Turkey WT/TPR/S/44
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I. ECONOMIC ENVIRONMENT
(1) INTRODUCTION
1. The Turkish economy experienced a severe recession in 1994, following a financial crisis in
the early part of the year.  However, with the implementation of a stabilization and structural
adjustment programme, economic recovery was rema rkably quick, with annual growth of 7 to 8% in
GNP in the three following years.1  The current account deficit, although widening, remained at
manageable levels and international reserves ha d accumulated to US$19 billion at th e end of 1997
(equivalent to almost five months of merchandise imports), as the currency depreciated broadly in line
with inflation differentials.  The new trading cond itions inherent in the customs union between Turkey
and the EU, which entered into force in January 1996, assisted the recovery.  Despite these
improvements, large fiscal imbalances and persistently high inflation put into question the medium-term sustainability of recent growth performance.  Moreover, slow progress has been made in
carrying out the large outstanding structural reform agenda, notably in reforming the social security
system and the banking sector and pursuing the privatization programme.
2. The healthy average growth rates, albeit with high variations, since the mid-1980s have been
translated into a general improvement in livin g standards; GDP per capita doubled between 1985
and 1995.  Other social indicators, such as life expectancy, infant mortality, and school enrolment at
secondary level, all show continued improvement (Table I.1).  However, after Mexico, Turkey has the
most unequal  income distribution of all OECD c ountries (in 1994 the poorest 20% of the population
received only 5% of the income, while the richest 20% received 50%).
2  As discussed below, the
chronically high inflation is also likely to have adversely affected income distribution.
Table I.1
Basic social indicators, 1970-97
1970 1980 1990 1997
Population (million, mid -year) 35 44 56 65
Growth of population (percentage change) a.. 2.3 2.4 2.2
Urban population (per cent of total) 38 44 59 70 b
Life expectancy at birth (years) 57 61 66 68 c
Total fertility rate (births per woman) 5.3 3.4 2.7 2.7 d
Infant mortality rate (per '000 live births) 150 126 67 40 c
School enrolment ratio (%)e:
     Primary school 110 96 110 105 d
     Secondary school 27 35 54 56 d
Human Development Indicator (HDI ranking/total countries) .. .. 73/173 74/175f
GNP per capita (US$, current prices) 356 1,569 2,714 2,994
.. Not available.
a Average annual growth for the previous ten (or seven) years.
b 1996 data.c Provisional.
d 1995 data.
e Enrolment ratios may exceed 100% because pupils may be older or younger  than the standard school age.
f 1994 data.
Source: State Institute of Statistics (1996), 1995 Statistical Yearbook of Turkey
; World Bank (1997), 1997 World Development
Indicators (urban population, school enrolment ratios, fertility rate and infant mortality rate); and UNDP (1997),  Human
Development Report.
                                                     
1 In line with the practice of the Turkish authorities, GNP, rather than GDP, is mainly used throughout
the report.  In the case of Turkey the difference between GNP and GDP is not large, with net-factor incomeincreasing GDP by between 0.5 and 1.9% during the 1990s.
2 State Institute of Statistics (1996), p. 292.WT/TPR/S/44 Trade Policy Review
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(2) RECENT ECONOMIC DEVELOPMENTS
(i) Overview
3. Since the previous Trade Policy Review in 1994, economic management has been focussed
on recovery from the financial crisis of that year and structural reforms.  The crisis stemmed from
high fiscal deficits during the previous three years; over the period 1991 to 1993, the public sector
borrowing requirement (PSBR) was more than 10% of GNP and annual average inflation was closeto 70%.  The real exchange rate had been allowed to appreciate, implying a loss of international
competitiveness, over a period of years.  Large increases in imports resulted in a current account
deficit of over US$6 billion in 1993.  In January 1994, Turkey's credit-rating on sovereign debt was
reduced to sub-investment grade, triggering a rapid fall in the real exchange rate, outflows of
short-term capital and a decline in the Istanbul stock market.  These factors, in combination withuncertainties about the directions of future policie s, rendered it more difficult for the Government to
borrow abroad.
4. To address this situation, in April 1994 the Government announced an emergency
stabilization programme, consisting of increases in prices charged by state economic enterprises, a
one-off capital levy, and an announcement of moving ahead with structural reforms, including aprivatization programme.  The programme contributed to a remarkable turnaround in the economy.
GNP performance rebounded from a contraction of 6% in 1994 to annual growth of some 7 to 8% in
the three succeeding years (Table I.2).  The stock market index rose by as much as 86% in 1997 in
dollar terms.  Over the same period, external developments remained favourable.  The current account
deficit, although widening, was kept at a manageable level.  International reserves rose
to US$19 billion equivalent to almost five months of merchandise imports at the end of 1997, as the
lira was depreciated in nominal terms broadly in line with inflation differentials.
