15/3/2007 FINANCIAL CRISIS OF 2000-2001 in TURKEY Ismail ARDIC Ozgur BAL Himmet PARMAKSIZ May 2007.

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 FINANCIAL CRISIS OF 2000-2001

in TURKEY  

Ismail ARDIC

Ozgur BAL

Himmet PARMAKSIZ 

May 2007

225/3/20075/3/2007

OUTLINE 

1- A Decade Before The Crisis

International Environment

Domestic Circumstances

2- The Context of The Exchange Rate Based Stabilization Program

3- The Outbreak of The Crisis

November 2000

February 2001

4- Conclusion

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A Decade Before The Crisis

International Environment

Politics:

• Collapse of the Soviet Union and the Eastern Bloc

• Reunification of Germany

•The Kuwait Crisis and the Gulf War

Economics:

•Recession in Europe

•Asian Crisis in 1997

•Russian Crisis in 1998

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Domestic Circumstances

Politics:

•The Decade of Populist Coalition Governments

•Integration to the EU

Economics:

•Recession in Europe

•The Customs Union with the EU

•Unstable Growth Rates

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MACROECONOMIC VARIABLES

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REAL GDP GROWTH

-8,0

-6,0

-4,0

-2,0

0,0

2,0

4,0

6,0

8,0

10,0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

YEARS

PE

RC

EN

T

Source: EIU Market Indicators and Forecasts.

The Characteristics of Real GDP Growth:

•Too Much Volatility

•Artificial Growth

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TRADE BALANCE

-30000

-20000

-10000

0

10000

20000

30000

40000

50000

60000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

YEARS

MIL

.US

D

Exports fob imports fob Trade balance

Source: EIU Market Indicators and Forecasts.

The Characteristics of Trade Balance:

•Somewhat stable, but persistent trade deficit

•Exports heavily rely on imported raw and semi-finished materials

•Negative effects of recession in Europe

•Temporary effects of the customs union

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PUBLIC DEBT

0

10

20

30

40

50

60

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

YEARS

PE

RC

EN

T O

F G

DP

Source: EIU Market Indicators and Forecasts

The Characteristics of Public Dept:

•Increasing trend from 33.2% in 1990 to 53.5% in 1999

•Domestic borrowing rather than international borrowing

•High interest payments; almost all of the government revenues in 1999 paid for high interest payments

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PUBLIC FINANCE

0

50

100

150

200

250

300

350

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

YEARS

AN

NU

AL

PE

RC

EN

TA

GE

CH

AN

GE

EXPENDITURES REVENUES BUDGET DEFICIT

Source:Ministry of Finance

The Characteristics of Public Finance:

•Persistent budget deficits

•Expansionary fiscal policies

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MONETARY VARIABLES

0

20

40

60

80

100

120

140

160

180

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

YEARS

AN

NU

AL

PE

RC

EN

TA

GE

CH

AN

GE

12 Mths. Weighted Savings Interest Rates Change in CPI

M1+M2 Nominal exchange rate

Source: Central Bank, the IMF-International Financial Statistics (IFS)

The Characteristics of Monetary Variables:

•Chronic high inflation; average around 77%, starting from 1995 81%

•Expansionary monetary policies

•Somewhat stable nominal exchange rate, except in 1994 (167%)

•High interest rates; average around 82%, starting from 1995 94%

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The Context of the Exchange Rate Based Stabilization Program

Main Aim of the Program;

“decreasing the inflation rate to a single digit by the end of 2002 associated with economic growth”

Three pillars of the program;

1. Determination of exchange rates under a pre-announced crawling peg arrangement

2. Fiscal discipline encompassing both of the central government budget and the rest of public sector

3. Implementation of structural reforms, especially an acceleration in privatization

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The Context of the Exchange Rate Based Stabilization Program

The Measures of the Program;

•Adopting of the exchange rate basket of the US dollar and the Euro as a nominal anchor

•Increasing tax revenues

•Controlling government spending

• Decreasing interest rates

• Increasing non-interest fiscal surpluses

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AT THE BEGINNING OF THE PROGRAMAT THE BEGINNING OF THE PROGRAM

TThere was optimism in the markets here was optimism in the markets aboutabout the new the new

economic program. There were two main reasons for this economic program. There were two main reasons for this

““initial optimisminitial optimism”: ”:

PPositive expectations about ositive expectations about thethe PProgramrogram

IImprovements in the Turkey-European Union relations. mprovements in the Turkey-European Union relations.

