Nicholas Birch in Istanbul -

Will they sign or won't they? Eight months after Turkey began negotiating with the International Monetary Fund for a new loan agreement, it's the question on everybody's lips. But analysts say ongoing speculation about the government's intentions mask a more crucial concern: regardless of the global crisis and the IMF, do Turkish politicians have the political will to ensure that Turkey retains the international trust that made it a number one destination for foreign investment in the early years of this millennium?

"Turkey may be able to roll over debt this year, but that is not the issue," says Elif Bilgi, managing director of EFG Securities, an Istanbul brokerage. "The issue is whether Turkey is going to continue with the fiscal prudence - the 'A' of state management - that led foreign investors to talk of a paradigm shift in the Turkish economy until 2007."

Bilgi is referring in part to Turkey's budget deficit, which rose to 268% in the first four months of this year to TRY20.1bn ($12.8bn) and is expected to reach $50bn - or 7% of GDP - by year-end. Turkey's political leaders say the deficit reflects efforts to stimulate a slowing economy, and insist there is no need for concern. And with counter-cyclical fiscal easing going on all over the globe these days, and the US and UK economies running much bigger deficits, they have a fair point. After six years in which it maintained budget surpluses averaging 4%, Turkey does have a little money to spend on a rainy day. Increasing financing pressures in any case look likely to be offset by a current account deficit that is expected to plummet from $42bn last year to $10bn this year on the back of lower petrol prices and slower trade.

But their assurances are a touch disingenuous too. For a start, Turkey began loosening fiscal policy in the run-up to general elections in 2007, well before the start of the global crisis. More importantly, analysts say, the budget deficit today is as much the result of Turkey's failure to put off crucial structural reforms while the global going was good, as it is of more recent efforts to stimulate a domestic economy in crisis. "The whole Turkish fiscal adjustment story was good, but over-rated: a lot of tweaking of indirect taxes - on alcohol, for instance - and little effort to attack structural weakness in the budgetary system," says Murat Ucer, Istanbul-based economist for the New York economic intelligence company GlobalSource.

Taxing questions

The shortcomings of Turkey's budget system are legion. According to a May report by the UK-based International Budget Partnership, Turkey trails far behind its developing peers in Central and Eastern Europe and South America in terms of budget transparency. Recent changes to regulations on municipal spending have reduced central government oversight even further, says Guven Sak, head of the Economic Policy Research Foundation of Turkey, an Ankara-based think-tank.

But the key problem is a tax system that depends for 70% of revenue on indirect taxation, leaving the country's finances extremely sensitive to economic downturn. IMF officials overseeing the $10bn standby arrangement Turkey completed in 2008 talked constantly about the need to reduce an unregistered economy that analysts believe amounts to a third of Turkish GDP.

On May 20, Treasury Minister Mehmet Simsek highlighted the urgent need to "up the fight against the unrecorded economy" and "collect income tax" from a broader base. But putting words into action now looks set to be more difficult than ever. The IMF expects Turkey's GDP to shrink by 5.1% in 2009, hardly an ideal environment for zealous tax inspection. For Guven Sak, this is where a new IMF loan could play a useful role. "IMF funds could reduce Treasury reliance on banks for loans, freeing banks up to finance companies hit by more efficient taxation," he argues. He is unsure whether bureaucrats and ministers are conveying this message to Prime Minister Recep Tayyip Erdogan.

But there are also political reasons for the Turkish leader's apparent unwillingness to tackle budget and tax reform: general elections in 2011.

Political considerations

As the head of a party that won 47% of votes at general elections in 2007, Erdogan was clearly stunned when his AK Party garnered only 39% of ballots at local elections this March. "The 2011 polls will define all of Erdogan's actions from now on," says Murat Yetkin, Ankara bureau chief for the liberal secular daily Radikal. "If he thinks [a new policy] will cost him votes, he will take all risks and not sign along the dotted line."

Upping the efficiency of income and corporate tax collection never was a vote-winner. What makes the issue especially sensitive for Erdogan is that tax evasion is most widespread among the small businesses and Anatolian businessmen who form the bedrock of AK Party support.

Few analysts foresee Turkey facing major economic problems in the short term, with or without a new IMF deal. For Murat Ucer, though, the government's ongoing failure to agree on the need for a fiscal rule bodes ill for the middle term. "Turkey is losing sustainability of public finances," he says. "For the past three years, we have been at a crossroads: are we going to tackle structural reforms, or are we going to basically risk going back to the 1990s, with unsustainable debt and high inflation? We haven't started that game yet, but the trend is in that direction."

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