Turkish Economy: 1980–2001

1. Introduction 

The Turkish economy has experienced relatively high inflation coupled with unsuccessful disinflation programs during the past 30 years. Although yearly inflation was over 100% in certain years, it never reached hyperinflationary levels but increased in a stepwise fashion over time: the average annual inflation rate was 20% in the 1970s, 35–40% in the early 1980s, 60–65% in the late 1980s and early 1990s, and around 80% before the government launched yet another disinflationary program in 1998 (see Figure 1). 

An early attempt to reduce inflation on a permanent basis and to put the economy on a sustainable growth path began on January 24, 1980. The government declared its intention to liberalize the economy, and to pursue an export-led growth policy. After the implementation of the program, a military regime was installed in September 1980. The January 24 program reached its initial targets very soon in terms of a lower inflation, a higher GDP growth, and a relatively liberalized external trade regime and financial system. However, after the general elections and a new parliament in 1984, inflation started to rise again.

Figure 1: Inflation and Real Exchange Rate in Turkey

a) Annual inflation, CPI (percent).

(b) Monthly inflation, CPI (seasonally adjusted, percent).

(c) Consumer price index in USD terms, 1994=100.

(d) Real exchange rate index, TRTWIN, 1987=100. An increase in the real exchange rate index indicates an appreciation of the Turkish lira.

Sources: Central Bank of the Republic of Turkey, State Institute of Statistics and Reuters.

The basic elements of disinflation efforts in the late 1980s were in various forms of nominal anchoring and monetary tightening without any serious effort to reduce the public sector borrowing requirement. This policy combination necessitated a higher interest rate on domestic assets and a lower depreciation rate in order to secure short-term capital inflow. Especially after 1989 (the year the capital account was liberalized), the new disinflationary strategy pronounced itself strongly. However, the government did not take necessary measures on the fiscal front and the disinflationary attempts were futile. Due to the unsustainable nature of the fiscal policy and the external deficit, the economy experienced a major crisis in early 1994. The Government announced a new stabilization program on April 5, 1994 and a stand-by arrangement was approved by the International Monetary Fund (IMF) Board two months after the program started. However, it soon became clear that the government was not strongly behind the April 5 program and the stand-by agreement came to an end in 1995. During the following two years, there was no serious attempt to stabilize the economy and to reduce inflation.

In July 1998, the Turkish government started another disinflation program under the guidance of an IMF Staff Monitored Program (SMF). The program achieved some improvements concerning the inflation rate and fiscal imbalances but it could not relieve the pressures on the interest rates. The Russian crisis in August 1998, the general elections in April 1999 and two devastating earthquakes in August and October 1999 led to a deterioration of the fiscal balance of the public sector.1

The government started implementing another far-reaching restructuring and reform program after the general elections in April 1999. The aim of the program was to reduce inflation from its current 60–70% per year to single digits by the end of year 2002. The program gained further momentum after the country signed a stand-by arrangement with the IMF in December 1999. The main tool of the disinflation program was adoption of a crawling peg regime; i.e., the percent change in the Turkish lira value of a basket of foreign exchanges (1 US dollar plus 0.70 Euro) is fixed for a period of a year and a half. Although there was turmoil in financial markets in late November and early December 2000, the program seems to be on track as of February 2001 thanks to a substantial infusion of additional funds from the IMF after the crisis in December 2000. This short-lived financial crisis showed that the financial system is very fragile. Ironically, the crisis made it clear that the continuation of the disinflation program and the stability of the banking system in the short run depend on short-term capital inflows. Therefore, unless the government creates an environment in which foreign direct investment finds itself comfortable, the program is probably destined to fail and inflation might start to rise again.

The aim of this chapter is to give an overall account of the Turkish economy during the 1980–2000 period.2 The growth performance of the economy is presented in Section 2. The external balance and foreign trade developments are reported in Section 3. The fiscal position and domestic debt dynamics are reviewed in Section 4. After a detailed overview of the Turkish banking sector in Section 5, we conclude in Section 6.

