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Financial System Development Lecturer : Prof. Dr. Heike Joebges Research Paper on: 2001 Currency Crisis in Turkey:Could the IMF Have Influenced Turkey In a Way to Prevent From Currency Crisis? Volkan Emre, 534436 Berlin, February 2012 1
TABLE OF CONTENTS Page1.Introduction 042. General overview of the Turkish Economy before the financial stability 04. agreement3.Main causes and features of the crisis 064. Design and implementation weaknesses of the IMF Financial Stability 07Program and the potential actions of IMF to prevent the negative outcomes4.1 Preparation and timing 074.2 Inflation targeting and pre-announced path of exchange rates 084.3 Monetary policy 094.4. Number of structural reforms and privatization goals 104.5 Amount of money injected to the financial system during the crisis 115.Conclusion 11 LIST OF TABLES & CHARTSTable 1 Selected Macroeconomic Indicators, 1996 – 2001 04Table 2 Selected Central Bank Figures & Crisis in December 2000 and February 2001 05Table 3 Selected Macroeconomic Indicators, 1998 – 2001 06 2
“Turkeys program is strong and well balanced. The large adjustment in the primary fiscal balance will help re-establish fiscal solvency and reduce inflation. With full implementation, the program should restore Turkeys credibility vis-à-vis markets” 22.12.1999 Stanley Fisher1 1. Introduction The Turkish Economy was seriously hit by two crises which resulted in a deep recession at the beginning of the new millennium. It took almost a decade for Turkey to recover. Although Turkey had structural problems in that particular time period, the main cause of both crisis was the collapse of the IMF-directed economic stabilization program within the first year of its implementation. The first crisis was a liquidity crisis in November 2000. The second came three months later, this time as a currency crisis. This paper aims to analyze whether the IMF could have influenced Turkey to prevent the February 2001 Currency Crises. With that regard the research paper divided into three main chapters . The first chapter gives a quick overview of the Turkish Economy before the standby agreement with the IMF which was signed in December 1999. The second chapter briefly underlines the causes and features of both crises with some graphical explanations. The third and last chapter focuses on the design and implementation weaknesses of the IMF Financial Stability Program and the potential actions which IMF could have taken to prevent or relieve the negative outcomes of the currency crisis. 2. General overview of the Turkish Economy in late 90’s and the financial stability agreement The entire 90’s is called as a lost decade for Turkey by some scholars. In 1994 Turkish Economy was hit by the biggest crisis of its history. Country spent the rest of the decade with recovering from the deadly outcomes of the past crisis. However it is hard to claim that there was a nice picture in pre 2000’s. Real GDP growth was very volatile. High inflation, weak currency and increasing government sector debts were harming the macroeconomic stability (Table 1). Undisciplined fiscal policies were decreasing the credibility and reputation of the treasury and therefore increasing the real interest rates and thus cost of borrowing (Table 1). Budget and current account balances had been continuously growing on deficit between 1996 and 1999 (Table 1). In addition to all of the mentioned structural problems two shocking external factors; first the 1998 Russian Crisis and then August 19991 First Deputy Manager of IMF, Stanley Fisher’s quote was retrieved fromhttp://www.imf.org/external/np/sec/pr/1999/pr9966.htm 3
Earthquake and exacerbated the worsening of the Turkish economy. Russia was the second biggest trade partner of Turkey at that time and the Marmara Earthquake hit the highly industrialized zones and led to the negative GDP growth. In September 1999 it was clear that the situation was not sustainable anymore and Turkey knocked IMF’s door once again. Table 1. Selected Macroeconomic Indicators, 1996-2001 Annual Increases (%) 1996 1997 1998 1999 2000 2001 Reel GDP 7,1 8,3 3,9 -6,1 6,3 -9,4 CPI Inflation 79,8 99,1 69,7 68,8 39,0 68,5 Money Supply(M2) 109,7 84,0 79,4 101,5 42,5 80,0 Net Domestic Credits 110,7 113,5 55,8 52,7 62,6 24,8 Billion US$ 1996 1997 1998 1999 2000 2001 GDP (Current US$) 181,5 189,8 269,3 249,8 266,6 196,0 Foreign Debt Stock (Short Term+Long Term) 79,6 84,6 94,8 102,6 119,0 118,1 Short Term Debt Stock 17,3 17,7 20,8 22,9 28,3 20,1 Mid - Long Term 62,3 66,9 74,0 79,7 90,7 98,0 Debt