Kibritçioğlu, November 8, 2004, (1/79) An Analysis of Early Warning Signals of Currency Crises in Turkey, 1986-2004 Aykut Kibritçioğlu Associate Professor

Kibritçioğlu, November 8, 2004, (1/79)

An Analysis of Early An Analysis of Early Warning Signals of Warning Signals of Currency CrisesCurrency Crisesin Turkeyin Turkey, 1986-2004, 1986-2004

Aykut KibritçioğluAykut KibritçioğluAssociate Professor of EconomicsAnkara University, Turkey

Vienna, November 8, 2004


Thanks for inviting meto Vienna to give seminars andfor giving me the possibility to

make further research on Turkey-EU related issues...

Thanks for inviting meto Vienna to give seminars andfor giving me the possibility to

make further research on Turkey-EU related issues...

OesterreichischeNationalbank

Wiener Institut für internationale Wirtschaftsvergleiche


Research Visit to the ÖNB & WIIW(Vienna, Austria, November 1-15, 2004)

Research Visit to the ÖNB & WIIW(Vienna, Austria, November 1-15, 2004)

“An Analysis of Early Warning Signals of Currency Crises in Turkey, 1986-2004”

“Real Exchange Rate Misalignment in Turkey, 1987-2003”

“An Overview of Macroeconomic Developments in Turkey”(with special reference to the AK-Party Era, 2002-04)

http://dialup.ankara.edu.tr/~kibritci/http://dialup.ankara.edu.tr/~kibritci/wiiw.htmlwiiw.html


Dr. sc. pol. Aykut KibritçioğluAssociate ProfessorDepartment of EconomicsFaculty of Political SciencesAnkara UniversityTR-06590 Cebeci, Ankara, Turkey

Tel.: +90-312-3197720, ext. 340Fax: +90-312-3197736E-mail: [email protected]: http://dialup.ankara.edu.tr/~kibritci/wiiw.html


Personal Background (1)Personal Background (1) born in Istanbul, Turkey, 1962 education:

Istanbul High School, Turkey (1973-1980) Economics, Ankara University, Turkey

(B.A., 1981-1985; M.A., 1985-1988) Economics, Christian-Albrechts-Universität zu

Kiel, Germany (Dr.sc.pol., 1989-1994)

work: Department of Economics, Ankara University

Research & Teaching Assistant (1986-1994) Assistant Professor of Economics (1994-1999) Associate Professor of Economics (1999-2004)

Chief-Advisor to the Minister of State for Economic Affairs (2000)

Visiting Scholar, University of Illinois at Urbana-Champaign, USA (2000-2002)


Personal Background (2)Personal Background (2) teaching specialization:

international economics economics of growth and technology (open economy) macroeconomics economics of integration & EU

current research specialization: economics of European integration financial and real sector crises high inflation (Turkey)

selected publications 1994: Die internationale Wettbewerbsfähigkeit der türkischen

verarbeitenden Industrie 2000: “EMU, Euro and EU-Membership: An Evaluation From The

Turkish Macroeconomic Perspective” 2002: Inflation and Disinflation in Turkey (with Selçuk & Rittenberg) 2003: “Monitoring Banking Sector Fragility”, ABR 2004: “Inflation, Output Growth, and Stabilization in Turkey, 1980-

2002”, JEB (with Dibooğlu)


An Analysis of Early Warning An Analysis of Early Warning Signals of Currency Crises in Signals of Currency Crises in

Turkey,Turkey,1986-20041986-2004

Abstract: Within a signals approach framework à la Kaminsky, Lizondo and Reinhart, this paper aims both to detect the early warning signals of currency crises in Turkey and to discuss the reliability of an early warning system for this country. To determine major leading indicators of currency crises in Turkey, more than 45 variables are tested, and by using the most relevant 15 variables, a composite index is constructed to estimate the probabilities of currency crises in the country.

JEL Classification: E31, F31, F47, C22

Key Words: Currency crises, signals approach, early warning system, real exchange rate misalignment, foreign trade, Turkish economy


Outline of the PresentationOutline of the Presentation Introduction: Motivation and Aims

Macroeconomic Background

Literature Review

Signals Approach for Turkey Overview of the Methodology

Identification of Crises Episodes

Comparison of Individual Performances of Potential Leading Indicators

Composite Leading Indicators and Estimation of Crisis Probabilities

Concluding Remarks


Introduction:Introduction:Motivation and AimsMotivation and Aims


Usage of the Concept of “Crisis” in Economics Usage of the Concept of “Crisis” in Economics LiteratureLiterature

(according to JEL EconLit records, Jan. 1969 – Oct. 2004)

697262

(518)

1608

(2501)

414

(5023)

55

(132)

72

(185)

930

(1008)1969-2004

640225

(460)

1444

(2201)

404

(4889)

44

(99)

42

(98)

215

(264)1995-2004

3925

(39)

73

(138)

7

(130)

8

(18)

14

(47)

322

(334)1990-1994

1810

(17)

85

(156)

2

(3)

2

(14)

16

(39)

393

(409)1980-1989

02

(2)

6

(6)

1

(1)

1

(1)

0

(1)

0

(1)1969-1979

ContagionBanking

Crisis(+Crises)

Financial Crisis

(+Crises)

Currency Crisis

(+Crises)

Exchange Rate

Crisis(+Crises)

Balance ofPayments

Crisis(+Crises)

Debt Crisis

(+Crises)

Search Period

Krugman (1979)Krugman (1979)

The concepts of “currency crisis” and “financial crisis” are relatively new in economics.