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SOME POSITIVE ECONOMIC SIGNALSSOME POSITIVE ECONOMIC SIGNALS

Net capital inflows:Net capital inflows: $15.2$15.2 billion billion for first ten months of 2000 for first ten months of 2000..

Decrease in interest rates:Decrease in interest rates: Interest rate of Interest rate of Treasury Treasury bills bills

decreased from decreased from 106%106% tto o 37%37% per annum by January 2000 per annum by January 2000..

Government budget primary surplus:Government budget primary surplus: ReachReached at ed at 2.8% of GDP 2.8% of GDP

despite despite the target of 2.2%the target of 2.2% within first ten months. within first ten months.

Economic growth:Economic growth: Reached at Reached at 6.5-7%6.5-7%,, whereas,whereas, -6.1% growth -6.1% growth

rate of 1999rate of 1999..

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OUTBREAK OF THE CROUTBREAK OF THE CRIISSIISS

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Problems Problems Prices were stickier than expectedPrices were stickier than expected IInflation rate was converging to the nflation rate was converging to the devaluation rate very slowly and the end-devaluation rate very slowly and the end-year target was overshot. year target was overshot.

r => C + I =>AD => Pr => C + I =>AD => P

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MONTHLY INFLATION (CPI)

0,00

2,00

4,00

6,00

8,00

10,00

12,00

MONTHS

PE

RC

EN

TAG

E

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ProblemsProblems Significant appreciation of the currency Significant appreciation of the currency

in real termsin real terms

The inflation rate was converging to theThe inflation rate was converging to the predetermined predetermined devaluation rate very slowly and devaluation rate very slowly and the the end-year targetend-year target was overshot was overshot. .

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Problems Problems Drastic deterioration of the trade deficitDrastic deterioration of the trade deficit..Expansion in import had reached to 35% in 2000 while Expansion in import had reached to 35% in 2000 while

export growth remained at 7 %. Current account export growth remained at 7 %. Current account

deficit/GDP ratio reached nearly to 4.9% level at the end deficit/GDP ratio reached nearly to 4.9% level at the end

of the 2000 whereas it had been 0.7% at the end of the of the 2000 whereas it had been 0.7% at the end of the

19991999..

Appreciation of the currencyAppreciation of the currency reduced the competitivenessreduced the competitiveness

of domestic goodsof domestic goods in international markets and increased in international markets and increased

the trade deficit the trade deficit

Thanks to Thanks to low interest rate investment, consumption and low interest rate investment, consumption and

therefore imports increased. And because of the over therefore imports increased. And because of the over

valued currency exports decreased.valued currency exports decreased.

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ProblemsProblems

Drastic deterioration of the trade deficitDrastic deterioration of the trade deficit

(II).(II).

The rise of the US dollar against the Euro The rise of the US dollar against the Euro

also had resulted in a deterioration of the also had resulted in a deterioration of the

current account deficitcurrent account deficit. .

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ProblemsProblems

Structural problems and fragilities in the Structural problems and fragilities in the

financial sectorfinancial sector

Some difficulties in the privatization of Some difficulties in the privatization of

state owned enterprisesstate owned enterprises

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November 2000November 2000

The first signs of trouble appeared in September when net The first signs of trouble appeared in September when net

capital flows turned out to be negative.capital flows turned out to be negative.

At the end of October banks tried to close their open foreign At the end of October banks tried to close their open foreign

exchange positions due to regulatory and balance sheet exchange positions due to regulatory and balance sheet

purposes. This movepurposes. This move created a liquidity squeeze and caused created a liquidity squeeze and caused

interest rates to increase. Central banks can sterilize the interest rates to increase. Central banks can sterilize the

effects of this seasonal outflow through expansionary open effects of this seasonal outflow through expansionary open

market operations. However, the Cmarket operations. However, the Central entral BBank (CB)ank (CB) had to act had to act

as a semi-currency board. as a semi-currency board.

