Turkey debate: In a crisis, Turkey emerges stable and more confident

SB, Euromoney Let’s start by looking at the crises of 2000/01 and 2007 and how investors should view the Turkey that has emerged?

SU, IEC The 1990s were a lost decade for Turkey and the main failure of the Turkish economy throughout that decade was governance. The 2000/01 crisis created the impetus for the overhaul of the governance structures of the economy – the independence of the central bank, the overhaul of agricultural support policies, the strengthening of banking regulation, the strengthening of other regulatory authorities and the setting up of new ones. This created the infrastructure that has allowed the country to withstand the current crisis so well.

It also created the foundations for the sustainable growth patterns post-2001. Previously, Turkey’s economy was much more volatile. Yes, we had spurts of high growth, but they always culminated in a crisis in which growth then plunged 5% or 6%. That has changed. That up-and-down cycle of growth came to an end with the radical overhaul of governance structures and has been replaced with high and continued growth. And other areas have benefited. Take foreign direct investment: over the past couple of decades FDI averaged between $500 million and $1 billion annually. In 2007, Turkey had an FDI inflow of $20 billion. One driver of that has been the more benign global economic environment but Turkey was able to attract this investment in competition with other emerging markets because Turkish economic governance structures gave confidence to international investors.

CY, Ak AM I agree. After the 2000/01 banking crisis the government started a rapid but well-defined financial reform programme. Public banks were recapitalized and made subject to increased supervision. Insolvent banks were transferred to savings deposit insurance funds, and were resolved quickly through mergers, transfers, sales and liquidation. Private banks obtained capital increases and restructured bad loans.

One crucial lesson the banks learnt was the importance of liquidity. Consequently, more than 60% of the banks’ balance sheets are now funded by deposits. As a result I agree that, thanks to the 2000/01 financial crisis, the Turkish banking system has become stronger than many of its foreign peers.

SB, Euromoney Botan, is that how Fitch would characterize the developments, and is that reflected in your analysis?

BB, Fitch Yes. Turkey had managed to overcome some of its fiscal deficiencies during the 1990s, such as putting an end to the central bank’s monetization of the government debt, by signing the protocol between the treasury and the central bank. In addition, financing the agricultural sector had been somewhat addressed, and financing by [state grain board] TMO had been stopped. But weakness remained because Turkey had misaligned its regulations (especially the financial sector regulation) with the liberalization policies that were adopted during those years.

At the time of the 2000 crisis the banking sector was betting heavily on interest rate arbitrage by borrowing heavily from foreign markets and lending to the domestic market through buying Treasury bills. By taking a high risk the banking sector was making high profits but in a period of a month when the Turkish lira depreciated sharply all that profit disappeared because of banks’ high open positions in foreign exchange. And outside the banking sector there were problems because of a lack of control over the non-bank financial sector.

So I would see the 2000/01 crisis as a mismatch of the regulation and liberalization policies. There was a mismatch between the pace of those two, and right after the crisis this changed. [Bank regulator] BRSA started to function as an autonomous institution and immediately issued regulations on the recapitalization of the banking sector and redefined the risk structure of the banking sector. The strength of the banking sector today was achieved during the crisis times of 2000/01 and so, yes, the crisis is a key reason why today Turkey is standing up better than many other countries.

BS, CMB I will approach the situation from a different view. After the 2000/01 crisis we did something that made the banking system and the other financial systems more conservatively structured: we let some banks fail. And yes, we also imposed a more conservative regulatory system for the banking system and for the financial system. We also changed the economic governance of the state, the governance structure of the Treasury, and the system. And all these were very significant.

However, what is more important is what has happened since 2003: political stability in Turkey, and the funds surplus outside Turkey. These two things were more crucial in putting the banks in Turkey into a better position than others in the latest crises.

SB, Euromoney Ufuk, you were in risk management at the Treasury, how do you think things have changed between that previous crisis and this one, and where do you see the most improvement?

UH, Turkish Treasury I agree with what has been said already but, if anything, what they have underplayed is the sectoral and structural transformation performed. In 2001 the non-performing loan ratio in the banking system was 21.3%; in 2009 it is around 3.9%. In 2001, the entire balance sheet of the banking system had exchange rate risk of $5.4 billion, now it is around $200 million. The average capital ratio during that first crisis was around 5%, it is now 17%. So, structure-wise, the Turkish financial sector is much more developed. We did not even have any risk management activities during 2000/01. Starting from 2002 with Law 4749 we established a risk management unit within the Treasury and now it is one of the main essentials of the private financial sector as well.