How the IMF Ruined the Turkish Economy

Henry C.K. Liu

This article appeared in AToL on September 16, 2003

I was invited to give a lecture on "The Global Economy in Transition" at the Seventh International Conference on Economics held on September 6-9 at the Economic Research Center of the Middle East Technical University in Ankara. The conference brought together from all over the world prominent economists with diverse viewpoints and special expertise, ranging from central bankers and policy specialists to academicians and scholars. The ideological range covered neo-classical to Marxist economics, as well as apolitical macroeconomics and mathematical modeling experts.

The event also gave me occasion to review the economic situation of Turkey, a country that paid dearly for playing by the rules of the International Monetary Fund (IMF) and neo-liberal market fundamentalism. The Turkish government, in its good-faith efforts to join the European Union, has managed to plunge the country's economy from the frying pan into the fire.

The financial press reported that both Turkey and Argentina, beginning in late November 2000, experienced a sudden drop in investor "confidence", whatever that is, posing the biggest challenge to the IMF and the United States since the Asian financial crisis of the 1997. Both nations were desperately seeking emergency IMF loans, the largest bailout packages since an IMF rescue of Brazil in 1998.

The precipitating troubles were linked to the sharp slowdown in the growth rate of the United States economy and the selloff in US stock markets. Export-oriented developing nations in Latin America, Asia and the Middle East had depended heavily on robust expansion in the United States to power their own tentative recoveries from a recession in the late 1990s, and to service their dollar debts. The IMF agreed on December 6, 2000, to provide US$7.5 billion in new loans and deliver about $3 billion in already promised loans early to bolster Turkey, where stocks plunged and overnight, interest rates soared on fears that the nation's banking system could collapse. The turmoil raised fears not only that Turkey's ambitious economic overhaul would fail but also that investors would lose faith in the prospect of other major emerging economies worldwide.

Unlike other situations, Turkey appears to have been the victim of sound economic management along neo-liberal lines. In Turkey, the coalition government of former prime minister Bulent Ecevit, acting with dubious IMF advice and counterproductive support, began an economic overhaul early in 2000 intended to bring the economy up to European standards, part of its bid to join the EU. Dancing to the tune of IMF doctrines, Turkey set up a strict currency-management system, imposed budgetary discipline and moved to privatize state assets, all in accordance with the Washington Consensus. The effort reduced government borrowing and sharply lowered hyper-inflation. Unlike Japan, Turkey adopted a program that forced its 81 banks to improve their operations or face terminal consequences. Turkey had a neo-classical long-term economic plan, it had the most stable government in a decade, and it had been on a self-imposed austerity program since mid-1998.

Notwithstanding that such drastic austerity will destroy any booming economy, let alone a troubled one, the IMF handed $4 billion to Turkey to back a new three-year program, matched by another $4 billion from the World Bank. The stated aim: to bring inflation, which had averaged more than 80 percent in each of the previous eight years, down to single digits by 2003. The IMF money created a brief illusion of success for a program heading for systemic disaster.

The Turkey program was implemented in January 2000, and all went well at first, thanks to the sudden injection of $8 billion from the IMF. Interest rates on government paper plummeted to 45 percent from highs of more than 140 percent in 1999. Turkish planners could make financial plans at last, thanks to exchange-rate policies that were designed to devalue the Turkish lira slowly and in an orderly manner until mid-2001. The government even started fixing up social security and agricultural subsidies, much to the delight of supply-side, neo-liberal economists. By the summer of 2000, Turkey had raised more money through privatization and the sale of mobile-phone licenses than it had in the previous 15 years, using the US formula of "air ball" financing - loans based on future cash flow rather than hard assets or current profits.

