30.7 Real GDP Growth (%) 8.5 5.2 6.1 3.2 7.4 Private Consumption 7.9 3.0 5.4 3.7 6.1 Government Consumption 8.0 3.1 3.9 9.5 5.0 Gross Fixed Capital Formation 13.8 5.1 9.3 2.2 7.8 o/w Construction 21.1 6.5 4.7 2.8 12.2 o/w Machinery and Equipment 8.1 3.9 18.5 1.2 0.8 Exports 1.1 8.2 4.3 -1.9 11.9 Imports 8.0 -0.4 1.7 3.7 10.3 Change in Inventories -18.5 28.8 48.4 -11.0 -22.9 GDP (constant prices, % share) Private Consumption 62.6 61.3 60.9 61.2 60.4 Government Consumption 13.7 13.4 13.1 13.9 13.6 Gross Fixed Capital Formation 29.0 28.9 29.8 29.5 29.6 o/w Construction 15.9 16.1 15.8 15.8 16.5 o/w Machinery and Equipment 10.8 10.7 11.9 11.7 11.0 Exports 22.1 22.7 22.3 21.2 22.1 Imports 25.6 24.2 23.2 23.4 24.0 Change in Inventories -1.7 -2.1 -2.9 -2.5 -1.8 Sources: TURKSTAT, WB Staff Calculations 49 TEM, December 2018: Steadying the ship Annex 5: Prices Consumer and Producer Prices: End of period y-o-y, percentage change   2013 2014 2015 2016 2017 CPI (All items) 7.4 8.2 8.8 8.5 11.9 CPI (Food and non-alc. Beverages) 9.7 12.7 10.9 5.7 13.8 CPI (Core C) 7.1 8.7 9.5 7.5 12.3 Alcoholic beverages, tobacco 10.5 7.7 5.7 31.6 2.9 Clothing and footwear 4.9 8.4 9.0 4.0 11.5 Housing & Energy 4.8 6.8 6.7 6.4 9.6 Furnishings 9.7 7.7 11.0 7.9 10.6 Health 4.8 8.6 7.2 9.7 11.9 Transport 9.8 2.1 6.4 12.4 18.2 Communication 1.2 1.6 3.6 3.2 1.4 Recreation and culture 5.2 5.7 11.6 5.9 8.4 Education 10.1 8.3 6.4 9.5 10.5 Restaurants and Hotels 9.9 14.0 13.2 8.6 11.5 Miscellaneous goods and services 2.2 9.7 11.0 11.1 12.8 PPI (All items) 7.0 6.4 5.7 9.9 15.5 Consumer and Producer Prices: Annual average, percentage change 2013 2014 2015 2016 2017 CPI (All items) 7.5 8.9 7.7 7.8 11.1 CPI (Food and non-alc. Beverages) 9.1 12.6 11.1 5.8 12.7 CPI (Core C) 6.3 9.2 8.0 8.5 10.1 Alcoholic beverages, tobacco 15.2 4.1 4.5 18.1 15.4 Clothing and footwear 6.4 8.0 6.2 7.4 7.1 Housing & Energy 7.2 5.7 7.6 6.6 8.0 Furnishings 7.8 9.5 8.7 10.6 4.4 Health 2.7 8.4 7.3 9.6 12.4 Transport 6.8 9.8 1.5 7.4 16.8 Communication 5.1 1.0 3.1 2.8 2.7 Recreation and culture 2.5 7.3 9.0 7.1 9.8 Education 7.1 9.1 7.0 8.2 10.0 Restaurants and Hotels 9.3 13.3 13.5 10.2 10.3 Miscellaneous goods and services 4.9 7.2 10.1 11.3 12.3 PPI (All items) 4.5 10.2 5.3 4.3 15.8 Sources: TURKSTAT, WB Staff Calculations 50 World Bank Group Annex 6: Balance of Payments Balance of Payments Statistics   2013 2014 2015 2016 2017 2018-Sep   US$ Billion, unless otherwise indicated Current Account -63.6 -43.6 -32.1 -33.1 -47.4 -46.0 Trade Balance -56.3 -36.9 -23.9 -25.6 -39.0 -35.5 Exports 161.8 168.9 152.0 150.2 166.2 172.7 Imports 241.7 232.5 200.1 191.1 225.1 231.6 