to International Institutions 8,9 8,1 8,0 7,8 11,4 20,9 Trade Balance -10,6 -15,4 -14,2 -10,0 -22,4 -4,8 Current Account Balance -2,4 -2,6 -2,0 -1,4 -9,8 3,3 Net Capital Inflows 5,6 7,0 -0,8 4,9 9,6 -13,9 Changes in Reserves -4,5 -3,4 -0,5 -5,2 3,0 12,9 Net Errors and Omissions 1,4 -1,0 -0,7 1,6 -2,8 -2,3 Index (1995=100) 1996 1997 1998 1999 2000 2001 Reel Exchange Rate Appreciation 101,80 115,9 120,9 127,3 147,6 116,2Source: Central Bank of Turkey, State Planning Organization of Turkey, World Bank Development Indicators, Own extractions and calculations Turkey and IMF signed a 4 billion US$ stand-by credit agreement on 22’th of December in 1999. The new program aimed at tackling interest rates and inflation with a strategy based on a new monetary policy which Turkey had not experienced before. Preannounced exchange rates were supposed to be used as an anchor to stabilize the exchange rate. This approach was in line with the money rule, which refers to provide liquidity to the markets parallel to the volume of the existing foreign exchange reserves. By doing so, IMF wanted to increase the credibility of Turkey in the mid-term and reduce its cost of borrowing and create primary surplus. On the other this method actually aimed to reduce the inflation at the same time . Success of the new IMF directed policy was mainly relying on the credibility 4
of Turkey supported by IMF itself. Political and institutional credibility of the country weregetting ready for an important test in the international arena.3. Main causes and features of the crisisEverything seemed to be on track within the first months of the implementation afterJanuary 2000. There was a significant increase in net capital inflows, appreciation in the reelexchange rate, decrease in the domestic interest rates and increase in the domestic creditstock. Government’s borrowing opportunities abroad had been increased due to theimprovements in the primary balance. However some other indicators are ringing the alarmbells. Current account deficit was the most important one. With the negative effects of thedomestic currency appreciation, the current account had risen five times than in 1999 whiletrade deficit had doubled (Table 1). The open positions of commercial banks which hadrisen significantly were showing the exchange rate risk. and the liquidity need of the stateowned banks were also strengthening the crisis infrastructure. Additionally, the totalamount of the foreign debt were exceeding the Turkish Central Bank’s exchange reserveswhich made the system more vulnerable against speculative attacks. Table 2. Selected Macroeconomic Indicators, 1998 -2001 1998 1999 2000 2001 Rate to Money Supply (%) Total Domestic Debt / M2 57,5 57,1 65 118,7 Domestic Debt in Cash / M2 47,1 50,3 52,5 56,7 Commercial Banks (%) Total Domestic Debt / Total Liabilities 35 34,1 35 70,1 Domestic Debt in Cash / Total Liabilities 28,7 30,1 28,3 33,5 Credits to Government 85,6 139,7 123,6 181 Sector / Credits to private sector Deposits longer than 23 28,2 15,1 11,6 Source: Central Bank of Turkey, State Planning Organization, Own Extractions Under that fragile economic conditions one major private bank which heavily invested in government securities came to a point at which it could not refinance itself anymore and demanded loans from the Turkish Central Bank. Central bank’s refusal to lend and 5
enforcement to sell the bank its government securities started the liquidity crisis inNovember 2000. Table 3. Selected Central Bank Figures & Crisis in December 2000 and February 2001 Overnight Interest Rates(%) Exchange Rate (TL/$) Monthly Average Monthly Average Reserves (Billion US $) 2000 July 26,5 630,3 24,5 August 42,6 648,2 24,5September 47,4 666,9 24,2 October 38,5 679,8 23,5November 95,4 686,2 18,8December 183,2 680,4 22,2 2001 January 42,7 674,1 24,8February 400,3 750,4 21,4 Source: Central Bank of Turkey, Own ExtractionsAt that point IMF stepped in and injected money to the central bank reserves whichhelped markets to calm down and prevent interest rates from jumping to the sky. ButIMF’s intervention was too little to change the main dynamics of the economy. The mainproblems remained constant and the appreciated domestic currency continued to harmthe current account. And the credibility of the Turkish Authorities had been continued todecrease. External positions of government and especially private sectors weakened dayby day due to the increasing foreign debt. Weak fiscal position of the public sector led tothe ultra high level of interest payments and unhealthy maturity conditions of debt.Under these unsustainable circumstances the debt roll over capacity of the ministry oftreasury tested by the high interest rates respectively in January and February 2000.Finally the currency crisis started after a public dispute between the prime minister andpresident. Speculative attacks on Turkish Lira started on 19.02.2012. Overnight interestrates were skyrocketed in one day (Table 3). Soon after the exchange rate systemcollapsed and Turkish authorities had to led the exchange rate float. 6