Timing of Macroeconomic Crises in Timing of Macroeconomic Crises in TurkeyTurkey

(January 1979 – December 2001)(January 1979 – December 2001)Döviz Krizleri

1979.01

1980.01

1981.01

1982.01

1983.01

1984.01

1985.01

1986.01

1987.01

1988.01

1989.01

1990.01

1991.01

1992.01

1993.01

1994.01

1995.01

1996.01

1997.01

1998.01

1999.01

2000.01

2001.01

2002.01

Bankacılık Krizleri1979.01

1980.01

1981.01

1982.01

1983.01

1984.01

1985.01

1986.01

1987.01

1988.01

1989.01

1990.01

1991.01

1992.01

1993.01

1994.01

1995.01

1996.01

1997.01

1998.01

1999.01

2000.01

2001.01

2002.01

Reel Sektör Krizleri1979.01

1980.01

1981.01

1982.01

1983.01

1984.01

1985.01

1986.01

1987.01

1988.01

1989.01

1990.01

1991.01

1992.01

1993.01

1994.01

1995.01

1996.01

1997.01

1998.01

1999.01

2000.01

2001.01

2002.01

Enflasyon Krizleri1979.01

1980.01

1981.01

1982.01

1983.01

1984.01

1985.01

1986.01

1987.01

1988.01

1989.01

1990.01

1991.01

1992.01

1993.01

1994.01

1995.01

1996.01

1997.01

1998.01

1999.01

2000.01

2001.01

2002.01

Hükümet Değişmeleri1979.01

1980.01

1981.01

1982.01

1983.01

1984.01

1985.01

1986.01

1987.01

1988.01

1989.01

1990.01

1991.01

1992.01

1993.01

1994.01

1995.01

1996.01

1997.01

1998.01

1999.01

2000.01

2001.01

2002.01

CurrencyCurrencyCrisesCrises

BankingBankingCrisesCrises

Real SectorReal SectorCrisesCrises

InflationInflationCrisesCrises

GovernmentGovernmentChangesChanges

Source: Kibritçioğlu (2001): “Economic Crises and Governments...”


MotivationMotivation Turkey liberalized international capital

movements in 1989.

The country experienced then two severe currency crises, firstly in 1994 and secondly in early 2001.

However, country-specific studies on the predictability of currency crises in Turkey are still far from being adequate.

By employing the signals approach for the period of April 1986 – April 2004, the current study is aimed both to determine the major macroeconomic indicators,

which send early warning signals prior to currency crises in Turkey, and

to discuss the reliability of an early warning system for Turkey.


Macroeconomic Macroeconomic Background:Background:

Turkey, 1978-2004Turkey, 1978-2004


The 1980-1989 TransformationThe 1980-1989 TransformationThe 1980-1989 TransformationThe 1980-1989 Transformation

1978 - 1980:1978 - 1980: Balance-of-payments crisis, productivity slowdown and accelerating inflation

January 1980:January 1980: Announcement of a substantial stabilization and structural adjustment program in order to gradually liberalize the economy

1980 - 1982:1980 - 1982: Domestic financial liberalization

May 1981:May 1981: Abandonment of the fixed exchange-rate regime

June 1984 June 1984 -- August 1989: August 1989: Capital account liberalization and convertibility of the Turkish lira


Post-1989 Macroeconomic Post-1989 Macroeconomic DevelopmentsDevelopments

Post-1989 Macroeconomic Post-1989 Macroeconomic DevelopmentsDevelopments

December 1993 - April 1994:December 1993 - April 1994: A major currency crisis and acceleration in the inflation

August 1999:August 1999: Negative macroeconomic impacts of the Marmara earthquake

December 1999:December 1999: Announcement of an exchange-rate-based stabilization program for 2000-2002

November 2000 & February 2001:November 2000 & February 2001: Two successive banking and currency crises and political instability in Turkey

May 2001:May 2001: Announcement of the new economic program


Governments & Political InstabilityGovernments & Political Instabilityin Turkeyin Turkey, 1969-2004, 1969-2004

1969-2004 = 36 years = 432 months Average period between two general elections = 48

months = 4 years Average life of governments = 15.4 months = 1.3

yearsICRG=International Country Risk Guide

The Frequency of General Elections and Government Changes in Turkey (Jan. 1969 - Dec. 2004)

19

69

.01

19

70

.01

19

71

.01

19

72

.01

19

73

.01

19

74

.01

19

75

.01

19

76

.01

19

77

.01

19

78

.01

19

79

.01

19

80

.01

19

81

.01

19

82

.01

19

83

.01

19

84

.01

19

85

.01

19

86

.01

19

87

.01

19

88

.01

19

89

.01

19

90

.01

19

91

.01

19

92

.01

19

93

.01

19

94

.01

19

95

.01

19

96

.01

19

97

.01

19

98

.01

19

99

.01

20

00

.01

20

01

.01

20

02

.01

20

03

.01

20

04

.01

35

40

45

50

55

60

65

70

75

Government Changes (28 times) ICRG's Political Risk Index for Turkey General Elections (9 times)


Volatility in Long-Run Growth (1950-2000)Volatility in Long-Run Growth (1950-2000)

Turkey’s economic growth performance was highly volatile.

Real GDP per capita rose 22 times, from 1950 to 2000.