Services Balance 23.6 26.7 24.2 15.3 19.9 23.4 Primary Income Balance -8.6 -8.2 -9.7 -9.2 -11.1 -11.7 Secondary Income Balance 1.3 1.5 1.4 1.7 2.7 1.2 Capital Account -0.1 -0.1 0.0 0.0 0.0 0.1 Financial Account -63.0 -42.6 -22.4 -22.1 -46.7 -24.0 Direct Investment -9.9 -6.1 -12.9 -10.2 -8.2 -7.6 Portfolio Investment -24.0 -20.2 15.7 -6.3 -24.5 2.9 Other Investment -38.7 -15.9 -13.3 -6.5 -5.8 5.3 Net Errors & Omissions 1.0 1.1 9.8 11.0 0.7 22.0 Reserve Assets 9.9 -0.5 -11.8 0.8 -8.2 -24.6 Overall Balance 9.9 -0.5 -11.8 0.8 -8.2 -24.6 memo item: Energy Balance -49.2 -48.8 -33.3 -24.0 -32.9 -38.4 Gold Balance -11.8 -3.9 4.0 1.8 -10.0 -10.3   Percent of GDP, unless otherwise indicated Current Account -6.7 -4.7 -3.7 -3.8 -5.6 -5.6 Trade Balance -5.9 -4.0 -2.8 -3.0 -4.6 -4.3 Exports 17.0 18.1 17.6 17.4 19.5 21.0 Imports 25.4 24.9 23.2 22.1 26.4 28.1 Services Balance 2.5 2.9 2.8 1.8 2.3 2.8 Primary Income Balance -0.9 -0.9 -1.1 -1.1 -1.3 -1.4 Secondary Income Balance 0.1 0.2 0.2 0.2 0.3 0.1 Capital Account 0.0 0.0 0.0 0.0 0.0 0.0 Financial Account -6.6 -4.6 -2.6 -2.6 -5.5 -2.9 Direct Investment -1.0 -0.7 -1.5 -1.2 -1.0 -0.9 Portfolio Investment -2.5 -2.2 1.8 -0.7 -2.9 0.4 Other Investment -4.1 -1.7 -1.5 -0.8 -0.7 0.6 Net Errors & Omissions 0.1 0.1 1.1 1.3 0.1 2.7 Reserve Assets 1.0 -0.1 -1.4 0.1 -1.0 -3.0 Overall Balance 1.0 -0.1 -1.4 0.1 -1.0 -3.0 memo item:             Energy Balance -5.2 -5.2 -3.9 -2.8 -3.9 -4.7 Gold Balance -1.2 -0.4 0.5 0.2 -1.2 -1.3 Sources: TURKSTAT, WB Staff Calculations 51 TEM, December 2018: Steadying the ship Annex 7: Monetary Policy Monetary Survey   2013 2014 2015 2016 2017 2018-Sep Total Assets (TL Billion) 1228.4 1394.3 1627.4 1894.4 2224.6 2735.1 Net Foreign Assets -3.8 -41.5 -65.7 -42.4 -80.0 -96.3 Foreign Assets 364.6 385.8 443.6 561.8 631.2 1012.4 Monetary Authorities 283.5 299.4 326.7 380.3 417.1 525.5 Deposit Money Banks 75.2 80.3 107.3 167.4 201.2 459.5 Participation Banks 4.4 4.6 7.1 6.7 7.3 16.8 Investment & Development Banks 1.4 1.6 2.6 7.4 5.6 10.6 Foreign Liabilities 368.4 427.4 509.3 604.2 711.2 1108.7 Monetary Authorities 16.2 11.0 9.7 10.5 12.0 49.5 Deposit Money Banks 313.2 372.0 441.6 514.8 607.5 917.5 Participation Banks 17.8 18.4 20.0 22.2 22.4 30.7 Investment & Development Banks 21.3 26.1 38.0 56.7 69.3 111.1 Domestic Credits 1232.3 1435.8 1693.0 1936.8 2304.5 2831.4 Net Claims on Central Government 165.7 170.5 175.2 174.5 178.1 229.8 Claims on private sector 1023.2 1214.3 1456.3 1687.0 2025.9 2481.4 Total Liabilities 1228.4 1394.3 1627.4 1894.4 2224.6 2735.1 Money 165.9 185.5 217.1 270.1 297.4 322.2 Currency in Circulation 66.2 75.4 91.9 111.3 118.5 139.3 