Succinctly and superficially, Turkey’s economic crisis of 2001, which led to a downturn of around 12 percent, was caused by too-high public deficits, out of control inflation and the subsequent devaluation of the lira (Kriwoluzky and Rieth p 356). But to understand how this happened, we must first look at Turkey’s history of chronically high inflation, its banking crisis of the previous year, the anti-inflationary policies of 1999, and the austerity measures in place since 1994 that were the result of yet another economic crisis. It might seem that Turkey is stumbling from crisis to crisis, but that is because the causes are either persistent and interrelated, or the cure for one crisis is the cause of another is up, or a combination of the two. Some crises have been home-made, others the result of external shocks. And while it is not the purview of this paper to discuss the political evolution of the Turkish governmental structures, some brief explanation is necessary in order to show why certain policies were (or were not) implemented. This paper will conclude with policy prescriptions that may have prevented them, and a brief description of more recent crises.
Inflation and the 1994 Crisis
Turkey was a leader in Import Substitution Industrialization (ISI) in the Middle East, and also the transition away from ISI to export-led growth. On January 24, 1980, Turkey began extensive plans to stabilize and liberalize its economy, which the military regime installed that year seemed to accomplish: lowering inflation, raising GDP growth and liberalizing trade and financial systems, but following general elections in ‘84, inflation began to rise again (Ertuğrul and Selçuk p. 13-14). The efforts after 1984 involved monetary tightening but no real effort reducing borrowing in the public sector, which meant higher and higher interest rates on local assets and a lower depreciation rate because of the need to get short-term capital inflow, but Turkey did not take the needed precautions fiscally; that combined with the growing external deficit, there was a major crisis in 1994 (Ertuğrul and Selçuk p. 14-15). Indeed, it was this over-dependence on short-term capital inflows followed by the (arguably premature) liberalization of capital accounts, that led to the 1994 crisis of balance of payments; the exports simply could not keep up with the boom in imports (Öniş p. 4-5). A general policy prescription would be a currency peg, “to break the inflationary psychology… [m]ost populations are willing to sacrifice monetary sovereignty in the name of fighting inflation only when hyperinflation is fresh in their minds,” (Frankel p. 28). Inflation had been a persistent problem since before the transition phase. Since late in the 1970s Turkey has faced chronic high inflation; naturally, the high levels of spending led to fiscal imbalances and exchange rate adjustment, but further fueling the inflation was the delaying of stabilization, particularly in the 1990s, and the coalition government instead put in place populist measures like lowering the interest rates and keeping the lira overvalued (Nas p. 88). This is not unusual in political situations like Turkey’s. As Bird and Willet note, “coalition governments and those facing other configurations of political power that generate numerous veto players will often find their hands tied… If devaluation is perceived by the general public as carrying economic costs and is politically unpopular, it is hardly likely that opposition parties will want to be seen as entreating the government to devalue,” (Bird and Willet p. 66). Turkey’s persistent inflation, which was up to 60 percent before the 1994 crisis reached levels of 125 percent during it (Cömert and Yeldan, p. 8). The ‘94 crisis was not just the result of inflation, but was predominantly finance-led like the subsequent 2001 crisis would be (Cömert and Yeldan, p.21). But the program that was put in place to fix it would do little to help prevent the next crises, rather the reverse.
The 1999 Disinflation Program
In 1999, Turkey began a disinflation program based on an exchange rate stabilization plan. (Ekinci and Ertürk p. 29). This was backed by an International Monetary Fund standby agreement that amounted to $4 billion to fight inflation and support the fiscal adjustment (Nas p. 88). It hoped that by focusing on disinflation, it “would contribute towards the reduction of real interest rates to acceptable levels and the increase of the growth potential of the economy,” with tightening fiscal policy as the basis for the program (Öniş p. 9). What made the successive crises surprising is that they occurred in the during an IMF program. While domestic politics are certainly a primary cause, the IMF is not without blame. Domestically, the current account deficit grew partially because of the nature of Turkish politics. Following elections in April 1999, a coalition government was formed from a diverse range of party ideologies (Öniş p. 10) and major conflicts emerged over economic policy, namely the far-right nationalist party opposed the reduction of agricultural subsidies (which would have hurt them in future elections, as the rural poor was their base demographic). But under the pressure of the EU and others in the international community, reform was passed through, but “the half-hearted nature of the commitment… progressively undermined investor confidence and constituted one of the underlying sources of the speculative attack and the massive exodus of short-term capital in November 2000,” (Öniş, p. 11). While the IMF and the Washington Consensus did, likely prematurely, push developing countries to capital account and financial liberalization, it was Turkey’s own internal decision to do that in 1989 (Öniş & Rubin, p. 189). That does not mean the IMF is without blame in the 2000 crisis. One reason would be that it failed to collect the necessary information about Turkey’s disequilibrium in the banking and public sector, which was also part of the cause of the 2001 crisis. If the IMF had better acquainted itself with specifics of the countries to which it made loans instead of applying a standard model, a different program could have been applied and would likely not have precipitated another crisis (Öniş p. 12).