5. However, fiscal deficits have persisted, albeit now more linked to the social security system
and interest payments than to the operations of state economic enterprises.  Under the new Bank of
Turkey Act, the Central Bank has reduced the monetization of the deficits ("printing money"), and the
Government has increased its reliance on government securities as a source of financing.  Despite the
macroeconomic imbalances, the economy, as noted above, has demonstrated surprisingly stronggrowth.  The customs union with the EU and implem entation of some important structural reforms
(Box I.1) in an environment of a flexible private sector, may be some of the factors explaining the
recent growth performance.  Strong and concerted efforts in the reform of the social security system,
the privatization programme and other structural reforms seem to be the key to reducing inflationary
expectations and providing for a healthy stable long-term growth.Turkey WT/TPR/S/44
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Table I.2
Selected economic indicators, 1985-97
1985-92a1993 1994 1995 1996 1997b
Real GNP, market prices (percentage change)c5.0 8.1 -6.1 8.0 7.1 8.0
GDP by expenditure component
Real GDP, market prices (percentage change)c4.9 8.0 -5.5 7.2 7.0 7.2
    Private consumption 4.0 8.4 -5.4 4.8 8.5 8.6
    Government consumption -5.5 5.4 -5.5 6.8 8.6 5.9
    Gross fixed capital formation 4.5d24.9 -16.0 9.1 14.1 12.4
    Exports, goods and services 8.9 7.7 15.2 8.0 22.0 22.6
    Imports, goods and services 6.5 35.8 -21.9 29.6 20.5 23.5
Prices and interest rates (Per cent )
Consumer price index, urban areas (annual average) 56.5 66.1 120.7 88.5 75.9 81.8
Wholesale price index (annual average) 51.2 58.4 106.3 93.6 80.4 85.7
Interest rate on 3-months T-bill (annual rate) 54.6e69.8 101.2 95.0 81.7 ..g
Real exchange rate (1982=100)f0.9 -1.1 -21.4 32.1 -1.7 -2.4
Savings and investment (Per cent of GNP)
Gross domestic savings 22.4 22.7 23.1 22.1 20.0 20.1
      Public sector .. -2.7 -1.1 -0.1 -1.9 -1.7
Gross fixed investment 23.2 26.3 24.5 24.0 25.0 25.3
      Private sector 14.8 19.1 19.6 19.8 19.9 19.6
Government budget
Public sector borrowing requirement -6.6 -12.3 -7.7 -4.8 -9.1 -8.1
General government balance -3.5 -8.9 -5.8 -5.5 -9.0 -8.1
Consolidated budget balance -3.4 -6.7 -3.9 -4.0 -8.3 -7.5
     Primary balance -0.6 -0.9 3.8 3.3 1.7 0.3
Monetary sector (end-of-period) (Percentage change)
Nom. money plus time and savings deposit (M2) 57.9 49.6 125.4 101.3 118.9 90.1
(Per cent)
Private sector share of banking system credit 74.9 74.5 73.5 83.3 87.3 92.3
External sector (Per cent of GNP)
Current account balance -0.5 -3.5 2.0 -1.4 -2.9 -2.4
     Current account, adjusted for shuttle trade .. .. .. .. -1.3 -1.4
Capital account balance 1.2 4.9 -3.2 2.7 5.3 4.7
      Foreign direct investment 0.4 0.3 0.6 0.6 0.5 0.5
      Portfolio investment 0.7 2.2 0.9 0.1 0.3 0.8
Total external debt 38.6 37.0 50.1 42.6 45.9 47.1
      Short-term 7.1 10.2 8.6 9.1 11.1 11.1
      Public medium- and long-term 30.1 23.6 36.8 29.1 26.4 24.4
Debt-service ratioh32.4 27.0 30.5 28.7 24.1 21.1
In't reserves, mos. of merch. importsI2.4 2.5 3.8 4.2 4.6 4.7
Merchandise trade (imports and exports) 25.4 25.0 31.3 33.3 36.1 38.2
(Twelve-month growth rate, end-of-period, per cent)
Merch. export growth valuej9.8 4.8 17.8 19.5 7.4 13.5
Merch. import growth valuej11.6 29.0 -24.1 55.7 22.3 11.8
Memorandum item:
    Nominal GNP (billion US$) .. 181.8 130.9 171.9 184.6 196.1
.. Not available.
a Annual average.b Provisional.
c At 1987 prices.
d 1988-1992 data.e 1986-1992 data.
f Decrease equals depreciation.  The weights in the currency basket are 0.5 for US$ and 0.5 for DM prior to 1987 and thereafter
the shares are 0.75 and 0.25, respectively.
g Sales of three-months T-bill were not realized in 1997.
h Debt-service (interest plus medium- and long-term debt repayments) as % of foreign exchange receipts.
i Total reserves, excluding gold.j Current US$.