2. Growth Performance: Boom-Bust Cycle

 The export-led growth strategy of the early 1980s was quite successful. The average annual growth rate of real gross domestic product (GDP) was an impressive 5.8% between 1981–88 and the economy did not experience any recession, making the country an exemplary one in annual reports of international financial institutions such as the IMF. Also, the real increase in industrial value added was above the GDP growth rate; it averaged 8.1% during the same period.

Starting in 1988, the economy entered into a new phase and the growth performance has been sluggish since then, with two minor and two major recessions. The annual real GDP growth averaged 3.7% during this period. The average annual growth rate of industrial value added was slightly higher at 4.4% (see Figure 2). The exemplary economy of the 1980s became a textbook case of “boom-bust” growth performance with a relatively lower average growth rate and high volatility in the 1990s.

The dynamics of the growth performance of the Turkish economy after 1989 can be linked to unsuccessful disinflationary efforts and debt financing policies of the government. The Turkish policy makers started to slow down the depreciation rate of the Turkish lira, in part to control the inflation, but mainly to be able to borrow easily from the domestic markets in 1989. Although there was a crisis in 1994 which interrupted this policy, the authorities have pursued the same exchange rate policy for the last ten years. As Calvo and Végh (1999) and Guidotti and Végh (1999) show, the credibility of a slowed down devaluation in fighting inflation in moderate to high inflation economies is almost always low, both because of inflation inertia and because of the failure of the previous disinflation programs. The developments in the Turkish economy after 1987 are in line with stylized facts from exchange rate-based stabilization programs in different economies, as summarized in Calvo and Végh (1999):

(1) Slow convergence of the inflation rate (measured by the CPI) to the rate of change in exchange rates.

(2) Initial increase in real activity – particularly, real GDP and private consumption – followed by a counteraction.

(3) Real appreciation of the domestic currency.

(4) Deterioration of the current account balance.  

(5) A decrease in domestic ex-post interest rates in the initial stages.

Possible explanations for an initial increase in real activity, followed by counteraction, in exchange rate-based stabilization programs are given in Calvo and Végh (1999). At the initial stage of slowed down depreciation, the interest rate parity condition leads to a lower domestic interest rate. If the convergence of inflation is slow, the real interest rate will fall as well, leading an increase in domestic demand, especially in private durable and semi-durable goods consumption and private investment. Eventually, a reduction in consumption and investment, and a real depreciation is inevitable because of resource constraints. 

Figure 2: Real Growth in the Turkish Economy: Percentage Change in Gross Domestic Product and Economic Activities at Producers’ Prices (at 1987 prices)

(a) Real GDP growth (percent). (b) Industrial production. (c) Agriculture. (d) Domestic trade. Source: State Institute of Statistics. 

Figure 3: Cyclical Movements of Real GDP Components in Turkey

(a) Private sector durable goods consumption (deviations from logarithmic trend). (b) Private sector semi-durable goods consumption (deviations from logarithmic trend). (c) Private sector investment expenditure (deviations from logarithmic trend). (d) External deficit (deviations from the sample mean). Calculated from the expenditure side of gross domestic product (at 1987 prices). Series are filtered to remove seasonalities. Source: State Institute of Statistics.

As a result, the economy experiences a recession right before or immediately after the program ends. If the economy goes through several “slowed down depreciation-correction” cycles, the overall economic activity will also experience boom-bust cycles. The amplitude of these cycles will be higher if the intertemporal elasticity of substitution is high in the economy.3

With regard to economic growth after 1987; there were four recessions in Turkey (see Figure 2). Both the 1991 and 1994 recessions were preceded by a substantial increase (appreciation) in the real exchange rate, as shown in Figure 1. Also, private durable and semi-durable goods consumption and private investment were well-above their trend values before those recessions (see Figure 3).