Not surprisingly, after 11 months, privatization had slowed to a crawl, with potential buyers waiting for further declining prices and pending deregulation. Lower domestic interest rates in the context of fixed exchange rates had fed a consumer-lending boom that sucked in imports, putting pressure on Turkey's foreign-currency reserves. The lower rates also constrained the easy profits once made by midsize banks that survived mostly by lending money to the government. Criminal cases were publicized to uncover decades of corrupt bank management, to lay blame on human frailty rather than policy error. The same corruption, albeit real, was not credited for the brief "success" of the flawed program. Turks at all level of wealth began to move money abroad cashing in their Turkish liras for US dollars. Foreign investors/creditors began withdrawing credit lines from Turkey at the beginning of December 2000, after fears developed that many Turkish banks, which were under heavy pressure to reorganize, had become insolvent.

Unlike Argentina, which faced a different problem - investors there were worried that Argentina's slow-growing economy might not have the wherewithal to repay its hefty foreign debt - Turkey's crisis was caused by faulty monetary and fiscal policies that even the United States would not have been able to afford. Ironically, the government's seizure of 10 troubled banks in November 2000 to clean up the banking system had the opposite effect. The move, instead of promoting "market discipline", caused foreign investors to panic about the solvency of the banking system. In reality, the foreign banks were merely upset that their hope of buying up Turkish banks on the cheap had been spoiled by the government. A $7.5 billion package of emergency IMF funding announced on December 6, 2002, brought a fragile stability to Turkish markets. With a straight face, the IMF said Turkey would not then need extra bridge loans from other international institutions, as foreign banks cut their exposure to the country with vengeance.

A full-scale financial crisis was triggered by a minor "bloodletting" among Turkish banks. The crisis had its roots in 1999. Turkey, a country of 65 million people, with a $200 billion economy that overtook Russia's gross national product in 1998, applied for its 17th standby agreement with the IMF, with a promise to adopt Fund prescriptions. Consumer lending that had helped the economy return to growth after a massive August 1999 earthquake had ground to a halt. Growth was now expected to be flat in the first quarter of 2001, causing severe economic pain.

Already overburdened Turkish taxpayers again paid the price for budgetary- and economic-stability policies at the wrong time and on a wrong schedule. It was at this critical juncture that a "blood feud", as the big newspaper Hurriyet called it, broke out in the banking sector.

One of the midsize banks, Demirbank, had been taking business from Turkey's big established banks. It had also bet big on the anti-inflation program's success in bringing interest rates down still further. At one point, Demirbank held 10 percent of Turkey's domestic debt. But it was funding its operations from Turkey's short-term money markets, which were supplied by the same big-money banks it had alienated. The funny thing was that these money-center banks, with their international network, got their funds from the short-term US repo debt market through New York international banks.

When delays hit a big Demirbank foreign-loan syndication, the bank suddenly found its lines of credit cut. Demirbank was forced to dump its Turkish treasury bills at a loss to meet margin calls and other obligations. A classic fire sale began, not much different from the situation faced by the hedge fund LTCM in the United States, except on a much smaller scale. Normally, the Turkish central bank would have stepped in to ease Demirbank over its liquidity crisis, as the New York Fed did with LTCM, and all would have been fine. But a key condition of IMF support for Turkey's anti-inflation program was a cap on the total foreign and local currency in circulation in Turkey. So when the Demirbank crisis triggered a small rush to buy dollars from the central bank, it drained Turkish lira out of circulation just when they were most needed to ease lending between banks.

Already spooked by trouble brewing in Argentina, emerging-market investors stampeded out of Turkey on November 22, 2000, before the long US Thanksgiving holiday weekend. As yields on Turkish domestic assets slid from 35 percent to 4.5 percent, many investors started selling Turkish treasury bills to cut their losses. They sought safety in dollars, sucking the central bank's currency reserves down farther. Deutsche Bank alone sold $700 million worth of Turkish treasury bills in a day, mostly on behalf of clients (read hedge funds) but also for its own proprietary trading accounts.

Briefly breaking with the IMF plan, the Turkish central bank supplied local currency to the banks. But it was too late.

Turkish markets stalled and plunged into a panicky tailspin. Within two weeks, $7 billion of Turkey's $24 billion of pre-crisis foreign-currency reserves had fled the system. Fears spread that Turkey would be forced to devalue its currency, which would wreck the Turkish economic program, shake global "confidence" in emerging markets and undermine the stability of the ruling order of Turkey, a rare secular democracy in the Muslim world.