Source: Government of Turkey;  and IMF (various issues), International Financial Statistics
.WT/TPR/S/44 Trade Policy Review
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Box I.1:   Key structural reforms since the 1994 Trade Policy Review
-Trade Reform.    As a result of the customs union with the EU, which entered into force in January 1996,
Turkey substantially reduced its app lied tariff rates, including the abolition of various import surcharges,
except for a few lines, which are still subject to a Mass Housing Fund (MHF) levy (see Chapter III for
details).  The new import regime applies the EU common external tariff (CET) to most imports of industrial
and processed agricultural products from third countr ies.  The simple average MFN tariff has, as a
consequence, fallen from 27% in 1993 to 13% in 1998 (sec ond half).  However, tariffs on agricultural
(except processed) products have been relatively unaffected as they are no t required to be lowered by the
Customs Union Decision.  All trade restrictions ju stified on balance-of-payments grounds were eliminated
as of 1 January 1997.
-Privatization and private sector participation.   In November 1994, a privatization law (Law No. 4046) was
passed, establishing the Privatization High Council as the ultimate decision making  body.  The legalisation
allowed for the sale of 49% of the state telecommunications enterprise TTAS, granting licensing of somevalue added telecommunications services to private investors,  and privatization of 49% of the aviationstate economic enterprise THY.  Private-sector participation in infrastructure projects has been boosted byenactment of the build, operate (BO) law (Law No. 4283) in addition to the already existing build, operate
and transfer (BOT) law (Law No. 3096 and 3996).
-Foreign investment.  The already liberal foreign direct in vestment regime policies were simplified and
bureaucratic procedures streamlined.
-Financial market.   Following the mini-crisis in early 1994, legislative reforms were passed in June:
(i) increase in the minimum paid-up  capital to open up a bank (to TL 1 trillion); (ii) a tightening of limits
on credits extended to related parties, equity partic ipation in non-financial institutions and real estate
investments; and (iii) stronger public disclosure requireme nts.  With the passing of the Bank of Turkey Act
in 1994, the legal limits of Central Bank financing of the increase in government appropriations wasreduced from 10% to 6% between 1996 and 1997 an d to 3% thereafter. In 1996 Turkey launched an
international bond market in Istanbul (under the auspices of the Istanbul Stock Exchange) in order to cutthe cost and remove obstacles to trade in Eurobonds and other securities.
-Competition.   In February 1997, two years after the Law to Protect Competition was passed, a competition
board was formed.
- Domestic tax reform.   A two-year programme was signed in 1997 with the U.S. Internal Revenue Service
(IR) for reorganization of tax admi nistration in Turkey.  A law exten ding the use of unique tax payer
identification numbers has recently been approved by the Parliament.  A draft law has been prepared,aiming at widening the tax base while ensuring a more equitable distribution of the tax burden.  The billprovides for major changes in the definition of income, restricts the number and scope of exemptions,
reduces the tax rates, and includes a more efficient penalty system, and measures to cover all taxable
items.
-Social security .  A draft law raising the retirement age over a five-year period to 55 (from 43) for men and
50 (from 38) for women will be prepared towards the end of 1998.
Source:  Government of Turkey.
(ii) Growth and economic structure
6. Turkey's recent growth performance has been characterized by large fluctuations.  Following
two years of high growth, the Turkish economy unde rwent a financial crisis in 1994, and the economy
contracted by 6% (Table I.2).  Output in the industrial sector, notably manufacturing, was the most
affected.  Since then, however, the economy has shown a remarkable turnaround:  annual growth
of 7% or 8% in 1995 and 1996 primarily reflecting recovery in private consumption and investment,Turkey WT/TPR/S/44
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and strong export growth.  The industrial sector was the most dynamic, followed by services, while
the agriculture sector also picked up due to favourable weather conditions.  In 1997, growth was
estimated at about 8%, again driven primarily by domestic demand, but with exports also strongly
increasing.  Manufacturing and services were mainly responsible for the most recent recovery,
whereas value added in the agricultural sector declined by 2%.
7. Since 1993, the structure of the Turkish economy has continued to shift slowly towards
services and industry, away from agriculture.  While the share of the agricultural sector in GDP
(measured in constant prices) decreased by almost 2 percentage points between 1993 and 1997
to 14%, the services and industry sector both expanded over the same period accounting for 49%
and 37% of GDP in 1997, respectively (Chart I.1).  The expansion in services has in recent years been
driven by activities in trade, and transport and communications.  Despite its modest contribution toGDP, agriculture employs about half of the labour force, while the manufacturing industry provides
some 14% of the job opportunities (Chart I.1).
