[Economic data in the course of being updated]

Despite the weakness of the public sector and current economic problems, the Turkish economy remains resilient. Ranked by the World Bank as the world’s 16^th largest economy on a purchasing power parity basis (with a GNP of US$410bn), the country’s geographical proximity to the European Union and dynamic private sector are a source of strength.

The Turkish economy is supported by a large informal economy, which some estimates suggest is around 50% of GNP. Although adversely affected by the Russian collapse, anecdotal evidence suggests the sector remains robust and will remain an important support for the economy.

Political instability has been a root cause of Turkey’s economic problems and is a primary factor in the country’s sub-investment sovereign credit rating, although a modest up-grading is in prospect. The lack of strong government has been a serious disadvantage for Turkey, but the new government of Prime Minister Ecevit has made an encouraging start in implementing the structural reforms necessary to overcome Turkey’s fiscal deficit problems.

Despite political weakness, the real economy has enjoyed some success. Growth this year is expected to reach 5-5.5% and inflation is at its lowest level since 1996. Privatisation has marked up some successes, although with the slippages which are a feature of change in Turkey. Whilst an appalling human tragedy, the August earthquake last year did not have a large impact at a macro level. The country is remarkably resilient, and recovery has been swift. A major weakness, however, remains in the very low level of direct foreign investment.

IMF support remains of paramount importance to Turkey. The Government is committed to the 3 year stabilisation programme entered into in 1999 and updated in June this year and this has largely been adhered to- a record in the long history of Turkey’s relations with the IMF.

Politically, it is encouraging that the coalition government has held together and with the acceptance of Turkey as a candidate for entry to the European Union, and the reduction in violence in SE Turkey following the capture of Abdullah Ocalan, the way is more open for a move to greater democracy. The election of a new President who is, for the first time for many years, neither a politician nor a former general has been widely welcomed.

GML continues to structure bank-guaranteed transactions, in both the private and public sectors, generally in the 1 to 2 year maturity range. The yield in these transactions provides a substantial pick-up versus the headline borrowing rates that apply for the same banks in the syndicated loan market, and GML transactions are arguably of higher credit quality in that there are underlying transactions which are self-liquidating, and both the corporate borrower and the guaranteeing bank provide sources for repayment.

Summary
Following several years of poor performance, 1998 marked a significant improvement in Turkey’s fiscal position. At the same time, tight demand management policies combined with weaker commodity and oil prices to contribute to a substantial fall in inflation. The latter two factors along with easing demand pressures and reverse currency substitution helped the external position. Foreign exchange reserves soared to record highs in June, supported by strong capital inflows during the first half of the year. However, these gains were not repeated in the second half as the economy was hit by the impact of the Russian financial crisis. Almost over-night, foreign investors deserted the market, sending domestic interest rates to over 140%, and wiping some $7bn off reserves. Adding to economic troubles, political uncertainties intensified following the collapse of the Yilmaz government in November 1998. It was hoped that the appointment of a caretaker government would help stabilise the economic situation. Instead economic reform ground to a halt and fiscal pressures intensified sharply. In April, however, the political environment took a turn for the better. Although the election was not conclusive, the resulting coalition government is one of the strongest in parliament for a number of years. The formation of the new government has renewed hopes of structural reform.

Tight demand management policies combined with weaker external demand led to a rapid cooling down in the economy in 1998. Real GNP, which had increased by 9% in the first quarter contracted by 1.4% in the final quarter as the domestic and external environments deteriorated. The slowdown intensified in the first quarter of this year (real gnp contracted by 8.5%), and the outlook for the remainder of the year is not encouraging. Industrial production has continued to contract throughout the first half, and it now seems as if real gnp growth will be restricted to around 0.5-1% this year. However, the combination should help contain inflation and will limit any slippage in the current account.

