For over three weeks during the months of November-December 2000, Turkey’s financial system was in deep turmoil. The overnight inter-bank interest rates climbed reached as high as 1700 per cent. At one point, these rates even touched 1950 per cent. Domestic interest rates reached at 60 percent, almost double from the pre-crisis period. As foreign investors started selling equities, the Istanbul stock market became extremely volatile and almost lost half of its value at the beginning of the year. The contagion effects of the Turkish "flu" were also witnessed in the Russian and Hungarian stock markets.

As witnessed in the case of the Southeast Asian financial crisis, financial flows also reversed sharply in Turkey. Fearing an impending liquidity crisis, foreign investors immediately took their money out from Turkey. The exodus of foreign funds was so sudden and swift that nearly $6 billion left the country within just 10 days. On 22^nd November alone, $2.5 billion left Turkey.

It is important to note that this financial turmoil in Turkey was not triggered by the macroeconomic fundamentals which, on the contrary, witnessed dramatic improvements in the past couple of years after almost three decades of high inflation and erratic growth. In December 1999, the IMF supported a $4 billion loan package for a three-year disinflation program to bring down inflation to a single digit by 2003. Since significant achievements were made in controling inflation, the IMF praised the disinflation program in Turkey as a "success story."

The crisis was ostensibly triggered by concerns about the health of the banking system of Turkey. It all began with a criminal investigation into 10 insolvent Turkish private banks that were taken over by the government last year after pumping $6 billion. This investigation led to the arrests of key bankers who were accused of siphoning money from these banks. Among those arrested included the nephew of ex-President of Turkey, Yaha Murat Demirel, who plundered millions from his own bank, Egebank, before it was seized by the state in December 1999. When the turmoil was in full swing, Demirbank, the ninth largest bank in Turkey, became the 11^th bank to be taken under state control.

There is no denying that corrupt practices in the banking sector of Turkey are not a new phenomenon. Mismanagement and corruption in the banking sector became more rampant when the Turkish authorities began relaxing regulations and controls in the banking sector under the liberalization program started in the 1980s. The ruling elite of Turkey and their cronies misused lax banking regulations to plunder millions of dollars for their individual enrichment and aggrandizement. Many of the failed Turkish banks were involved in corrupt deals by providing unsound loans to politically well-connected people. Several banks made huge profits by borrowing foreign currencies at low rates and then using the proceeds to buy domestic assets, particularly high-yielding Turkish treasury bills. But when the interest rates dropped significantly in Turkey, these banks could not sustain such risky arbitrage activities.

Instead of welcoming such a positive step by the Turkish authorities to clean up the banking sector, the financial markets started speculating on the connections between accused bankers and other banks. All kinds of rumors were afloat that other banks would also go bust. This prompted foreign investors, many of them already suffered heavy losses in Argentina just a few weeks ago, to immediately sell off their Turkish assets and cut lending. As a result, demand for dollars increased and interest rates shoot up. Fearing an imminent devaluation of the Turkish lira, as happened in the past, they left the country hurriedly. According to the Bank of International Settlements, German banks had a major overall loan exposure to Turkey with $11billion, out of total $42 billion.

For few days, the central bank of Turkey provided emergency funding to the banking system to contain the liquidity crisis but it could not sustain this because of the money supply limits fixed under the disinflation program of the IMF. The central bank also did not opt for devaluation because it would have undermined disinflation program. The calm in the financial markets was only restored in the first week of December when the IMF announced its package of $7.5 billion to Turkey.

This loan package was the 18th such loan from IMF to Turkey. Departing from its usual procedures, the IMF hurriedly approved this loan package to Turkey. Analysts point out two main reasons for this. Firstly, the failure of the disinflation program in Turkey could have further damaged the IMF’s already much-tarnished credibility in the world. And secondly, the US strongly supported the loan package as it considers Turkey as a barrier against neighboring Iran and Iraq.

The victims of Turkey’s crisis are both the financial sector and the real economy. Those banks and financial institutions that suffered heavy losses because of liquidity squeeze are almost on the verge of bankruptcy. Already, foreign banks such as Citibank and HSBC have declared interest in acquiring Turkish banks. Analysts anticipate rapid consolidation in the banking sector through mergers and acquisition. The government has laready decided to go ahead with the privatization of four state-owned banks, which account for 40 per cent of Turkish banking assets.

In order to restore the confidence among foreign investors, the Turkish government has decided to privatize key public sector companies such as Turk Telekom and Turkish Airlines. Companies with heavy exposure to the banks are having problems in rolling over loans and are facing higher financing costs. The country is unlikely to achieve its targeted economic growth of 4.5 per cent for 2001.

The country, already undergoing a strict belt-tightening disinflation program, will confront new taxes and cuts in public spending. This will severely affect the poor people of Turkey, many of whom earn less than $150 a month. Unlike other European countries, the vast majority of Turkish people live in abject poverty and almost half of the population is still dependent on agriculture. On December 1, an estimated 30,000 public sector workers and other striking employees marched in Ankara to protest against pay curbs and spending cuts agreed under the disinflation program with the IMF. Further cuts in public spending and freeze on public sector wage hike may lead to more protests and strikes which can, in turn, further weaken not only the ruling three-party coalition but also the fragile political system in the country. Besides, this crisis has created more hurdles for Turkey to meet the European Union's economic criteria for its membership.

The Turkish episode not only reveals the severe economic and social costs of fragile domestic banking system operating under a lax regulatory environment but also the eminent role of unregulated short-term financial flows in precipitating a financial crisis. Isn’t a paradox that financial markets can punish even those countries that are sincerely reforming their economies?

THE END