(a) GDP (1997 )Per cent, and constant 1987 prices
Source :    State Planning Organization (1998), Main Economic Indicators , March; and State Institute of 
                 Statistics (1997), 1996 Statistical Yearbook of Turkey ,  February.Chart I.1 
Sectoral distribution of GDP an d labour force
Ownership of 
dwelling  5.1
Transport and 
telecommunications
13.5
Total:  TL 112 billion Total:  21 millionOther 3.2
Energy
3.1Other  1.1Agriculture
47.8Community, social
& personal
13.0
Trade, restaurants 
and hotels  
12.2(b) Labour force (October 1995)
Trade
23.3Government 
services  4.2Agriculture  14.0
Mining and quarrying  1.5
Construction  
6.1
Manufacturing
26.0Services
49.3Industry
36.7
Manufacturing
13.8Finance, insurance
real estate & business  
2.3
Construction
5.7Transportation
communication & storage  
4.0Services
31.5
(iii) Public finances
8. Turkey's fiscal position has been at the root of its macroeconomic imbalances; as noted above,
the currency crisis in 1994 was directly linked to a deterioration in the fiscal balance.  The publicsector borrowing requirement (PSBR) escalated in the 1990s from 7.6% of GNP in 1990 and peaked
at 12% of GNP in 1993 (Chart I.2 and Table AI.1) .  The stabilization plan of 1994, which included
some one-off tax surcharges and spending freezes, lowered the PSBR by almost 5 percentage points.
However, since the underlying causes of the imbalances were not addressed, the PSBR deteriorated
again to 8% of GNP in 1997.WT/TPR/S/44 Trade Policy Review
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9. In the past, the financing of state economic enterprises was the most important source of the
overall fiscal deficits, but since 1994 this has been reduced while the financing of social security
transfers and interest payments have become relatively more important.  The share of the social
security transfers (before transfer from the Budget) increased from 0.4% of the PSBR in 1990, to 10%
in 1993 and to 33% in 1997.  Over the same period, state economic enterprises as a share of PSBR fellfrom 60%, to 39% and to 5%.
3  The PSBR net of interest payments improved by as much
as 3.5 percentage points in 1990, 5.8 in 1993 and 8.6 in 1997.
10. The consolidated budget deficit in 1997 was some 85% of the PSBR, but the difference,
consisting of a number of "extra-budgetary" items, was substantially higher in earlier years (Chart I.2
and Table AI.1).4  Extra-budgetary items consist mainly of subsides and financing to specific sectors
such as agricultural subsides and transfers to state economic enterprises that are required to extend
credits at below cost and are not subject to the same budgetary controls as other government
expenditures.5  Since 1994 a number of extra-budgetary funds have been transferred to the
consolidated budget and are thereby subject to the more stringent budgetary vetting process.
11. The initial 1998 Budget aimed for a PSBR of 8.1% of GNP.  However, according to the
recent IMF Staff Monitored Programme, the Government committed itself to decrease the budget
deficit to 7.6% of GNP, relying heavily on privatization receipts of US$2 billion or 1% of GNP as asource of financing.
6  Whether the Government will be able to achieve the target will depend on,
among other things, the long-delayed privatizatio n of 20% of the state telecommunications company,
                                                     
3 These numbers are based on Table AI.1.  Numbers supplied by other Government authorities indicate
that the share fell from 49% to 16% and to 6% over the same period.
4 The consolidated budget includes the central Government, budgetary funds, and annex budgets
(covering some autonomous organizations such as universities).
5 World Bank (1996), p. 23.
6 The Government accounts privatization proceeds as  a revenue item, as opposed to a financing item
(i.e. below the line).-14-12-10-8-6-4-202468
1990 1991 1992 1993 1994 1995 1996 1997-30-101030507090110130
1990 1991 1992 1993 1994 1995 1996 1997Chart I.2
Public sector position, 1990-97
Note:
Source :The primary balance is the fiscal deficit net of interest obligation on public debt. PSBR = Public Sector Borrowing Requirement .
Government of Turkey.(a) Public sector balances
Per cent of GNP(b) Financing of PSBR
Per cent of PSBRDomestic borrowing, net
Foreign borrowing, net
Central Bank
PSBRConsolidated 
budget balancePrimary balance 
consolidated budgetTurkey WT/TPR/S/44
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Türk Telecom.  In the first half of 1998, US$1 billion had been raised from privatization and used for
budget-balancing purposes.
12. The persistently high deficits, caused by successive government overspending, have had
serious macroeconomic implications.  Monetization - causing inflation - was heavily used in the past
but it has now been largely replaced by domestic borrowing (Chart I.2).  Nevertheless, as much
as 17% of the PSBR in 1996 was money financed.7  Resort to monetization has been substantially
limited with the passing of the 1994 Bank of Turkey Act, under which the legal cap of Central Bank
of Turkey financing of the increase in government appropriations was reduced from 10 to 6%
between 1996 and 1997 and to 3% thereafter.  In fact, since 1997, the Treasury has not borrowed from
the Central Bank.  As a result of these changes, deficits are now mainly being  financed through
domestic borrowing (mainly Treasury bills), causing increased real interest rates and the associatedcrowding out of private investment.
8  By contrast, there was no net foreign borrowing in the three
years after the crisis; rather, a net inflow of funds led to increasing international reserves.
(iv) Exchange rate and monetary policies
13. The main priorities of the Central Bank of Turkey are to ensure stability in money and foreign
exchange markets.  Although it states an unofficial inflation target, since 1995 its only apparentofficial goal is to hold the real exchange rate by ensuring that the Turkish lira depreciates by no more
than inflation differentials against the Deutsche Mark and U.S. dollar.  Day-to-day operations are
directed towards smoothing fluctuations in the overnight lending rate.