Demand Deposits 99.7 110.1 125.3 158.8 178.9 183.0 Quasi Money 826.3 923.5 1071.6 1245.5 1453.9 1837.9 Time and saving deposits 496.2 550.8 589.7 682.4 764.1 848.7 Residents’ foreign exchange deposits 289.4 328.5 439.2 517.6 631.4 932.2 Securities Issued 0.0 0.0 0.0 0.0 0.0 0.0 Restricted Deposits 0.0 0.0 0.0 0.0 0.0 0.0 Other Items (Net) 236.2 285.3 338.6 378.9 473.3 575.0 Source: CBRT 52 World Bank Group Annex 8: Monetary Policy Central Bank of Turkey Balance Sheet (TL Billion)   2013 2014 2015 2016 2017 2018-Oct CBRT Assets 265.9 281.9 293.2 345.4 396.2 430.4 Foreign Assets 283.5 299.4 326.7 381.0 436.8 487.3 Domestic Assets 4.6 5.3 -0.8 18.2 16.4 -3.3 Treasury Debt: Securities 8.9 9.2 9.0 13.9 14.5 13.8 Cash credits to Public Sector 8.9 9.1 8.9 13.8 14.4 13.7 Cash credits to Banking Sector 13.3 19.3 22.7 37.6 48.1 74.3 Credits to SDIF 0.0 0.0 0.0 0.0 0.0 0.0 Other Items -17.6 -23.1 -32.4 -33.1 -46.1 -91.4 FX Revaluation Account -22.2 -22.9 -32.7 -53.8 -57.0 -53.6 CBRT Liabilities 265.9 281.9 293.2 345.4 396.2 430.4 Total FX Liabilities 199.8 207.7 244.1 260.9 299.7 345.9 Foreign Liabilities 16.1 10.8 9.7 10.0 9.1 23.6 Domestic Liabilities 183.7 197.0 234.4 251.0 290.6 322.3 Central Bank Money 66.1 74.2 49.1 84.5 96.5 84.5 Reserve Money 91.2 107.2 122.3 168.0 174.1 203.2 Other Central Bank Money -25.1 -33.1 -73.3 -83.5 -77.6 -118.7 Source: CBRT 53 TEM, December 2018: Steadying the ship Annex 9: Fiscal Operations General Government Budget   2013 2014 2015 2016 2017 TL Billion, unless otherwise indicated Revenues 625.3 691.2 799.3 904.3 1028.2 Tax Revenues 334.4 361.9 418.7 470.4 549.8 o/w Indirect 231.1 243.7 285.7 315.1 367.2 o/w Direct 92.6 106.0 118.9 138.1 164.3 Non-Tax Revenues 29.5 38.9 42.8 46.3 47.8 Factor Incomes 90.8 99.4 112.7 129.6 144.8 Social Funds 158.0 178.9 212.9 248.4 280.7 Privatization Revenues 12.6 12.1 12.1 9.6 5.0 Expenditures 637.0 701.9 801.5 940.5 1085.5 Current Expenditures 281.6 314.6 357.6 426.5 480.1 Investment Expenditures 65.8 66.9 81.1 91.4 115.1 Transfer Expenditures 289.6 320.4 362.8 422.6 490.3 o/w Current Transfers 272.0 295.8 339.4 399.9 466.4 o/w Capital Transfers 17.6 24.6 23.4 22.7 23.9 Overall Balance -11.7 -10.6 -2.3 -36.2 -57.3 Interest Expenditures 51.7 51.7 54.9 52.7 60.3 Government Debt Stock 567.9 588.2 646.5 738.5 877.9 Primary Balance 40.0 41.1 52.6 16.6 3.0 Percent of GDP, unless otherwise indicated Revenues 33.9 33.8 34.2 34.3 32.9 Tax Revenues 18.5 17.7 17.9 18.0 17.7 o/w Indirect 12.8 11.9 12.2 12.1 11.8 o/w Direct 5.1 5.2 5.1 5.3 5.3 Non-Tax Revenues 1.6 1.9 1.8 1.8 1.5 Factor Incomes 5.0 4.9 4.8 5.0 4.7 Social Funds 8.7 8.8 9.1 9.5 9.0 