TURKEY: FINANCIAL CRISES IN CONTEXT
CRS Report for Congress
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Turkey: Financial Crises in Context
Specialist in Middle Eastern Affairs
Foreign Affairs, Defense, and Trade Division
In December 1999, with International Monetary Fund support, Turkey launched a
major economic reform program intended to cure chronic inflation. Its main elements
were a crawling exchange rate peg, structural reforms, and privatization. Some progress
was made in 2000, but implementation was uneven. A severe liquidity crisis in late
November 2000 required a new IMF loan. On February 22, 2001, after a second crisis,
Turkey abandoned the currency peg and, with it, the program. Analysts concur that
stabilization, privatization, and banking reform are still needed, but Turkey’s statist
ideology and divided coalition government may continue to undermine the prospects for
radical change in economic policy. Neither the government nor individual ministers have
taken responsibility for the crises, yet there may be no alternative to the current
government under present circumstances. The crises set back Turkey’s hope to comply
with economic criteria for EU membership. U.S. officials believe that the United States
needs a stable Turkey for geopolitical reasons and, as a result, the U.S. supports
continuing economic reforms. See also CRS Report RS20253, Turkey: Continuity and
Change after Elections.
Turkey’s April 1999 national elections brought to power a three-party coalition
government that launched an ambitious economic program with International Monetary
Fund’s (IMF) approval of a three-year $4 billion standby-credit in December 1999. The
program’s main goal was to cut the country’s chronically high inflation rate from about
65% at the end of 1999 to single digits by the end of 2002 and, thereby, enhance the
prospects for economic growth and an improved standard of living (Turkey: Letter of Intent,
[http://www.imf.org/external/np/loi/1999/120999.htm]). The main policy tool was a
“crawling” exchange rate peg which allowed for nominal depreciation of the lira against
the dollar and euro monthly according to a pre-announced schedule. The peg was
intended to keep the lira from becoming overvalued, thus preventing pressure for a
potentially destabilizing large devaluation, and to decrease inflationary expectations. To
succeed, the program required the support of major structural reforms and accelerated
privatization of state enterprises.
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However, the government’s implementation of the program was uneven, and reforms
were undermined by other factors as well. The stability of the government, and by
extension confidence in its economic program, was repeatedly questioned because of the
philosophical incompatibility of the ruling coalition partners as well as an ongoing court
case to ban the opposition Islamist Fazilet Party, the third largest party in parliament. If
the party is banned and more than 100 deputies are expelled from parliament, early
elections are likely. In addition, Turkey’s arrangement with the IMF had a built-in exit
strategy to shift to a more flexible exchange rate in July 2001, creating expectations that
the crawling peg system would change. It was widely believed that there would be a
devaluation before July because the lira was perceived as overvalued.
Problems multiplied. The government postponed privatizing Turk Telekom, the state
telecommunications agency, after its initial offering of 20% ownership with no
management rights drew no bids. The sale had been expected to generate at least $2
billion in revenues to help offset an anticipated fiscal deficit of 11.3% of gross national
product for 2000. At the same time, investigations into corruption revealed scandals in the
banking and energy sectors. Investor and public confidence deteriorated. At the end of
November 2000, the failure of a small bank sparked a major outflow of capital and a
severe liquidity crisis. The IMF provided $7.5 billion in new loans to replenish reserves
on December 21, 2000.
The government admitted that it would not meet its inflation rate target of 25%, and
projected inflation at 39% for 2000. Energy prices had risen, while lower nominal interest
rates fueled consumer spending. By year’s end, exports had grown by 6.4%, while
imports soared by 34.7%, producing a very large current account deficit.1 The current
account deficit had grown from $1.36 billion in 1999 to $9.76 billion in 2000, or 5% of
the gross national product compared to a program target of 1.8% of GNP. Meanwhile,
as the government took over weak banks, it exacerbated the projected fiscal deficit. By
the end of December, the fiscal deficit would increase to an estimated 12.6% of GNP.
