Turkish Economic Stimulus Package Foresees Temporary Tax Cuts in Automotive and Other Sectors

The Turkish government announced a comprehensive economic stimulus package on Friday. The decision comes against the background of deteriorating economic indicators that signal a serious recession and mounting pressure from market players for the government to act swiftly to alleviate the crisis. Industrial production showed a record decline in January, falling 21.3 percent from the previous year (www.tuik.gov.tr, March 9). Accompanying drops in capacity utilization and growth figures and the rapid devaluation of the Turkish lira further exacerbated concerns about the economy.

The International Investors Association of Turkey (YASED) published the results of a recent survey conducted among its members. Investors shared pessimistic expectations for the Turkish economy in 2009 and anticipated a recovery only in 2010. Among the measures they expected to be taken were the introduction of an urgent economic package and the conclusion of a loan agreement with the IMF (www.yased.org.tr, March 11).

The government previously had maintained that the Turkish economy was better equipped than that of other countries to deal with the global financial crisis and would be able to survive the storm. The government therefore adopted a reluctant attitude toward negotiations with the IMF and sought to address the crisis with its own methods. It previously introduced three smaller packages, which did not satisfy expectations. Until now the most serious measure adopted by Ankara to avoid a recession was the decision made by the Central Bank in February to lower its benchmark interest rates to a record low of 11.5 percent. This move, however, was not sufficient enough to address the mounting economic problems in Turkey (Hurriyet Daily News, March 12).

The government appears to have acknowledged that irrespective of the Turkish economy’s strengths, shrinking world markets and the resulting contraction in foreign and domestic demand remain the main challenges and that more serious measures are needed to stimulate the economy. On March 13 the government announced a package of economic measures amounting to 5.5 billion Turkish liras ($3.2 billion). The package will introduce temporary tax cuts for three months in the housing, home appliances, and automotive sectors. The new regulations will lower the private consumption tax rates (OTV) on the automotive sector and remove the OTV completely on home appliances, while the value added tax (VAT) on apartments over 150 square meters (1,614 square feet) in size will be lowered from 18 to 8 percent. The package also foresees measures to boost exports by allocating an additional 500 million liras ($296 million) to Eximbank, a state-owned bank geared to supporting exporters (Anadolu Ajansi, March 13). Pending cabinet approval, the package is expected to be put into force within the week (Anadolu Ajansi, March 15).

The new tax regulations seek to stimulate domestic demand in Turkey’s leading industries. Industry Minister Zafer Caglayan explained the details of the reduction of the OTV on motor vehicles and said that it might be implemented as early as Monday. For automobiles with engines of up to 1,600 cubic centimeters, OTV will be reduced from 37 percent to 18 percent, and for vehicles with engines of between 1,600 and 2,000 cubic centimeters, it will be reduced from 6o percent to 40 percent (Anadolu Ajansi, March 15).

The representatives of major automobile producers had been expecting the government to make such a decision for some time, and overall they welcomed this development. They noted, however, that although the package might relieve the sector’s problems temporarily by helping reduce the current inventory, it would be insufficient alone to solve the structural demand-side problems of the sector. Representatives from other economic areas also pointed out that given the three-month time limit on the tax cuts, the package would fall short of expectations and fail to stimulate the economy in the long run. Representatives of the housing sector noted that since only 5 percent of Turkey’s total real estate consisted of homes of more than 150 square meters, reducing the VAT on property was not likely to have a major effect. The VAT on houses with fewer than 150 square meters is already 1 percent (www.ntvmsnbc.com, March 13).

In a related development, Turkey held direct talks with the IMF after a long break. Although the market players believe that an agreement with the IMF is urgently needed to restore confidence in the Turkish economy and reduce the volatility in financial markets, the government balked at such an accord. Turkey maintained that the conditions set forth by the IMF were "unacceptable" and against the country’s national interests, and indefinitely suspended direct talks with the IMF (EDM, January 29; February 18).

The IMF announced last week that it had forwarded new proposals to Turkey regarding three issues that had caused disagreements, and Economy Minister Mehmet Simsek said that the IMF had acted more flexibly toward Turkish sensitivities. The reports boosted the markets, helping the lira regain its strength after hitting an all-time low against the dollar (www.yurthaber.com, March 12). A Turkish delegation led by Simsek attended the G-20 Summit in London, where they met with IMF Managing Director Dominique Strauss-Kahn and First Deputy Managing Director John Lipsk. Upon his return to Turkey, Simsek told reporters that Turkey and the IMF had agreed on consultations and to exchange opinions on the new offer. Noting that Turkey and the IMF had an agreement of principle, Simsek stated that Turkey had taken the IMF’s benchmarks into account in introducing its own package and would be mindful of the medium-term financial implications of such short-term measures (Cihan Haber Ajansi, March 15).

It remains unclear how Turkey will finance the stimulus package, especially with further tax cuts; and a growing budget deficit set to increase this year. Nor is it clear at this stage whether incentives on consumption alone can really boost the economy without complementary measures to improve consumers’ income or decrease unemployment. Following local elections at the end of March, Turkey might finally go ahead and conclude the IMF loan agreement. With the IMF concerned about maintaining budgetary discipline and business circles seeking a more comprehensive economic recovery package, it is difficult to see how the government will find a middle road that will satisfy both parties.