Privatization Revenues 0.7 0.6 0.5 0.4 0.2 Expenditures 35.2 34.3 34.3 36.1 34.9 Current Expenditures 15.6 15.4 15.3 16.4 15.5 Investment Expenditures 3.6 3.3 3.5 3.5 3.7 Transfer Expenditures 16.0 15.7 15.5 16.2 15.8 o/w Current Transfers 15.0 14.5 14.5 15.3 15.0 o/w Capital Transfers 1.0 1.2 1.0 0.9 0.8 Overall Balance -0.6 -0.5 -0.1 -1.4 -1.8 Interest Expenditures 2.9 2.5 2.3 2.0 1.9 Government Debt Stock 31.4 28.8 27.6 28.3 28.3 Primary Balance 2.2 2.0 2.2 0.6 0.1 Sources: Strategy and Budget Office, Treasury and Finance Ministry, WB Staff Calculations 54 World Bank Group Annex 10: Banking Sector Balance Sheet Money and Banking Statistics of Financial Institutions   2013 2014 2015 2016 2017 2018-Sep Assets Billion TL, unless otherwise indicated Total assets 1708.0 1972.4 2338.3 2732.6 3263.0 4234.3 Net foreign assets -279.3 -342.1 -397.5 -433.2 -521.4 -643.7 Claims on nonresidents 81.2 86.7 117.3 182.2 214.9 488.4 Liabilities to nonresidents 360.4 428.8 514.8 615.4 736.3 1132.2 Claims on Central Bank 198.0 221.4 260.3 295.8 355.3 385.3 Currency 9.8 11.2 12.9 13.6 15.2 15.6 Reserve deposits and securities 188.2 210.2 247.3 282.2 339.7 369.7 Other claims 0.0 0.1 0.1 0.0 0.3 0.0 Net claims on central government 211.3 217.7 231.0 242.9 279.5 372.8 Claims on central government 249.0 261.6 287.8 307.1 353.8 450.9 Liabilities to central government 37.7 44.0 56.8 64.2 74.3 78.1 Claims on other sectors 1078.0 1276.9 1533.7 1790.7 2168.0 2696.2 Claims on other financial corporations 28.9 35.2 40.8 48.8 61.8 70.4 Claims on state & local governments 14.0 15.3 17.6 23.4 34.4 43.7 Claims on public nonfinancial corporations 0.9 0.9 3.7 3.8 5.5 8.2 Claims on private sector 1034.3 1225.5 1471.6 1714.7 2066.3 2573.9 Liabilities Billion TL, unless otherwise indicated Liabilities to Central Bank 50.8 65.6 112.9 106.8 99.2 166.7 Transfer deposits included in broad money 173.3 194.3 230.4 282.3 343.9 430.0 Other deposits included in broad money 687.5 761.0 881.7 1028.7 1184.3 1473.8 Securities other than shares included in broad 24.5 26.5 27.4 26.3 38.9 37.9 money Deposits excluded from broad money 0.0 0.0 0.0 0.0 0.0 0.0 Securities other than shares excluded from broad 1.3 2.5 1.2 1.5 2.3 1.6 money Loans 2.6 12.2 12.3 17.4 30.4 43.8 Financial derivatives 1.3 1.2 1.6 2.7 2.7 9.4 Insurance technical reserves 0.0 0.0 0.0 0.0 0.0 0.0 Shares & other equity 194.0 237.5 269.0 308.3 366.2 418.5 Other items (Net) 72.8 73.1 91.1 122.2 213.5 228.7 Sources: CBRT, BRSA, IFS 55 56 56 Annex 11: Banking Sector Ratios Selected Ratios for Banking Sector   2013 2014 2015 2016 2017 2018-Sep Liquidity Position in percent, unless otherwise