The last recession in 1999 was mainly caused by the response of monetary authorities to the Russian crisis in late 1998 and two devastating earthquakes in 1999. The real interest rates were kept higher to defend the Turkish lira for a considerable period of time after the Russian crisis. Nevertheless, it is worth noting that there was a small appreciation (approximately 10%) from January 1996 up until the Russian crisis in July 1998. During this period, we observe again a boom in both private consumption and private investment. Since the recent disinflationary program also relies on a slowed-down depreciation policy, it is reasonable to expect another boom-bust cycle in economic activity starting 2000, regardless of the outcome of the program. If the slow-down in economic activity arrives relatively early, it might be a real concern for the Government and the program might come to an unexpected end.

3. External Balance

With the introduction of a comprehensive stabilization program in January 1980, an outward oriented development strategy was accepted and external balance became a major concern of governments as protracted current account imbalances made the Governments more sensitive about the sustainability of external imbalances. 

The export-led growth policy was quite successful in the early stages of its implementation. The openness of the economy increased immediately: the total exports-GDP ratio increased from 4.1% to 13.3% during the period of 1980–88. The total imports - GDP ratio also increased but the rate of increase was smaller as it went up from 11.3% to 16.4% during the same period. Therefore, the external balance situation improved significantly. The external deficit-GDP ratio went down from 7% in 1980 to negative 1% (surplus) in 1988. The real depreciation of the Turkish lira (approximately 40%) and several tax incentives to exporters in this period were the major driving forces of the export-led growth policy.4

The policy reversal after 1987 had an adverse effect on the external balance situation of the economy. Because of the slowed-down depreciation, the Turkish lira appreciated in real terms 22% in 1989 and continued to appreciate in 1990 at a slower rate. Consequently, the rate of increase in the total exports slowed down and that of total imports jumped up. The external deficit - GDP ratio increased to 2% in 1989 and to 4% in 1990. Although there was a slight decrease in 1991 and 1992, the external deficit reached to approximately 6% of the GDP in 1993 (see Figure 4).5

Towards the end of 1993, it was clear that both fiscal policy and external balance situation was not sustainable. In January 1994, international credit rating agencies lowered Turkey’s sovereign debt rating to below investment grade. This triggered a panic in financial markets. The Turkish lira was devaluated twice, in January and in April of 1994. Total exports increased dramatically while total imports contracted. As a result, the external balance was positive in 1994 at 1% of GDP.

Figure 4: External Trade

(a) Exports (in billion USD). (b) Imports (in billion USD). (c) Exports and Imports to GDP Ratios (in percent). (d) External deficit to GDP ratio (in percent). External deficit figures are taken from the national income accounts of the State Institute of Statistics. Export figures do not contain the shuttle trade estimates of the Central Bank. See Footnote 3 on unofficial exports and imports. Source: State Institute of Statistics. 

Figure 5: Capital Flows

(a) Foreign direct investment (in billion USD). (b) Portfolio investment (in billion USD). (c) Other long-term capital (in billion USD). (d) Short-term capital (in billion USD). All figures are net. Source: Central Bank of the Republic of Turkey.  

Between April 1994 and December 1994, the Turkish lira appreciated in real terms significantly (22% in five months) and the corrective nature of the devaluation during the first half of the year disappeared. According to the national income statistics, the external deficit was 5% of the GDP in 1995 and approximately 6% in 1996 and 1997. However, the worsening external balance situation did not result in large current account deficits in these years.6 The external deficits in 1998 and 1999 were relatively low, thanks to extremely high real interest rates after the Russian crisis and a shrinkage in total demand. Total exports have been stagnant for the last four years at around USD 26 billion and changes in total imports are dominating the current account dynamics.

