Turkey is to drop the 15 per cent withholding tax that it imposed on foreign investors in January, in an attempt to stem losses on the country’s financial markets.

The move brings Turkey in line with European Union norms on domicile and residence rules for taxation of individuals, Kemal Unakitan, finance minister, said.

Under the proposed changes, the withholding tax on income and dividends from financial instruments held by non-residents would drop to zero, while the rates applied to Turkish residents would be cut from 15 to 10 per cent. Ankara will retain the 15 per cent withholding tax on deposits and repos held by domestic investors, while the tax exemption for derivative instruments will stay.

The Istanbul bourse has fallen more than 20 per cent and the lira about 20 per cent since foreign investors began pulling out of riskier emerging markets last month.

“This is certainly a step in the right direction, but not enough to stop the sell-off,” said Mahmut Kaya, head of research at Garanti Securities in Istanbul. Investors would like to see more concrete action from Ankara; it was critical to continue political stability and to resolve the Cyprus issue blocking smooth EU negotiations, he said.

Mr Unakitan stressed the government’s determination to stick to strict fiscal discipline, saying “one of the most significant indications of our resolution” was that Ankara had met 63 per cent of its primary budget surplus target within the first five months of 2006.

The minister said the government would keep deficit social security spending at no more than 4.5 per cent of gross national product and hold to inflation targets of 4 per cent in 2007 and 2008.

Mr Kaya said fiscal restraint did not address the “more profound issues” behind the loss of investor confidence in Turkish assets. The transformation of Turkey’s economy in recent years stood on three legs, he said: a favourable global environment of high liquidity, political stability in Ankara, and the loan agreements with the IMF coupled with the increasing likelihood of EU accession.

Now that the global environment had turned against emerging markets, it was important that Ankara address investors’ concern about next year’s presidential election, and also do everything it could to keep EU accession on track, he said.

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