In order to maintain sustainable growth, Turkey needs to introduce necessary reforms to increase national savings and reduce its dependency on consumption-based revenues and short-term capital flows, the World Bank has said in a new report.
“Fiscal policy needs to adjust to support the increase in national savings, reduce the reliance on cyclically volatile consumption-based taxes, and in turn, lay the foundation for sustained growth in the coming period,” the institution said in its “Turkey in Transition: Time for a Fiscal Policy Pivot?” report launched June 2.
The report begins with praising the country’s “prudent” fiscal policy, which distinguished the country’s successful policies from other emerging markets in the aftermath of 2001 crisis.
It says “expenditure restraint helped contain fiscal deficits and revenue growth was supported by a compositional change in revenues from direct to indirect – or consumption-based – taxation.”
The report also states the boom in public revenues enabled the government to allocate more of the budget for social expenditures, by about 5 percentage points of the GDP.
“The consolidation of public finances also helped the country attract greater international capital flows, reinforcing the decline in interest rates and fueling private sector growth,” the report adds.
However the report continues with saying access to cheap global liquidity also precipitated a trend decline in domestic savings and a corresponding increase in external imbalances.
According to the World Bank, there are several areas requiring urgent reforms to keep the country’s successful fiscal performance on track.
The recommendations in the report include “shifting spending toward public investment and restraining growth in current spending to establish a growth model less dependent on debt-financed consumption.”
Heavy reliance on external financing contributed to an increase in investment volatility, which is significantly higher in Turkey than in benchmark countries, the report states.
The report also underlines that the country needs to diversify its main revenue resources by finding alternatives, “such as broadening the tax base and taking structural measures to boost employment creation, perhaps combined with expenditure cuts, to offset the diminishing incremental revenues from structural change.”
As part of this, the government should make adjustments in taxation composition as well, the report notes, suggesting shifting from consumption-based taxes to higher effective capital taxation as a way to maintain faster growth with higher domestic savings and continued fiscal prudence.
Recalling the macro-prudential measures introduced by the banking authority to curb domestic consumption and increase savings, the report warns it may lead to mixed results, saying higher effective capital taxation may be a way out.
“A key policy objective of the government is to increase the national savings rate. However, given the structure of taxation, an increase in private savings would negatively affect public savings because it implies a decline in consumption-based tax revenues,” the report cautions.
The World Bank report also adds increasing the participation of women in the labor force as another policy requirement for raising public revenues.
At 31 percent, the female labor force participation rate in Turkey is the lowest in the OECD and low compared to other fast growing emerging markets, according to the report.
The report also notes there are limits to what fiscal policy can do to support higher sustained growth without corresponding policy changes in other areas.
“Improvements in the business environment are needed to boost Turkey’s competitiveness, attract more foreign direct investment and facilitate export-led growth. This will also allow Turkey to absorb and benefit from the stream of youth and women entering the labor market, in turn enhancing Turkey’s production capacity,” it said.