On February 19, at a meeting of Turkey’s National Security Council, President
Ahmed Necdet Sezer proposed that the State Inspections Board look into the banking
sector. Prime Minister Bulent Ecevit considered this an insult to his government’s anti-
corruption efforts, although investigations have not snared allegedly corrupt ministers who
many believe have been protected partly by the need to hold the coalition together.2 After
an unseemly confrontation, Ecevit left the meeting and declared to a waiting press that
there was a “serious crisis.” He was assumed to be questioning his government’s stability.
Investors panicked and capital took flight from lira to dollars. Interest rates soared briefly,
making it difficult for banks to secure funds and remain solvent, and the stock market
plunged. On February 22, 2001, the government abandoned the crawling peg and let the
lira float, causing a 24% devaluation as of March 2. By February 23, hard currency
reserves had fallen by $5.4 billion, or from $27.9 billion to $22.5 billion. The economic
reform program was apparently dead.
1 The current account measures the balance of trade in goods, services, and other transfers funded
by external dollar borrowing.
2 Bulent Aliriza, Turkey’s Crisis: Corruption at the Core, CSIS Turkey Update, March 5, 2001.
Ideological and Political Context
The Turkish Republic founded in 1923, adopted statism as a fundamental principle,
giving the state the central role in directing the economy. Liberalization of the economy
began only in the late 1980s and, by 1999, still had not reached critical sectors of the
economy or changed the people’s expectations of their government. State ownership of
enterprises persisted despite inefficient performance because they employed thousands.
They also drained the treasury. A social security system with inordinately low retirement
ages further contributed to the fiscal deficit. For many years, growth in the money supply
and high interest rate bonds financed the deficits, producing chronically high inflation.
The government formed in 1999 included two parties, the Democratic Socialist Party
(DSP) and the Nationalist Action Party (MHP), which are ideologically committed to the
central role of the state in the economy. The leftist DSP believes in a strong state to serve
the people, while the xenophobic, rightist MHP advocates state, not foreign, ownership
of resources. The Motherland Party (ANAP), the third partner, generally favors a market
economy. Although some DSP and MHP ministers publicly supported the economic
reform program, they delayed or obstructed implementation. They were abetted by
ideological purists, public sector labor unions, opposition parties, or others outside of the
government who filed lawsuits or demonstrated against reform initiatives. Court action
succeeded in part because the 1982 Constitution and many laws mandate or protect
Turkish opponents, and even advocates, of economic reform commonly referred to
it as the “IMF Program” or denigrated the IMF desk officer for Turkey, an Italian national,
as if this somehow influenced the terms of the program. This line of attack made the
program appear as a foreign imposition, prompting concerns about national sovereignty
and making the program an easy target for nationalist media and politicians. Prime
Minister Ecevit and others have blamed the IMF for the program’s failure. Others point
out, however, that the most controversial, and arguably the weakest, element of the
program, the crawling peg, had been a Turkish idea used despite IMF skepticism about its
Privatization. After the failure of its 20% offering, the government announced in
January 2001 that it would sell 33.5% of Turk Telekom with management rights and
requested bids by May 14. Critics contended that the government would not grant
substantive management rights to minority shareholders. They also observed that the
government had waited too long to enhance the offering, and did so during a glut in the
international telecommunications market. In February, the government admitted that it
had no bidders and that the May 14 deadline would slide. The terms of the offer may have
to be improved for a sale to go forward. This will require new authorization legislation,
which requires time to pass. Parliament has passed a law to allow privatization of electric
power production and distribution, although investors may want to see detailed regulations
before bidding. Officers of the state power company were arrested for taking kickbacks
3 Paul Blustein, Turkish Crisis Weakens Case for Intervention, The Washington Post, March 2,
for contracts in a major recent scandal. Privatization of 51% of Turkish Airlines (THY)
also is in the offing. THY owns prime routes and other lucrative assets that would be
attractive to investors, but foreigners will only be allowed to purchase 24%, which may
lessen their interest.
Banking. Some Turkish banks reputedly profited by borrowing foreign currency
at low interest rates, changing it into lira, and lending to the government at higher rates.