14. A real overvaluation of the lira had been built up since the early 1980s, and in January 1994,
when serious macroeconomic imbalances were apparent, Turkey's reduced credit rating triggered a
rapid fall in the lira; both the nominal value of the lira and the real exchange rate plummeted.
However, as a result of the change in the exchange  rate policy the lira remained almost unchanged in
real terms through 1996 and 1997.
15. Most monetary indicators suggest that, in general, monetary policy has recently been
accommodating or neutral.  Moreover, the Central Bank's decision to set a target between 18 and 20%
for the increase in reserve money suggests that monetary policy will not be tightened to eliminate
inflationary pressures.  Without structural measures to reduce public expenditure and slow domesticdemand, increased interest rates are likely to increase the cost of financing the Government's
borrowing requirement and translate into higher inflation.
(v) Inflation and interest rate developments
16. Overall, control of inflation is the main preoccupation of macroeconomic management.
Turkey's poor record in getting inflation under control is harmful to efforts to improve the distributionof wealth and income, as well as weakening growth prospects (Box I.2).  In 1994, consumer price
inflation peaked at 121% as a result of the sharp nominal depreciation of the currency and price
adjustments by state economic enterprises, dropping to 82% in 1997 (Table I.2).  Annualized inflation
                                                     
7 Until 1994, the Treasury could borrow from the Central Bank up to 15% of the budget expenditures
paying almost no interest to the Central Bank; this facility is called short-term advances to the Treasury.
8 OECD (1997a), p. 43, shows that the proportion of bank loans for investment purposes to the size of
M2Y (i.e. M2 plus foreign currency deposits held by residents in Turkish banks) has decreased fromaround 75% ten years ago (when inflation averaged some 40%) to about 50% in 1996, indicating that crowdingout has increased over the period.WT/TPR/S/44 Trade Policy Review
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again accelerated to more than 100% by the beginning of 1998, but dropped somewhat in the first half
of 1998 to an annual rate equivalent to 94%.9
Box I.2:  The high cost of inflation
Redistribution of income and wealth.   Inflation tends to have a negative effect on a country's distribution o f
wealth and income:
- as opposed to real assets (such as real estate , durable goods, foreign exchange, and precious metals),
the value of nominal non-indexed assets is eroded by  inflation.  Therefore, poor people with  little or no
real assets tend to have fewer po ssibilities to hedge against the erosio n of value.  Moreover, wealth
shifts from rentiers to borrowers as re al interest rates become negative; and
- high inflation, unless all prices increase at the sa me pace, redistributes income by distorting relative
prices.  Those who lose out could include retired people, and those on fixed incomes and with limited
political influence.
Decline in future output.    Several empirical studies have found a negative relationship between inflation and
growth (Fischer, 1991, 1993; Cozier and Selody, 1992; Barro, 1995, 1996; and Andrés and Hernando, 1997).The reason is that high inflation is often associated with more variable inflation.  The more variable inflationis, the more difficult it becomes to disentangle relative price change s (which may require change in behaviour)
rather than just inflation.  Therefore, if firms and households confuse movements  in the price level with
changes in relative prices, this can lead to distortions, productivity decline and lower growth.  Also, highvariable inflation, without relative price changes, may have a deterrent effect on growth since it complicatesthe possibility to forecast inflation, a variable that is used in investment decisions, and may therefore lead toinefficient decisions.  Some countries facing persistently high inflation, resort to indexation instead of tacklingthe underlying cause.  However, indexation may worsen th e situation because it tends  to freeze the hierarchy
of all relative prices and to lock-i n real rigidities in the economy.
Source: Burda and Wyplosz (1993), Macroeconomics - A European Text
; and OECD (1997), Economic
Surveys - Turkey 1997.
17. The high budget deficits and the associated fast growth in monetary aggregates, as described
above, represent the main underlying cause of inflation.  Indexation, which is widely used in settingwages and salaries, was also a contributing factor in maintaining inflationary expectations.  In the
short-run, the rate of nominal depreciation of the Turkish lira  is also a key element that may become
even more important as the economy is opened up and the share of imports in the domestic economy
increases.
18. Real interest rates on Treasury bills are very high.  Some policy slippages at the time of the
September 1995 call for early elections, and in combination with the suspension of some
macroeconomic performance criteria (notably nominal limits on exchange rate movements that had
been introduced under the 1994 IMF Stand-by Agreement), resulted in a hike in T-bill rates.  By
spring 1996 the Treasury was able to fund its borrowing only at a real interest rate of 40% and an
average maturity of four months.
10  The real interest rate has recently fallen and maturities rose to a
year in 1997.
(vi) Balance of payments
19. From the crisis in early 1994 until the end of 1996, the current account deficit (excluding
shuttle trade) increased to over US$5 billion in 1996, or 2.9% of GNP (Tables I.2 and AI.2).  These
                                                     
9 State Planning Organization (1998).  As measured by the whole-sale-price index, the rate of inflation
in the 12 months to June 1998 was 76.7%, down from 91.0% in the 12 months to December 1997.
