Turkey’s KrizBy: John Truszkowski

Outline•Turkey’s Economic Past

•Case Presentation

•Discussion Questions

Economic Past•Post World War II

▫Stagnate Economy

•1980s ▫Economic Liberalization

•1990s▫Crises

Post World War II•Economic development weak and volatile

until 2001▫Policies:

Import substitution Subsidization of agriculture High tax rates on labor Labor market rigidities

1980s•Economic liberalization

▫Removal of: Price controls Subsidies Interest ceilings

▫Foreign trade and FDI increased▫Country became more productive

Inadequate support from:Macroeconomic policiesReforms

1990s•Four crises pointed out weaknesses

▫1991, 1994, 1998, and 1999•Lack of fiscal discipline•Deficits since the 1970s•Monetary financing

1. High inflation2. T-bill interest rate rose

Reviewhttps://www.youtube.com/watch?v=xCkH-jKeXpQ

Key points from video•1983 Turkey shifts toward a more open

economy•Large amounts of foreign loans led to

rapid growth•Increased macroeconomic volatility from:

▫High inflation▫Weak banking system

Case Presentation•The Balance of Payments Accounts•Turkish Banking•Economic Death Spiral•Turkish Kriz

The Balance of Payments Accounts

The Balance of Payments Accounts

The Balance of Payments Accounts•Large Current Account deficit from:

▫Fast increase of imported goods•Large Capital Account surplus from:

▫“net other investment”▫TelSim

Turkish telecommunications company Imported billions worth of equipment

On credit▫Defaulted

Turkish Banking•Notoriously corrupt in late 1990s•Licenses to operate banks were

▫“given or sold as political favors”•Banks were then seen as reliable

borrowers to international community

Turkish Banking

Borrowed Billions of $ at low U.S. rates

Converted $ to Lira

Bought high yielding Turkish T-bills

Turkish Banking•Uncovered Interest Arbitrage

▫Not hedged▫Very risky

Turkish Banking•Increased demand for lira kept the

government from devaluing the currency▫Open market would have allowed for

earlier correction•Demand for T-bills hid warning signs

▫Deficit and national debt

Economic Death Spiral•Turkey’s economy was in a boom state in

fall of 2000▫Inflation had gone down significantly

•National Debt was becoming an imminent problem

•October 2000▫Major Turkish bank was unable to pay

debts

Economic Death Spiral•Interest and Inflation rates began to rise•IMF bailed out the country

▫$11 billion between 1999 – 2001▫REQUIREMENTS:

Reduce foreign indebtedness Reform banking system Privatization of SOE

Economic Death Spiral•Difficulties with requirements

▫Austerity was politically unpopular▫SOEs could not sell ownership interests

Turkish Kriz•February 18, 2001

▫Public argument between President & PM▫President Ahmet Necdet Sezer critisized

Prime Minister Bulent Ecevit “half-hearted” effort to reduce corruption

•February 19, 2001▫$5 billion of foreign investment left Turkey▫¼ of the total foreign reserves

Turkish Kriz•The Turkish Lira plummeted immediately

▫TL685,000/$ TL1,000,000/$•TL continued to fall in proceeding months

▫Numerous Turkish banks failed

Turkey’s Current State•Economy rebounded after 2001 crisis

▫Tight fiscal and monetary policies▫Real GDP began to grow

•Most significant reform▫“…adoption of a target for the public sector

primary surplus of 6.5%” Signals change of focus from inflationary

controls to BOP controls

Turkey’s Current State•2002 – 2007

▫GDP grew an average of 6.8% annually▫17th largest economy in the world

•2007+▫Economy slowed

•Effected by global recession in 2008•Concerns over current economic state

▫ http://www.presstv.ir/Detail/2015/01/14/393027/Turkey-Lira-devaluation-2014-unseen-since-2008-financial-crisis

Discussion Questions• Where in the current account would the

imported telecommunications equipment be listed? Would this correspond to the increase in magnitude and timing of the financial account?• The equipment would be listed in the Imported Goods

and Services section of Turkey’s current account since it was purchased from foreign companies.

• The equipment was a major factor resulting in the increase of the balance of payments through the financial account since it was bought on credit from foreign suppliers.

Discussion Questions• Why do you think that TelSim defaulted on its

payments for equipment imports from Nokia and Motorola?▫ Turkey was experiencing a devaluation of their currency

after the equipment was acquired, so as they tried to repay their loans to the foreign debtors it became more expensive for them to convert their currency into the currencies required to pay the debts.

Discussion Questions• Was the Turkish lira’s collapse the result of a

balance of payments crisis, an inflation crisis, a political crisis, or an economic crisis?▫ Many things came together to bring down the lira.

Political corruption led to inefficient banks which borrowed too much. The excessive borrowing created a balance of payments crisis, because the banks didn’t have the ability to pay off these debts. Also, the economy wasn’t allowed to respond naturally to inflation, in regards to the exchange rate, because of the “propping up” of the lira which was caused by the importing of borrowed dollars to invest in government T-bills.

Discussion Questions• Describe precisely how the Turkish banks were

performing uncovered interest arbitrage. Do you feel that this was an inappropriate investment policy?▫ Turkish banks were taking out loans in dollars from the

US to convert into Turkish liras in order to buy government T-bills that had a larger interest rate than the loans. If the exchange rate remains steady, the banks make large profits, but if the exchange rate shifts, they can lose significant amounts.

▫ It seems inappropriate to me, because they are essentially gambling with debt.

Discussion Questions• How could the Turkish banks be contributing to

financial crisis if they were purchasing Turkish government bonds and helping finance and support their own government?▫ By converting the borrowed dollars into Turkish liras, the banks

were increasing demand for their own currency when natural market functions would have devalued the currency in relation to the inflation rate.

▫ Demand for Turkish government bonds kept the yields from increasing, so they were less desirable to foreign investors and they couldn’t generate substantial revenue from the T-bills.

▫ Actions put banking system in jeopardy, because when the loans came due, demand for the lira decreased which led to a depreciation of lira to the dollar.

Discussion Questions• Which do you think is more critical to a country

such as Turkey, fighting inflation or fighting a large trade and current account deficit?▫ Turkey should focus more on controlling the current

account and paying more attention to the balance of payments overall. Banks practicing UIA created a dangerous situation for the entire country, because the government was not able to respond to the “dangers of its growing deficit spending and national debt”. These practices soon led to speculation and the withdraw of $5 billion of capital from the country, and a few days later the lira’s value plummeted.

Discussion Questions• The quote from Corporate Finance magazine,

although noting the outside possibility of a devaluation, was largely positive regarding Turkey’s future in January 2001. What would you have thought?▫ I would have thought that the root causes of the problem

must be found, and the national debt was a massive problem both economically and politically. The over spending loomed over Turkey along with the corruption that had become very prevalent in the banking sector. As long as these problems are not permanently fixed, I would be skeptical of the effectiveness of the SBA from the IMF.

Questions?