4. Design and implementation weaknesses of the IMF Financial Stability Program and the potential actions of IMF to prevent the negative outcomesSome design and implementation weaknesses of the IMF seriously caused damages on thecredibility of the financial stability program and led Turkish economy to end up with aserious currency crisis. Especially the increasing current account deficit and growing publicdebt were serious clues for the upcoming crisis. In this chapter some of the important designand implementation weaknesses of the IMF are discussed as in the following.4.1 Preparation and timingOne of the most important weaknesses was the lack of time spent for the design of thefinancial stability program. IMF and Turkish authorities agreed on a program in less thanfive months. Although Turkey’s immediate crisis situation, IMF could have spent moretime in designing the program by negotiating details in a slower pace. This could havehelped to increase the commitment of the members of the program and by providing abetter harmony between them which would led to a more consistent and carefulmanagement. All of the mentioned improvements would increase the credibility of theprogram which was clearly one of the most important reasons behind the failure of IMF’sprogram which ended up with a currency crisis after the speculative attacks on TurkishLira.Some important structural problems of the banking sector were neglected which laterbecame obstacles to the success of the program during its implementation. Balance sheetsof the state owned banks were dominated by duty losses. Since those state owned bankscould not get sufficient funds from the general budget due to the tight fiscal policy aspectof the program, state owned banks tend to finance their short term debt obligations fromdomestic market loans. Those loan seeking activities were heavily dependent onovernight funds which avoided them from their actual banking activities and triggered theinflation and created a maturity mismatch risk to the banking system. In my opinion thisvicious circle could have been prevented to some extent if IMF have forced and helpedTurkish authorities to inject more capital to the state owned banks which were sufferingfrom the duty losses before the implementation of the financial stability program. Withthat regard IMF could have even directly provide funds in order to strengthen the balancesheets of the state owned banks. The second option would be to force Turkish authorities 7
to structure the balance sheets of the state owned banks as a precondition of the standby agreement. On the other hand there was a contradictory situation in private banking sector. IMF forced Turkish government to support the highly indebted, risky private banks and hence encouraged the establishment of Saving Deposits Insurance Fund of Turkey in 23 June 1999. This local fund aimed to strengthen the balance sheets of the seven selected banks by establishing a direct control in them and to introduce new implementations. But market interpreted that action as a negative sign considering the credibility of the program and the general hesitation has increased among the economic agents in terms of trust in the IMF program. At that point it can be claimed that IMF could have changed its priorities between state owned and private banks other way around. Thus this could have helped to the credibility of the program in the eyes of the local and foreign economic agents in a more positive way. Another vulnerability of Turkish banking sector which was almost neglected in the IMF program at the preparation period was the lack of regulation. IMF did not have any serious enforcement towards regulation in its agenda despite the fact that crisis triggered elements strongly related to the both private and state owned and government banks’ dangerous activities which were mentioned before. State owned banks were object to interest rate risks and maturity mismatch on the other hand private banks were carrying the exchange rate risk with currency mismatch. IMF subsequently realized its mistake, as evidenced by its post-crisis increase in regulatory measures. In my opinion, if IMF could have given that interest before the implementation of the program, the crisis triggering threats within the banking would have reduced significantly. I think Turkey’s Banking Sector’s success during the 2008 global financial crisis heavily depends on the regulatory enforcements of IMF after the 2001 currency crisis and this fact might support my initial argument to some extent. 