10 OECD (1997a).Turkey WT/TPR/S/44
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deficits were financed by private and official borrowing, of which a substantial part was short-term,
particularly in 1996.  International reserves accumulated to US$19 billion (equivalent to almost five
months of merchandise imports) at the end of 1997; however, in a situation of macroeconomic
imbalances and delays in the implementation of important structural reforms, the external position
continues to attract attention.
20. Interpretation of the external accounts is complicated by the large unrecorded trade with the
countries of the former Soviet Union and Eastern Europe (Box I.3).  Balance-of-payments data prior
to 1996 do not include this so-called "shuttle" trade, which is understood to be mainly in textiles,
leather goods and households products.  Although no firm estimates are available, some observers put
the shuttle trade as high as 25 to 50% of Turkey's total exports of goods.  The Central Bank's
estimates of the adjusted current account deficits in 1996 and 1997 show an improved position ofsome US$3 billion and US$2 billion while the capital account surpluses were US$1 billion and
US$0.7 billion lower, respectively (Table AI.3).
Box I.3:  What is shuttle trade?
Recent studies indicate that official data substantially underestimate trade in goods.  Large unrecorded trade
(notably in textiles, leather goods  and household products) takes place with the former Soviet Union and
Eastern Europe.  This "shuttle" (or "suitcase") trade  is transported by cargo planes, buses equipped with
cargo trailers, and refitted cruise ships.
There are no firm estimates on the magnitude of the shu ttle trade.  One recent study by the State Institute o f
Statistics (SIS), which used a survey of 3,000 foreign vi sitors, estimated it to be US$1.6 billion in the first six
months of 1996.  A nother study, by the Central Bank of Turkey (CBT), which directly measured the trade
undertaken by 1,000 shuttle traders, estimated tota l shuttle trade in 1996 at almost US$9 billion.
What are the implications for the cu rrent account?  In addition to the uncer tainties in the si ze of the shuttle
trade, there are some problems in the official estim ate on trade in services; while trade in goods is
under-reported, trade in services is over-reported.   Data for a large proportion of services credits are derived
from data on foreign exchange transactions in the bankin g system.  Some of these transactions are believed to
be shuttle trade.  Moreover, the recent liberalization of foreign exch ange accounts in Turkey and the
increasing dollarization of the economy may imply that a large proportion of these accounts representsresident-to-resident trans actions, but these transactions are excluded from the balance-of-payments records.
Taking all these factors into account, the CBT estimates the revised current account balance to increase by
some US$3 billion in 1996 (deficit of US$2.4 billion compared with US$5.4 billion), with a corresponding
adjustment in the capital account.  The adjustment on the 1997 current account was US
$2 billion.  Balance-of-
payments data for 1996 and 1997 adjusted for shuttle trade are presented in Table AI.3.
Source: IMF (1997), Staff Country Report No.97/110 , November;  and State Planning Organization (1998),
Main Economic Indicators, March.
Current account developments
21. The current account deficit (excluding "shuttle" trade) averaged some 0.5% of GNP
from 1985 to 1992 (Table I.2).  However, slack fiscal and monetary policies contributed to the
widening of the trade deficit to US$14 billion and the current account deficit increased to 3.5% of
GNP in 1993 (Table AI.2).  Corrective actions under the stabilization programme in 1994 led to a
US$10 billion reduction in the trade gap.  In 1995 domestic demand again accelerated and the trade
deficit widened correspondingly; this was further stimulated by the inception of the EU customsunion.  Overall, the current account deficit reached a 2.4% of GNP in 1997, or 1.4% when adjusted
for "shuttle" trade.WT/TPR/S/44 Trade Policy Review
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22. Turkey has a substantial, and increasing, credit balance on "other goods, services, and income
transfers" amounting to about US$12 billion in 1997, sharply up from US$4 billion in 1993
(Table AI.2).  The main credit item, tourism, which increased from US$4 billion in 1993
to US$7 billion in 1997, was to some extent offset by travel abroad.  On the debit side, interest
payments on Turkey's large foreign debt amounted to as much as US$4.6 billion in 1997.
23. Net private unrequited transfers, consisting almost entirely of workers' remittances, amounted
to some US$4.6 billion in 1997.  Official unrequited transfers have decreased in importance
since 1993, down from US$0.7 billion to US$0.3 billion in 1997.  Presently, it is dominated by
payments from Saudi Arabia and other countries, as partial compensation for the cost to Turkey of
applying sanctions against Iraq.
Capital flows and foreign debt developments24. Capital inflows grew rapidly up to  1994, owing to a sharp increase  in private inflows, as well
as official flows (plus the continued high levels of workers remittances as noted above).  However,
overall capital inflows fell sharply in 1994.  At the time of the currency crisis, foreign private
creditors declared their reluctance to finance the current account, which they considered too high;
credit disbursement by private lenders plummeted from US$3.8 billion in 1993 to US$0.9 billionin 1994.