The momentum for economic reform has improved since the formation of the new government of Prime Minister Ecevit. The new administration has already demonstrated that it is willing to work with the IMF, and although it is likely to pursue a policy of gradual reform, it appears committed to the process. Its first priority will be to contain fiscal pressures following on from the sharp increase in the central government deficit in the first five months of the year, but it must also press ahead with social security reforms before the IMF is likely to consider replacing the current staff-monitored programme with a financial lending programme. The scale of Turkey’s fiscal problem is apparent in latest budget revisions for 1999. The budget deficit is projected to almost treble to TL9316 trillion lira, and interest payments are set to rise by 67% to Tl10410 trillion.

The tragic earthquake of August 1999 had less economic impact than at first feared, firstly, because the main damage was to residential buildings, rather than to factories or office buildings. Production was resumed quickly at many of the industrial plants which were effected, the exception being the Tupras refinery in Izmit, which was been severely damaged. Apart from the rebuilding costs, Turkey had to increase its oil imports with an obvious effect on the trade balance.

Secondly, there were major inflows of foreign aid, from the World Bank, the IMF and other sources. So whilst a setback, of appalling human consequences, the earthquake did not push Turkey off course, and the rating agencies were been quick to state that they saw no lasting economic deterioration as a result.

THE EUROPEAN UNION- A FACTOR FOR STABILITY
Acceptance of Turkey by the European Union as a candidate member is important not for any expectation of any great immediate progress, but as reinforcing the pro-Western direction of Turkish politics. In the short term it will help relations with Greece (which have in any case improved in recent years), and will provide ammunition for those inside Turkey seeking to bring about greater democracy into its institutions. The recognition of the need to being seen be improving human rights was an important factor in the Government’s evident unwillingness to carry out the death sentence on the PKK leader, Abdullah Ocalan, after his capture and trial last year.

Politics – WILL THE CHANGES LAST?
Despite a long democratic tradition (a multi-party democratic regime has operated since 1945), Turkey’s political system has consistently failed to deliver stable government, and policies capable of overcoming severe macro-economic imbalances.

Since July 1996, when the country’s first Islamist-led coalition government (headed by Necmettin Erbakan’s now-banned Welfare Party (RP)) took office, the political environment has been in a perpetual state of turmoil. Although the Welfare government proved less radical than some of its pre-election rhetoric had suggested, its inability to manage the economy proved its undoing as public opinion turned against it and its coalition partner, Tansu Ciller (leader of the True Path party). Vehemently opposed by Turkey’s staunchly secularist military, as well as most of the media and local businessmen, the Erbakan government collapsed less than one year after taking office. Unable to secure the votes needed to install Mrs Ciller as Prime Minister when Erbakan’s allotted year in office came to an end (Erbakan had agreed to share the premiership with Ciller as a condition of True Path’s support) President Suleyman Demirel dismissed the government.

The Erbakan government was replaced by a three-party minority coalition government, led by Mesut Yilmaz, leader of the centre-right Motherland Party (Anap). The Democratic Left Party (DSP, centre left), led by Bulent Ecevit, and the Democratic Turkey Party (DTP, centre-right), led by Husamettin Cindoruk, joined what proved to be a brittle coalition and Parliament voted to hold a general election in April 1999. However, the Republican Peoples Party (CHP), which had given broad support to the Government, decided to vote with the opposition to censure Yilmaz and the state minister for the economy Gunes Taner, and the government fell in November.

The collapse of the Yilmaz government plunged the country into a six week political crisis, which finally came to an end in January 1999 with the appointment of Bulent Ecevit as caretaker prime minister. Although the caretaker DSP government was dependent on the support of the two main right-of-centre parties, Anap and True Path, more importantly, it enjoyed the support of Turkey’s military establishment.

Another coalition government for Turkey - but this one seems different
A skilled politician, Bulent Ecevit used his brief period in office to enhance the DSP’s prospects in the 18^th April polls. Not only did the government back track from implementing the politically sensitive 1999 budget and reform of the social security system, as promised, but Mr Ecevit also capitalised on the capture of Kurdish rebel leader, Abdullah Oclan, taking most of the credit for his arrest.

As expected the DSP emerged as the biggest single group in the new parliament, securing 22.2% of the poll, and 136 seats. The main election surprise was the success of the Nationalist Action Party (MHP), led by Devlet Bahceli, which won 18% of the total vote and 129 seats.

