FINANCIAL CRISIS OF 2000-2001
in TURKEY
Ismail ARDIC
Ozgur BAL
Himmet PARMAKSIZ
May 2007
5/3/2007
1
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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2
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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3
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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4
MACROECONOMIC
VARIABLES
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5
REAL GDP GROWTH
10,0
8,0
PERCENT
6,0
4,0
2,0
0,0
-2,0
-4,0
-6,0
-8,0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
YEARS
Source: EIU Market Indicators and Forecasts.
The Characteristics of Real GDP Growth:
•Too Much Volatility
•Artificial Growth
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6
MIL.USD
TRADE BALANCE
60000
50000
40000
30000
20000
10000
0
-10000
-20000
-30000
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
YEARS
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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7
PUBLIC DEBT
PERCENT OF GDP
60
50
40
30
20
10
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
YEARS
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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8
PUBLIC FINANCE
350
ANNUAL PERCENTAGE CHANGE
300
250
200
150
100
50
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
YEARS
EXPENDITURES
REVENUES
BUDGET DEFICIT
Source:Ministry of Finance
The Characteristics of Public Finance:
•Persistent budget deficits
•Expansionary fiscal policies
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ANNUAL PERCENTAGE CHANGE
MONETARY VARIABLES
180
160
140
120
100
80
60
40
20
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
YEARS
12 M ths. Weighted Savings Interest Rates
Change in CPI
M 1+M 2
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%10
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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
government budget and the rest of public sector
3. Implementation of structural
acceleration in privatization
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reforms,
central
especially
an
11
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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12
AT THE BEGINNING OF THE PROGRAM
There was optimism in the markets about the new
economic program. There were two main reasons for this
“initial optimism”:
Positive expectations about the Program
Improvements in the Turkey-European Union relations.
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13
SOME POSITIVE ECONOMIC SIGNALS
Net capital inflows: $15.2 billion for first ten months of 2000.
Decrease in interest rates: Interest rate of Treasury bills
decreased from 106% to 37% per annum by January 2000.
Government budget primary surplus: Reached at 2.8% of GDP
despite the target of 2.2% within first ten months.
Economic growth: Reached at 6.5-7%, whereas, -6.1% growth
rate of 1999.
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OUTBREAK OF THE CRISIS
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Problems
Prices were stickier than expected
Inflation rate was converging to the
devaluation rate very slowly and the endyear target was overshot.
r => C + I =>AD => P
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16
02
.9
9
04
.9
9
06
.9
9
08
.9
9
10
.9
9
12
.9
9
02
.0
0
04
.0
0
06
.0
0
08
.0
0
10
.0
0
12
.0
0
02
.0
1
04
.0
1
06
.0
1
08
.0
1
10
.0
1
12
.0
1
PERCENTAGE
MONTHLY INFLATION (CPI)
12,00
10,00
8,00
6,00
4,00
2,00
0,00
MONTHS
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17
Problems
Significant appreciation of the currency
in real terms
The inflation rate was converging to the
predetermined devaluation rate very slowly and
the end-year target was overshot.
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18
Problems
Drastic deterioration of the trade deficit.
Expansion in import had reached to 35% in 2000 while
export growth remained at 7 %. Current account
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
1999.
Appreciation
of
the
currency
reduced
the
competitiveness of domestic goods in international
markets and increased the trade deficit
Thanks to low interest rate investment, consumption
and therefore imports increased. And because of the
over
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19
Problems
Drastic deterioration of the trade deficit
(II).
The rise of the US dollar against the Euro
also had resulted in a deterioration of the
current account deficit.
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20
Problems
Structural problems and fragilities in the
financial sector
Some difficulties in the privatization of
state owned enterprises
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November 2000
The first signs of trouble appeared in September when net
capital flows turned out to be negative.
At the end of October banks tried to close their open foreign
exchange positions due to regulatory and balance sheet
purposes. This move created a liquidity squeeze and caused
interest rates to increase. Central banks can sterilize the
effects of this seasonal outflow through expansionary open
market operations. However, the Central Bank (CB) had to act
as
a semi-currency board.
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November 2000
The initial optimism has worn out. The rapid
flight of capital from country started. Because
of:
Disappointing inflation results for October,
Unexpectedly high monthly trade deficits,
Political difficulties faced in privatization,
Worsening relations with the EU,
The economic crisis in Argentina,
Rising the US official interest rate,
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November 2000
The outflow was followed by the rise in the interest
rates at the last week of November and the market
risk in Turkey increased.
The banks in need of short-term funding began to