11  In addition, net portfolio investment fell.  Since the crisis, however, external financing,
although expensive, has not yet posed a serious problem, with lower debt-service ratios than in
the 1980s.
25. Net portfolio investment fluctuated considerably more in the 1990s than the flows of net
foreign direct investment (Table AI.2).  While it rose steadily in the early 1990s, it fell sharply during
the crisis in 1994 and continued to fall in 1995.  In 1997, portfolio inflows increased substantially,
attracted by high real interest rates.
26. An increase in foreign direct investment had be en expected following the establishment of the
customs union with the EU but this has not yet materialized.  Deterrent factors may include continued
political uncertainties, high inflation and corresponding foreign exchange rate adjustments, and a
continued degree of regional instability.  Successful implementation of the privatization programme
(Chapter III (4)(i)) would provide scope for additi onal inflows in the short-run, but its more lasting
benefit would be through efficiency gains and a boost to private sector confidence.  Net foreign direct
investment has varied between some US$550 million and US$770 million since 1993 (Table I.3).
Except at aggregate levels, data are not available on realized foreign direct investment by sector or
country of origin.  However, annual data on approved permits indicate that inflows of foreign direct
investment continue to be heavily dominated by the EU (Table I.3);  between 1993 and 1997 thelargest shares were from France (accounting for 29% of total permits) and the Netherlands (12% of
total permits).  The majority of the foreign direct investment permits during this period were for the
manufacturing sector followed by services, albeit with large fluctuations over the period (Table I.3).
27. Despite downgradings of Turkey's credit rating, external debt built from US$67 billion
(or 37% of GNP) in 1993 to US$81 billion (equivalent to 42% of GNP) in the first quarter of 1997; ofthis, about one quarter was accounted for by short-term debt.  However, Turkey has so far had no
difficulties in servicing its debt; as noted, the ratio  of external debt service to total foreign exchange
receipts is still below the levels of the 1980s.
                                                     
11 Uygur (1996), p. 25.Turkey WT/TPR/S/44
Page 11
Table I.3
Foreign investment, 1990-97
(US$ million, and %)
1990 1991 1992 1993 1994 1995 1996 1997
Foreign direct investment (US$ million)
    Permit 1,861 1,967 1,820 2,125 1,485 2,938 3,837 1,678
    Inflows (realized) 788 910 912 797 637 935 937 558
    Net (realized) 700 783 779 622 559 772 612 554
Portfolio, net (US$ million) 547 623 2,411 3,917 1,158 237 570 1,634
Total investment, net (US$ million) 1,247 1,406 3,190 4,539 1,717 1,009 1,182 2,188
Total as per cent of GNP 0.8 0.9 2.0 2.5 1.3 0.6 0.6 1.1
Foreign direct investment permits by country of origin (per cent of total):
EU 69 53 62 56 66 64 85 61
      France 36 13 19 11 17 16 62 6
      Netherlands 4 14 15 10 13 19 9 12
      Germany 8 10 11 8 15 13 6 17
      Italy 4 9 7 20 11 3 1 7
      United Kingdom15465464 7
      B e l g i u m - L u x e m b o u r g 1222432 2
Switzerland 7 23 11 19 11 8 5 10
U n i t e d  S t a t e s 76 1 174 1 14 3
Others 17 18 16 19 20 17 6 25
Foreign direct investment permits by activity (per cent of total):
A g r i c u l t u r e 3121212 1
M i n i n g 3211020 2
Manufacturing 65 56 70 76 75 68 17 52
S e r v i c e s  ( i n c l u d i n g  c o n s t r u c t i o n ) 2 94 12 72 22 32 98 1 4 6
Source: State Planning Organization (various issues), Main Economic Indicators;   and data supplied by the Undersecretariat of Treasury,
General Directorate of Foreign Investment.
(3) COMPOSITION AND DIRECTION OF TRADE
28. The share of merchandise trade to GNP increased from 9% in 1979, when the economy still
pursued an import-substitution policy, to 25% in 1993 and to 38% in 1997.  However, as noted above,
the trade data are underestimated due to lack of detailed information on "shuttle" trade with thecountries of the former Soviet Un ion and Eastern Europe (Box I.3).