indicated Liquidity Requirement Ratio 146.5 144.3 143.5 135.6 144.5 140.3 Loan-to-Deposit Ratio 107.4 113.9 117.2 117.4 121.3 125.0 Capital Adequacy in percent, unless otherwise indicated TEM, December 2018: Steadying the ship Core Capital Adequacy Ratio - 14.0 13.3 13.2 14.1 14.3 Capital Adequacy Standard Ratio 15.3 16.3 15.6 15.6 16.9 18.1 Total Risk Weighted Assets (Net) / Total Risk Weighted Assets (Gross) 69.6 68.8 68.6 43.3 64.4 64.8 Regulatory Capital / Total Risk Weighted Assets 15.3 16.3 15.6 15.6 16.9 18.1 Profitability in percent, unless otherwise indicated Profit (Loss) Before Tax / Average Total Assets 2.0 1.7 1.5 1.9 2.0 1.4 Net Income / Average Total Assets 1.6 1.3 1.2 1.5 1.6 1.1 Net Income / Average Shareholder’s Equity 14.2 12.3 11.3 14.3 15.9 11.6 Net Interest (Profit) Revenues (Expenses) / Average Total Assets 3.7 3.5 3.5 3.7 3.8 2.9 Asset Quality in percent, unless otherwise indicated Non-Performing Loans (Gross) / Total Cash Loans 2.7 2.8 3.1 3.2 2.9 3.2 Provision for Non-Performing Loans / Gross Non-Performing Loans 76.3 73.9 74.6 77.4 79.3 70.1 Credit Growth (FX-adjusted, eop, y-o-y) 29.6 15.4 11.7 10.8 20.1 6.5 Interest Rates (end-of-period) in percent, unless otherwise indicated Weighted average of Central Bank Cost of Funding 6.8 8.5 8.8 8.3 12.5 24.0 Weighted average Interest Rate for Deposits 8.0 9.5 11.0 9.6 12.8 24.0 Consumer Loans Rate 12.6 13.1 16.4 14.7 17.7 37.0 Commercial Loans Rate 10.6 11.1 15.7 14.3 17.1 35.9 Sources: CBRT, BRSA, IMF Annex 12: Doing Business Index (2019) Doing Business Indicators   UMC HIC Turkey Poland Argentina S. Africa Hungary Malaysia Global Rank 93 49 43 33 119 82 53 15 Starting a business Rank 101 63 78 121 128 134 82 122 Procedures - Men (number) 7 5 7 5 11 7 6 9 Time - Men (days) 26 11 7 37 11 40 7 13 Cost - Men (% of income per capita) 22 5 10.6 11.8 5.3 0.2 4.9 11.6 Procedures - Women (number) 7 6 7 5 11 7 6 10 Time - Women (days) 27 11 7 37 11 40 7 14 Cost - Women (% of income per capita) 22 5 10.6 11.8 5.3 0.2 4.9 11.6 Minimum capital (% of income per capita) 3 6 0 10 0 0 40.1 0 Dealing with construction permits Rank 89 64 59 40 174 96 110 3 Procedures (number) 15 14 18 12 21 20 22 11 Time (days) 153 162 103 153 341 155 193 54 Cost (% of Warehouse value) 3 2 3.9 0.3 2.9 2 0.8 1.4 Building quality control index (0-15) 10 11 13 10 11 12 13 13 Quality of building regulations index (0-2) 2 2 2 1 2 2 2 2 Quality control before construction index (0-1) 1 1 1 1 1 1 1 1 Quality control during construction index (0-3) 2 2 2 2 2 2 2 2 Quality control after construction index (0-3) 3 3 3 2 3 3 3 3 Liability and insurance regimes index (0-2) 1 1 1 2 1 0 1 1 Professional certifications index (0-4) 3 3 4 2 2 4 4 4 57 World Bank Group 57 58 58 Getting electricity Rank 91 52 60 58 103 109 122 4 Procedures (number) 5 5 4 4 6 5 5 3 Time (days) 84 72 55 122 92 109 257 24 Cost (% of income per capita) 705 81 389.5 17.3 21 156.7 82.6 26 Reliability of supply and transparency of 5 7 5 7 5 4 7 8 tariff index (0-8) Total duration and frequency of outages per 1 2 0 2 0 0 2 3 customer a year (0-3) TEM, December 2018: Steadying the ship System average interruption duration index (SAIDI) 22 19 22.4 1.3 3.7 44 2.1 0.7 System average interruption frequency index (SAIFI) 12 2 12.6 1.1 13.9 6.5 1.1 0.6 Minimum outage time (in minutes) 5 3 5 3 3 5 3 1 Mechanisms for monitoring outages (0-1) 1 1 1 1 1 1 1 1 Mechanisms for restoring service (0-1) 1 1 1 1 1 1 1 1 Regulatory monitoring (0-1) 1 1 1 1 1 1 1 1 Financial deterrents aimed at limiting outages (0-1) 0 1 1 1 1 0 1 1 Communication of tariffs and tariff changes (0-1) 1 1 1 1 1 1 1 1 Registering property Rank 94 61 39 41 119 106 30 29 Procedures (number) 6 5 6 6 7 7 4 6 Time (days) 32 37 5 33 51.5 23 17.5 11.5 Cost (% of property value) 6 4 4 0.3 6.6 7.8 5 3.5 Quality of land administration index (0-30) 15 21 23 19 13.5 15 26 27.5 Reliability of infrastructure index (0-8) 4 6 8 7 5 5 8 7 Transparency of information index (0-6) 3 3 4 2.5 2.5 3.5 3.5 5.5 Geographic coverage index (0-8) 2 5 4 4 2 2 8 8 Land dispute resolution index (0-8) 5 6 7 5.5 4 4.5 6.5 7 Equal access to property rights index (-2-0) 0 0 0 0 0 0 0 0 Getting credit Rank 86 73 32 32 85 73 32 32 Strength of legal rights index (0-12) 6 6 7 7 3 5 9 7 Depth of credit information index (0-8) 5 6 8 8 8 7 6 8 Credit registry coverage (% of adults) 22 22 77.7 0 45.7 0 0 63.3 Credit bureau coverage (% of adults) 34 57 0 98.1 100 67.3 91.2 86.6 Getting Credit total score 11 12 15 15 11 12 15 15 Protecting minority investors Rank 91 64 26 57 57 23 110 2 Extent of disclosure index (0-10) 6 6 9 7 7 8 2 10 Extent of director liability index (0-10) 5 6 5 2 2 8 4 9 Ease of shareholder suits index (0-10) 6 7 6 9 6 8 6 8 Extent of shareholder rights index (0-10) 6 6 8 6 8 8 6 8 Extent of ownership and control index (0-10) 4 5 7 5 7 7 5 6 Extent of corporate transparency index (0-10) 6 7 8 8 7 5 7 8 Extent of shareholder governance index (0-10) 5 6 7.7 6.3 7.3 6.7 6 7.3 Strength of minority investor protection index (0-10) 6 6 7 6 6 7 5 8 Paying taxes Rank 100 53 80 69 169 46 86 72 Payments (number per year) 21 14 10 7 9 7 11 8 Time (hours per year) 299 150 170 334 311.5 210 277 188 Total tax rate (% of profit) 39 38 40.9 40.7 106 29.1 40.3 39.2 