Bad or corrupt bank management appeared common, according to many reports. As the
government’s anti-inflation program began to work, interest rates on lira dropped and the
weaknesses of some banks’ operations were exposed. State banks in particular are the
major vulnerability of the banking sector. Four state banks control a third to a half of all
bank assets, employ 65,000 people, and have thousands of branches.4 They lost an
estimated $20 billion in 2000, partly due to their state-imposed obligations to support
assigned sectors of the economy, such as agriculture, real estate, and small businesses.
Two state banks defaulted on obligations to domestic banks on February 20.
Most analysts agree that restructuring banks to get rid of insolvent ones must be the
highest priority in a new economic reform program. Some members of the government,
however, reportedly oppose privatization of state banks. This may be because
privatization would require truthful audits and disclose misdeeds, but it also reflects
traditional statist ideology as well as loyalty to key constituencies that the banks serve.
The government supports the banking sector by providing unlimited guarantees on
deposits, creating large liabilities. A semi-independent Banking Regulation and Inspection
Board created in 2000 has taken over 12 banks. In mid-November, it had been allowed
to draw $6.1 billion from the treasury to assume the insurance burdens of banks taken
over. Complete restructuring of the banking sector will be far more costly.
Economy. On March 2, 2001, Prime Minister Ecevit appointed World Bank Vice
President Kemal Dervis, a Turkish national who has since resigned from the Bank, to be
State Minister in charge of the Treasury, with responsibility as well for the Banking
Board, the Central Bank, the Capital Market Council, two state banks, and the Turkish
Development Bank. All of these agencies are DSP portfolios. MHP and ANAP, which
are responsible for the privatization program, the State Planning Organization, other state
banks, and foreign trade, reportedly refused to surrender these responsibilities to Dervis.
Dervis’ lack of complete control over the economy may detrimentally affect his ability to
coordinate policy changes and make reforms rapidly. Nonetheless, he is a respected
international banker and his appointment is generating confidence in domestic and
The financial crises have produced higher unemployment (20%), thousands of small
business failures, and price hikes on basic commodities. The devaluation greatly
diminished the value of lira assets, impoverishing those who have few or no dollars. The
coalition members had gambled their political futures on the benefits to the people that
would follow what they assumed was the short-term pain of the now failed economic
program. They are already looking for ways to deal with social pressures which may
4 Elif Kaban, Skeletons in state bank cupboards rattle Turkey, Reuters, February 28, 2001.
require new spending. Moreover, in the midst of the turmoil, the Constitutional Court
voided some articles of a social security reform that had changed retirement eligibility from
25 years of work with no age limit to 58 years of age for women and 60 for men. The
Court said that the law could apply only to individuals who began work after the law was
passed in 1999. Therefore, a large drain on the budget may continue for some time.
With the abandonment of the crawling peg, the government may have to adopt a
more orthodox macroeconomic stabilization program -- one focused on inflation targeting
through tighter monetary policy, fiscal restraint, structural reform, and privatization of
state enterprises. It will likely be even more painful than the failed program, and face the
same political obstacles. The details of a new program will determine how much
assistance international financial institutions will be willing to provide.
Government. The government has not accepted responsibility for the crisis. Since
February 20, no ministers have resigned, although the head of the Central Bank and the
Undersecretary of the Treasury, who were public advocates of the currency peg, and the
head of the Banking Board have stepped down. The cabinet rode out the crisis intact
apparently because the governing parties could not agree on which ministers to sacrifice.
Prime Minister Ecevit, who is 75-years-old and physically frail, refuses to leave. His DSP
holds a party congress in April. It might provide an opportunity for him to give way to
a successor in a setting that is more palatable than the immediate aftermath of the failure
of his government’s economic reform program. Given the make-up of parliament, there
is no real alternative to the current government. The two opposition parties have uneven
records. The True Path Party is led by former Prime Minister Tansu Ciller, who had been
criticized for inept handling of a 1994 financial crisis, her reputation for alleged
corruption, and her role in bringing Islamists to power in 1996. The Islamist Fazilet Party
(FP) faces a possible ban and is splintering. If a ban leads to the expulsion of over 100 FP
deputies from parliament, it may trigger new elections. A party not now represented in
parliament, the Republican People’s Party (CHP), might enter parliament or government
after an election. Led by Deniz Baykal, it has its own factional problems. After an
election, most, if not all, parties will have the same leaders.