4.2 Inflation targeting and pre-announced path of exchange rates In the preparation period, IMF projected the 2000-2001 fiscal years inflation as 20 percent and set its exchange rate peg in accordance with its estimation. Short after the implementation it was clear that there was something wrong. According to Miller2 price2 Miller, 2006. Pathways Through Financial Crisis: Turkey 8
and wage stickiness in particular sectors which were not object to the foreign trade and their effects on the appreciation of Turkish Lira and hence on the deterioration of the competitiveness of the country were clearly showing the deviations from IMF’s estimations. But there was no revaluation of the exchange rate determination process at IMF’s side. An exogenous oil price shock (increase in world crude oil prices) made things worse and threatened the success of the program. If IMF would not insist on its estimations and be more flexible in changing the exchange rate announcement mechanism, the destructive damages of the TL appreciation on the trade balance and current account could be prevented till a certain degree. 4.3 Monetary Policy With an approach similar to currency board, IMF put some limits on the net domestic assets in the Central Bank of Turkey and let interest rates determined by the market. IMF aimed at keeping central bank reserves at a certain level while interest rates are going down. The expected result was disinflation in a more predictable macroeconomic environment. The key element to success was again the credibility of the central bank in the eyes of market players. According to the Yenal3, such restrictions might be very risky if there is a bottleneck in the capital inflows since the number of instruments would be restricted in order to keep domestic and foreign assets in balance under the preannounced exchange rate regime. And what observed between the first and second crisis was very much in line with Yenal’s thoughts. Turkish central bank could not resist to the capital outflows after the speculative attacks on Turkish Lira. IMF could have given more autonomy to the central bank authorities especially after the first liquidity crisis hit the Turkish Banking Sector in December 2000. An exit from the preannounced exchange rate regime and letting the rates to float would automatically give the interest rate tool to the central bank which would be much more useful to deal with the capital flows in order to prevent the upcoming crisis. Such an exit could be possible right after the first crisis in December 2000.3 YENAL 2002 9
4.4 Number of structural reforms and privatization goals Structural reforms are designated to make the fiscal adjustment implemented in 2000 sustainable over the medium term, to lower the burden of interest payments on public sector debt, to improve transparency and economic efficiency, and to reduce the contingent liabilities of the public sector (IMF)4. Despite IMF’s ambition towards structural reforms and privatization, most of the structural reforms formed in line with the inappropriate priorities. As already discussed in previous sections , lack of importance given to the regulation in the banking sector might be a good example. Adverse selection problems in the priorities stemmed partly from the lack of time spent in the preparation period. Despite the success in the short term primary surplus creation in the budget, failures in the implementation structural reforms which were very important in the eyes of the financial investors led to a loss in programs credibility within first months of the financial stability program. Including numerous structural reforms with high level of implementation uncertainities increased the fragility of the program and led to the deteriorations in the expectations of the economic agents. IMF’s expectations in the privatization were also too ambitious. According to the IMF’s experts, Turkey could get roughly 7.5 billion US$5 through privatization in year 2000. This meant roughly 3% of the Turkey’s GDP in 19996. Such high expections were definitely extra risk factors for the stability program’s credibility. Especially for the