The 2001 crisis then and now and the central bank
by Durmuş Yılmaz*

The significant increase in interest rates during the November 2000 crisis drastically altered the fiscal structures of banks within the Savings Deposit Insurance Fund (TMSF) and public banks that had heavy overnight borrowing needs. Even before the November crisis, public banks and fund banks met their liquidity needs from other banks and the Central Bank of Turkey and the unequal distribution of the Turkish lira’s liquidity increased interests rates and their volatility, which minimized the effectiveness of the exchange rate commitment and the Turkish lira liquidity management.

Essentially, after the November 2000 crisis two main problems appeared. The first of these problems was that interest rates, which increased due to the crisis, were at a level much higher than the hike targeted in the exchange rate (despite the decline after the stand-by agreement made with the IMF). Secondly, the damage the crisis caused to the financial structure of the entire banking system, and particularly in the public banking sector, made the system more fragile.

This inconsistency and increasing fragility triggered the political tension that manifested before the Treasury tender in late February 2001, which created panic in markets that were constantly in a state of unease. Confidence in the system was completely lost and the Turkish lira faced another serious speculative attack on Feb. 19, 2001. The demand for $7.6 billion in foreign currency with a one-day effective date put significant pressure on the exchange rate. To assuage the effects of this pressure, the central bank did not renew repurchase agreements that expired the next day and took back $6.1 billion of the foreign currency it sold the previous day either by purchase or by cancellation. With the sale of more foreign currency, the remaining amount of Turkish lira liquidity decreased, exacerbating the problems of the public banks, which had high daily liquidity needs. As a result, the payment system was locked. In addition, the lack of confidence regarding the sustainability of the exchange rate system deepened further. The decline in reserves and increase in interest made the execution of the program impossible. As a result, the exchange rate commitment was abandoned and it was decided to allow exchange rates to float freely and the exchange rate target strategy and the 2000 Disinflation Program was ended, as explained in the press release of the Central Bank of Turkey dated Feb. 22, 2001.

In the two months after the February 2001 crisis, the Central Bank of Turkey met the market’s liquidity needs, giving priority to making the payments system function again. The main element that removed the barriers for the central bank to provide liquidity to the system was the transition to a floating exchange rate system and the elimination of an exchange rate level that had to be protected.

The high deficit position of the banking system in the first months of the floating exchange rate regime following the 2001 crisis created pressure on the exchange rate. But the banking system’s deficit was met with the central bank’s sale of nearly $7 billion of foreign currency (in the first five months after the crisis) and with the Treasury’s issuance of $8.1 billion foreign exchange denominated or foreign exchange indexed government domestic bonds to public and TMSF banks in return for duty losses and the pressure on the exchange rate declined relatively. Additionally, the $6.6 billion debt swap in June 2001 also helped reduce the banks’ deficits.

Could the 2001 crisis repeat itself?

The chances of a crisis connected to the balance of payments occurring under an active monetary policy and a floating exchange rate regime is very small. A floating exchange rate regime has shock absorbing capabilities in situations stemming from capital fluctuations. Looking at previous experiences within this context, we see that 52 balance of payments crises occurred in 19 countries, including Turkey, between 1980 and 2001 and almost all of these crises happened under the managed currency regime, which was in effect in Turkey prior to the 2001 crisis. In countries where the managed currency regime remained in effect after these crises, the fragility of the economy increased for various reasons and consecutive new crises occurred. All countries that switched to a floating currency regime, except Argentina, did not experience a balance of payments crisis again. In the case of Argentina, the floating exchange rate regime was adopted during one crisis but then the managed currency regime was reinstated in another crisis.

Without a doubt, there were important structural changes behind the steps that were taken to achieve macroeconomic stability after the crisis. First of all, a turning point in this area was the amendments made to the Central Bank Law in May 2001, which ensured independence, transparency and accountability. The amendments prevented the Central Bank of Turkey from giving advance payments to the Treasury, extending loans to the public, thus preventing the monetization of public debt and removing the main cause of chronic inflation over the last 30 years. In addition to the important steps taken to ensure fiscal discipline by way of high primary surplus and structural reforms, the Banking Regulation and Supervision Agency (BDDK) took precautionary measures in the banking sector, which helped strengthen the sector’s capital structure and make the financial sector more resistant to shocks. The transition to an inflation targeting regime after these steps is another major building block in this structural change. Public balances, which improved as a result of the prudent monetary and fiscal policies observed after the 2001 crisis, and the gains in inflation are certainly important steps that were taken to ensure macroeconomic stability.

As is known, economic prosperity improves only if sustainable growth is ensured. In return, sustainable growth implies economic growth in which price stability is not disrupted and in which growth rates close to the potential growth rate level are achieved perpetually. Even in Turkey, we saw that rapid growth caused by high inflation rates in the 1980s was not long term. After a certain period, growth was replaced with even higher inflation rates and economic stagnation. On the other hand, in the period between 2002 and 2007, when the effects of the global crisis first started appearing, not only was there high economic growth but also a profound decline in inflation.

In this respect, the monetary policy created by the Central Bank of Turkey with the purpose of ensuring price stability has supported the establishment of price stability in Turkey and has made a lasting contribution to improving the competitiveness of the entire economy and the export sector. The phenomenon of high currency substitution, which had negatively affected our economy since the 1990s, ended during this period. The Turkish lira gained value again and Turkish institutions and citizens started gaining confidence in Turkish lira investment and borrowing instead of foreign money. The policies observed after 2001 have left future generations a valuable inheritance.

In brief, the current economic conditions in Turkey are vastly different compared to the period of the 2001 crisis. However, the high current account deficit, the expansion in credit volume and the continuing effects of the global financial crisis across the world pose certain risks for macroeconomic stability in our country. In line with this, the monetary policies of developed countries entered a second quantitative expansion period and consequently capital flow to developing countries increased and short-term capital inflow fostered divergence in the growth rates of domestic and foreign demand. These returns caused a rapid increase in the current account deficit, which calls for measures that minimize macrofinancial risks and critical changes to the Central Bank of Turkey’s strategies. During this period, inflation continued mainly in line with the targets, allowing the monetary policy to focus on financial stability. Our new monetary policy is using a combination of policies that consist of more than one tool so as to ensure domestic and foreign balance. In this respect, both policy interest rates and required reserve ratios are used together to ensure price stability and financial stability.

If no concessions are made to fiscal discipline and structural reforms are implemented, equilibrium real interest rates in the Turkish economy are expected to remain in the single digits in the upcoming fiscal cycle as well.