1.52.9

7414

340-15

-10

-5

0

5

10

15

20

25

30

19

50

19

51

19

52

19

53

19

54

19

55

19

56

19

57

19

58

19

59

19

60

19

61

19

62

19

63

19

64

19

65

19

66

19

67

19

68

19

69

19

70

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

0

1000

2000

3000

4000

5000

6000

7000

8000

Growth in Real GDP ($) Per Capita, %

Population Growth, %

Real GDP (TL) Growth, %

Real GDP ($) per Capita [right axis]

PWT6.1


In the late 1990s, Turkey was not able to join the global disinflation process that we observed explicitly.

Annual Consumer Price Inflation(%, log scale)

0.1

1.0

10.0

100.0

1000.0

10000.0

100000.0

19

49

19

51

19

53

19

55

19

57

19

59

19

61

19

63

19

65

19

67

19

69

19

71

19

73

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

MaximumInflation Rate(worldwide)

Turkey

DevelopingCountries

World Average

United States

Austria

Global Inflation & Disinflation and TurkeyGlobal Inflation & Disinflation and Turkey(1949-2003)(1949-2003)


-5

5

15

25

35

45

55

65

75

85

95

105

115

125

135

145

19

69

.01

19

70

.01

19

71

.01

19

72

.01

19

73

.01

19

74

.01

19

75

.01

19

76

.01

19

77

.01

19

78

.01

19

79

.01

19

80

.01

19

81

.01

19

82

.01

19

83

.01

19

84

.01

19

85

.01

19

86

.01

19

87

.01

19

88

.01

19

89

.01

19

90

.01

19

91

.01

19

92

.01

19

93

.01

19

94

.01

19

95

.01

19

96

.01

19

97

.01

19

98

.01

19

99

.01

20

00

.01

20

01

.01

20

02

.01

20

03

.01

20

04

.01

monthly

annual

Turkey suffered from high and persistent inflation since more than three decades. But, finally, it’s declining now...

Annual & Monthly Consumer Price Inflation in Annual & Monthly Consumer Price Inflation in TurkeyTurkey

(1969-2004, %)(1969-2004, %)


Annual WPI and CPI increases fell below 15 percent as September 2004.

Inflationary expectations in the country are also changing in a positive direction.

Annual Changes in Wholesale and Consumer Price Indices (SIS, percent)

11.9

7.50

10

20

30

40

50

60

70

80

90

1998

.01

1998

.04

1998

.07

1998

.10

1999

.01

1999

.04

1999

.07

1999

.10

2000

.01

2000

.04

2000

.07

2000

.10

2001

.01

2001

.04

2001

.07

2001

.10

2002

.01

2002

.04

2002

.07

2002

.10

2003

.01

2003

.04

2003

.07

2003

.10

2004

.01

2004

.04

2004

.07

2004

.10

Selected Events WPI CPI

Recent Developments in Inflation (1998-Recent Developments in Inflation (1998-2004)2004)


Foreign Exchange Market Foreign Exchange Market DevelopmentsDevelopments

In Turkey, the black-market for foreign exchange disappeared gradually since early 1980s.

Source: CBRT and PCY/WCY; own calculations.

1

10

100

1000

10000

100000

1000000

10000000

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

Black Market Exchange Rate (TL/USD)

Official Exchange Rate (TL/USD)

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

Official Exchange Rate to “Black-Market”Exchange Rate

“Black-Market” Exchange Rate = 1.0


0

1

2

3

4

5

6

7

8

9

50.0

1

52.0

1

54.0

1

56.0

1

58.0

1

60.0

1

62.0

1

64.0

1

66.0

1

68.0

1

70.0

1

72.0

1

74.0

1

76.0

1

78.0

1

80.0

1

82.0

1

84.0

1

86.0

1

88.0

1

90.0

1

92.0

1

94.0

1

96.0

1

98.0

1

00.0

1

02.0

1

04.0

1

-35

0

35

70

105

140

175

210

245BMER / OER (left axis) Annual Increases in OER (right axis)

Since May 1981, Turkey has a relatively flexible exchange rate system. This gradually removed the “black-market” for FX in Turkey.

In 2000, the monthly growth rates of nominal exchange rates were pre-determined to gradually disinflate the economy.

““Black-Market” Exchange Rates (BMER) vs. Official Exchange Rates Black-Market” Exchange Rates (BMER) vs. Official Exchange Rates (OER)(OER)

and Annual Increases in OER (1950-2004)and Annual Increases in OER (1950-2004)


0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.401

98

5

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

FX Deposits to M2

Currency Substitution in Turkey (1985-Currency Substitution in Turkey (1985-2004)2004)

High inflation and low credibility of government policies in the 1990s created a strong currency substitution. But it’s changing now...


There is a tendency towards reverse currency substitution during the AK-Party era.

Government’s success in disinflating the economy and its increasing credibility may significantly be contributing to this process.

Two Indicators of Currency Substitution in Turkey (1998-2004, %)

42.5

71.8

30

50

70

90

110

130

150

1998

.01

1998

.04

1998

.07

1998

.10

1999

.01

1999

.04

1999

.07

1999

.10

2000

.01

2000

.04

2000

.07

2000

.10

2001

.01

2001

.04

2001

.07

2001

.10

2002

.01

2002

.04

2002

.07

2002

.10

2003

.01

2003

.04

2003

.07

2003

.10

2004

.01

2004

.04

2004

.07

2004

.10

Selected Events Foreign Exchange Deposits / TL-denominated Deposits (M2Y - M2) / M2

Two Indicators of Currency Substitution in Turkey (1998-Two Indicators of Currency Substitution in Turkey (1998-2004, %)2004, %)


Nominal Exchane Rates (TL/USD and TL/Euro)

0

200000

400000

600000

800000

1000000

1200000

1400000

1600000

1800000

200000019

98.0

1

1998

.05

1998

.09

1999

.01

1999

.05

1999

.09

2000

.01

2000

.05

2000

.09

2001

.01

2001

.05

2001

.09

2002

.01

2002

.05

2002

.09

2003

.01

2003

.05

2003

.09

2004

.01

2004

.05

2004

.09

Selected Events TL/USD Exchange Rate TL/Euro Exchange Rate

During the last 27 months, nominal exchange rates do not show any tendency towards a sharp increase, as it has been observed in previous years.