Ecevit was subsequently asked to form a new government, and after lengthy negotiations formed an alliance with the nationalist MHP and the centre-right Motherland party of former Prime Minister Mesut Yilmaz. At first glance the new coalition appeared to be similar to the administrations that have been in power since the December 1995 election and that have proved so ineffective at running the country. However, with a combined strength of 351 MPs (only 16 seats short of the two-thirds majority needed to change the constitution and more than sufficient to secure the 276 votes needed to win a confidence vote), the new administration has considerable power. Not since Turgut Ozal held office in the mid-1980s has an administration had such a formidable majority in parliament. While it remains an eclectic mix of former leftists, hard-line nationalists, centre-right reformists, the new government is nonetheless probably the best that could have been hoped for from the election.

Political parties: breakdown of parliamentary seats

For Turkey’s other main parties, the election was a disaster. Tansu Ciller’s True path party (DYP) saw its share of the vote fall to 12% from over 19% in the December 1995 election. The biggest loser, however, was the Republican People’s party (CHP), which failed to win a seat in the new Assembly. Both parties suffered from a backlash among voters against the corruption and political manoeuvrings of recent years. The Motherland Party (Anap) led by Mesut Yilmaz, also appears to have suffered from this - its share of the vote fell from 19.6% in 1995 to 13.2% in 1999 - although its fortunes have improved since joining the DSP and MHP in government. The pro-Islamic Virtue Party, the successor to the Welfare party of Necmettin Erbakan, also lost out in the polls, winning only 15.4% of the vote. In the past the party has attracted a large protest vote, but has lost out to the nationalist MHP. For Virtue the combination of complex leadership struggles, lack of funds and doubts about its existence (Turkey’s chief state prosecutor has legally challenged the party’s existence) have cost it votes.

The role of the military
The army considers itself a guardian of the secular state under the Constitution, and plays an active part in the country’s politics. It was the army that identified the Islamists as a serious threat and was instrumental in the dissolution of the Welfare-led government in 1997. It wields considerable power through the National Security Council (the country’s highest consultative body) and has become increasingly active in politics in recent years, in part because of the growth in the Islamic vote. It also enjoys substantial independence, particularly in its war against the Kurdish separatists in the south east of the country. The arrest of the leader of the outlawed Kurdistan Workers Party (PKK), Abdullah Ocalan, was considered a major triumph by the military establishment. Since 1984, the PKK has waged a violent guerrilla campaign against the authorities and other Kurdish groups, in the South East.

Ocalan was found guilty of treason and sentenced to death, but the sentence has not been carried out and the case is before the European Court of Human Rights. Ocalan called for an end to the armed struggle, a call the ruling council of the PKK subsequently endorsed, and there has been a marked drop in violence. The military has now turned its attention to trying to root out of the public service anyone suspected of Islamic fundamentalism, a move which is resisted by the new President, and to continuing to oppose the use of Kurdish as a medium for education and in the press and television.

Improving macro-economic management
The repeated failure of successive Turkish governments to stabilise the fiscal position is the primary cause of the country’s macro-economic problems of the past decade - high inflation and interest rates. Between 1989 and 1997, the public sector borrowing requirement - which includes the consolidated government, local authorities, extra-budgetary funds, social security funds and state enterprises - never fell below 5% of GDP.

In a welcome departure from past governments, however, the coalition government of Mesut Yilmaz proactively started addressing the country’s problems. As part of a three-year programme aimed at drastically cutting inflation, demand management was tightened significantly and structural reforms advanced. Under the terms of the programme a marked increase in the primary fiscal surplus was targeted; large public deficit sectors were to be reduced; public sector wages and agricultural support prices adjusted in line with targeted inflation; structural reforms introduced to ensure a lasting strengthening in public finance; the privatisation programme stepped up; the banking sector strengthened; and limits imposed on Central Bank net domestic assets to ensure consistency of overall policies. The programme won the support of the IMF, which in June 1998, agreed to implement an 18-month staff-monitored programme (SMP). Although the SMP carries no financial commitment from the IMF, it was regarded as an endorsement of the government’s new policies.