The capital account of the balance of payments indicates that the Turkish economy became dependent on short-term capital flows, especially after 1989 (see Figure 5). Foreign direct investment (net) was extremely low up until 1988. Then, there was a surge in foreign direct investment, reaching USD 800 million in 1992 from USD 100 million in 1987. The foreign direct investment averaged USD 600 million between 1993 and 1998 and became low again during the last two years as a result of longterm capital outflows, in particular in the category of investment by domestic residents abroad. Overall, it is safe to conclude that the Turkish economy has not been able to attract significant foreign direct investment for the last 20 years. The total foreign direct investment during the last fifteen years was 7.7 billion, roughly equivalent to total long-term borrowing by the private sector (excluding banks) in just one year (1999). Another noticeable development in long-term capital figures is the surge in the “Other Long Term Capital” item, starting in 1996 (see Figure 5). A close inspection of the statistics reveals that the private sector (excluding banks) has increased its external borrowing for the last five years. This development signals that the foreign exchange exposure of the country is increasing. Total external debt figures confirm this conclusion. The outstanding external debt was USD 79.6 billion in 1996 and 106.9 billion in 2000(Q3), indicating a 34% increase in four years. The composition of the external debt has also changed. In 1996, only 21% of the total debt had a short-term maturity while 25% did in 2000(Q3). The share of commercial banks in short-term external debt is 60% (USD 15.6 billion). The private sector, excluding banks, carries 38% (10.5 billion) of the short-term debt. Incidentally, the total short-term external debt of the country is roughly equivalent to the total reserves of the Central Bank.

4. Fiscal Balance and Domestic Debt  

The public sector borrowing requirement (PSBR) in Turkey consists of six components: central government, extra-budgetary funds, local authorities, state economic enterprises, social security institutions and revolving funds.7 Following the January 24, 1980 program, the PSBR as a percent of GNP decreased immediately from 9% in 1980 to 4.5% in 1981 and stayed less than 5%. After 1986, the PSBR started to increase in a steady fashion and reached 12% in 1993. Although there was a correction in 1994 and 1995, it kept increasing again and reached over 15% in the year 1999 (see Figure 6).

Figure 6: Public Sector Borrowing Requirement and Financing

(a) Public sector borrowing requirement in percent of GNP. (b) Domestic borrowing in percent of GNP. (c) Foreign borrowing in percent of GNP. (d) Primary deficit in percent of GNP. Source: State Planning Organization. 

There was not only a change in deficit dynamics, but also in deficit financing policies of the governments after 1987. The share of domestic borrowing in PSBR financing kept increasing and the share of foreign borrowing declined. After 1993, the share of foreign borrowing in PSBR financing was negative. As a result, the domestic debt started to increase. Right from the beginning of 1990, the total domestic debt dynamics in Turkey clearly indicated that the fiscal policy was on an unsustainable path (see, for example, Selçuk and Rantanen, 1996). Total domestic debt of the government in 1988 was a mere USD 4 billion. As of December 2000, the stock reached USD 53.8 billion. The ratio of domestic debt to GNP also increased from 6% in 1988 to 30% in 1999. Note that this figure does not include some other public liabilities such as unpaid duty losses of the state banks (approximately USD 20 billion). It is hard to imagine that the domestic debt problem can be solved in a smooth fashion.

Figure 7: Daily Weighted Average of Overnight Interest Rates (simple annual, percent)

The overnight interest rates reached to extreme levels in 1994 and in late 2000. Therefore, these periods are excluded. (a) January 2, 1990 – December 31, 1993. (b) January 2, 1995 – November 17, 2000. Source: Central Bank of the Republic of Turkey. 

The role of the Central Bank’s monetary policy in debt management in recent years was one of accommodation.8 A close inspection of the daily overnight interest rates in Figure 7 preceding the IMF program reveals two distinct periods. There was a volatile period after 1994 crisis (June 1, 1994 – April 16, 1996) followed by a relatively less volatile period (April 17, 1996 – December 31, 1999).9 During the first period, the sample mean and the standard deviation of the overnight rates were 73.6% and 26.3%, respectively. The second period had almost the same sample mean (72.3%) but much lower standard deviation (7.4%). During the stand-by period in 2000, the sample mean of overnight interest rate decreased. Also, the standard deviation of interest rates increased, as to be expected. The mean of overnight rates between January 3, 2000 and November 17, 2000 was 39% and the standard deviation was 14%.10 Clearly, the Central Bank had an implicit ceiling on overnight borrowing rates starting April 1996, especially after the Russian crisis in 1998 until January 2000. This implicit ceiling provided a cushion for the commercial banks against the interest rate risk in the market, reducing their risk management capabilities. However, the average interest rate during this “controlled interest rates” period indicates that it was not profitable to buy domestic debt instruments and to fund them from the money market. It was still “borrowing abroadlending home” strategy, which left a hefty profit margin in dollar terms (see Figure 9).

