Turkish banks at root of crisis

Turkey's economic crisis started with the banks

Much of the blame for Turkey's political and economic crisis can be laid at the door of the country's troubled banking sector.

Turkey's banks have long been the economy's Achilles heel. Last time Turkey had a financial crisis, in November 2000, it was again sparked by problems with the banks.

The events in Turkey over the past few days - plunging stock prices, spiralling interest rates and high inflation - are familiar economic demons.

The country was experiencing the same adverse conditions only three months ago, following the collapse of 10 insolvent private banks.

November's crisis knocked 40% off the stock market

The two-week long financial crisis that followed knocked 40% off the stock market and saw inter-bank interest rates rocket to as high as 2000% as foreign investors fled the country.

The arrest of bank executives had fuelled rumours that other banks were in trouble and re-ignited alarm over corruption in the sector.

Doubts over Turkey's ability to meet inflation and privatisation targets - as part of a wholesale reform programme supported by the International Monetary Fund - also re-surfaced.

The flames of that crisis were eventually doused when the IMF agreed to provide $7.5bn in new emergency loans.

The IMF also brought forward nearly $3bn in loans that were available to Turkey under a previous IMF deal.

But the new loans came with strings attached - Turkey had to make a fresh commitment to reform its banking sector and to accelerate its privatisation programme.

Crisis revisited

Turkey seemed finally to be back on track until a furious row broke out between its president and its prime minister on Monday.

Investors thought the worst, fearing that the government was about to collapse.

Mr Ecevit tried to calm Turkey's financial jitters

And the cause of the argument? Corruption in the banking sector.

President Ahmet Necdet Sezer had accused the prime minister of being "too passive" in the fight against corruption and of trying to prevent an investigation of the banking sector, according to the news channel CNN-Turk.

The Prime Minister Bulent Ecevit, who believes his government has a better track record on corruption than former administrations, took offence.

Later Mr Ecevit tried to calm the country's financial jitters, but the political dispute had already rocked the markets.

"Careless politicians," remarked one analyst.

In too deep

Turkey's main 100 share index on the Istanbul Stock Exchange lost 18% of its value on Wednesday - its steepest ever fall.

Inter-bank interest rates - the rate at which banks to lend to each other - then rose to a record 5000% on Wednesday, as the government embarked on a marathon session to respond to the crisis.

Turkey was forced to float the lira by the force of the market

As investors scrambled to buy foreign currency, the Turkish central bank reached the point where it could no longer support the exchange rate, which was linked to a "peg".

"The weight of the market was too heavy," said Paul Rawkins, a senior director in sovereign ratings at the ratings agency Fitch IBCA.

The currency peg, which controlled the movements of the lira, also happened to be the centrepiece of the IMF-backed financial reform package designed to combat inflation.

Horst Köhler, managing director of the IMF, who nonetheless supported the lira's devaluation, admitted, "the change in the exchange rate regime requires a revision of the macroeconomic framework for the economic programme".

What next?

Fitch believes that Turkey has no choice now but to implement high interest rates and tight budgetary restraints.

"But this would mean that domestic demand would collapse and Turkey would probably go into recession," said Mr Rawkins.

This would mean that domestic demand would collapse and Turkey would probably go into recession

Paul Rawkins
Fitch IBCA

Although there are fears that the Fund may withdraw its support if the fight against corruption is not renewed, Mr Köhler has remained fairly upbeat.

He has even hinted at the possibility of giving Turkey further "resources" to cover the increased fiscal cost of restructuring the banking sector.

Some also say the IMF will have to remain engaged with Turkey to avoid a loss of confidence in other emerging markets.

But everyone agrees that Turkey's efforts to salvage its fragile economy, overhaul its banking sector and shore up investor confidence will continue for some time yet.