Nominal Exchange Rates (TL/USD and Nominal Exchange Rates (TL/USD and TL/Euro)TL/Euro)


Note that annual growth rate of nominal USD exchange rates turned to negative values between May 2003 and April 2004.

Annual Changes in Nominal Exchange Rates (percent)

5.4

9.9

-30

-15

0

15

30

45

60

75

90

105

120

135

150

1998

.01

1998

.04

1998

.07

1998

.10

1999

.01

1999

.04

1999

.07

1999

.10

2000

.01

2000

.04

2000

.07

2000

.10

2001

.01

2001

.04

2001

.07

2001

.10

2002

.01

2002

.04

2002

.07

2002

.10

2003

.01

2003

.04

2003

.07

2003

.10

2004

.01

2004

.04

2004

.07

2004

.10

Selected Events TL/USD Exchange Rate TL/Euro Exchange Rate

Annual Changes in Nominal Exchange Rates Annual Changes in Nominal Exchange Rates (%)(%)


Following the 2000-2001 crisis, gross FX reserves of the Turkish Central Bank increased significantly.

They are now about 38 percent higher than the level of reserves prior to the crisis.

Central Bank's Gross Foreign Exchange Reserves (billion USD)

33.7

23.5

15

18

21

24

27

30

33

36

19

98

.01

19

98

.04

19

98

.07

19

98

.10

19

99

.01

19

99

.04

19

99

.07

19

99

.10

20

00

.01

20

00

.04

20

00

.07

20

00

.10

20

01

.01

20

01

.04

20

01

.07

20

01

.10

20

02

.01

20

02

.04

20

02

.07

20

02

.10

20

03

.01

20

03

.04

20

03

.07

20

03

.10

20

04

.01

20

04

.04

20

04

.07

20

04

.10

October 2000 level

Central Bank’s Gross FX Reserves (billion Central Bank’s Gross FX Reserves (billion USD)USD)


The increasing deficit in net exports of goods is eliminated by an increasing surplus in net exports of services, and hence the CAB deficits are declining since March 2004.

Current Account Balance: Selected Indicators (SIS, billion USD, monthly)

-2.3

0.4

0.1

-2.60

-1.95

-1.30

-0.65

0.00

0.65

1.30

19

98

.01

19

98

.05

19

98

.09

19

99

.01

19

99

.05

19

99

.09

20

00

.01

20

00

.05

20

00

.09

20

01

.01

20

01

.05

20

01

.09

20

02

.01

20

02

.05

20

02

.09

20

03

.01

20

03

.05

20

03

.09

20

04

.01

20

04

.05

20

04

.09

Selected Events Net Exports of Goods (billion TL)

Net Exports of Goods and Services (billion TL) Current Account Balance (billion TL)

Current Account Balance: Selected ItemsCurrent Account Balance: Selected Items(billion USD, monthly)(billion USD, monthly)


However, the cumulative BoP data shows that the recent improvements have not fully translated into the annual data yet.

In 2003, the CAB/GDP ratio amounted to -2.8%. However, it will possibly climb to -4% in 2004.

Current Account Balance: Selected Indicators (SIS, billion USD, cumulative)

-21.9

-9.8

-12.3

-24

-20

-16

-12

-8

-4

0

4

8

1998

.01

1998

.04

1998

.07

1998

.10

1999

.01

1999

.04

1999

.07

1999

.10

2000

.01

2000

.04

2000

.07

2000

.10

2001

.01

2001

.04

2001

.07

2001

.10

2002

.01

2002

.04

2002

.07

2002

.10

2003

.01

2003

.04

2003

.07

2003

.10

2004

.01

2004

.04

2004

.07

2004

.10

Selected Events Net Exports of Goods (billion TL)

Net Exports of Goods and Services (billion TL) Current Account Balance (billion TL)

Current Account Balance: Selected ItemsCurrent Account Balance: Selected Items(billion USD, as of12-monthly cumulative values)(billion USD, as of12-monthly cumulative values)


-12

-10

-8

-6

-4

-2

0

2

4

6

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Erratic Nature of Net Short-Term Capital Erratic Nature of Net Short-Term Capital Inflows (billion USD, annual data)Inflows (billion USD, annual data)

capitalcapitalaccountaccount

liberalizationliberalization



19941994crisiscrisis19941994crisiscrisis

2000-012000-01crisiscrisis

2000-012000-01crisiscrisis


One indication that Turkey’s policies are on the right track would be a return to positive short-term inflows at a steady and sustainable level. But a substantial increase in longer term capital inflows is not observed in Turkey.

Net Short-Term Capital Inflows (billion USD)Net Short-Term Capital Inflows (billion USD)

-14-12-10-8-6-4-202468

1986

.01

1987

.01

1988

.01

1989

.01

1990

.01

1991

.01

1992

.01

1993

.01

1994

.01

1995

.01

1996

.01

1997

.01

1998

.01

1999

.01

2000

.01

2001

.01

2002

.01

2003

.01

2004

.01

monthly 12-monthly






Short-term capital outflows that rose following the 2000-2001 financial crisis declined significantly after January 2002.