In most cases the programme has been a success. The primary fiscal surplus has strengthened in line with programme targets, inflation has fallen significantly, the Central Bank has limited expansion of net domestic assets, thus supporting the reserves position, and some progress has been made on structural reform, particularly during the first half of 1998. However, external shocks associated with the collapse of Russia, as well as the heightened political uncertainties of the second half of the year, undermined the structural reform process and put tremendous upward pressure on real interest rates. It is hoped that the new government of Prime Minister Ecevit can push through the necessary reforms to restore stability.

Turkey, the IMF and structural reform
There was some progress on structural reform in 1998. Agricultural support prices were raised broadly in line with inflation and tax reform legislation aimed at cutting tax collection lags and broadening the tax base was adopted. However, in other areas, the pace of reform was disappointing. Plans to strengthen banking supervision were derailed by the collapse of the Yilmaz government and early elections disrupted social security reforms.

The disruption caused by the financial crisis in Russia last year, as well as political developments since late-1998 have caused some problems for Turkey. Performance under the staff monitoring programme agreed with the IMF last year has been somewhat mixed. While wholesale price inflation was cut in half over 1998 and fiscal policies remained restrictive, despite the surge in interest rates in the second half of the year, pre-election spending and poor revenue collection have seen the fiscal deficit increase sharply in early 1999. An IMF delegation visited in the immediate aftermath of the formation of the new government and although a standby facility was not announced, it is hoped that the staff monitoring programme will be replaced with an IMF lending programme sometime in the near future. Although details of IMF conditions are not known, the Fund is known to want to see a sustainable improvement in Turkey’s fiscal position. To its credit the coalition government has recently passed legislation reforming the banking sector and has signalled its commitment to containing inflation by supporting a 20% pay rise in state sector wages, despite stiff trade union opposition. One area of concern is the recently announced "economic stimulation" package which is likely to undermine fiscal deficit targets this year. Nevertheless, provided the government adheres to agreed structural reforms, the IMF is likely to remain supportive.

Fiscal position
There was a genuine improvement in central government accounts in 1998, with the primary fiscal surplus slightly higher than the programme target of 4.1% of GNP, and substantially higher than the 1997 surplus of 0.1% of GNP. Reflecting, in the main, significantly better revenues (tax revenue was up 16% in real terms and official non-tax revenues rose by 65%), the primary surplus helped stabilise the consolidated budget deficit at around 7.2% of GNP, compared with 7.6% in 1997. This was despite the unexpected rise in interest rates in the second half of the year, a shortening of maturities from 12 to 8 months and an increase in interest outlays to 11.7% of GNP from 7.8% of GDP in 1997. Despite the improvement in the primary balance, the broader public sector deficit continued to widen last year because of ongoing losses at public sector enterprises.

Consolidated budget, 1998 (TRL million)

Fiscal position (% of GNP)

Political uncertainties prevented timely passage of the 1999 budget. Interim expenditure targets and domestic borrowing limits were set for the first half of the year by the caretaker government, which vowed to keep spending broadly in line with the draft 1999 budget. Under the draft budget the central government deficit was to narrow to 7% of GNP. However, in the first four months of 1999, the deficit had soared to nearly 17% of GNP. The non-interest balance shifted to a deficit of 2% of GNP, from a 6% of GNP surplus a year earlier, revenues were down 13% in real terms on a year ago, while expenditure was 10% higher.

In view of the poor performance in early 1999, the central government deficit is expected to be around 11% of GNP this year.

Revisions to government budget

Monetary policy
Since the debacle of 1994, when the then prime minister, Tansu Ciller, sought to drive down short term interest rates by monetising the fiscal deficit and borrowing overseas, rather than issuing domestic debt, there has been a fundamental improvement in monetary policy management in Turkey. A non-binding agreement between the Central Bank and the Treasury, which shifts responsibility for interest rate management to the Central Bank and pledges to end Central Bank financing of the deficit, has restored the authorities’ credibility.