(i) Composition of merchandise trade
29. The share of manufacturing in Turkey's merchandise exports has increased in the 1990s,
continuing the trend seen in the 1980s.  The share increased from 72% in 1993 to 75% in 1997 and
increased by 78% in value, while primary products fell from 28% to 24%.  In addition to the leadingtextiles sub sector, important contributions to the expansion of the manufacturing sector were made by
machinery and transport equipment (Table AI.4 and Chart I.3).  The contribution of clothing has
fluctuated over the past four years, accounting for 26% in 1997.  The iron and steel sector reduced its
share of total merchandise exports, but continues to be an important export item.  However, reflecting
their comparative advantage, labour-intensive industries, textiles, food, and iron and steel, stillaccount for about 40% of merchandise exports.WT/TPR/S/44 Trade Policy Review
Page 12
Chart I.3
Product composition of merchandise trade, 1993 and 1997
1993 1997
(a)    Ex ports
Agriculture
24.4
Iron and 
steel
11.9Other manufactures
12.9
Textiles and
clothing
38.7
Machinery and 
transport equipment
8.4Mining
3.7 Manufactures
71.9
Total:   US$15.3 billion Total:   US$26.2 bi llion
(b)    Im ports
Chemicals
11 9Other 
mining 
4.7Fuels
13.5
Mining
18.2Other 
0.5 Agriculture
10.5
Machinery and 
transport 
equipment
38.2Iron and 
steel
6.8Other 
manufactures
8.4
Manufactures
70.8Mining
15.1Agriculture
10.1Other
2.8Other 
manufactures
10.3
Machinery and
transport 
equipment
38.4
Other semi-
manufactures
5.2Fuels
10.3
Other 
mining
4.8Manufactures
71.9
Chemicals
13.2
Total:   US$29.4 billion Total:   US$48.6 bi llion
Source :  UNSD, Comtrade database (SITC Rev.1).Per cent
Other semi-
manufactures
5.5Agriculture
20.8
Iron and 
steel
8.6Other manufactures
15.3
Textiles and
clothing
38.3Machinery and 
transport equipment
12.7Mining
3.2
Manufactures
74.9Other 
1.0
Iron and 
steel
4.8WT/TPR/S/44 Trade Policy Review
Page 14
Chart I.5
Direction of merchandise trade, 1993 and 1997
1993 1997
(a)    Ex ports
Germany
23.8
Middle East
14.0 EU15
49.5
United States
6.4
Other EU15
15.4
Former USSR
6.4Germany
20.0Other 
10.2
Middle East
9.9
EU15
46.7
Former USSR
12.4Other EU15
15.6United 
States
7.7Other Asia
5.2
Other Europe
7.9Italy
5.3United 
Kingdom
5.8
Total:   US$15.3 billion Total:   US$26.2 billion
(b)    Imports
Italy
8.7
United States
11.4Middle 
East
9.6EU15
47.1Other 
5.9
Germany
15.4
Former USSR
7.6Other Europe
6.3Other Asia
12.1
Other EU15
16.4France
6.6Germany
16.5Other
9.8
France
6.1Middle East
5.6
Former USSR
7.5Italy
9.2
Other Europe
5.3
Other EU15
19.4United States
8.9EU15
51.2
Total:   US$29.4 billion Total:   US$48.6 billion
Source :  UNSD, Comtrade database (SITC Rev.1).Other 
6.7
Other Asia
10.0Per cent
Italy
4.9United 
Kingdom
5.4
Other Europe
7.0
Other Asia
11.7Turkey WT/TPR/S/44
Page 15
32. Turkey's intra-industry trade (ITT) with the EU , which refers to trade of goods in the same
industrial category, is small, albeit growing, with the ratio of ITT to total trade increasing from 13
in 1993 to 21 in 1997.  Turkey's ITT with the rest of the world is only slightly higher than that with
EU, with an ITT ratio of  28 in 1997.
(iii) Trade in services
33. Services are an important part of international trade for Turkey.  Balance-of-payments data
indicate that Turkey has continued to be a substantial net exporter of services since its previous
Review.12  Receipts on services increased from US$10.7 billion (equivalent to 6% of GNP) in 1993 to
US$13.0 billion (7% of GNP) in 1996; in 1996 tourism accounted for about 43% of total receipts,
while construction services made up another 15%.  The major items on the debit account, which
amounted to US$6.4 billion in 1996, are personal, cultural and recreational services (29% of debitsin 1996), freight services (20%) and travel (20%).  Data on trade in services by major trading partners
are not available.
(4) OUTLOOK
34. Although the prospects for the Turkish economy have improved considerably since the last
Review, the economy is still performing below its full potential.  The imbalance in the governmentbudget continues to be detrimental for the outlook of the economy.  Inflation remains high and the
borrowing requirement of the public sector has driven up real interest rates increasing the costs of
private investment. Moreover, slow progress in the implementation of key structural reforms, such as
the overhaul of the social security system, risk delaying the recovery of the fiscal position.  The
efficiency of the economy would also benefit from  speedy privatization of state economic enterprises
and the banking sector.
35. The recently concluded customs union between Turkey and EU is expected to have a major,
positive impact on the economy, but it has also created a number of challenges, including the need to
replace revenues from border taxes.  An expected upsurge in foreign direct investment does not
appear to have materialized; rather, the increase in  inflows of short-term capital in recent years may
give cause for concern over the future burden of foreign debt financing.  Controlling the debt burden -
internal and external - may therefore be the major constraint on Turkey's macroeconomicperformance.
                                                     
12 It should be noted that official statistics on  services over-record actual flows (see Box I.3).