Net short-term capital inflows (in terms of cumulative data) are positive in 2004.

Net Short-Term Capital Inflows (billion USD)

2.6

5.45.4

-12.3

-15

-12

-9

-6

-3

0

3

6

1998

.01

1998

.04

1998

.07

1998

.10

1999

.01

1999

.04

1999

.07

1999

.10

2000

.01

2000

.04

2000

.07

2000

.10

2001

.01

2001

.04

2001

.07

2001

.10

2002

.01

2002

.04

2002

.07

2002

.10

2003

.01

2003

.04

2003

.07

2003

.10

2004

.01

2004

.04

2004

.07

2004

.10

Selected Events Monthly 12-monthly

Net Short-Term Capital Inflows (billion USD)Net Short-Term Capital Inflows (billion USD)


The volatility of the CAB to nominal industrial output is significantly lower than that of the net short-term capital inflows to output ratio.

Current Account Balance to Output & Net Short-Term Capital Inflows to Output(January 1999 = 1.0; as of 12-monthly cummulatives)

-2.8

2.11.0

-25

-20

-15

-10

-5

0

5

10

19

98

.01

19

98

.05

19

98

.09

19

99

.01

19

99

.05

19

99

.09

20

00

.01

20

00

.05

20

00

.09

20

01

.01

20

01

.05

20

01

.09

20

02

.01

20

02

.05

20

02

.09

20

03

.01

20

03

.05

20

03

.09

20

04

.01

20

04

.05

20

04

.09

Selected Events Current Account Balance to Output Net Short-Term Capital Inflows to Output

Ratios of CAB & Net Short-Term Capital Inflows to OutputRatios of CAB & Net Short-Term Capital Inflows to Output(January 1999 = 1.0 ; as of 12-monthly cumulative values)(January 1999 = 1.0 ; as of 12-monthly cumulative values)


Feb. '02

Aug. '97

Feb

. '01

Sep. '88

Feb. '87

Nov. '83

Aug. '82

May '80

Jun. '79

Dec. '82

Jan. '86

Nov. '90

No

v. '9

1

Oct. '93

Apr. '94

Oct. '94

Jul. '99

Oct

. '00

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jan-

79

Jan-

80

Jan-

81

Jan-

82

Jan-

83

Jan-

84

Jan-

85

Jan-

86

Jan-

87

Jan-

88

Jan-

89

Jan-

90

Jan-

91

Jan-

92

Jan-

93

Jan-

94

Jan-

95

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

High Fragility BSF3 BSF2

Banking Sector Fragility in TurkeyBanking Sector Fragility in TurkeyBanking Sector Fragility in TurkeyBanking Sector Fragility in Turkey

Turkish banking sector experienced difficulties many times within the last 25 years, as a result of their own excessive risk-taking behavior in the past.

(The BSF3 index is a weighted average of real annual changes in foreign liabilities,claims on private sector, and total deposits. The BSF2 then covers only the first two of them.) For Methodology: see Kibritçioğlu (2003), “Monitoring ...”.


Deposit Banks: Foreign Liabilities to Foreign Assets (percent)

708090

100110120130140150160

19

98

.01

19

98

.05

19

98

.09

19

99

.01

19

99

.05

19

99

.09

20

00

.01

20

00

.05

20

00

.09

20

01

.01

20

01

.05

20

01

.09

20

02

.01

20

02

.05

20

02

.09

20

03

.01

20

03

.05

20

03

.09

20

04

.01

20

04

.05

20

04

.09

The recent developments in the FL to FA ratio indicate that the external “open”, or “short”, position of the Turkish banking system is decreasing now...

Banking Sector Fragility in TurkeyBanking Sector Fragility in TurkeyBanking Sector Fragility in TurkeyBanking Sector Fragility in Turkey


Macroeconomic BackgroundMacroeconomic BackgroundMACROECONOMIC MACROECONOMIC

ENVIRONMENTENVIRONMENT(1978 – 2001)(1978 – 2001)

Political instability

Volatile economic growth

High and persistent inflation

Inflation-depreciation spiral

Strong currency substitution

Volatile short-term capital flows

Large current account deficits

Fragile banking sector

Public sector deficits

External shocks (oil prices, etc.)

Moral hazard problems

BANKING &BANKING &CURRENCYCURRENCYCRISESCRISES

January 1980

1982-1985

Early 1994

November 2000 – February 2001


Literature ReviewLiterature Review


InflationCrisis

StagnationCrisis

Crises in M arketsfor Goods and

Services

Crisis inLabor

M arket

Real Sector Crises

BankingCrisis

Balance ofPayments

Crisis

ExchangeRate

Crisis

CurrencyCrisis

Crisis inStock Exchange

Financial Crises

MacroeconomicCrises

General Definition:“An economic crisis occurs, if the price and/or quantity in the market for goods, services, assets or factors drastically changes.”

fixed exc. rate system

flexible exc. rate system


Currency Crisis

MarketSentiments

“Weak”

Macroeconomic

Fundamentals

International

Contagion

Effects

Unexpected

Events

“Weak” Financial

Structure

Moral Hazard

& Adverse

SelectionSpeculative

Attack& Herding Effect

Sharp

Depreciation

Loss of

Intern. Reserves

Sharp Increase

in Interest Rates


Main Channels of theMain Channels of theCurrency Crises Currency Crises (CCs) (CCs) LiteratureLiterature

