Re: Turkish banking crisis: another indication of global turbulence

["Johannes Schneider" <Johannes.Schneider@xxxxxxxxxxx>]

More on Turkey IMF from todays Frankfurter Allgemeine Zeitung at www.faz.com


IMF Could Come Under Fire If Turkey Fails to Contain Inflation

By Rainer Hermann

The International Monetary Fund (IMF) is taking a calculated risk with
Turkey. By granting it a loan in excess of $10 billion, of which $7.5
billion will be a special new credit, the IMF is hitching its own
credibility to the success of the Turkish government's stabilization
program.

In support of the program, the IMF had extended a three-year, $4 billion
standby loan on Dec. 22, 1999. This was the IMF's 18th such loan to Turkey.
It was accompanied for the first time by a comprehensive plan to lower
inflation and reform public finances. The goal was to get inflation down to
single-digit numbers by 2002 after having hovered for years between 60
percent and 80 percent.

After a remarkable stabilization success story in the first half of 2000,
however, the government was forced to send an SOS to the IMF in recent
weeks. Reaction was swift: It extended a new assistance package to Turkey
amounting to over $10 billion that has pulled Turkey out of an increasingly
precarious situation.

The crisis began when, in mid-October, interest rates began to rise slowly
and nearly imperceptibly. The tide of reform ebbed as politicians went back
to putting insignificant, daily disputes before serious structural reform.
Instead of getting on with privatization, they preferred squabbling about
the best starting positions in the run-up to new elections for the
presidencies of both the country and its parliament. Instead of making
progress on fiscal consolidation, Premier Bulent Ecevit and the new
president, Necdet Sezer, squabbled among themselves.

Statisticians first presented Turkey with the bill for focusing on the wrong
areas. Inflation, 4.9 percent in January and 0.7 percent in June, began to
climb again in the second half of the year. As a result, the target of 25
percent year-on-year in December has slipped well out of reach. It is now
more likely that it will wind up at 35-40 percent.

On top of this, a rapidly rising current account deficit looked set to spin
out of control. And then in mid-October interest rates began to rise,
chiefly because both domestic and especially foreign investors had lost
confidence in the government's ability to reform. This caused liquidity to
shrink accordingly. The central bank's monetary policy only funneled Turkish
liras onto the market after hard-currency inflows. Investors held back and
privatization ground to a halt. Currency inflows dried up more and more.

In fact, currency flows reversed themselves completely. On Nov. 22 alone,
$2.5 billion surged out of the country. In the days following, the outflows
reached $6 billion as mainly foreign investors took their money out. One
reason was, the need to record profits in their year-end financial
statements after having suffered losses in Argentina, another important
emerging market.

Secondly, they feared a devaluation of the Turkish lira as the Turkish trade
deficit ballooned. Just then, a leading European bank unexpectedly raised
its probabilities for a devaluation of the Turkish lira from close to zero
to 40 percent. That increased the suspicion among Turkish monetary
authorities that there was a concerted speculation against the lira. If, in
the face of heavy outflows, they would have had to devalue the currency,
foreign investors who had taken their money out beforehand would have done
very well.

Another outflow source was repayments by the Demirbank, a leading mid-sized
financial institution in Turkey. It became the first prominent victim of
rising interest rates, forcing the Turkish banking supervisory authority to
place the bank under its administration, the eleventh of its ilk. Demirbank
hand grown by investing in government bonds, knowingly undertaking risk in
so doing. The bank financed two-thirds of the Turkish-lira denominated bonds
through foreign currency loans. The axe came down, however, when the bank
started investing in bonds with 30-percent yields.

As interest rates started to climb, these bonds, collateral for the foreign
currency loans, progressively lost value. In the end, the losses from the
government-bond business quickly exceeded the bank's equity capital. The
central bank had no other alternative but to pour money into the banking
system to alleviate a liquidity shortfall due to the currency outflows.

Within 10 days its foreign currency reserves had shrunk by $5 billion. There
was no way the central bank could continue fighting on two fronts: Defending
against a currency devaluation on the one hand, while simultaneously
fighting to maintain liquidity on the other. It opted to defend the currency
because a devaluation in the face of speculation would have made a farce out
of its anti-inflationary campaign.

The crisis exposed the structural weaknesses of the Turkish financial sector
and the confidence so arduously built up in foreign markets evaporated. But
the current crisis comes with a second bill. The economic growth, which was
pulling the economy out of the previous year's recession, will be halted due
to the high interest rates. But perhaps this lesson will be enough to
prevent the government from wasting in the future. Experience, however, has
shown time and again that Turkish governments only act when they are under
outside pressure. Now, privatization -- something which has appeared
impossible for a long time -- is to be implemented overnight.

Should the government fail to keep its promises, international financial
markets will certainly pass their own ruthless judgements. But its is
equally clear that the IMF will not let things go that far.