Monetary policy was severely tested in 1998. In line with tighter fiscal demand management policies, monetary policy was tightened significantly in the first half of the year, but eased considerably in the second half to offset the withdrawal of foreign liquidity triggered by the turmoil in Russia. Increased foreign investor interest in the local Turkish market (both through direct T-bill buying and through the local banking system) saw foreign exchange reserves rise from US$20bn at the end of 1997 to over US$26bn at the end of June 1998. Nevertheless, throughout the first half of the year, pre-announced targets for reserve money growth were realised - in real terms with inflation in excess of targets, monetary tightening was far greater than projected.

Reserve money growth was replaced as the Central Bank’s aggregate target by net domestic assets following the Russia crisis. Around US$7bn was drained from foreign exchange reserves in the second half of 1998 as foreign liquidity pulled out of the market, initially because of the crisis in Russia, but also because of the deteriorating domestic political environment. Nominal interest rates, which had come down significantly in the first half of the year, rebounded towards 140% in September. Such was the severity of the liquidity situation in the third quarter, that the Central Bank allowed net domestic assets to expand beyond levels originally detailed in the SMP. After withdrawing around US$7.3bn of liquidity from the market via open market operations in the first half of 1998, the central bank was forced to inject roughly the same amount in the third quarter. Yields on T-bills eased marginally in October, but broke through 140% in November/December amid heightened political uncertainty and fears about the government’s ability to roll over around $16bn of domestic debt due in the first quarter 1999. Yields eased back marginally in early February after the government successfully rolled over its January debt. Yields fell below 100% in April, but edged back to nearer 105% in May.

Exchange rate adjustment

Since 1994 the focus of monetary policy has been on stabilising the real effective exchange rate of the lira against a basket made up of USD1 and DM1.5, allowing the currency to depreciate broadly in line with wholesale price inflation. During 1998, however, the currency appreciated by around 7% in real terms, in part because of central bank intervention following the Russian crisis. Although export growth has slowed sharply over the past year, the authorities do not consider the lira overvalued and are unlikely to deviate from current policy, at least in the near future.

Privatisation hopes for 2000-2001

The year 2000 has been the first year to show serious results for the privatisation programme. Privatisation and licence sales in the first half of this year totalled over $5 billion (although receipts for these have not all been received by the Treasury). Apart from the sale of GSM licences, shares have been sold in Tupras, the oil company, and in Petrol Ofisi, the petrol station chain, and the government has now put up for sale shares in Turk Telekom and Turkish Airlines. The sale of these two companies, however has been held up by a turf war between two ministers over the future management of these companies.

Although privatisation targets were not realised, 1999 and 2000 signalled a major improvement on previous years - privatisation revenues totalled only $3.5bn in the period 1986 to 1997. The next major area may be in the energy sector where sell-offs have in the past faced considerable legal obstacles. The green light now appears to have been given following the approval of the Council of State (Turkey’s highest administrative court) of the sale of electricity distribution rights in six regions and the sale of a further ten concessions. Significantly, the Parliament has also approved the constitutional change allowing international arbitration in the resolution of commercial disputes with foreign investors. This is expected to unblock billions of US dollars in investment that will flow into the energy sector.

Structural reforms make some progress
The government made some progress in structural reform during 1998. In particular, agricultural support prices were raised broadly in line with inflation while tax reform legislation aimed at cutting tax collection lags and broadening the tax base was adopted. In other areas, however, the rate of reform was disappointing. A consumption tax on luxury goods, which was aimed at streamlining the VAT system, was not implemented in 1998, neither was a long-postponed social security reform (the purpose of which was to raise the minimum retirement age and extend the minimum contribution period to be eligible for full benefits). However, these bills should now be implemented in the near future. Importantly, a banking sector reform bill (aimed at establishing an independent regulatory body and depoliticising supervision practices) has already been passed.

It is recognised by the new government that Turkey needs to adopt a more comprehensive and determined approach to structural reform, in order to achieve sustainable, long-term reduction in the country’s high real interest rates.