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November 2000November 2000

The initial optimism has worn out. The initial optimism has worn out. The The rapid rapid flight of capital from flight of capital from country started. Because country started. Because of:of:

Disappointing inflation results for October, Disappointing inflation results for October,

Unexpectedly high monthly trade deficits, Unexpectedly high monthly trade deficits,

Political difficulties faced in privatization, Political difficulties faced in privatization,

Worsening relations with the EU, Worsening relations with the EU,

The economic crisis in Argentina, The economic crisis in Argentina,

Rising the US official interest rate, Rising the US official interest rate,

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November 2000November 2000The outflow was followed by the rise in the interest The outflow was followed by the rise in the interest rates at the last week of November and the market rates at the last week of November and the market risk in Turkey increased. risk in Turkey increased.

The banks in need of short-term funding began to The banks in need of short-term funding began to sell government securities. Rush to liquidity was sell government securities. Rush to liquidity was inflamed because of the competitive maneuvering inflamed because of the competitive maneuvering among some private banksamong some private banks.. The decline in the The decline in the value of government securities and the rise in the value of government securities and the rise in the sovereign risk because of the fragility of the sovereign risk because of the fragility of the financial system led foreign investors to accelerate financial system led foreign investors to accelerate their exit from the Turkish markettheir exit from the Turkish marketss by selling their by selling their securities.securities.

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November 2000November 2000 Overnight interest rate were at an average of Overnight interest rate were at an average of 72.472.4%% in November and in November and 223.8223.8%% in December. in December.

MONTHLY INTEREST RATES

0

50

100

150

200

250

300

350

400

450

MONTHS

PE

RC

EN

TA

GE

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November 2000November 2000 The CB faced with a dilemma; The CB faced with a dilemma;

either to stick by the program and monetary either to stick by the program and monetary rule rule ““at the expense of a deep financial at the expense of a deep financial crisiscrisis””, ,

or to inject liquidity to the market exceeding or to inject liquidity to the market exceeding its defined target for net domestic assets in its defined target for net domestic assets in order to rescue the financial system. order to rescue the financial system.

After some hesitation it started providing After some hesitation it started providing extra liquidity to the troubled banks. extra liquidity to the troubled banks.

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November 2000November 2000

On November 22On November 22ndnd and following days, foreign and following days, foreign

exchange reserves of the CB declined rapidly. exchange reserves of the CB declined rapidly.

Within a few days, on November 30Within a few days, on November 30 rdrd, 2000 the CB , 2000 the CB

reversed its policy and announced that it would no reversed its policy and announced that it would no

longer fund the commercial banks in the interbank longer fund the commercial banks in the interbank

market and this announcement market and this announcement skyrocketedskyrocketed the the

overnight interest rates to four-digit levels. overnight interest rates to four-digit levels.

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November 2000November 2000 On December 6On December 6thth, the IMF announced that it was going to , the IMF announced that it was going to

support the program by opening a new credit line with the support the program by opening a new credit line with the

extension of a $7.5 billion Supplementary Reserve Facility extension of a $7.5 billion Supplementary Reserve Facility

to Turkey. Government reached a new agreement with the to Turkey. Government reached a new agreement with the

IMF, the new Letter of Intent was announced on the 18IMF, the new Letter of Intent was announced on the 18thth of of

December, and the CB announced its new monetary December, and the CB announced its new monetary

program in December 22program in December 22ndnd. .

The original limits on the balance sheet of the CB were The original limits on the balance sheet of the CB were

revised; but the path of the rate of depreciation of domestic revised; but the path of the rate of depreciation of domestic

currency remained same. currency remained same.

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After November TurmoilAfter November Turmoil

AAt the end of 2000t the end of 2000 t the markets seemed to he markets seemed to have calmed down and the erosion of have calmed down and the erosion of international reserves stoppedinternational reserves stopped.. By mid-By mid-January international reserves had been January international reserves had been refilled, exceeding their pre-crisis level, and refilled, exceeding their pre-crisis level, and interest rates had fallen below 60%interest rates had fallen below 60%..

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After November TurmoilAfter November Turmoil However, However, mmaturities in government security aturities in government security started to shorten drastically in late-January started to shorten drastically in late-January and interest rates started to shoot up, and interest rates started to shoot up, reaching 70% in mid-February. These gave reaching 70% in mid-February. These gave rise to serious doubts on the sustainability of rise to serious doubts on the sustainability of public debt. Rising public debt, high inflation public debt. Rising public debt, high inflation and the continuing appreciation of theand the continuing appreciation of the Turkish Lira (TL) Turkish Lira (TL) brought considerable brought considerable doubtsdoubts about the sustainability of the about the sustainability of the crawling peg system.crawling peg system.

