Anatomy of a Currency Crisis -- Turkey 2001

It was in fact the banking sector of the Turkish economy which was blamed for having led to hundreds of thousands of job losses and steep price increases in the 2001 currency crisis, triggered by September 11th. Who else if not the state could the Turk's finger? Since 2001--2002 macroeconomic indicators such as inflation have dropped from mainly as a result of monetary and structural reforms. For example, a former vice president of the World Bank (Kemal Dervis) was appointed as the economy minister, and the Turkish parliament approved a law which gave the Central Bank of Turkey, the bank which regulates the fractional reserves and discount rates, independence from political interference. A free central bank is such a basic need for a market economy. Turkey still works closely and compliantly with the IMF's Washington Consensus-builders, however. Bank reform was one of the measures which had been demanded by international lenders before they agree to give further financial support to the Turkish government, regardless of IMF and World Bankers.

A wave of mergers, acquisitions and IPOs has been noticeable since 2001's crisis. The number of banks fell dramatically from 81 in 1999 to 54 in 2002 through what Schumpeter calls “creative destruction”, mainly because of bank failures and domestic consolidation between minor players. Global bankers such as France's BNP Paribas bought the largest shareholder of the largest asset-holding bank in Turkey.

Foreigners, mostly Europeans, acquired more than two-thirds of the available equity but the public sector holding company, the General Directorate of Foundations, still owns 58%. The consensus among analysts is that the wave of mergers and acquisitions is now coming to an end. But foreign investors with organic-growth-based business plans still purchase minor banks for their licenses. The attention now is on the state-owned Halkbank, which is slowly privatizing its assets with IPOs. Halkbank is known for its broad client network of small and medium sized enterprises (SMEs).

Banks based in Benelux countries, especially Holland, have bought several Turkish banks to form strong financial bridges. The Dutch Fortis Groups has acquired several banks entirely through tender calls. Finansbank is the largest foreign-controlled publicly listed bank in Turkey, owned by Greek bankers. It is clear in the bank's purchase agreements that the original owners value the control they retain. Power in the board of directors at Garanti will remain evenly split according to the agreement. Akbank and Citibank stipulated that Citigroup may only purchase further shares from Sabanci Holding, not directly from family members. This is a significant improvement, considering the studies of the GLOBE and Geert-Hofstede institutes which described inter-familial trust very unpromisingly in Turkey. Turkish society apparently is becoming more trusting, more engaging, and the institutes describe this as conducive behavior for market economies.

There were several reforms which made this creative process possible. During the Lira crisis, the state Central Bank fixed the exchange rate of its 35% overvalued lira. The Turkish government then independently decided to float the currency with international prices and introduced new banknotes to regain trust and address the capital flight and liquidity crisis caused by investors' choices. Many EU members argued that since Turkey is queuing to join the EU, it would be wrong to support it financially because this would send out a signal that the Union is prepared to bail out anybody running into difficulties ahead of joining.

After the 2001 crisis, Mr Dervis announced that an independent board of managers would be created to control three of Turkey's four main state banks. The financial burden on state banks was transferred directly to Turkey's government budget, to the high publicly-owned debt. In 2006 public debt was 67% of GDP. The now independent Central Bank of Turkey initiated several modern reforms such as the implementation of a full-fledged inflation targetingregime from the beginning of 2006. Every other Western country has been using this strategy since the 1980s, however. It was a basic and simple reform.

Why was so much of the blame for Turkey's political and economic crisis can be laid at the door of the country's banking sector? Turkey's banks have long been the economy's Achilles heel. Turkey's financial crisis in November 2000 was similarly sparked by problems with the banks. The large number of small banks with insolvent reserve ratios led to their collapse. Corruption in many banks is due to fraudulence and illegal practices against the banking regulatory agency. The arrest of bank executives had aided rumors that other banks were in trouble and re-ignited alarm over corruption in the sector.

After floating the currency 40% of the Istanbul Stock Exchange dropped and inter-bank interest rates rocket to as high as 2000% as foreign investors fled the country. Since then the currency leveled out; doubts over Turkey's ability to meet inflation and privatization targets—as part of a wholesale reform program supported by the International Monetary Fund—also resurfaced. The IMF eventually agreed to provide $7.5bn in new emergency loans. The IMF also brought forward $3bn in loans that were available to Turkey under a previous IMF deal.

Of course, the new loans came with IMF agreements: Turkey had to make a fresh commitment to reform its banking sector and to accelerate its privatization program. The currency peg during the fixed exchange period, which controlled the movements of the lira, also happened to be the centerpiece of the IMF-backed financial reform package of the time designed to combat inflation. Yet the IMF supported the Turkish government's unilateral decision to float the currency anyway. Horst Köhler, managing director of the IMF, who nonetheless supported the lira's devaluation, admitted to the BBC that "the change in the exchange rate regime requires a revision of the macroeconomic framework for the economic program".

In defense of banks, it appears to me that the heavy statist approach of the Turkish government in nearly every sector of its economy is to blame for the historical buildup to the currency crisis in 2001. If the state could be trusted in monetary controls, if banks were allowed to respond to prices and supply conditions freely, if state banks were not staffed by corrupt insiders, and if the old Lira was pegged to something truly fixed and fully reserved, perhaps September 11th would have had little impact on the Turkish economy.