Many Turks have recognized that economic progress may only be possible with
radical political changes that would produce a different governing establishment endowed
with the political will to carry out needed economic reforms. On March 4, President Sezer
voiced this thought, declaring that greater democratization through Constitutional
amendment, and new political parties’ and election laws are essential. He emphasized the
need to intensify the fight against corruption. The President noted that these and other
measures could produce a state governed by the rule of law and worthy of the confidence
of the people.5 Polls indicate that Sezer has the overwhelming support of the people, but
apparently not of the entrenched party leaders whose power would be diluted by such
reform measures. Thus, fulfilling Sezer’s goals is not on the government’s legislative
European Union Membership. Turkey’s candidacy for European Union
membership was affirmed in December 1999. Turkey does not currently meet EU criteria
for membership. However, successful completion of the economic program would at least
5 Details Sezer Holiday Message, Ankara Anatolia, March 4, 2001.
have assisted Turkey in meeting the economic criteria, including adoption of a functioning
market economy with the capacity to cope with competitive pressures and market forces
within the Union. The program’s failure is a serious setback for Turkey’s EU hopes.
Implications for the United States
U.S. government officials generally agree that the United States needs a stable
Turkey. U.S. and British overflights to enforce a no-fly zone over northern Iraq
(Operation Northern Watch) stage from Turkey’s Incirlik Air Base. The Turkish
parliament has extended the mandate for Operation Northern Watch repeatedly for over
ten years. Turkey also has been key to the enforcement of international sanctions against
neighboring Iraq despite some violations. During the Kosovo conflict, Turkish and U.S.
planes flew side-by-side and Turkey temporarily hosted thousands of Kosovar Albanian
refugees. Turkish troops participate in NATO peacekeeping in Bosnia and Kosovo.
Turkey supports U.S. policy to stabilize southeast Europe. With U.S. encouragement,
Turkey and Greece are developing a rapprochement that could abate historic tensions
between these two NATO allies. Turkey is a linchpin of U.S. policy seeking to ensure the
independence of Caucasian and Central Asian countries through energy pipelines and
transport routes that bypass Russia and Iran. Turkey has developed strong ties with Israel,
and has served as an intermediary between Israel and the Palestinian Authority.
Because of Turkey’s geopolitical importance, therefore, political considerations may
supersede the debate over the weaknesses of the IMF’s approach to financial crises and
the value of large bail-outs. Treasury Secretary Paul O’Neill, a critic of crisis intervention,
has backed “the IMF’s ongoing support for Turkey’s economic reform program.” On
February 23, 2001, President Bush spoke to Prime Minister Ecevit, urging continued
economic reforms. On February 27, President Bush sent a letter to President Sezer,
reportedly pledging continued support for Turkey’s program of political and economic
modernization.6 At the same time, the U.S. Ambassador to Turkey and his staff have
actively consulted Prime Minister Ecevit, Deputy Prime Minister Ozkan, and Turkey’s
Acting Treasury Undersecretary. It is uncertain, however, what the Administration’s
position will be when Turkey, as anticipated, requests substantial new assistance from the
The Turkish crisis has limited economic implications for the United States. No U.S.
bank holds more than 1% of its assets in Turkey, and investment funds reportedly reduced
their Turkish holdings after the November crisis. Bilateral trade totals $7 billion and some
U.S. companies may feel a profit pinch. So far, however, Proctor and Gamble is the only
large corporation to show a decline in earnings projections for the second half of 2001 due
to the Turkish situation. Turkey is P&G’s twelfth largest market.
6 Bush says US backs Turkish reform - Turkish officials, Reuters, March 1, 2001.