3-Financial Liberalization and Financial

Crisies (1989-2001)

12 August 1989 Turkey decide to liberalize the capital

account and in February 1990 Turkey applied to the IMF for
the full convertibility of the Turkish Lira.
With this decision the liberalization process of Turkish Economy
was completed and full integration of Turkish Economy with
the World economy was realized.
The timing of this important decision can be explained with
political developments and economic problems at the end of
the 1980s. The policy response of the government to these
developments and problems was to liberalize fully the capital
account in 1989.
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Domestic financial markets was liberalized before

fiscal discipline had been secured and inflation
brought under control.
The foreign exchange regime had already been
liberalized in certain respects in 1984, bringing current
account convertibility and allowing residents to hold
foreign currency deposits in domestic banks and to
engage in specified foreign exchange transactions.
New legislation in 1989 effectively lifted restrictions on
inward and outward financial transactions by
residents and non-residents alike, thereby exposing the
economy to the whims of international capital flows.

Capital account liberalization in August 1989 increasingly forced

the Turkish economy to become dependent on the newly emerging
financial cycles, and the arbitrage-seeking infows and outflows
led to deepening external and domestic instability.
Depending high inflows of financial capital, growth rates of
the GDP tend to increase.
Yet periods of capital flight mean direct recession even
outright collapse, as in 1994, 1999, and 2001.

a-Developments in Post-Capital Account Liberalization

Period (1990s)

The capital account liberalisation was made at least in part to

attract short-term capital inflows, or hot money, to help
finance the deficits especially the financing of public sector
deficits without crowding out private investment.
In the longer term, however, the decision to liberalise the
capital account before achieving macro-economic stability
and creating a strong regulatory infrastructure for the
financial sector was very costly.
During the 1990s interest rates on government debt
exceeded the inflation rate, on average, by more than 30
per cent.
As the economy became increasingly vulnerable to external
shocks and sudden outflows of capital, the 1990s turned
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into the most difficult period in the post Second World war Era.

Public Sector Deficits

Public-sector deficits continued to widen in the 1990s,

with programmes directed towards various segments of the
electorate, cheap credit to small businesses, lower
retirement age and more generous retirement benefits and,
most importantly, high support prices for the agricultural
producers.
The war, which began in 1984 against the PKK in SouthEastern Turkey, also imposed a large fiscal burden in the
1990s.
Domestic and external borrowing was the most important
mechanism for financing the growing deficits.
High interest-rates and a pegged exchange rate regime
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attracted large amounts of short term inflows

Private banks rushed to borrow from abroad in order to lend

to the government. In addition, large public-sector banks
were directed by the governments to finance part of these
outlays.
In these years monetary expansion was also used as a regular
instrument for fiscal revenue.

Government was increasingly engaged in Ponzi financing

whereby rising interest payments could only be met by issuing
new debt instruments.
While interest payments on domestic debt absorbed less than
20 per cent of tax revenues at the end of the 1980s, this
proportion rose steadily throughout the 1990s exceeding 75 per
cent at the end of the decade.
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The PSBR (Public Sector Barrowing Requirement) rose

rapidly during the same period reaching, 24 per cent of GDP.
In the beginning of 1993, there was a change in party
leadership of the leading coalition partner DYP, and Ms. Ciller
was elected as Prime Minister in mid June.

Towards the end of July, the Central Bank governor resigned as

a result of disagreements between him and the Prime Minister on
the conduct of monetary policy.
In the meanwhile, it was often stated by the government that the
most important short term policy goal was to lower the
burden of the share of interest payments on short term debt,
by lowering the nominal interest rates.
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b- 1994 Crisis and 5 April Decisions

Between 1990 and 1993, cumulative net capital inflows by

non-residents reached $25 billion while the current account
deficit remained below $10 billion.
Only a small part of the surplus was absorbed by increases in
reserves while a large proportion was used to finance net
capital outflows by residents who apparently took the
opportunity offered by the new capital account regime to diversify
their portfolios by acquiring assets abroad.
The boom in capital inflows was associated with an appreciation
of the currency, a strong recovery during 1992-1993 and
widening current account deficits.
Between 1990 and 1993, the average inflation was around 65
per cent, average annual increase in the dollar against the
lira was 52 per cent while the average interest rate on shortterm government debt was over 85 per cent
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The boom was followed by a bust in the beginning of 1994, with

a rapid reversal of net capital inflows.

The downgrading of the Turkish credit rating in international

markets as well as efforts by the government to impose lower
interest rates on banks participating in Treausary-bill
auctions played an important role in triggering the reversal
of capital flows.
The Turkish lira depreciated by almost 70 per cent against the
dollar in the first quarter of 1994. The Central Bank heavily
intervened in the foreign exchange market and as a result, lost
more than half of its international reserves.
Inflation reached three digit levels, and interest rates
rocketed to exceed 150 per cent. The economy went into a
deep recession in 1994 and the current account swung into
surplus as a result of massive cuts in imports.
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5 April Decisions (5 April 1994)

In 5 April 1994, about a week after the local elections, the

government announced a stabilization programme. This
involved:
price increases of 70 to 100 percent on SEE goods,
public sector wages would be freezed,
the planned government deficit was halved for 1994 (this
deficit reduction would be achieved mainly through onetime taxes on the net assets of firms, wealth and
corporate taxes, also by the real decline in the wage bill,
and a cutting down on public investment)
full insurence were granted deposits in the banks
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c- 16. Stand-by Agreement (6 July 1994)

After the 5 April 1994 stabilization program was announced

by the government, the IMF approved a stand-by of
US$ 742 million in June 1994, which strongly urged the
rapid implementation of the structural reform
measures.
In fact, the stabilization program did not achieve any of its
medium term structural adjustment measures to date, such
as the implementation of the privatization programme, and
social security and tax reform.

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