Privatization - hardly business as usual
The earthquake on August 17 in Turkey's most populous and industrial region was perhaps more predictable than some of the country's recent political and economic upheavals. Seismologists had estimated that there was a 12% chance of an earthquake occurring south of Istanbul in the 30 years from 1996 to 2026.
That didn't diminish the shock which caused extensive damage in the provinces bordering the Sea of Marmara, including Istanbul and Izmit. However, it took its toll more on human life, private households and infrastructure than on the industrial base. Central bank governor Gazi Ercel estimated the repair cost of the damage (excluding private sector plants) at $5 billion to $7 billion. Erkut Yucaoglu, chairman of the Turkish Industrialists' and Businessmen's Association (Tusiad), put earthquake damage closer to $20 billion. Merrill Lynch said that while it was difficult to gauge the economic cost "preliminary damage reports argue that the negative economic impact will be significant. The direct costs could easily exceed $5 billion". Merrill Lynch guessed that the government might be hard pressed to fund rebuilding as it already pays "punishingly" high borrowing rates.
Speaking to Euromoney Ercel said that "while the loss in human terms is catastrophic and the pain is inestimable, the material damage we can bear. The Turkish economy can bear the brunt of reconstruction with help from abroad." Although aid poured in the sums were small and the key question of how to fund reconstruction efforts hangs in the air.
It is unlikely that Turkey will be able to raise large sums in the international capital markets because the earthquake diminishes its already weak borrowing ability. The government will probably announce a financial package including one-off taxes.
But even the reconstruction question is secondary to the question of what effect the earthquake will have on Turkey's three-year economic stabilization programme which the International Monetary Fund recently agreed to support. When the earthquake struck, the economy was going through its worst recession since the crash of 1994. Growth declined by 8.5% in the first quarter and an estimated 2.5% in the second. In the January-April period tax revenues declined by 13% while non-interest expenditure rose by 25% in real terms. The budget deficit rose by 62% compared with the first four months of 1988 to TL3.5 quadrillion. ($8 billion) Exports fell by some 8% and imports, undermined by weak domestic demand, by 25.4%. The year-end inflation rate was estimated to be in the region of 60% to 70%. Growth for the year as a whole was targeted to be 0.5%.
The "framework for an economic programme" hammered out between Turkish and IMF bureaucrats was meant to make a dramatic reversal in this trend. Inflation, which has averaged 60% a year over the past 20 years, would be lowered to 10% by the end of 2001. The fund agreed to provide financial support - the amount is still under consideration - on condition that Turkey made structural reforms. Ecevit and his coalition allies confounded sceptics by keeping parliament in session throughout the summer and one by one passing the reform laws. A new banking law was passed and the constitution amended clearing obstacles to privatization and foreign investment and infrastructure projects. Social security reform, which caused Ecevit the biggest headache, was about to go through, when the earthquake struck.
Ercel says the economic programme - which Ecevit had earlier called "a road of no return" - could not be unaffected by the calamity. Almost certainly fiscal discipline will be relaxed as salvaging the earthquake victims gains ascendancy over salvaging the economy.
"The obvious worry," says Merrill Lynch, reflecting market sentiment, "is that the need to rebuild will significantly undermine efforts to achieve fiscal prudence."
The international community recognizes that the conditions have altered and will accept a certain amount of digression from pre-quake targets. The question is the degree of digression which will take place. This will probably depend on the amount of foreign aid or loans Turkey lines up to finance the reconstruction effort. Certainly the magnitude of the catastrophe and the plight of the victims has created a lot of sympathy for Turkey. IMF managing director Michel Camdessus said that the IMF would stand ready to help Turkey "in any way we can". But the IMF is not an earthquake relief organization and before the aid comes will have to make sure that Turkey will remain at least roughly within the fiscal boundaries it set for itself.
Although the rebuilding effort may have a revitalizing effect, most of the earthquake's economic effects will be negative: interest rates - already among the highest in the world - will rise while the stock market index declines. (The Istanbul Stock Exchange index opened 10% lower on August 26, the first day of trading after the quake; the financial sector did worst with a 12% fall while other service industries were off only 4%. Volumes were about average.) The budget deficit - probably the single biggest economic worry - will grow. Inflation will climb. Bank deposits will be withdrawn and the conversion of Turkish lira to foreign currency will accelerate. Companies in the earthquake zone will sustain severe losses. There will be a drop in tourism revenues, a large source of foreign currency. Insurance companies will have a bad year and some small ones face extreme difficulties.
The banking sector faces a liquidity squeeze as deposits are run down. People are drawing their savings for emergency expenditure and renewing clothes and household goods lost under the debris. But there is some hope that this money - unless it is converted into foreign currency and kept under the pillow - could quickly be recycled and returned to the banks. Remittances from expatriate workers in Europe could rise sharply. But a negative impact on bank balance sheets could come from the declining quality of loans (even undamaged companies are likely to have short-term problems owing to work stoppage) making banks even more selective in their lending. The Turkish financial sector is severely distorted by heavy government borrowing requirements. A lame overseas borrower since the 1994 crisis, the treasury has been obliged to tap the domestic market where interest rates are exceedingly high. In 1998 the average real interest rate for the year as a whole was over 24%. The real interest rate ranged between 3% in July and 56% in December, at the height of political uncertainty. Real interest rates in the first half of 1999 ranged between 10% and 48%. Additional upward pressure comes from state banks which offer high real interest rates in order to raise funds to subsidize sectors chosen by the government.