PULSE of TURKEY No 53............SATURDAY, SEPTEMBER 19^th 1998

Recent economic crises in various countries and the effect of the Russian crisis on Turkey have induced the Government to carry out a scientific survey into the problem. The matter is closely concerned with the second item of the Turkish-American Action Plan. Is foreign capital a blessing or a scourge as international rules and practice stand now?

The shock drop in the IMKB (Istanbul Stock Exchange) index on September 17^th to below 2000 (1948 to be exact) was the limit for the Prime Minister who instantly called a meeting of his ministers and top bureaucrats to review the situation the following day. The impact of the meeting was instant. The bourse more than recovered the previous day’s 8.4% drop the following day even before the outcome of the long meeting was known.

It was already common knowledge that the Government was bent on what to do about the exodus of foreign capital from the market and various economists were being consulted about it. A survey entitled “Macro Economic Effects on Developing Countries of International Capital Movements” written after the 1995 Mexican crisis by three university teachers was like a prophecy about the current crises in Russia and Turkey, even though it had been written much earlier.

The findings of the Turkish scholars in 1995 were absolutely fitting to the developments of the Asian-Pacific crisis and the Russian one too. To sum up this survey, the three economists say:

• Capital movements enter developing countries in two ways. The first group consists of direct capital movements that enter into the real economic sector, resulting in the host country’s increase in production. It expands the supply aspect of the economy. The second group of capital enters into financial assets in the form of portfolio investments and expands the demand aspect of the economy.
• Capital movements upset the balance of payments structure of the host countries. The foreign exchange surpluses due to capital arrivals result in time in the appreciation of the local currency against hard currencies. This, for its part, causes a decline in the country’s competitive power and rapidly enlarges the external trade gaps and current transaction deficits. But, because the continuing foreign capital arrivals finance current transaction deficits no hard currency shortage is felt. The Central Bank reserves that are swollen by capital arrivals provide the rulers with a false sense of security. This policy continues until the Government or the market devalues the excessively appreciated local currency. Devaluation immediately triggers off a financial crisis because foreign capital that had been financing the current transaction deficits until then rapidly demands dollars and leaves the country. This excessive demand for foreign exchange accelerates devaluation. The Central Bank melts down its foreign exchange reserves and as foreign investments are in financial assets (such as stocks, bonds, treasury notes and mutual fund papers) foreigners rapidly sell off these papers, thus causing a slump in the market.
• As the central banks mint local currency in exchange for increased hard currencies due to foreign capital arrivals, the money supply expands and this expansion becomes dependent on foreign exchange arrivals. This creates difficulties for the central banks to manage the monetary policy within the limits they foresee. To offset the harm of this over-expansion of the money supply central banks resort to a “sterilization” policy in order to curb excessive expansion. This means withdrawing money from the market by putting up interest rates, but the increased interest rates attract more hard currency and accelerate the arrival of capital.

The Turkish economy withstands global economic crises

The findings of Turkish economists from the analysis of the Mexican crisis 3-4 years ago is exactly what Turkey is facing today, but it is at a much lesser intensity than the other countries concerned - Mexico, the Far East and Russia. The economy rulers of Turkey maintain that this relatively mild impact of the international crisis on the Turkish economy is due to the enforcement of the economic stability program.

Experts, however, believe that the reason is much deeper than that. During the April 5^th, 1994 economic crisis in Turkey, not a single penny came from abroad in loans for over a year, but Turkey could still repay over $10 billion external debts during that year. This surprising performance made international economic quarters realize Turkey’s hitherto unknown economic strength – the unregistered economy that is bigger than the official GNP figures.

It is claimed that Turks have $130 billion abroad, including the savings of migrant Turkish workers in Europe and the “black money” from drug trafficking. This figure is a rough estimate and may be inaccurate, but it is a fact that the Turkish economy is much stronger than what official figures show.

This is one of the main reasons why the impact of the crisis in the Far East last year and the Russian crisis this year has not hit Turkey too badly. The worst hit sector was the Stock Exchange, but what happened in the IMKB on September 18^th was a big eye opener for everyone. When the index of the shares market went down to 1948 a day before, the Prime Minister held a meeting with his economy ministers and top bureaucrats on Friday and before he announced the decisions taken the IMKB index went up by 16.93 % and closed the week at 2278.

This phenomenal achievement has not yet been tested to prove its durability, but a quick look at the structure of the IMKB and where it stands today will be a good indicator of what to expect for the future.

On July 16^th the IMKB dollar index was $1.69 and on September 15^th it was 79 cents. Two days later it fell to a record low of below 75 cents, but the Prime Minister’s meeting with economy rulers the following day reversed the trend.

The main reason for this drop was $4.5 billion quitting the Turkish economy up until the first week of September and today it is more than $5 billion. Of the $4,5 billion, $1 billion was from IMKB, $3 billion from the bonds market and $500 million was syndicated loans that were not renewed when matured. This exodus of $1 billion from the IMKB since the beginning of the Asian crisis reduced the share of foreign capital in the Istanbul Stock Exchange from 55% to 41.87% on September 15^th. The total value of the shares open to circulation in IMKB was $9.2 billion at the end of August and foreigners’ shares accounted for 46%. Today this share is just under 40%, but because they act together and constantly sell their shares regardless of the value, they dominate the market by imposing their downtrend values on the majority of 60%. Prime Minister Yılmaz is expected to hold a press conference soon to give a boost to the IMKB. Friday’s 17% remarkable rise in the market proves that the foreigners’ constant sale of shares has not yet affected the Turks so much and if big capital begins to buy shares the IMKB index may again soar.

TL1 quadrillion domestic debt-servicing a month is telling for the Turkish economy

Likewise, the compound interest rates of treasury bonds went up to 140% towards the end of last week, but the Government managed to bring it down to 131% again.

According to the 1999 draft budget, the Government will have to pay TL1 quadrillion a month for interest payments. This means that more than 50% of the budget will go to debt servicing next year. This rate was 18% in 1992, 38% in 1996 and 40% this year.

Next year’s budget is estimated to be TL21-22 quadrillion and the interest payment is TL11-12 quadrillion. These amounts are based on the assumption that the inflation rate will be 20% at the end of 1999 and the deflator 32-33%. With the economic growth during this year and in 1999 (estimated to be 4.4%) the deflator may be increased to 36-37%. The Finance Ministry aimed at keeping the interest payments and State personnel expenditure at TL14,789 trillion next year, but it will not be possible to do so and these two items will total TL15.5-16 quadrillion.

This year the domestic debt interest payment will be TL1,672 trillion in September and TL1.8 quadrillion in the last quarter (TL114.4 trillion in October, TL801.6 trillion in November and TL886.1 trillion in December). It means once the tight budget for September is over the Treasury will relax until the end of the year. It will also enable the Government to pull down the interest rates to below 130%. Finance Ministry sources underline that it was quite an achievement to keep the interest rates at 130%, despite the heavy debt servicing in September and the continuous sale of bonds and shares by foreigners. For the rest of the year, the economic fundamentals, as well as the market indicators will be much better, they say.

The State Minister for the Economy, Güneş Taner, made contacts with international finance circles in Germany and the UK last week, while the Prime Minister tried to complete the preparations to end the crisis in the Stock Exchange. The Prime Minister is expected to hold a press conference on Monday, 21 September to announce a number of measures to enliven the IMKB. Judging the remarkable 17% rise in the market without even announcing these measures it is certain that this press conference will be a turning point in taking the economic crisis under control in Turkey.uras@ada.net.tr September 19^th, 1998

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