[stop-imf] A 'made-in-IMF' origin mark on crisis in Turkey?

[Robert Weissman]

Finance: A 'made-in-IMF' origin mark on crisis in Turkey?

Geneva, 28 May (Chakravarthi Raghavan) -- After coming under tutelage and
supervision of the International Monetary Fund in 1998, and two consecutive
standstill and stabilization programs (in 2000 and 2001) launched with 
strong IMF
support and bailout packages, Turkey is in an unprecedented crisis, with 
employment
and economic activity depressed.

The crisis in Turkey is similar in many respects to that in Argentina
and 
several other
countries that followed the advice of the Bretton Woods Institutions.

However, while Argentina has been left to sink - since not many other 
economies,
except perhaps for Uruguay, have had an adverse effect -  as a
front-line 
state vital to
the US 'war on terrorism' and the campaign to overthrow Iraq's Saddam Hussain,
Turkey has been getting trade and other benefits. Some of these trade 
benefits, like
textiles and clothing quotas, are in violation of WTO obligations, but
the 
US and
Turkey have been resisting even to disclose and notify them, despite 
rulings by the
WTO's Textiles Monitoring Body.

However, so far Turkey has been unable to overcome the crisis and turn
the 
economy
around, and Turkey is now worse off than when the IMF programs were 
instituted in
December 1999.

In an UNCTAD discussion paper (April 2002), 'The Making of the Turkish 
Financial
Crisis', Yilmaz Akyuz and Korkut Boratav, suggest that the failure of
the 
stabilization
program, though  formulated and launched with strong IMF support, "is in 
large part
because of serious shortcomings in design as well as in crisis
intervention 
which
appears to have drawn no useful lessons from the recent bouts of crises
in 
emerging
markets."

Akyuz and Boratav are well-known economists, and from Turkey. Akyuz is Director
of the UNCTAD Division on Globalization and Development Strategies.
Boratav is
Professor of Economics at the University of Ankara.

The paper analyses the two stabilization programs of 2000 and 2001,
though 
there are
references to earlier problems and programs. Turkey had a major crisis
in 
1994, and
had IMF stabilization programs for two years, and then Turkey managed without
external aid for two more years. In 1998, the IMF took over the
supervision of
Turkey; and in December 1999, the government launched an exchange-rate-based
stabilization program with the support of the Bretton Woods Institutions 
(BWIs) to
bring down inflation and check what looked like "an unsustainable
process 
of public
debt accumulation."

The program seemed to be in course in the subsequent nine months,
enjoying wide
public confidence and support as well as gaining praise from IMF
officials, 
but started
running into problems in the autumn of 2000, necessitating a large IMF 
bailout to
keep it on course. After a few months of muddling through, it became
clear 
that the
program was not viable, and in the face of massive attacks on currency
and 
rapid exit
of capital, the currency peg had to be abandoned in February 2001, and 
replaced with
a regime of free floating, "again on advice of the IMF."

As in most other episodes of financial crisis, the currency overshot, 
interest rates rose
sharply and the economy contracted at an unprecedented rate. After
another IMF
bail-out package, the financial and currency markets stabilized towards
end 
of 2001,
"but employment and economic activity remain depressed."

What went wrong?

Akyuz and Boratav point out that the Turkish crisis has a number of 
features common
to crises in emerging markets that implemented exchange-rate based 
stabilization
programs - that typically use the exchange rate as a credible anchor for 
inflationary
expectations, often leading to currency appreciation and relying on
capital 
inflows
attracted by arbitrage opportunities to finance growing external deficits.

The consequent build-up of external financial vulnerability eventually 
gives rise to
expectations of sharp currency depreciations and a rapid exit of
capital, 
resulting in
overshooting of the exchange rate in the opposite direction and hikes in 
interest rates.
Through such a boom-bust financial cycle, some countries (e.g. Mexico, 
Brazil and
Russia) have succeeded in overcoming their chronic price instability and 
avoiding a
return of rapid inflation, despite the collapse of their currencies and
the 
external
adjustment necessitated by the crisis.

The Turkish program initially followed a similar path, but ran into 
difficulties at a
much earlier stage of the disinflation process, forcing policy-makers to 
abandon the
peg and setting of a sharp economic downturn in the context of a high 
inflation.

The difficulties arose largely because the program was launched in the
face of
structural problems and fragilities on many fronts, notably in public 
finances and the
banking sector, which was heavily dependent for its earnings on high-yielding
Treasury bills associated with rapid inflation, and was thus highly 
vulnerable to
disinflation.