Theoretical Models on Determinants of CC(Three Generations of CC Models)

International Contagion Effects

Timing, Possibility and Predictability of CCs

Recent CCs and the so-called “New Financial Architecture” Debate

Domestic Macroeconomic Effects of CCs and their Sectoral Diffusion Dynamics


Structural Models Non-Structural Models

Collapse Models

(Standard Econometric Approaches)

Probit and Logit Models

(Multivariate Approach)

Event Analysis (Parametric and Non-Parametric

Tests)

Signals Approach (Early Warning System

Approach)

Single-Country Analyses

Blanco and Garber (1986), Cumby and van

Wijnbergen (1989),

Goldberg (1994)

Schardax (2002: selected Central and

Eastern Europe countries), Muradoğlu

and Feridun (2004: Turkey)

Yap (1998: Philippines), Üçer et al. (1998: Turkey), Kibritçioğlu (2000: Turkey), Park (2002: Korea), El-Shazly (2002: Egypt), Tambunan (2002: Indonesia), Adiningsih et al. (2002: Indonesia), Edison (2003: Mexico), Plata and Schrooten (2003: Argentina)

Multi-Country Analyses

Edwards (1993), Klein and Marion (1994), Sachs,

Tornell and Velasco (1996)

Eichengreen, Rose and Wyplosz (1996),

Kaminsky ve Reinhart (1996), Frankel and

Rose (1996), Goldfajn and Valdes (1997a), Kruger, Osakwe and

Page (1998), Esquivel and Larrain (1998), Demirguc-Kunt and Detragiache (1999)

Eichengreen, Rose and

Wyplosz (1994, 1995)**, Moreno (1995), Frankel

and Rose (1996)

Kaminsky and Reinhart (1996), Kaminsky et al. (1998), Brüggemann

and Linne (2001, 2002)

Structural Models Non-Structural Models

Collapse Models

(Standard Econometric Approaches)

Probit and Logit Models

(Multivariate Approach)

Event Analysis (Parametric and Non-Parametric

Tests)

Signals Approach (Early Warning System

Approach)

Single-Country Analyses

Blanco and Garber (1986), Cumby and van

Wijnbergen (1989),

Goldberg (1994)

Schardax (2002: selected Central and

Eastern Europe countries), Muradoğlu

and Feridun (2004: Turkey)

Yap (1998: Philippines), Üçer et al. (1998: Turkey), Kibritçioğlu (2000: Turkey), Park (2002: Korea), El-Shazly (2002: Egypt), Tambunan (2002: Indonesia), Adiningsih et al. (2002: Indonesia), Edison (2003: Mexico), Plata and Schrooten (2003: Argentina)

Multi-Country Analyses

Edwards (1993), Klein and Marion (1994), Sachs,

Tornell and Velasco (1996)

Eichengreen, Rose and Wyplosz (1996),

Kaminsky ve Reinhart (1996), Frankel and

Rose (1996), Goldfajn and Valdes (1997a), Kruger, Osakwe and

Page (1998), Esquivel and Larrain (1998), Demirguc-Kunt and Detragiache (1999)

Eichengreen, Rose and

Wyplosz (1994, 1995)**, Moreno (1995), Frankel

and Rose (1996)

Kaminsky and Reinhart (1996), Kaminsky et al. (1998), Brüggemann

and Linne (2001, 2002)

A Classification of Selected Empirical A Classification of Selected Empirical StudiesStudies

of Currency Crisisof Currency Crisis

A Classification of Selected Empirical A Classification of Selected Empirical StudiesStudies

of Currency Crisisof Currency Crisis


Explanatory Variables to Predict CCsExplanatory Variables to Predict CCs(according to theoretical & empirical models)(according to theoretical & empirical models)

Explanatory Variables to Predict CCsExplanatory Variables to Predict CCs(according to theoretical & empirical models)(according to theoretical & empirical models)

government budget deficits to GDP excess real money balances real appreciation of the domestic currency terms-of-trade export and import growth current account deficits to GDP loss of international reserves of the central

bank foreign debt to exports real interest rates output growth stock prices domestic credits to GDP broad money supply (M2) to reserves stock prices and banking crises


Single-Country Studies for TurkeySingle-Country Studies for TurkeySingle-Country Studies for TurkeySingle-Country Studies for TurkeyÜçer Üçer et al.et al. (1998): (1998): signals approach.The ratio of short-term foreign debt to GNP, the ratio of exports to imports, the ratio of short-term advances to Treasury over GNP, and the ratio of M2Y plus government domestic debt to GNP have strong predictive power for the 1994 crisis in Turkey, rather than the indicators which take place in the study of Kaminsky et al. (1998).

Kibritçioğlu, B. (2000):Kibritçioğlu, B. (2000): signals approach; Feb. 1986 – Sep. 1999.The deviation of effective real exchange rate from its trend value, and as well as the exports to imports ratio, foreign trade balance to GDP ratio, current account balance to GDP ratio and the short-term capital movements to GDP ratio are among the major leading indicators of Turkish currency crises.

Muradoğlu & Feridun (2004):Muradoğlu & Feridun (2004): probit model; 1991-2000.Consumer price index, Turkish Lira/US dollar exchange rate, and domestic credit are the significant variables in explaining financial crises. Results of the out-of-sample tests indicate that the predictive power of the model is moderately high.

