Turkey Economy: IMF Relents

The IMF and the Turkish government appear to have reached a compromise on the planned changes to the social security system which had seen them at loggerheads for several months. This accommodation is likely to result in the release of further tranches from the Fund's three-year US$10bn standby credit agreement. The government has bolstered its bargaining power with the IMF as a result of Turkey's increasingly healthy budgetary position. However, it can ill afford to let the issue of social security reform drag on indefinitely.

The proposed reform bill was a central element in the stand by agreement, which was signed in May, and the government has pledged to get it approved by parliament before the summer recess in July-September. That deadline was missed, and, as a result, the first IMF programme review was not concluded and the credit tranche was withheld. The delay was at least in part justified by the government's other priorities, particularly trying to ensure that EU membership negotiations opened, as agreed, on October 3rd. During the summer months the IMF insisted that the bill should be approved when the parliament reconvened in October. However, no progress was made and the conclusion IMF review was postponed further. It now appears that the IMF is now prepared to approve the release of the next two credit tranches, worth a total of about US$1.6bn, in December, bringing the disbursements back on schedule, without insisting on prior parliamentary approval of the social security reform bills. The greater flexibility shown by the IMF is likely to have been influenced by Turkey's continued strong fiscal performance in 2005 and the government's tight draft budget for 2006. It remains unclear whether the two sides have agreed on a new deadline for passing the reform legislation.

Deficit

Despite Turkey's favourable demographics, the country's social security system is already running a large and growing deficit, currently of about 4.5% of GDP a year. The imbalance puts pressure on the public finances and therefore if it continues to widen may jeopardize the macroeconomic stability that Turkey has achieved since the 2001 financial crisis. The cumulative deficit in the past ten years adds up to about YTL475bn (US$350bn) at constant 2004 prices, which is equivalent to 150% of the government's total debt last year. Yet only 48% of the work force is covered by a social insurance institution, and 20% of the population has no health insurance at all.

The share of GDP transferred to the pensions system tripled during the 1990s, thanks to the introduction of an unsustainable set of reforms that included lowering the effective retirement age to 38 for women and 43 for men. Limited parametric corrections were introduced in 1999, including increased contributions, decreased benefits and a gradual increase of the retirement age to 52/56 for women/men for current workers, and 58/60 for new entrants, with a transition period of ten years. Although the minimum contribution period was also increased to 25 years for new entrants and 17 for current workers (again with a ten year transition period), effective retirement age remains low, with over 60% of new retirees in 2004 below the age of 58/60.

Joined-up

Among the major problems that remain is the lack of coordination between the five institutions that make up the social security system. Collection of premiums is low, largely owing to significant incentives not to pay, such as previous amnesties on past debts and a policy (until 2003) of applying a low rate of interest to overdue payments. The low requirement for minimum contribution (ranging from 7,000 to 9,000 days) still means the effective retirement age is still very low. Regulations regarding private pension schemes are underdeveloped and chaotic, failing to nurture a much needed private pensions market that could reduce the pressure on the public system.

With Turkey's dependency ratio set to increase rapidly within the next few decades, the social security system is expected to become an even greater burden on the economy. In a period of just 27 years (between 2012 and 2039) the ratio of those aged 65 and above to the rest of the population will rise from 7% to 14%. If no action is taken, transfers to the system could increase to as much as 12% of GDP by 2020. Reforms are needed not only for the sake of improved finances, but also because Turkey's current social security system fails to provide adequate pensions, sufficient health care or a social protection net that includes effective poverty relief and unemployment benefits.

Comprehensive

The social security reform to go before parliament as part of the IMF backed programme is comprehensive as it covers all aspects of social protection: healthcare, social welfare benefits and services, and retirement pensions. It has four complementary components:

* General health insurance: the five existing services will be merged into one and an obligatory premium based insurance system is to be established with the state paying for the least well-off. A national database is to be set up to provide doctors with access to the medical information of all insured members;

* Social benefits and services: aimed at the least well off with benefits determined by objective minimum subsistence level criteria and funded by the state out of tax revenue;

* Retirement insurance: the five different funds are to be merged into one system under which rights and obligations will be the same for all. New regulations will be established for parametric issues such as retirement age and the replacement rate;

* Institutional restructuring, which is to be carried out over a three year period, aims to ensure the three functions of the social protection system work efficiently together, improving premium collection, facilitating access to services for citizens and swifter payment of healthcare providers.

The proposed reform probably could have gone further, given the relatively weak opposition that the government has faced from workers' and employers' unions, and from the main opposition party, the Republican People's Party (CHP). This would avoid repeated tinkering with the system in the future (something that in Italy, for example, has contributed to considerable uncertainty). In particular, the proposed reform fails to address adequately the issue of Turkey's low effective retirement age, which is one of the main problems plaguing the system. The proposed increase in the minimum contribution period to 9,000 days (about 20 years' service) will do little to raise the effective retirement age. A minimum of 9,000 days was already the required contribution period for two of the three main social security institutions, covering 45% of all contributors.

The reform also lacks incentives to keep people in the work force beyond the minimum period of contribution by increasing pensions for later retirement and restricting re-employment immediately after retirement. The proposed replacement rate of about 75% is also still too high, compared with an OECD average of 57% and measures have not been proposed to boost Turkey's private pension funds. The total assets of private pension funds is 113% of GDP in the Netherlands, 52% in Ireland, 5% in Hungary, but under 1% in Turkey. Finally, the major administrative improvements needed to curb informal employment (the benefit of which is not limited to a more efficient social security system) and improve collection of premiums will not be easy to implement.

More delay?

The political costs of an indefinite delay are considerable. The additional time allowed by the IMF was probably necessary to draft the reform and give the government time to explain its benefits. However, any delay much beyond the first quarter of 2006 will drag the public discussion of the issue closer to the general election due by late 2007, which might cause the government to be less willing to take on opposition, especially from workers' and employers' unions. If this happens the reform may be abandoned or diluted, damaging relations with the IMF and making further changes necessary in the not-too-distant future.