Economic performance
The effects of the global crisis, specifically Russia’s financial collapse, have had a severe impact on Turkish economic growth over the past year. Following a spectacular 9% rise in the first quarter, real GNP slowed sharply, to 4% in the second quarter and a meagre 1.9% in the third quarter, before contracting by 1.4% in the final quarter. Having grown by 7.5% in 1997, real gdp slowed to 2.85 last year. Growth slowed as a result of the fiscal and monetary tightening of the first half of the year and the dramatic increase in T-bill yields over the latter part of the year which intensified the crowding out of private consumption and investment. On the external front, currency devaluations in Asia combined with significantly weaker OECD demand (the OECD accounts for over 60% of Turkish exports), and the Russian crisis (an important source of export earnings for both the recorded and unrecorded economies) depressed external demand. Manufacturing growth stagnated, although industrial production increased by 2% thanks to strong growth in mining and energy output.

The weakness in economic activity intensified in the first quarter of this year. Real gdp contracted by 8.5%, far worse than expectations, and reflected sharp falls in industry (down 9.3%) and commerce (-15.4%).

Real GNP growth (%)

Inflation benefits from tight policies & slower growth
Tighter demand management policies have combined with slower domestic and global demand to cut inflation. Wholesale price inflation fell from 92.5% in January 1998 to 54.3% in December, largely on the basis of the continued decline in international commodity prices, particularly oil, over the year, rather than due to any fundamental shift in structural reforms. The December figure was higher than the original 50% target set by the SMP, but was within the revised 58% target. Consumer price inflation also slowed during the year, from 101.6% in January to 69.7% in December. Both inflation indices recorded further improvement in early 1999 - wholesale price inflation hitting a low of 48% in March and consumer inflation 63% in May.

Inflation (%, year-on-year)

External accounts
Despite the upheavals of the past year, the external accounts have remained remarkably stable. Although capital flight saw around $7bn drain from foreign exchange reserves in the second half of 1998, the external accounts proved the least problematic areas of the economy. Slower growth in domestic spending and reverse currency substitution helped support the external position last year. The trade deficit narrowed to $14.3bn from $15.4bn, and combined with a larger invisibles surplus of $16.2bn ($12.7bn in 1997) to cut the current account deficit to $1.9bn, from $2.6bn in 1997.

Reflecting the deterioration in domestic and international demand over the year, both exports and imports contracted in 1998, 4.4% and 5.1%, respectively. Shuttle trade exports to the former Soviet Union, which showed signs of slowing in 1997, continued to weaken through the year. Shuttle export volumes were down 30% year on year. After falling by an average of 10% in the first half, Turkish exports to Russia plummeted by 40% and 65% in the third and fourth quarters respectively. Unrecorded, or suitcase trade with Russia also collapsed in the same period.

According to balance of payment statistics, net surpluses in the services and income accounts combined with a substantial increase in workers remittances provided further support to the current account deficit, which fell to 0.9% of GDP from 1.4%in 1997.

Trade data

Capital inflows were significantly larger than the current account deficit in the first half of 1998, but this trend was reversed in the second half of the year, as foreign investors withdrew liquidity from the Turkish market. As a result, foreign exchange reserves, which had risen to US$26.5bn in June, ended the year at $19.5bn, only marginally higher than the end-1997 level of US$18.7bn. Short term borrowing from abroad was $5.5bn in the first half of 1998, of which US$2.5bn was net purchases of T-bills by non-residents. Net medium and long term borrowing amounted to over US$4bn, including $1.9bn in international bond issues by the Treasury. Turkish spreads widened over the latter part of 1998 as domestic political uncertainties compounded markets already un-nerved by developments in Asia and Russia, but have since fallen back.

Foreign exchange reserves (USD mn)

A weak credit rating….
Despite the dynamism of the private sector and the relative success of the real economy in recent years, Turkey attracts a sub-investment credit rating. Moody’s and Fitch IBCA classify the country as four notches below investment grade (B1 and B+ respectively) on a par with Lebanon and Bulgaria. Standard and Poor’s assigns it an even lower rating (B). Although the real economy is relatively robust and has notched up successes in recent years, the cause of Turkey’s weak rating lies in its political risks. A succession of unpredictable coalition governments have failed to tackle fundamental structural macro-economic imbalances. However, it is hoped that the new coalition government will get to grips with structural reform. Legislation has already been passed, and a social security reform bill is currently being debated.