As a result there was an inconsistency in policy since much of the
fiscal 
adjustment
was predicated on declines in the very nominal and real interest rates
on 
which many
banks depended for their viability. While the program incorporated a 
pre-announced
exit from the crawling peg after 18 months, it failed to meet inflation 
targets despite
full implementation of  monetary and fiscal policy targets. Thus, what 
initially looked
like a strength of the program backfired, as persistently high
inflation, 
together with
widening current-account deficits, fed into expectations of a sharp 
depreciation of the
currency.

The IMF, post-facto, has been blaming wide spread corruption and bad
implementation by the Turkish government for the failure. However, say 
Akyuz and
Boratav, the shortcomings in the design of the program, rather than a 
failure to
implement it, are the main reason why the boom in capital inflows was
much 
shorter
in Turkey than in most other experiments with exchange-rate-based 
stabilization, and
why the crisis broke out before inflation was brought under control.

"The recent bouts of liquidity crises in emerging markets have 
significantly eroded
the confidence of international investors in the sustainability of such 
soft pegs, so that
rapid exits tend to be triggered at the first signs of trouble. The
Turkish 
experience
also suggests that the chances of successful disinflation by means of an 
exchange-rate
anchor may now be significantly lower." Also, the behaviour of private 
capital flows
to emerging markets in the current  downturn in the world economy shows that,
unlike in the first half of the 1990s, international investors have
become 
much more
nervous in raising their exposure to emerging markets despite falling 
investment
opportunities in the major industrial countries.

That the Turkish crisis has proved much deeper than most crises in
emerging 
markets
is not only due to problems in the design of the stabilization program. Equally
important is mismanagement in crisis intervention (by the BWIs), which
had been
premised, as in most other emerging markets, on restoring confidence, 
maintaining
capital-account convertibility, and meeting the demands of creditors 
through fiscal
and monetary tightening.

"While the implementation of the program had created a trade-off between 
public and
private finances, abandoning the peg and moving to free floating under
full 
capital
account convertibility and extensive dollarization aggravated the 
difficulties of both
public and private sectors," say Akyuz and Boratav.

The collapse of the currency hit hard those sectors with high exposure
to 
exchange
rate risks that the earlier peg had encouraged. Public finances were 
squeezed from
rising external and domestic debt servicing obligations due to the
collapse 
of the
currency and the hike in interest rates. Fiscal austerity and monetary 
tightening have
served to deepen recession, and even growth in exports has remained relatively
modest despite the sharp depreciation of the currency because of 
disruptions in the
credit and supply systems, in very much the same way as in the earlier 
phase of the
crisis in East Asia.

Various packages of legislation passed in order to initiate structural 
reforms in the
public and private sectors have failed to restore confidence, while
their 
initial impact
was to add to stagflationary pressures. Furthermore, the external economic
environment deteriorated further with the downturn in the major
industrial 
countries
and the events of 11 September.

Add Akyuz and Boratav: "However, these events have also helped Turkey in
mobilizing unprecedented amounts of external support from the IMF due
the 
strategic
position that the country occupies in the United States 'war against 
terrorism'. Despite
four IMF bailout packages in two years, however, the economy has shrunk
at an
unprecedented rate of some 9.5 per cent in 2001, and prospects for a
strong 
recovery
are highly uncertain."

As in other recent crises in emerging markets, the IMF has come up with
a 
number
of ex post facto explanations for why the crisis broke out and why it
has 
proved so
deep. These ex post facto explanations have put the blame on "slippages in
implementation" of the policies agreed as well as on some adverse external
developments, "rather than on the design of the stabilization program or 
misguided
intervention in the crisis."

The paper cites some examples of such explanations (from senior IMF
staff): the
speculative attack on the Turkish lira took place against the background
of 
increased
political uncertainty, policy slippages and a weakening of economic 
fundamentals;
the Turkish authorities were initially very effective in implementing the
IMF-supported program, but they were less successful in coping with unexpected
events such the tripling of oil prices, the strong dollar, rising 
international interest
rates, and an overheating economy; and the recent difficulties in Turkey 
relate more
to banking sector problems, and the failure to undertake corrective
fiscal 
actions when
the current account widened, than to the design of the exchange rate 
arrangement.

However, point out Akyuz and Boratav, these explanations have been 
challenged by
many Turkish economists, including some former senior economists of the Bretton
Woods Institutions, on grounds that "the policies advocated were based
on a 
poor
diagnosis of economic conditions in the country and the Fund was 
experimenting with
programs that lacked sound theoretical underpinnings."