investors who were questioning the long term debt repayment capability of the Turkish government. Once privatization attempts started to fail, investors who were holding government bonds believed that the value of the bond is going to decrease . To sum up, IMF’s expectations in structural reforms and privatization before the implementation of the financial stability program were too ambitious and this picture could be easily captured by the majority of the financial investors. Additionally, failures in both reforms and privatization led further deteriorations in the credibility of the program among the other market players too . There was no intermediate revision of the goals during the4 Online press release at: http://www.imf.org/external/np/sec/pr/1999/pr9966.htm5 Celasun,2002: 2001 Krizi Öncesi ve Sonrası at : http://www.econ.utah.edu/~ehrbar/erc2002/pdf/i053.pdf6 According to World Bank Development Turkey’s GDP in 1999 was 249,654,780,792 US$. This data isobtained from : http://databank.worldbank.org/ddp/home.do 10
implementation and especially after the first crisis the credibility of the program hit to the ground and led the speculative attacks start on the Turkish Lira. What IMF could have done to prevent or to reduce the effects of the crisis was firstly to take more time in cooperation with Turkish authorities in defining the priorities. Revising the ongoing privatization processes during the implementation and reducing the number of structural reforms would be the further actions of the IMF. 4.5 Amount of money injected to the financial system during the crisis After the Turkish banking sector hit by the liquidity crisis in November 2000, IMF stepped in and injected money to the system. But it might be claimed that IMF was already too late and the amount of money which was injected to the system was significantly less than it was actually required7. In my opinion if IMF would have injected the same amount of money during the liquidity crisis in November 2000, the lack of credibility based currency crisis could have been delayed or even prevented to some extent. 5. Conclusion To conclude, the IMF showed serious weaknesses in the preparation and implementation periods of the financial stability program of Turkey. Those weaknesses decreased the credibility of the program which was the key component of the success. IMF could have influenced Turkey to prevent the February 2001 Currency Crises in five different ways . First of all, IMF could have spent more time on the design of the program by negotiating details in a slower pace. Secondly, if IMF would not insist on its inflation targeting and pre-announced path of exchange rates the the destructive damages of the TL appreciation on the trade balance and current account could be prevented to some extent. Moreover, IMF had the chance to give more autonomy to the Turkish Central Bank authorities at some different points, especially during the massive capital outflows were happening. This could have a direct influence on the upcoming currency crisis. Additionally, if IMF could have realized the exaggerated ambition of their structural reforms and unrealistic privatization agenda for Turkey, they would have had the chance to gain the commitment of Turkish authorities and establish the trust of the economic agents in the fiscal sustainability of the program again. Finally, the IMF could have influenced Turkey to prevent the currency crisis if it provided7 After the public conflict between prime minister and president, Turkish Central Bank lost 3,4 billion US$ inone day but IMF could provided 2,8 billion US$ as an immediate injection 11
enough amount of liquidity for the needs of the Turkish Central Bank during and after theNovember 2000 Liquidity Crisis. 12
References Celasun, 2002, 2001 Krizi,Öncesi ve Sonrası, available at: http://www.econ.utah.edu/~ehrbar/erc2002/pdf/i053.pdf Miller, 2006. Pathways Through Financial Crisis: Turkey, Global Governance, Volume 12, Pages : 449 - 464 Özatay, 2002, Bank of Albania in the Second Decade of Transition Confrenece Dufour at al, 2007, The 2000 – 2001 Financial Crisis in Turkey: A Crisis for Whom?, available at: http://mpra.ub.uni-muenchen.de/7837/ Macovei ,2009, Growth and Economic Crises in Turkey: leaving behind a turbulent past? European Commission, Economic Papers Volume 386 International Monetary Fund, 1999, Press Release No. 99/66, available at: http://www.imf.org/external/np/sec/pr/1999/pr9966.htm Alper, 2001, The Turkish Liquidity Crisis of 2000: What Went Wrong… Russian and European Finance and Trade, Vol. 37, No.6, Pages: 51-71 13