This program with its ‘no-sterilization’ requirement was meant to be mostly passive but it did allow short-term liquidity changes; so as of December 1999 there could be no changes in the domestic asset level of the monetary base, but fluctuations within 5 percent were allowed in the short-run, but domestic interest rates were still determined by the market, so the Central Bank had limited scope to act (Nas p. 89). Since Turkey’s liberalization had been a beleaguered and grudging process, the 1999 program for Disinflation and Fiscal Adjustment also stressed structural reforms “to make the fiscal adjustment sustainable, improve economic efficiency, and accelerate the privatization of SEEs [State Economic Enterprises]. That and an exchange-rate-based monetary policy that was an important aspect of the program were expected to lower interest rates and inflationary expectations,” (Nas, p. 90). As Eichengreen points out, “the removal of capital controls makes it harder to bottle up private financial transactions which apply pressure to the current constellation of exchange rates. This forces central banks today to undertake more extensive, more costly, and more difficult sterilization and intervention operations in order to maintain the status quo,” (Eichengreen, 2004 p. 6). But the principal crisis in 2000 was one of liquidity, and part of the stabilization program was a no-sterilization rule, which meant that only variations in the foreign exchange reserves could change the money supply (Nas p. 89). This no-sterilization rule that had been implemented in the post-1994 crisis reforms was meant to protect the economy from indiscipline and give credibility to the program, but, “The conditions engendered by this approach restricted the monetary autonomy of the Central Bank by forcing it to operate like a quasi-currency board, allowing the interest rate to be freely determined by the market while leaving the control of monetary policy in the hand of capital flows,” (Öniş p. 13). However, a currency board only issues currency that is backed fully by foreign assets, and fixed by law (Frankel, p. 18) which was not the case in Turkey, though it did lack monetary stability, due to its history of high, if not hyper-, inflation. Rather, Nas identifies the new exchange rate system as a crawling peg regime in which “exchange rate adjustments are declared in advance, and with a built-in feature of pre-announced exit strategy from the system of the exchange-rate policy.” (Nas p.89). In high inflation countries like Turkey, the peg ‘crawls’ through a series of regular mini-devaluations that have been announced ahead of time, and the ‘crawl’ rate is deliberately set lower than inflation, (Frankel p. 4).
2000-2001
The program lasted not even a year before the pressure on the banks faced a liquidity crunch, caused by a reversal of capital flow, and the program was ended (Ekinci and Ertürk p. 39). The largest private bank in the 2000 crisis, Demirbank, lost all its capital because of the implacability of the IMF and the Central Bank’s inflexible adherence to the program, which did not supply any emergency liquidity to Demirbank, and stem the outbreak of the crisis, (Öniş p. 13).
Because of the disinflation program’s currency arrangements, the central bank had no real ability to reduce losses and limit the risk of the speculative holdings, forcing them to rely on short-term financing “as they had to take over an ever-larger portfolio of government debt that was being unloaded,” by speculators, (Ekinci and Ertürk p. 38). The problem of the exchange-rate based program was that because the exchange risk was socialized (meaning it depended on the government to compensate banks for losses if keeping the exchange from moving failed) there was a moral hazard problem: there was reduced incentive to have strong balance sheets and good supervision, (Eichengreen 2001, p. 12).
Turkey’s banking problem was treated by the IMF with a debt management program, rolling over foreign debt, it aimed at “gaining the confidence of the international arbiters and financial speculators,” (Yeldan p.210). Turkey’s addiction to short-term foreign finance meant it had to keep high interest rates, but these rates clashed with the goal of debt sustainability, and cheap foreign currency became necessary to lower costs of imported intermediate goods: the only source of growth in a contracting economy dependent on international speculators, which was also a cause of the ‘94 crisis, (Yeldan p. 211). International speculative investors were attracted by the stabilization program, which had lowered rates and provided “safe one-sided bets,” (Ekinci and Ertürk p. 39) But banks, essentially gambling to stay afloat under the pressure and gasping for liquidity, sold off government securities, which led to a hike in the interest rate, which led global investors to pull out, causing a severe credit crunch that the central bank, constrained by the program, could not prevent by ejecting liquidity (Eichengreen 2001, p. 7). Finally, monetary authorities provided the much-needed liquidity, but the doubts raised by the moved caused even more capital flight, so the IMF gave $10 billion on the condition that the Turkish government’s strengthening the financial sector, budget, and privatization, (Eichengreen, 2001, p. 6). Public political disputes about the reforms caused doubt and uncertainty that led to interest rates shooting up several thousand percent, which forced the currency to float, losing half of its value and a sharp rise in inflation; add to this the public debt growth on account of the high interest rates and GDP fell, leading the IMF to dole out another $8 billion after the Turkish government passed structural reforms, including, at last, a new important banking law, (Eichengreen 2001, p. 7).
