Source: Japan Credit Rating Agency; Upgraded forex/local of Türkiye to BB- /positive Outlook; Mar 10th, 2005


The ratings reflect the political stability the current government has attained with its control of more than two thirds of parliamentary seats, the progress it has made on structural reforms, based on a standby credit agreement with the IMF, the macroeconomic stabilization brought by the reforms, and the fact that the European leaders, in evaluation of the country's reform efforts, decided at their summit in December 2004 to initiate EU membership talks with Türkiye on October 3, 2005.


The rating outlook remains positive


The Turkish government has agreed with the IMF on a new three-year standby credit facility. The conditional agreement calls for the government to submit to the parliament two bills on the banking and the social security reform and to enact the bill on revenue administration. The execution of the standby credit has been delayed due to slow progress in legislation of the three bills. However, JCR expects that the government will eventually move to enact the bills to pave the way for a formal agreement with the IMF as it is fully aware of the importance of improving market confidence through the implementation of structural reforms.


Meanwhile, the European Commission has urged Türkiye to sign the Protocol on the adaptation of the Ankara agreement prior to the start of accession negotiations. How Türkiye will address this matter remains to be seen as it would be the first pact between Türkiye and the EU since Greek Cyprus joined the EU in May 2004. The Turkish government will aim to solve the issue of Cyprus, which remains divided between the North and the South. It is not easy to resolve the issue which has a complicated background. And it is hard to predict how it will affect Türkiye's membership negotiations. However, the Turkish government is firmly resolved to attain the country's EU membership. It will continue its efforts to that end, although there might be some twists and turns in the process. If Türkiye can carry out structural reforms on the strength of its new standby credit agreement with the IMF and various other reforms aimed to expedite its EU membership, it will be able to continue improving its internal and external confidence, maintaining a virtuous circle of subdued inflation expectation and falling real interest rates, which in turn will spur private consumption and investment. It will also be able to expect an increase in FDI inflow, which is important to ensure sustainable development of the Turkish economy. On the other hand, the ratings are constrained by the country's weak fiscal position and external debt burden, despite their improving trend in recent years. JCR will closely watch how the political situation in Iraq will affect Türkiye as that could become another constraining factor.


(1) Economic situation


Türkiye has realized, through the implementation of an economic reform program agreed with the IMF, a virtuous circle of lowering inflation expectation, a fall in real interest rates and an accompanying expansion of private consumption and investment. Furthermore, exports mainly to the EU countries grew robustly thanks to the improved competitiveness of export products supported by the euro's appreciation and low wages in Türkiye. As a result, the real GDP growth rate for 2004 is believed to have reached around 8.0%, up from 5.9% the previous year.


Türkiye also succeeded in achieving the inflation target for three years in a row, with the inflation rate cut to 9.3% in December 2004 against the government's target of 12.0%. The yield on government bonds also decreased to the level of 17% as of February 2005 from the level of 25% at the end of 2003. The government carried out currency redenomination and adopted a new currency on January 1, 2005 against the background of the progress made in structural reforms including the decline of the inflation rate.


Real GDP growth rate slowed down sharply to 4.5% in the 3rd quarter of 2004 from 13.4% in the 2nd quarter. In the past, volatile economic growth rates were caused by unstable macroeconomy due to a lack of fiscal discipline. This is unlikely to repeat since the current economic environment has markedly improved in this respect. The economic growth is expected to return to a sustainable level as the base effect of the first half of 2003 and pent-up consumption demand have weakened. For 2005, a growth rate of around 5.0% will be achievable, driven by private investment expansion amid continuing growth of exports and falling real interest rates brought by the ongoing reform efforts. On the other hand, the current account deficit continued widening rapidly on a sharp expansion of the trade deficit as strong domestic demand sent imports soaring. The current account deficit to GDP ratio rose to 4.9% in 2004 from 3.4% in 2003. However, thanks in part to the government's tightening measures, domestic demand growth is expected to decelerate. Furthermore, with exports centering on those to the EU on the steady rise, the ratio is expected to turn declining in 2005.


In 2004, the government achieved a primary balance surplus equivalent to 5.8% of GNP against the target of 5.0%. It also held the fiscal deficit at 7.2% of GNP against the target of 10.9%. In the 2005 budget, the government envisages a primary balance surplus equivalent to 5.0% of GNP and a fiscal deficit equal to 6.0% of GNP. As the government has drastically improved its fiscal position by firmly keeping fiscal discipline, this improving trend is expected to be maintained for the present.


(2) The economic reform program with the IMF


Five IMF tranches from the seventh to the 11th had originally been scheduled to be disbursed in 2004. The seventh tranche was disbursed in April that year, but the remaining four tranches were reorganized into three at the request of the Turkish government. Of these, the IMF conducted its review for the eighth tranche and disbursed it in August 2004. The ninth review was scheduled for October 2004 and the final 10th review for February 2005. However, the government later announced that it will conclude a new three-year standby credit agreement amounting to US$10 billion with the IMF and that the remaining tranches will be incorporated into the new agreement. This would ease Türkiye's heavy burden of debt repayment to the IMF scheduled for 2005 and 2006.


The government has so far carried out a range of reforms. It enacted a bankruptcy-related bill and a social security reform bill, drafted a bill to enhance the efficiency and independence of the Regulatory and Supervisory Agencies, and enforced a public financial management and control law, reforms of direct taxes, personnel cutbacks in state enterprises and measures to strengthen the banking sector. Meanwhile, privatization of state enterprises such as TEKEL and Turkish Airlines amounting in value to US$1 billion was realized in 2004, after bleak results in the three preceding years. Top


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