It is particularly notable that the program was so designed that there
was 
little policy
space left for corrective macroeconomic action in the face of widening
current-account deficits. By the time the difficulties became apparent,
the 
2000
budget had already been finalized according to the deficit targets set
in 
the program,
and there was effectively little room either on the spending side or on
the 
revenue side
to act rapidly to slow demand expansion. This role could have been
achieved by
monetary policy, in the absence of the quasi-currency board and 
non-sterilization
rules incorporated in the stabilization program. There can be little
doubt 
that, given
the extent of fiscal profligacy and financial fragility, there was no
easy 
way to
stabilize the Turkish economy.

"However," say Akyuz and Boratav, "in many respects the Turkish economy 
today is
in a worse shape than it was on the eve of the December 1999
stabilization 
program....
The program has failed and the crisis has deepened in large part because
of 
serious
shortcomings in its design and implementation as well as in crisis management.

Anyone familiar with the Turkish banking system and the dynamics of the
exchange-rate-based stabilization programs could have anticipated the
risks 
entailed
by a rapid decline in interest rates as well as the vulnerability of the 
economy to
boom-bust cycles in capital flows. Certainly countries such as Brazil
have been
successful in exchange-rate-based stabilization despite large fiscal 
imbalances, but in
such cases the banking system had undergone an extensive restructuring
and 
strict
supervisory and regulatory provisions had been introduced well in advance.

Again, one of the lessons from the East Asian crisis was that the worst
time to
"reform" a financial system is in the middle of a crisis.  Overhauling
the 
banking
system before launching the stabilization program would have helped
greatly 
to avoid
many of these difficulties.  However, these lessons appear to have been 
overlooked
both in the design of the stabilization program and crisis intervention.

Even more, a careful examination of recent experiences with soft-pegs and
exchange-rate-based stabilization programs shows that many of the
weaknesses in
economic fundamentals, including currency appreciation, deterioration of 
the current
account, and increased exposure to exchange-rate risk, often result from 
the effects
of capital inflows themselves rather than from policy slippages. Such 
episodes are
often characterized by an upturn in economic activity and a surge in 
imports, financed
by inflows of arbitrage capital. In Turkey both the Fund and the
Government 
were
quite happy to see that the economy was making a strong upturn in 2000 
after a deep
recession in 1999, and they were not willing to discourage capital
inflows 
underlying
the process.

After the recent bouts of financial crises, the IMF has
willy-nillyadmitted 
that such
market-based restrictions over arbitrage flows (including Chilean type reserve
requirements) could be useful. However the Fund has never actually encouraged
developing countries to check such flows even when it was clear these
could 
not be
sustained over the longer term.

Experience also shows that even countries with strict financial
discipline 
have not
always been able to pursue counter-cyclical policies at times of massive 
capital
inflows to prevent overheating and currency appreciation. The room for
such 
policies
was much limited in Turkey, owing to the size of the initial fiscal 
imbalances and
extent of retrenchment already incorporated in the stabilization
program. 
On the other
hand, monetary policy was excluded from playing this role by
currency-board and
non-sterilization rules.

Analysing the policy response in Turkey to the speculative attacks on
the 
currency,
and comparing it with the responses to the East Asia crisis, Akyuz and 
Boratav point
out that "much of the IMF funding (to Turkey) has been used to pay
foreign 
private
liabilities, notably of banks, and to cover the withdrawals of foreign 
portfolio
investors." In effect, this has allowed the Turkish government to
translate 
part of its
domestic debt into external liabilities to the IMF.

Referring to the UNCTAD proposals to involve the private sector in
crisis 
revolution,
combined with temporary standstills and strict limits on access to IMF 
resources, and
restrictions on capital account transactions of both residents and 
non-residents, Akyuz
and Boratav note that the IMF board has now recognized that countries as
a 
last resort
might impose a unilateral debt standstill, but has been unable to
provide 
statutory
protection to debtors in the form of a stay on litigation, because of 
strong opposition
from some of the major economic powers and market participants.

More recently, the IMF Deputy Managing Director, Anne Krueger, has
voiced the
IMF new approach to managing the crises, though the proposals are
different 
from
that of UNCTAD, in that a standstill could be activated only by the
Fund. 
However,
the proposals amount to a recognition that the approach so far adopted
in 
official
intervention in emerging market crises, built on the principle of 
maintenance of open
capital accounts and convertibility and guaranteed repayment to
creditors, 
may not
always be successful in stabilizing the markets and avoiding costly crises.

This has certainly been the case in Turkey. But, even if orderly debt 
workouts become
part of the international financial architecture, present difficulties
in 
Turkey  have to
be resolved under existing rules. Only unlike in Argentina, Turkey may
not be
allowed to sink for US geo-political reasons.