Mr. Stanley Fischer
Acting Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Fischer:

1.  In the context of our disinflation program outlined in the Letter of Intent (LoI) dated December 9, 1999, this letter provides an update of economic developments since the approval of the stand-by arrangement (SBA) and outlines key policy measures to be implemented in the next few months.

2.  Policy developments since the inception of the program have been fully in line with those outlined in our December 9 LoI. All performance criteria for end-1999 (on the primary fiscal surplus, net domestic assets, external debt, and foreign exchange reserves) have been met by a comfortable margin (see attached table). In particular, the government's commitment to fiscal adjustment is reflected in the 1999 budget outturn: the primary surplus of the central budget was about 2 percent of GNP, comfortably above the targeted 1¼ percent of GNP. Most of this over-performance is attributable to revenues, but current expenditure was also kept below the ceiling. Preliminary data for January indicate that tax revenues remain buoyant, exceeding the monthly program targets by more than ¼ percent of GNP, while expenditure was contained within the program projections. Finally, against the background of our pre-announced exchange rate path, NDA has remained within the agreed band.

3.  In addition to meeting the program's performance criteria for end-December, a number of policy actions envisaged in the LoI have been undertaken since the approval of the SBA: (i) parliament approved a 2000 budget in line with the program's targets, as well as the Telecommunication Law (a structural performance criterion); (ii) public sector wage policy has been in line with targeted inflation; (iii) the government introduced a 2 percent cut in discretionary spending with respect to budgeted ceilings; (iv) the government published detailed information on existing contingent liabilities, meeting a structural benchmark of the program; and (v) tobacco prices were raised in line with targeted inflation. Finally, a restructuring operation was initiated in late December with the taking over by the Saving Deposits Insurance Fund (SDIF) of five commercial banks and the closure of one investment bank, a major step toward the strengthening of our banking system.

4.  The most visible result of our policy actions has been the drop in interest rates on government paper and other TL-denominated assets to levels unprecedented during the last decade. Following the beginning of the program, treasury bill auction rates have fallen to around 40 percent, down from over 90 percent in November. The stock market has reacted positively. Further, Turkey has been able to borrow from international capital markets at much better terms than in the recent past, including a 30-year bond issue (the longest maturity in the past was ten years) at a spread of 525 basis points over U.S. treasuries. Standard & Poors and Moody's have revised their assessment of Turkey's outlook from stable to positive, while JCRA upgraded Turkey by one notch.

5.  Developments in the real economy have been mixed but the most recent information is encouraging. The fall in output in the third quarter of last year was sharper than expected, and GNP is now estimated to have contracted by some 4½–5 percent in 1999, twice as much as projected when the program was designed. However, main activity indicators in the last quarter show that a recovery is underway and thus suggest that the downturn in the third quarter was primarily due to the direct and indirect effects of the Marmara earthquake. The recovery after the earthquake is also reflected in the external trade figures: in November both exports and imports registered the first positive year-on-year growth rates in several months. The current account deficit for the year as a whole is likely to be around ½ percent of GNP, as had been anticipated in the December 9 LoI.

6.  Inflation has remained high during December–February. This outcome reflected, in addition to inflation inertia, severe winter conditions which affected the supply of agricultural products, the increase in international oil prices, an acceleration of the depreciation of the Turkish Lira in the last two months of 1999, public sector price increases at end-1999, and the impact of the tax measures adopted at the onset of the program. These factors are expected to fade away soon, and indeed the February figures already showed a deceleration with respect to the previous two months.

7.  The macroeconomic outlook remains positive, and we expect that the policies implemented in the last few months, sustained by further actions this year, will allow the program's key macroeconomic targets for 2000 to be achieved: a GNP growth of 5–5½ percent; an external current account deficit of about 1¾ percent of GNP, and CPI inflation of 25 percent by end-2000 (20 percent for WPI).