Profit tax (% of profit) 17 14 18.1 14.5 3.9 21.8 9.1 21.8 Labor tax and contributions (% of profit) 16 19 20.3 25.2 29.3 4 29 16.4 Time to comply with corporate income tax audit (hours) 14 14 1.5 6 6 11 12 11.3 Time to complete a corporate income tax audit (weeks) 15 12 0 18.1 0 31.6 23 33.5 Post filing index (0-100) 56 74 50 77.4 47.9 60.3 63.9 52.7 59 World Bank Group 59 60 60 Trading across borders Rank 94 53 42 1 125 143 1 48 Trading across borders (score) 72 86 90.3 100 65.4 59.6 100 88.5 Time to export: Documentary compliance (score) 75 93 98.2 100 82.8 60.4 100 94.7 Time to import: Documentary compliance (score) 81 92 99.4 100 20.1 85.4 100 97.7 Time to export: Border compliance (score) 66 84 90.7 100 87.2 42.8 100 83.0 Time to import: Border compliance (score) 79 91 96.6 100 78.9 69.2 100 87.5 Cost to export: Documentary compliance (US$) 141 70 55 0 60 55 0 35 Cost to import: Documentary compliance (US$) 105 78 80 0 120 73 0 60 TEM, December 2018: Steadying the ship Cost to export: Border compliance (US$) 504 224 358 0 150 1257 0 213 Cost to import: Border compliance (US$) 470 278 46 0 1200 676 0 213 Enforcing contracts Rank 86 61 19 53 107 115 22 33 Time (days) 624 629 609 685 995 600 605 425 Filing and service (days) 43 36 30 60 90 30 60 35 Trial and judgment (days) 399 450 450 480 540 490 365 270 Enforcement of judgment (days) 183 142 129 145 365 80 180 120 Cost (% of claim) 30 22 24.9 19.4 22.5 33.2 15 37.9 Attorney fees (% of claim) 19 15 12 12 15 22.6 5 30 Court fees (% of claim) 6 5 3 5.4 6.5 7.6 8 1.7 Enforcement fees (% of claim) 5 3 9.9 2 1 3 2 6.2 Quality of the judicial processes index (score) 49 59 83.3 61.1 63.9 38.9 69.4 72.2 Quality of the judicial administration index (0-18) 9 11 15 11 11.5 7 12.5 13 Court structure and proceedings (0-5) 3 4 3.5 5 4.5 2 3 4 Case management (0-6) 2 3 5 1.5 4 2 4 4 Court automation (0-4) 1 2 4 1.5 1 0.5 2.5 2.5 Alternative dispute resolution (0-3) 2 2 2.5 3 2 2.5 3 2.5 Resolving insolvency Rank 99 50 109 25 104 66 65 41 Outcome (0 as piecemeal sale and 1 as going concern) 0 1 0 1 0 0 0 1 Time (years) 3 2 5 3 2.4 2 2 1 Cost (% of estate) 16 11 14.5 15 16.5 18 14.5 10 Recovery rate (cents on the dollar) 34 59 14.7 60.8 21.5 34.5 44.2 81.3 Strength of insolvency framework index (0-16) 8 10 10.5 14 9.5 11.5 10 7.5 Commencement of proceedings index (0-3) 2 3 3 3 2.5 3 2.5 3 Management of debtor’s assets index (0-6) 4 5 3 6 4 6 5 2 Creditor participation index (0-4) 2 2 3 2 1 2 2 2 Sources: WB, Doing Business 61 World Bank Group 61 62 62 Annex 13: Logistics Performance Index (2016) Logistics Performance Indicators   UMC HIC Turkey Poland Argentina