Turkey hung tough and took over Demirbank. This helped it earn the admiration of the IMF and the promise of $7.5 billion in emergency funds. As the outcome became clear, investors poured back in more than $1.5 billion - including at least $300 million through Deutsche Bank (less than half of one day's sale earlier). On December 10, 2000, 30 Europe-based banks met in Frankfurt, Germany, and pledged to keep credit lines open. Turkish and IMF officials would seek similar commitments a few days later in a meeting with US bankers in New York convened by Citibank. No one mentioned anything about the interest rates. The Turkish central banks had no option but to accept what the international banks demanded.

Speculators with liquid assets had won big. Some foreign speculators tried to point out that as many as one-third of the customers of the international banks at the December 29 meeting in Frankfurt were actually high-net-worth Turks, who bought dollars and euros with their lira and sent their foreign currency back into Turkey as foreign capital. International hedge funds, despite their new strategy of avoiding overwhelming the small markets, also bet hundreds of millions of dollars against the Turkish lira. They could achieve 10 percent gains in dollar terms in two weeks simply by playing the market for short-term deposits during the crisis. Indeed, a dollar-based gain on Turkish treasury bills of 29 percent to the end of June could still be locked in on December 11, according to Istanbul's Bender Securities. Far greater returns were theoretically possible at the Istanbul Stock Exchange, where prices fell 50 percent during the 30 days to December 5, and then rocketed back up 40 percent in two days. Speculators were laughing all to way not to the bank, but on their way out from the bank.

Meanwhile, the economy of Turkey lost big. The legitimacy of the reform process itself had also been thrown into question. Although Turkey vowed that the aim of its IMF-backed program was to privatize the economy and financial system, Demirbank became the 11th Turkish bank to be taken under state control in the past two years. More seemed likely to follow.

When would the IMF snake oil be exposed for the quack medicine that is actually was? Western bankers had vowed (as a non-binding commitment) to continue lending money to Turkey, giving a vital boost to efforts to restore "confidence" in that nation's finances just days after the Fund agreed to provide an emergency aid package. This loss of confidence was cause by the very IMF rescue policy earlier. It seems that the IMF and the international banks were a team: the IMF arrived first as a carrier of financial virus in the name of financial health, then the international banks came as vulture investors in the name of financial rescue. Market confidence returned as one big confidence game.

Gazi Ercel, then governor of Turkey's central bank, and Stanley Fischer, the No 2 official at the IMF, conducted the meeting in Frankfurt, which was organized by Deutsche Bank and included representatives from Dresdner Bank and Commerzbank of Germany and Citigroup of the United States, among other major lenders. (Less than three years later, Fischer joined Citigroup as vice chairman.)

In hindsight, it becomes clear that the Turkish financial crisis could have been avoided if the Turkish government had rejected IMF prescriptions earlier. Once the crisis began, it could have been defused with central-bank intervention to provide a timely inter-bank liquidity rescue. Alas, neo-liberal fixation on market fundamentalism caused the Turkish government to forgo that option, and the rest was history. Liberalization of financial market under dollar hegemony had plunged the Turkish economy into a protracted abyss from which it will not be able to extract itself unless Turkish leaders summon up the necessary political courage to expel the IMF, curb the "political independence" of its central bank, which views its mandate as protecting the value of money at the expense of the national economy, and reinstitute a national banking regime that uses the banking system to support the national economy.

Turkey must take decisive steps to protect itself from predictable harm from dollar hegemony. It should recapture the authority to issue sovereign credit to put its national economy on the path to new prosperity with equality and economic justice for all.

The lecture discussed the global economy in transition, focusing on the changing nature and role of money, debt, trade, markets and development. In summary, the lecture presented the view that an economy is not an abstraction. An economy is the material manifestation of a political system, which in turn is the interplay of group interests representing, among others, gender, age, religion, property, class, sector, region or nation. Click here to read more.