Turkey needs a fiscal rule
Tapering has revealed the vulnerability of the Turkish economy. What is Turkey’s problem? The current account deficit is going to be too high, the growth rate is going to be too low. You don’t need a Ph. D to know that is not sustainable. The Turkish economic policy makers are very much aware of this vulnerability, if you ask me. That is why they are taking a series of measures to limit credit card expenditures. The new regulation would limit the ability of the consumers to pay for purchases in equal installments in the coming months. In other words, it limits borrowing from the future. However, I find this to be palliative attempts at controlling the abhorrent level of the current account deficit. We have a structural problem here. Let me phrase it this way, “It’s the fiscal policy, stupid.” Turkey needs to change its concept of fiscal discipline if it is serious about tackling the current account deficit. It needs to put an expenditure limit on the budget. Turkey needs a fiscal rule and it needed it yesterday.
Let me start from the old concept of fiscal discipline in the country. Remember the 2001 crisis in Turkey?
Bank balance sheets exploded from the sheer volume of government debt instruments (GDI). The size of the banking system was small; the outstanding volume of GDI’s was big. Forget about the small size of the banking system for a second. Why was the volume of GDI so high? Because fiscal policy was far out of its bounds throughout the 1990s. Budget practice without any fiscal discipline led to an explosion in bank balance sheets. The subsequent adjustment program was based upon fiscal discipline, which in turn, was based upon one indicator: the primary surplus of the budget.
The primary surplus is the surplus of the budget if you deduct interest expenditures from the fiscal deficit. If you have a surplus thus defined, it shows investors the government’s intent to control the high volume of GDI outstanding. It worked. Investor confidence built up and Turkey managed to lower the GDI outstanding from around 100% of the GDP to around 35% today. It was impressive belt tightening that saved the day. Kemal Derviş, together with the IMF, designed the program and Tayyip Erdoğan simply had to follow the script. Along the way, Erdoğan learned that by abiding a primary surplus target, he could spend more. So he did.
That fiscal discipline concept, however, was intended to lower the GDI outstanding, and hence, served its purpose. Finito. Now Turkey needs a new fiscal discipline indicator. That should be a fiscal rule based upon a sort of expenditure limit. Why? This time, the nature of the problem is different. It is the current account deficit, not the high volume of GDI outstanding. The current account deficit is composed of public and private sector saving-investment gaps. That is the difference between the amount of savings and investments in both sectors of the economy. Between 2002 and 2012, the share of the public sector saving-investment gap in Turkey’s current account deficit has been around 45%. On average, half of the current account deficit comes from public sector.
Government expenditure is the culprit here. We need to control that, and the best way to do it would be to impose a fiscal rule on the level of budgetary expenditures. Looking for Turkey’s source of vulnerability? It’s the fiscal policy, stupid.