Mariano Mariano et al.et al. (2004): (2004): Markov switching financial vulnerability (Abiad, 2002); Feb. 1981 – Oct. 2002.Their experiments with monthly and weekly models indicate that “real exchange rate, foreign exchange reserves and domestic credit/deposit ratio are the most important determinants of financial vulnerability”.


Signals ApproachSignals Approachfor Turkey:for Turkey:Overview of the Overview of the

MethodologyMethodology


Signals ApproachSignals Approach Literature: Kaminsky and Reinhart (1996) and

Kaminsky et al. (1998)

The signals approach is based on monitoring the evolution of indicators that tend to show “unusual” behavior prior to currency crisis.

When an indicator exceeds (or falls below) a pre-determined threshold, then it is said to issue a “signal” that a currency crisis may occur within a given period, such as in 12, 18 or 24 months.

For this purpose, at first one should clearly define which periods should we call as crisis and what do we mean by saying unusual behavior of indicators.

One should also be specific about how many periods should be considered saying that “prior to crisis.”


Signals ApproachSignals Approachfor Turkey:for Turkey:

Identification of Crises Identification of Crises EpisodesEpisodes


Signals Approach: Signals Approach: Identification of Crises Episodes Identification of Crises Episodes (1)(1)

2

re

P r

rt

e

et

t

where et = (Et – Et-1)/Et-1 and rt = - (Rt – Rt-1)/Rt-1

E: nominal exchange rates (Turkish lira per US dollar)R: gross foreign exchange reserves of the Turkish central bank (USD)

The foreign exchange market pressure (P) index is defined as an average of monthly percentage changes in nominal exchange rates and the negative of monthly percentage changes in gross foreign exchange reserves of the Turkish central bank.

According to the equation above, the P index, and hence the pressure in the foreign exchange market, increases with the depreciation of Turkish currency and/or the decline in foreign exchange reserves.


Signals Approach:Signals Approach:Identification of Crises Episodes Identification of Crises Episodes (2)(2)

When the value of P exceeds this certain threshold value (TP), it means that the country has a currency crisis.The threshold value, in this study, is determined as the mean of the index (μP) plus 1.5 standard deviations (P):

TP = μP + 1.5 P

Then, a currency crisis (CC) can be observed when the P exceeds this threshold value:

CC = 1, if P TP

CC = 0, otherwise(Since the historic means are distorted in high-inflation periods, we define three sub-samples according to whether annual change in consumer prices is below 40 %, between 40 % - 80 %, or higher than 80 % and construct P for each sub-sample.)


Signals Approach:Signals Approach:Identification of Crises Episodes Identification of Crises Episodes (4)(4)

There are five major crisis periods to be considered in this study: (1) July 1988, (2) January 1991 and March 1991, (3) February 1994 to April 1994, (4) December 1995, and (5) February 2001 to April 2001 and June 2001.

In this study, we employ a 12-months window as signaling horizon, as it is also the case in many single-country studies in the literature. The gray-shaded areas above show the 12-months windows prior to individual crisis periods.

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

1986

.04

1986

.10

1987

.04

1987

.10

1988

.04

1988

.10

1989

.04

1989

.10

1990

.04

1990

.10

1991

.04

1991

.10

1992

.04

1992

.10

1993

.04

1993

.10

1994

.04

1994

.10

1995

.04

1995

.10

1996

.04

1996

.10

1997

.04

1997

.10

1998

.04

1998

.10

1999

.04

1999

.10

2000

.04

2000

.10

2001

.04

2001

.10

2002

.04

2002

.10

2003

.04

2003

.10

2004

.04

threshold (TP)

P index

window

1

window

2

window

3

window

4

window

5



Comparison of Individual Comparison of Individual Performances of Potential Performances of Potential

Leading IndicatorsLeading Indicators


Signals Approach: Signals Approach: Classification of Signals Classification of Signals SentSent

by an Early Warning Indicator by an Early Warning Indicator (1)(1) In the second stage of the signals approach, one should define

both (i) the specific thresholds for the indicators that are expected to send signals before currency crises, and (ii) the length of the signaling horizon in which the indicators would be expected to send a signal.

A signal, which is followed by a crisis within 12 months, is called a good signal, while a signal not followed by a crisis within 12 months is called a false signal or “noise”.

An individual indicator, on the other hand, is only accepted as sending a warning signal, when it goes beyond its own threshold value.

Kaminsky et al. (1998) define an optimal threshold as the one that minimizes the noise to signal ratio (NSR), which is obtained by dividing false signals as a share of possible false signals, by good signals as a share of possible good signals. In fact, this approach requires a classification of signals into four groups, as seen in the following table.



by an Early Warning Indicator by an Early Warning Indicator (2)(2)

An indicator is a perfect leading indicator, if it only has observations that belong either to cell A or to cell D.

Contrarily, an indicator, which has only observations of type B or C, would not be an early warning indicator of currency crises at all.

Realizations

Crisis

within 12 months

No crisis within 12 months

Total Observations

Signal issued

A B A+B

No signal issued

C D C+D

Total Observations

A+C B+D A+B+C+D


Practically, however, it is almost impossible to find an indicator, which sends solely good or bad signals. In terms of the four possible combinations defined in the table, there are various measures that are used in the literature to compare individual performances of possible crisis indicators in many respects:

A/(A+C)A/(A+B)B/(B+D)NSR = (B/(B+D)) / (A/(A+C))

By definition, the higher (lower) the first (last) two ratios are, the better is the performance of an indicator in preceding currency crises.