State economic enterprises are another contributing factor to the public sector borrowing requirement. Zaim and Taşkın (1997) compare the performance of the public enterprise sector to the private sector in Turkey and show that the public enterprise sector performance deteriorated in the 1980s. Although it was always on the agenda of every government, privatization performance of Turkey was quite weak until 2000. The existing legal framework, and populist policies of the governments were probably the main reasons for this result.11

5. The Turkish Banking System 

One of the main aims of the January 24, 1980 structural adjustment program was the liberalization of the repressed financial system. Concerning the financial deregulations, the governments started to liberalize the foreign exchange regime, certain restrictions on capital movements were removed, and the convertibility of the Turkish Lira was provided. Meanwhile, restrictions on interest rates were removed, a shortterm money market was established, the Central Bank was allowed to engage in open market operations and most of the regulations concerning the financial markets were eliminated in the context of liberalization and globalization. These deregulation efforts speeded up the linking of the domestic financial market to the rest of the world, and provided more competitive working conditions to the commercial banks. Liberalization and integration occurred more rapidly than expected, partly due to advances in the telecommunications sector.

It may be asserted that liberalization and integration might improve the overall efficiency in the economy. However, increasing interdependence makes the international linkage of policy implementations more important than before. A boom or a recession in one country spills over to other countries through trade flows and changes in interest rates and capital movements. Hence, the liberalization and integration of the financial sector may also increase the vulnerability of an economy to adverse shocks from the rest of the world. In this section, we investigate the developments in the Turkish banking system in three distinct periods: early liberalization efforts in the 1980s and developments especially after 1987 leading to the 1994 crisis, the 1994 crisis and afterwards, and the 2000 disinflation program. The last subsection also includes an account of the November 2000 crisis in the financial markets.

5.1 Liberalization and the Banking System

The structural adjustment program, which was implemented in the early 1980s, produced substantial changes in the banking sector. Starting in 1980 total assets of the banks increased from USD 18.5 billion (31% of the GNP) to USD 134 billion (68% of the GNP) by the end of 1999. The total deposits - GNP ratio also increased from 15.4% to 61% during the same period (see Figure 8).12 During this period, the market share of the state banks (in terms of their share in total assets) gradually decreased from 44% to 35% and the share of private banks increased from 41% to 50%. However, the state banks increased their share in total deposits (see Figure 8).  

Liberalization and integration efforts created important structural changes in the balance sheets of banking system, especially after 1987. Starting from 1987, when the government slightly changed its exchange rate and debt policy, the relative share of non-deposit funds in total liabilities of private banks permanently increased and reached a peak in 1993. In other words, during this period, the Turkish private banks tried to substitute non-deposit funds for deposits.

After 1987, the share of foreign currency denominated assets and liabilities of the banking sector started to increase. The share of foreign currency denominated assets in total assets rose from 26% in 1988 to 38% in 1999. Similarly, the share of foreign currency denominated liabilities in total liabilities rose from 25% in 1988 to 48% in 1999. Short-term borrowing-based deficit financing policies of the governments increased the interest rates and encouraged short-term capital flows into the economy. The policy facilitated managing the public deficit and helped the central bank to build up its foreign currency reserves. These deficit financing and reserve accumulation policies led commercial banks to open short positions in foreign currencies. The short positions in the banking system increased from 1.8 billion in 1990 to USD 5 billion in 1993. Although there was a decrease in 1994 as a result of a financial crisis in that year, the short positions of the banking system kept increasing and reached USD 13.2 billion at the end of 1999 (see Figure 9).