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February 2001February 2001 On February 19On February 19thth, 2001 political crisis , 2001 political crisis between between the the

Prime Minister the President seriously hit the markets. Prime Minister the President seriously hit the markets.

Over-night interest rate rose abruptly up to Over-night interest rate rose abruptly up to 2058%2058% on on

the 20the 20thth of February, and to of February, and to 4019%4019% on the next day. on the next day.

Rising interest rates, with overnight rates reaching Rising interest rates, with overnight rates reaching

5000%,5000%, could not stop the rapid flight from the TL. could not stop the rapid flight from the TL.

Not only non-residents but also residents and Not only non-residents but also residents and

especially the banking sector rushed to foreign especially the banking sector rushed to foreign

currency (dollarization). The CB lost big part of its currency (dollarization). The CB lost big part of its

foreign reserves in defending the currency peg. foreign reserves in defending the currency peg.

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February 2001February 2001

The government could not bear the pressures of the The government could not bear the pressures of the

markets any more and was obliged to abandon the peg markets any more and was obliged to abandon the peg

and set and set exchange ratesexchange rates to floatto float on February 22 on February 22ndnd, again , again

with the consent of the IMF. with the consent of the IMF.

Within a single day the currency lost about Within a single day the currency lost about one-thirdone-third of of

its value against the dollarits value against the dollar..

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Inferences from the CrisisInferences from the Crisis

The problems associated with exchange The problems associated with exchange rate-based stabilizationrate-based stabilization

Fiscal problemsFiscal problems

MMaturityaturity structure structure of the de of the debbtt

SStructural weaknesses in financial tructural weaknesses in financial marketsmarkets

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Problems associated with exchange rate Problems associated with exchange rate based stabilizationbased stabilization

Risks of exchange rate based stabilizationRisks of exchange rate based stabilization

FFragility of pegged exchange rateragility of pegged exchange rateovervalued currencyovervalued currencygrowing external deficitgrowing external deficitreliance on capital inflowsreliance on capital inflows

DDifficulty of abandoning it without causing a ifficulty of abandoning it without causing a crisis crisis

fear of loosing credibilityfear of loosing credibility in this contextin this context,, fear of capital outflow and fear of capital outflow and

recession recession

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Fiscal ProblemsFiscal Problems

Lack of fiscal dicipline in the pastLack of fiscal dicipline in the past

Incomplete implementation of fiscal structural Incomplete implementation of fiscal structural measures during the programmeasures during the program

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Maturity structure of the debtMaturity structure of the debt

TThe ratio of short-term foreign debt to the CB’s he ratio of short-term foreign debt to the CB’s international reservesinternational reserves reached at reached at 112% in June 112% in June 2000 and 145 % in December 2000.2000 and 145 % in December 2000.

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Transition to the Strong Economy Transition to the Strong Economy

ProgramProgram In May 2001 an agreement was reached with IMF on a new In May 2001 an agreement was reached with IMF on a new programprogram

MMain aim was to minimize short-term macro economic ain aim was to minimize short-term macro economic impact of recent crisis and to provide disinflation and growthimpact of recent crisis and to provide disinflation and growth

Tools of the program were;Tools of the program were; Continuing to floating currency Continuing to floating currency CBCB’s’s ffocusocusinging on the control of monetary aggregates on the control of monetary aggregates TTransparency of policies and implementationsransparency of policies and implementations RRestructuring of financial sector and fundamental estructuring of financial sector and fundamental

reforms of the state and the SDIF owned banksreforms of the state and the SDIF owned banks

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As a resultAs a result;;

SStructural weaknesses of financial sector, crawling tructural weaknesses of financial sector, crawling peg, downward inflexibility of prices, problems in peg, downward inflexibility of prices, problems in fiscal discipline, the maturity structure and magnitude fiscal discipline, the maturity structure and magnitude of the foreign and domestic debts led to the of the foreign and domestic debts led to the occurrence of the crisis. occurrence of the crisis.

It can be seenIt can be seen that that the “Transition To The Strong the “Transition To The Strong Economy” program, implemented successfully since Economy” program, implemented successfully since 2001, has also pointed out 2001, has also pointed out these factors athese factors and tried to nd tried to cope with them.cope with them.