S. Africa Hungary Malaysia Logistics performance index: Overall 2.7 3.6 3.4 3.4 3.0 3.8 3.4 3.4 Lead time to export, median case (days) 4.1 2.3 2.0 1.0 2.0 3.0 - 3.0 Lead time to import, median case (days) 3.7 2.7 2.0 1.0 4.0 3.0 - 7.0 Ability to track and trace consignments  2.7 3.6 3.4 3.5 3.3 3.9 3.4 3.5 TEM, December 2018: Steadying the ship Competence and quality of logistics services 2.7 3.5 3.3 3.4 2.8 3.7 3.4 3.3 Ease of arranging competitively priced shipments 2.7 3.5 3.4 3.4 2.8 3.6 3.4 3.5 Efficiency of customs clearance process  2.5 3.4 3.2 3.3 2.6 3.6 3.0 3.2 Frequency with which shipments reach consignee within 3.1 3.9 3.7 3.8 3.5 4.0 3.9 3.7 scheduled or expected time Quality of trade and transport-related infrastructure 2.6 3.6 3.5 3.2 2.9 3.8 3.5 3.4 Score, 1=low to 5=high Sources: WB, Logistics Performance Index Annex 14: Health Statistics (2016) Health Statistics Indicators   UMC HIC Turkey Poland Argentina S. Africa Hungary Malaysia Life expectancy at birth, total (years) 75.3 80.4 75.8 77.5 76.6 62.8 75.6 75.3 Life expectancy at birth, male (years) 73.1 77.8 72.5 73.5 72.8 59.2 72.3 73.2 Life expectancy at birth, female (years) 77.6 83.1 79.0 81.6 80.3 66.4 79.0 77.7 Mortality rate, infant (per 1,000 live births) 12.0 4.5 10.9 4.0 9.9 34.2 4.4 7.1 Sources: WB, World Development Indicators 63 World Bank Group 63 64 64 Annex 15: Education Statistics (2015) Education Statistics Indicators   UMC HIC Turkey Poland Argentina S. Africa Hungary Malaysia Educational attainment, at least completed primary, - - 88.3 98.9 - 82.4 99.6 - population 25+ years, total (%) (cumulative) Primary completion rate, total (% of relevant age group) 94.7 98.8 91.8 97.9 101.8 - 96.9 101.2 Educational attainment, at least Master’s or equivalent, - - 1.8 18.7 - 1.2 8.9 - TEM, December 2018: Steadying the ship population 25+, total (%) (cumulative) Educational attainment, Doctoral or equivalent, - - 0.3 0.6 - - 0.8 - population 25+, total (%) (cumulative) School enrollment, secondary (% net) 79.1 92.2 86.4 92.5 88.2 - 91.0 68.5 Educational attainment, at least completed upper secondary, - - 37.1 83.5 - 64.6 75.1 - population 25+, total (%) (cumulative) Educational attainment, at least completed lower secondary, - - 56.4 83.9 - 77.2 96.8 - population 25+, total (%) (cumulative) Adjusted net enrollment rate, 95.7 97.2 94.2 96.5 99.7 - 95.7 98.1 primary (% of primary school age children) School enrollment, primary (% net) 94.8 96.5 94.1 96.4 99.3 - 90.6 98.1 Sources: WB, World Development Indicators *Scores for Poland and Argentina represent 2014 figures. 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