Since 2001
Following Turkey’s liberalization, the IMF prescribed the same stabilizing policy prescription, putting stress on arguably the weakest part of the Turkish economy. These crises were a critical juncture in Turkey’s economic history. The austerity plan that followed was unusually effective:
“While recessions typically strengthen popular opposition to belt-tightening, the sheer depth of the financial crisis, the worst in postwar Turkish history, gave the state a unique window of opportunity to implement far-reaching reforms as it became clear that the previous policies had led to a state of near-bankruptcy of the Turkish economy, thus dramatically weakening popular resistance to Washington Consensus policies as well as to “Euro-skepticism” in Turkey (Öniç 2004). The crash and ensuing reforms paved the way to a significant restructuring of the Turkish political economy.” (Cammet p. 289)
There have been other crises since, however. The global financial crisis of 2008 affected Turkey, but it weathered it better than others. However, Turkey has experienced another crisis as recently as summer 2018. As it has throughout its history of industrialization, Turkey depends on importing capital, primary and intermediate goods in order to keep its industrial production going, (Oyvat p. 4). Its growth is therefore tied to rises in current account deficit, yet large investments have not led to a lasting technological change on a structural level that would lift Turkey’s industry, and economy out of its cyclical balance of payments trap (Oyvat p. 4-5). Instead, the current leadership (President Recep Tayyip Erdoğan and his Justice and Development Party) that has been in power since the 2001 crisis, has focused on policies that boost growth through various construction projects rather than foster industrial policies that focus on domestic value added, (Oyvat p. 5). The crisis of 2018, therefore was, “not merely an outcome of a political crisis instigated by Donald Trump. Turkey is now paying for the years of finance-led growth supported by speculative financial capital inflows, and a construction boom,” (Oyvat p. 10). Also, a key factor in the most recent crisis and what is important to prevent further economic downturn is to (re-)establish the autonomy of the central bank, (Kriwoluzky and Rieth p. 362).
Conclusion
Despite IMF involvement, the crises of 2000 and 2001 happened. It could be that the “volatile and reversible capital flows and the massive economic and social costs of speculative attacks result[ed] in massive outflows of capital”, meaning that some capital controls are needed for a true stabilization (Onis & Rubin, p 189). But to have prevented the 2001 crisis, and likely the 2000 crisis as well, rather than focusing its initial stabilization efforts on the current account deficit, it should have paid attention to the banking sector, which would have obviated the “November 2000 crisis [which] was primarily a crisis of the private banking sector,” and because the “February 2001 crisis stemmed from the disequilibrium in key components of the government-owned banking sector,” (Öniş p.13). So, it seems the banking sector was at the heart of both of these crises, and their inadequacy was the fault of the local political system and both the oversight and under-regulation by the IMF of the banking sector. However, that isn’t to say that this would have solved all of Turkey’s economic woes. It is arguable that Turkey’s economic crises of 2000-2001 were not preventable without likewise preempting the 1994 crisis. It may be that preventing crises are not politically viable before the fact, and the only way for a democracy (especially one with a divided government) to all agree to a corrective economic policy, is for the majority to have suffered from bad policy first. Turkey’s 2000-2001 was so deeply shocking that the electorate actually supported financial discipline, leading to a strict adherence to the austerity program that previous administration had agreed to with the IMF, (Cammet p. 290). However, Turkey’s continued financing of current account deficits would be less of an issue, certainly would lead to fewer crises, if Turkey’s growth were not dependent on them. As Oyvat mentioned, Turkey depends on imports of primary, intermediate, and capital for its industrial production, and has not prioritized structural technological transformation in its industrial policy. Rather than evolve, it borrows to buy what it needs to produce to keep its economy going, leaving the resulting situation of balance of payments issues, persistently high inflation, dependence of foreign borrowing, both in the public and private sector, vulnerable to schools that could set of yet another downturn. Some suggest that the For Turkey to have prevented past crises, or even avert the next one, it needs to change its entire growth model, and focus its industrial policy on structural technological change.