sell government securities. Rush to liquidity was
inflamed because of the competitive maneuvering
among some private banks. The decline in the
value of government securities and the rise in the
sovereign risk because of the fragility of the
financial system led foreign investors to accelerate
their exit from the Turkish markets by selling their
securities.
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November 2000
Overnight interest rate were at an average of
72.4% in November and 223.8% in December.
M ONTHLY INTEREST RATES
450
400
PERCENTAGE
350
300
250
200
150
100
50
01
.0
2
07
.0
1
10
.0
1
01
.0
1
04
.0
1
07
.0
0
10
.0
0
01
.0
0
04
.0
0
07
.9
9
10
.9
9
01
.9
9
04
.9
9
07
.9
8
10
.9
8
01
.9
8
04
.9
8
0
M ONTHS
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November 2000
The CB faced with a dilemma;
either to stick by the program and monetary
rule “at the expense of a deep financial
crisis”,
or to inject liquidity to the market exceeding
its defined target for net domestic assets in
order to rescue the financial system.
After some hesitation it started providing
extra liquidity to the troubled banks.
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November 2000
On November 22nd and following days, foreign
exchange reserves of the CB declined rapidly.
Within a few days, on November 30rd, 2000 the CB
reversed its policy and announced that it would no
longer fund the commercial banks in the interbank
market and this announcement skyrocketed the
overnight interest rates to four-digit levels.
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November 2000
On December 6th, the IMF announced that it was going to
support the program by opening a new credit line with the
extension of a $7.5 billion Supplementary Reserve Facility
to Turkey. Government reached a new agreement with the
IMF, the new Letter of Intent was announced on the 18th of
December, and the CB announced its new monetary
program in December 22nd.
The original limits on the balance sheet of the CB were
revised; but the path of the rate of depreciation of domestic
currency remained same.
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After November Turmoil
At the end of 2000 the markets seemed to
have calmed down and the erosion of
international reserves stopped. By midJanuary international reserves had been
refilled, exceeding their pre-crisis level, and
interest rates had fallen below 60%.
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After November Turmoil
However, maturities in government security
started to shorten drastically in late-January
and interest rates started to shoot up,
reaching 70% in mid-February. These gave
rise to serious doubts on the sustainability of
public debt. Rising public debt, high inflation
and the continuing appreciation of the
Turkish Lira (TL) brought considerable
doubts about the sustainability of the
crawling peg system.
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February 2001
On February 19th, 2001 political crisis between the
Prime Minister the President seriously hit the markets.
Over-night interest rate rose abruptly up to 2058% on
the 20th of February, and to 4019% on the next day.
Rising interest rates, with overnight rates reaching
5000%, could not stop the rapid flight from the TL.
Not
only
non-residents
but
also
residents
and
especially the banking sector rushed to foreign
currency (dollarization). The CB lost big part of its
foreign reserves in defending the currency peg.
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February 2001
The government could not bear the pressures of the
markets any more and was obliged to abandon the peg
and set exchange rates to float on February 22nd, again
with the consent of the IMF.
Within a single day the currency lost about one-third of
its value against the dollar.
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Inferences from the Crisis
The problems associated with exchange
rate-based stabilization
Fiscal problems
Maturity structure of the debt
Structural weaknesses in financial
markets
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33
Problems associated with exchange rate
based stabilization
Risks of exchange rate based stabilization

Fragility of pegged exchange rate
overvalued currency
growing external deficit
reliance on capital inflows

Difficulty of abandoning it without causing a
crisis
fear of loosing credibility
in this context, fear of capital outflow and
recession
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Fiscal Problems
Lack of fiscal dicipline in the past
Incomplete implementation of fiscal structural
measures during the program
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Maturity structure of the debt
The ratio of short-term foreign debt to the CB’s
international reserves reached at 112% in June
2000 and 145 % in December 2000.
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Transition to the Strong Economy
Program
In May 2001 an agreement was reached with IMF on a new
program
Main aim was to minimize short-term macro economic impact
of recent crisis and to provide disinflation and growth
Tools of the program were;
 Continuing to floating currency
 CB’s focusing on the control of monetary aggregates


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Transparency of policies and implementations
Restructuring of financial sector and fundamental
reforms of the state and the SDIF owned banks
37
As a result;
Structural weaknesses of financial sector, crawling
peg, downward inflexibility of prices, problems in
fiscal discipline, the maturity structure and magnitude
of the foreign and domestic debts led to the
occurrence of the crisis.
It can be seen that the “Transition To The Strong
Economy” program, implemented successfully since
2001, has also pointed out these factors and tried to
cope with them.
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