Turkey was directly affected by the global crisis, but showed considerable resilience thanks to important reforms implemented after the 2001 crisis. The adverse external shock originating in financial market turmoil and propagated by a sudden collapse of world trade was amplified by domestic confidence effects. With the experiences of the 2001 banking crisis fresh in mind, companies and households cut investment and durable goods consumption.

Turkey weathered the crisis remarkably well due to its strong macroeconomic policy framework and important structural reforms implemented after the 2001 crisis and GDP growth in 2010 is expected to be high. The challenge for policymakers now is to ensure that the cyclical recovery be followed by sustained and sustainable growth over the longer run.

Turkey is recovering from its most severe recession in several decades. The massive contraction in GDP is largely explained by the unprecedented collapse in foreign demand, which was aggravated in Turkey by negative confidence effects and structural problems with competitiveness prior to the crisis. In contrast to previous recessions, Turkey could afford counter-cyclical polices and the financial markets proved resilient. During the crisis, the authorities cut interest rates significantly and promptly and implemented fiscal stimulus. This truly novel experience was possible thanks to a better macroeconomic position, a sounder monetary and fiscal policy framework, and better financial market regulations. The immediate policy challenge is to gradually remove policy stimulus and address medium-term stability considerations in a way that does not jeopardise the recovery. Once growth gains full speed, the authorities will likely face the challenge of widening external imbalances and of ensuring a smooth functioning of the financial markets. The former will require improving competitiveness, raising domestic saving, attracting more FDI inflows and reducing energy import dependency. Improvements in many of these areas will require structural reforms in the labour and product markets.

Turkey, like other fast-growing emerging countries, has significantly improved its terms of integration with the global capital market before as well as after the international crisis. Emerging markets’ risk premia and interest rates are driven primarily by worldwide investment conditions and risk appetite, but steady progress in national economic fundamentals in the 2000s has considerably enhanced Turkey’s credibility and reduced capital costs. In comparison to peer countries, Turkey has enjoyed a strong fall in risk premia, an important decline in domestic interest rates, but improvement in credit ratings has been comparatively slower.

In the 2000s, Turkey has enjoyed rapid catching-up thanks to improving macroeconomic framework, increasing openness to trade and foreign investment and the great entrepreneurial spirit of Turkish businessmen. This was possible against the adverse business environment, reflecting restrictive product and labour market regulations, since the semi-formal and informal economy had a significant contribution to the expansion of the private sector. Productivity growth was strong, but labour utilisation remained very low, affecting negatively social cohesion and the growth performance. Looking forward, higher employment and productivity growth will not be possible without profound regulatory reforms. They primarily require labour market reforms to lower minimum wages, possibly via regional arrangements, to reduce severance payments and social security contributions and to introduce more flexible forms of job contracts. These reforms have been discussed for a long time, but political obstacles prevented implementing them. Resolving this deadlock calls for advancing an integrated strategy of labour reforms and formalisation via experimenting with new regulation on the voluntary basis to identify the most successful solutions that can be later rolled over to the whole economy. Moreover, Turkey has to ease further anti-competitive product market regulations by reducing barriers to entrepreneurship and foreign direct investment and by reducing government involvement in business. A successful implementation of these reforms would allow Turkey to enjoy golden decades.