.…But continuing support from international banks
Despite Turkey’s weak credit rating, foreign banks have continued to do business with the country’s banking sector. Although borrowing costs increased in the wake of the Russian crisis, and remained high until earlier this year because of domestic political uncertainties, access to the international loan and capital markets has been maintained. Foreign banks, particularly European banks, have continued to roll over loans and provide trade lines. Although some private banks ran into difficulties last year with the deterioration in the business environment – several small banks had to be rescued by the Turkish central bank - most banks have adjusted to the downturn in the economy. Non-performing loans have inevitably increased, and some lower tier private banks will experience further difficulties. However, comfort can be drawn from the Government’s support of the sector - a 100% deposit guarantee scheme was introduced during the financial crisis of 1994. Although the deposit guarantee scheme has been criticised for encouraging banks to assume greater risks in lending decisions, it has provided a considerable degree of comfort for foreign banks doing business with the Turkish banks.

BANKING REFORM ON TRACK

In June 1999, the long delayed banking bill, aimed at improving supervision and enforcing existing rules more stringently, was passed by the new government. With the new and more independent Banking Regulation and Auditing Agency installed in August 2000, with Parliament considering the bill to permit the commercialisation and privatisation of the state banks and with the Treasury lending up to $9 billion for the recapitalisation of the banks which failed last year and in previous years, we should see mergers and reorganisation in the sector, particularly among the smaller private banks. A straw in the wind is the interest shown by Societe Generale in Iktisat Bank. In the state sector, Vakifbank is planning the sale of 20% of its shares through an IPO. The World Bank, once the privatisation law is in place, is planning a $760 million loan for the financial restructuring of the state banks.

Outlook
Turkey’s economic prospects are inextricably linked to politics. The coalition government of Prime Minister Ecevit with its formidable parliamentary majority should provide Turkey with the political stability needed to overcome its macro-economic structural reforms. It has made an impressive start, but will need to continue with the current staff-monitored programme through the remainder of this year and in 2001 and beyond.

Inflation, the control of which has been one of the successes of the past year, should continue to reduce. The end-year target of 25% for WPI is not likely to be met, however, although at an expected 30% or so it will be a major improvement over last year’s 63%.

The external accounts should not cause any undue problems provided that investor confidence, and thus access to international capital markets, can be maintained. In any case, unlike Latin America (or Russia prior to August 1998) only a limited portion of the domestic debt stock is held by foreign investors. Although future prospects are very much dependent on political developments, and the fiscal position still has room for improvement, the authorities are expected to manage the current situation. Investor sentiment has improved since late 1998 as reflected in the substantial easing in risk premiums and lengthening of domestic debt maturities, but remains fragile. Nevertheless, with around $24bn of central bank foreign exchange reserves, short- and medium-term Turkish risk remains highly attractive at current levels of risk.

CONCLUSION
Following the election in April 1999, Turkey has probably the best government it has enjoyed in years. We are confident that the reform process is underway, and many of the economic lessons of the past decade have been well learned, both by the politicians and the technocrats, although as always with Turkey, this confidence has to be qualified by the proviso that the political situation does not deteriorate. Fortunately, having survived several tests of its ability to hold together, the coalition appears determined to stay in office until the next elections.

GML continues to focus on financing flows of goods, pre-export finance, short- and medium- term working capital finance, and infrastructural project finance. In the case of shorter term credits (typically 1 to 2 year maturity), our transactions are guaranteed by banks, both in the private and public sector. These transactions provide a very substantial pick-up in yield versus the headline rates of financing at which the guaranteeing banks borrow, typically in the syndicated loan market. Given that the majority of our transactions therefore provide additional comfort in the form of both credit risk on the corporate borrower, and the guarantor bank, we feel they represent an excellent investment opportunity, against the backdrop of steadily improving economic performance, and a more stable political climate.

Turkish spreads, which were at a historic high last year, have fallen back substantially, but on a risk adjusted basis we believe Turkey still offers outstanding value, particularly when the attractive capital adequacy requirements are taken into account.

Turkey - Key Economic Indicators

Quantitative indicators for the SMP , 1998-99