Zero margin for mistakes

Turkey is the world's fastest growing economy after China

In addition, inflation is falling, unemployment is on the wane and exports are rising. The progress has been praised by the IMF and rewarded by Fitch Ratings, which nudged Turkey's sovereign rating slightly upwards to B-. The Turkish parliament has passed a series of laws that brought Turkey very close to fulfiling the so-called Copenhagen criteria required to start membership negotiations with the EU. Relations with the US, which reached their nadir when Ankara refused American troops transit rights to enter northern Iraq, are improving. "All the things that should matter are moving in the right direction," says Morgan Stanley researcher Serhan Cevik.

Is this as good as it gets or is the Turkish economy at last turning the corner?

First the good news. With the help of a strong lira and a sharp fall in food prices, inflation is continuing to plunge. For the first time in 16 years prices are falling rather than rising. In July the consumer price index fell for the second month in a row, dropping by 0.4%. The year-on-year inflation rate fell to 27.4% in July, from 29.8% in June. It appears at long last that inflation expectations and the government's official inflation target - 20% in 2003 or almost half the 2002 rate - are converging.

"The inflation behaviour of the Turkish economy is going through a remarkable transformation," says Cevik. "The downward trajectory in price indices is not just a temporary trend. Our investigations point to further acceleration in the disinflation process."

In August, the executive board of the IMF expressed satisfaction with Turkey's economic performance and released $476 million under the standby agreement. With this tranche Turkey has drawn $15 billion of the $18 billion arranged by the standby agreement in 2002 and is entering a period when repayment to the IMF will exceed funds to be received from it. To ease the burden, at Turkey's request, the board agreed to lighten the debt repayment programme. According to this, in 2004/05 Turkey will repay the IMF $13 billion rather than $20 billion.

The IMF's green light increased chances of receiving $5.8 billion in financial support from the US as compensation for Turkish losses sustained as a side-effect of the coalition invasion of Iraq. The government has pledged to use these funds in debt relief, which, analysts say, should ease further concerns about Turkey's financing outlook over the next two years. However, Turkey may have to satisfy US demands that it should send troops to Iraq before it can unlock this bounty.

Erdogan: has to tread carefully to prevent dissent in the AKP ranks turning to factionalism and secession

IMF chairman Horst Köhler says Turkey's efforts deserve the "continu ed support" of the international community. "The government's recent actions bode well for the success of the Fund-supported programme," he says. "With strong output recovery and continued disinflation, the programme's projections of 5% output growth and 20% inflation in 2003 are within reach."

Köhler praised the government for making "strong efforts" to enact reforms and for putting in place measures "to maintain the primary surplus target of 6% of GNP". These actions brought policies back on track to achieve the basic objectives of the IMF-supported programme, "namely, disinflation, debt reduction, and sustained economic growth," he said.

Yet for all these favourable signs, the macroeconomic background offers a mixed picture.

The drop in inflation has been assisted by a sharply appreciating currency, which, according to some economists, was overvalued by 40% in July. This leads Lehman Brothers economist Tolga Ediz to conclude that the improvement in the economy is an "easing cycle" that is already over.

The central bank has acknowledged that there are two key risks on the inflation front for the second half of 2003. These are the possibility that the government might increase the prices of goods and services produced by the still huge public sector in order to close the fiscal gap and, second, a sharper-than-expected recovery in consumer demand. "We judge that both risks are likely to materialize," says Ediz.

The single most important object of the economic programme - to reduce the debt to GNP ratio - has not yet been achieved. Like Brazil, Turkey's problem is that it has a large and growing domestic debt stock that is highly sensitive to changes in interest and exchange rates. Both of these rates are susceptible to swings in market mood that are the hallmark of the Turkish economy. Despite a sharp improvement over the past year, the debt ratios remain heavy: the ratio of net debt to GNP is just under 80%.

The biggest problem on the debt front is that the markets have a deep mistrust of the government. This translates into a fat risk premium, which keeps interest rates high. In 2002 the real return on government bonds was 33%.

In November it will be a year since Tayyip Erdogan's Justice and Development Party (AKP) won a landslide victory. Electors gave AKP 363 of the 550 seats and a clear five-year mandate. The three parties that ruled before the AKP landslide were eliminated from parliament.

Opinion polls show that support for AKP is increasing but this does not reflect performance. The government has failed to manage the economy efficiently and has certainly not shown the reformist zeal expected by the market. Authority to conduct economic policy is divided between five ministers, including the prime minister, none of whom seem to have the vision and know-how required to take Turkey out of its economic impasse.

"Erdogan has some managerial abilities but no vision, no dream for Turkey," says an AKP member of parliament who does not want to be named.