8.  Nonetheless, the still strong inflation inertia apparent in the early 2000 inflation figures, compounded by the rise in international oil prices, involve some additional risks for both the inflation and the external current account targets. Vigilance is therefore necessary in maintaining the adjustment effort and in implementing rigorously the program's policies. The sharper than anticipated decline in interest rates, which should lower significantly the government debt service burden, does not justify relaxing the objective for the primary fiscal surplus. Indeed, the fall in interest rates has reflected the credibility arising from the implementation of the fiscal and structural reform program and the preannounced exchange rate path. This credibility has to be maintained over time by continued commitment to the program's policies. Further, the government stands ready to undertake additional fiscal measures promptly, particularly on the expenditure side, should inflation fail to decelerate sufficiently.

9.  We remain committed to all the measures and policies identified in the December 9 LoI. The key steps to be undertaken in the immediate future include: (i) reintroducing during the first quarter the quarterly advance payments of the corporate income tax (to become effective during the third quarter of 2000); (ii) enactment of a law subjecting agricultural cooperatives (ASCUs) to the existing cooperative law, which would make them autonomous (a structural benchmark); (iii) submitting to parliament and securing passage of the laws needed to close down 7 budgetary funds, and passing the required regulations to close down another 15 funds (more than sufficient to meet the relevant structural benchmark); (iv) allocating the funds to implement a fully integrated computerized accounting system that allows timely monitoring of public expenditure; and (v) submitting to parliament draft laws improving the administration of the social security system and creating the legal framework for private pension funds.

10.  In this respect, ahead of the next program review, the government will adopt the following measures to keep health expenditures of Bag Kur (one of the social security funds) in line with budgetary allocations and avoid any increase in arrears. First, administrative measures will be taken to strengthen control over costs and reduce abuse in this area. Second, the draft law being submitted to Parliament to improve the administration of Bag Kur will include provisions to enable the institution to collect health premia for dependents, as well as increasing co-payments for doctor consultations. The implementation of the administrative measures and the submission to parliament of the law will be structural benchmarks for the completion of the second review.

11.  While the terms of borrowing for the government have improved in both domestic and international capital markets, the need to achieve targets for privatization receipts for 2000 remains urgent, in light of the overall risks to the program's success. In this respect, the tender for sale of 51 percent of stakes in Petrol Ofisi A.S. (the main oil products distribution company) was completed on March 3, and we expect soon to launch a public offering for 15 percent of the shares of Tupras (the largest refinery in Turkey). Moreover, the process of auctioning two GSM licenses will be accelerated with a view to closing the tender before end-April. Further, the tender for 20 percent of the shares of Turk Telekom will be announced by end-April, and the sale will be finalized by end-August (a structural benchmark).

12.  In the area of banking, based on evidence of fraud, legal actions have been initiated against the former owners of four of the banks taken over in December by the Saving Deposits Insurance Fund (SDIF). A full auditing of these banks is under way. Once completed, a financial restructuring plan for these banks and the other banks in the SDIF portfolio will be designed and carried out. Following the issuance of new loan-loss provisioning regulations in December, a communiqué will be issued shortly clarifying that the new regulations will apply to renewed loans as well as to new loans. New regulations for consolidated accounting and proper valuation of securities will be introduced by end-April (a structural benchmark). Finally, the Board of the Bank Regulation and Supervisory Agency (BRSA) will be named by end-March (a structural performance criterion).

13.  The outcome of the upcoming wage negotiations in several sectors is critical for the success of our disinflation program. The government intends to intensify the consultations within the Economic and Social Council to try to facilitate agreements between employers and employees that are consistent with the goal of breaking the wage/inflation inertia.

Very truly yours,

 

Table. Turkey: Quantitative Performance Criteria for end-December 1999
	Dec. 31, 1999
	Ceiling/Floor	Outcome
1.  Floor on the cumulative primary balance of the consolidated      central government (in trillions of Turkish lira)	1,000	1,649
2.  Ceiling on the stock of net domestic assets of the CBT      (in trillions of Turkish lira)	–1,200	-1,437
3.  Floor on net international reserves (in millions of US$)	12,000	16,757
4.  Ceiling on contracting or guaranteeing of new external debt      (in millions of US$)	8,500	8,182
5. Ceiling on the stock of short-term external debt outstanding      (in millions of US$)	500	0
Source: Data provided by the Turkish authorities.