Turkey: Limping From One Financial Crisis to Another
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 22nd 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 11th 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?
Hardly a few weeks passed since Turkey faced a serious banking crisis in December 2000, a fresh financial crisis erupted again in the country in the last week of February 2001. As mentioned in my previous article on the Turkish financial crisis (visit www.ased.org) the country had faced a severe crisis during November-December 2000. The overnight inter-bank interest rates climbed as high as 1700 per cent while domestic interest rates reached 60 percent. 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 a week. On 22nd November alone, $2.5 billion left Turkey. The calm in financial markets was restored when the International Monetary Fund (IMF) announced a loan package of nearly US$10 billion.
The fresh crisis began on February 19th when the Turkish Prime Minister Mr Bulent Ecevit stormed out of a high-level meeting with President Ahmet Necdet Sezer, saying a “serious crisis” had erupted with the President. The Prime Minister was upset by the President’s criticism of the government’s anti-corruption drive. These words uttered by the PM led to a sharp fall in the financial markets and within hours interest rates jumped up. Fearing an impending political crisis following this clash between the country’s top political leadership, overnight inter-bank lending rates reached an annualized 7,500 per cent and the stock market witnessed its worst crash in recent times, losing nearly 18 per cent. This is despite the fact that Ecevit’s three-party coalition government is considered to be the most stable in the recent history of Turkey.
The foreign investors and creditors started panic buying of Euro to cover their exposure from impending economic and political crisis. Within a day, the value of Euro increased from $ 0.9233 to $ 0.9241. In particular, investors and creditors from Germany were much worried because they of their large exposure to Turkey. German banks are the biggest lenders to Turkey. Out of total US$ 43.88 billion, German banks have an exposure of US$ 12.12 billion while the US banks have an exposure of US$ 4.7 billion. This is largely due to closer trade ties between two countries and nearly two million Turks living in Germany. Just last year, Germany’s Commerzbank and other large banks lend huge money to Turkish private sector and the government.
In order to defend the lira, the central bank of Turkey reportedly sold nearly $5 billion in the markets out of its total foreign exchange reserves of $28 billion. But, the panic in the financial markets was far from over. Over the next two days, it became apparent that Turkey had very little choices except to allow the lira to float freely or devalue the lira. As devaluation would have badly affected the Turkish borrowers who borrowed in foreign currency, the central bank decided to go for free float of lira. On February 22nd, the central bank announced that it was scrapping Turkey’s currency exchange rate controls, a key element of its ongoing economic stabilization program, in order to stem the financial crisis. Thus, the lira was allowed to float freely. Given the nervousness in the markets, the free float of lira led to a loss of 36 per cent of its value against the dollar in just two days. Soon thereafter, the Turkish central bank governor, Gazi Ercel, one of the main architects of the ongoing IMF-backed stabilization program, offered to resign on moral grounds.
In such a panic gripped environment, the Turkish government appointed two technocrats to the posts of economy minister and central bank governor in order to give credibility to its economic stabilization program and restore the confidence of financial markets and international financial institutions. Kemal Dervis, an economist working as Vice-President of the World Bank, was appointed as Economic Minister while Sureyya Serdengecti was appointed as the new governor of the central bank. The appointment of Kemal Dervis was fully backed by the IMF. Mr. Dervis has been given sweeping powers with treasury, planning and privatization departments under his control. But the appointment of Kemal Dervis as a “super minister” led to a new crisis when Zekeriya Temizel, head of the banking regulation and supervision agency, resigned in protest within hours of Mr Dervis appointment. He refused to work under the Mr. Dervis. Mr Temizel, well known for his honesty and integrity, was appointed in September 2000 to clean up the banking sector from corrupt politicians and their cronies who had misused lax banking regulations for personal gains.
There is no disagreement that the appointment of Mr Dervis will help in getting financial support from the IMF, World Bank and the international financial community, but whether he alone can restructure the entire economy and put it on a sustainable growth path remains to be seen. In the past too, several developing countries including Pakistan and India have appointed technocrats at top level political positions to achieve economic miracles but the results have been totally disastrous. Thereby corroborating the fact that macroeconomic problems are complex, deep-rooted and structural in nature which cannot be fixed by one individual alone.
While much of attention during the crisis has been focussed on the fate of international investors and lenders, there is very little concern on the impact of the livelihoods of workers, students, small traders, daily wage earners and farmers. It is important to emphasize here that these sections of society are already bearing the burnt of the 14-month-old stabilization program supported by the IMF. In an interview to International Herald Tribune(February 26, 2001), Ergun Duran, 54, who runs a small Istanbul newspaper stand stated, “You become poorer and poorer after every crisis…But at some point, you cannot be poorer than you already are – you are on the bottom. This is how most of the people are living now. You work and work for 20 or 30 years, you still can’t make ends meet, you still wear the same clothes every year.” The 10 percent hike in gasoline prices will fuel another round of price hike of many essential goods. Thus, it is the poor and lower middle classes that will be badly affected by the price increases and new taxes.
In the coming days, there would be large-scale restructuring of the banking sector which, in turn, would lead to further closing down of the banks and massive layoffs. The sharp decline in the Turkish lira would lead to the failure of several small Turkish banks, as they are not in position to repay loans owed in foreign currencies. The Turkish government has already announced its commitment to sell-off the Turk Telekom and Turkish Airlines besides cutting down agricultural subsidies and cuts in public spending.
Apart from economic issues, there is an important geo-political angle to these developments in Turkey. The US has been a strong support of Turkey because the US trusts Turkey as a close ally to support its interests in this region. The US also sees Turkey as a “secular bulwark” against the political Islam. Given the country’s strategic location, particularly in the oil and mineral rich Caspian region, the US would do its best to provide financial support to Turkey in times of such economic crises. Thus, Turkey may continue to receive the backing from the US-controlled financial institutions such as the IMF and World Bank. But, whether such financial support is really helping Turkey to attain financial stability and sustainable economic growth is the moot question to be posed before the US administration.