Realizations

Crisis

within 12 months

No crisis within 12 months

Total Observations

Signal issued

A B A+B

No signal issued

C D C+D

Total Observations

A+C B+D A+B+C+D



by an Early Warning Indicator by an Early Warning Indicator (4)(4)Another criterion to measure the performance of individual indicators is to compare the probability of crisis conditional on signal from an indicator with the unconditional probability of crises, which is the difference between P(crisis|signal) and P(crisis), namely A/(A+B) – [(A+C) /(A+B+C+D)].

To the extent that an indicator has useful information in predicting currency crises, the conditional probability would be higher than unconditional one. The indicator, on the other hand, whose conditional probability is higher than the unconditional probability, is also the one whose NSR values is less than unity.


In the literature, many economists also consider the average persistence of signals sent within the window period prior to crises. It is usually measured as “the number of good signals per crisis period”.

Finally, to evaluate the performances of indicators, one should also consider the average number of months prior to crisis the first good signal occurs because an indicator with lower NSR can only be a useful predictor of currency crises, if it typically sends warning signals as earlier as possible, to give governments sufficient time to take the necessary measures to attempt to prevent approaching crises.




By using monthly data for April 1986 – April 2004 (217 observations), 46 variables are examined to find out which of them were the best indicators of currency crises in Turkey in the past.Depending on the theoretical expectation about the sign of the relationship between an individual indicator and the P index, some variables send signals when they fall below their specified threshold, while others are assumed as sending signals when they exceed their own threshold. Notice that the cut-off value for an indicator is measured in percentile of the observations.In this study, to determine the variable-specific optimal threshold values, we employed one of the two grids of reference percentiles between 75 percent and 90 percent or 10 percent and 25 percent, depending on the direction of the expected change of P following a signal sent by the individual indicator.

Signals Approach:Signals Approach:Results for Individual Indicators Results for Individual Indicators (1)(1)


The following table provides the comparative information about the performance of these selected individual indicators.

In this table, the potential early warning indicators of currency crises are ranked according to their NSR’s.

The results show that, in general, foreign-trade and exchange-rate related indicators give the best results in sending early warning signals prior to currency crises.



Signals Approach: Signals Approach: Results for Individual Indicators Results for Individual Indicators (3)(3)

Expected Sign

Threshold (in percentile)

Good Signals as a Percentage of Possible Good

Signals, A/(A+C)

Bad Signals as a Percentage of Possible Bad

Signals, B/(B+D)

Noise to Signal Ratio (NSR),

[B/(B+D)]/ [A/(A+C)]

P(crisis | signal) = A/(A+B)

P(crisis| signal) – P(crisis ) = [A/(A+B)] –

[(A+C)/(A+B+C+D)]

Number of Months Prior to Crisis the First Good Signal

Occurs

S1 Exports to Imports Ratio (-) 0.10 30.65 1.39 0.05 90.48 60.38 8.6S2 Turkish Exporters' New Order Expectations (Up - Down) (-) 0.10 22.81 3.10 0.14 76.47 45.83 4.2S3 Deviation of Reuters' Real Exchange Rate Index from its Trend (-) 0.10 25.81 4.17 0.16 72.73 42.63 4.0S4 Deviation of SPO's Real Exchange Rate Index from its Trend (-) 0.17 40.32 7.64 0.19 69.44 39.35 6.8S5 Deviation of JPM's Real Exchange Rate Index from its Trend (-) 0.20 46.77 9.72 0.21 67.44 37.34 8.4S6 Real Interest Rate Differential (id-if) (-) 0.17 37.10 9.03 0.24 63.89 33.79 5.6S7 Trade Balance to Output Ratio (-) 0.10 20.97 5.56 0.26 61.90 31.81 5.0S8 Annual Increase in Crude-Oil Prices (+) 0.90 20.97 6.25 0.30 59.09 28.99 5.6S9 US 3-Month Treasury Bill Rates (+) 0.75 48.39 14.58 0.30 58.82 28.73 8.4S10 Nominal Interest Rate Differential (id-if) (-) 0.14 29.03 9.03 0.31 58.06 27.97 7.2S11 (Trade Balance + Short-Term Capital Inflow) / Output (-) 0.11 17.74 5.56 0.31 57.89 27.80 4.4S12 Monthly Increase in ISE 100 Index (-) 0.11 16.13 5.56 0.34 55.56 25.46 3.8S13 Monthly Growth in Central Bank's Gross Foreign Exchange Reserves (-) 0.10 11.29 4.17 0.37 53.85 23.75 3.2S14 CAB to Output Ratio (-) 0.15 25.81 10.42 0.40 51.61 21.52 6.0S15 Average Compound Auction Rates of the Treasury (-) 0.22 38.71 16.67 0.43 50.00 19.90 7.2S16 Crude-Oil Prices in USD/br (+) 0.89 19.35 8.33 0.43 50.00 19.90 3.2S17 Deposit Money Banks' Net Foreign Liabilities to Total Deposits (+) 0.90 14.52 6.94 0.48 47.37 17.27 2.0S18 Quarterly Change in Banking Sector Fragility Index (-) 0.25 40.32 19.44 0.48 47.17 17.07 8.2S19 Monthly Growth in Imports (+) 0.86 20.97 11.11 0.53 44.83 14.73 10.8S20 Short-Term Capital Inflows to Output (+) 0.78 33.87 18.75 0.55 43.75 13.65 10.4S21 Monthly Growth of Consolidated Budget Balance / Output (-) 0.11 16.13 9.03 0.56 43.48 13.38 6.4S22 Monthly Increase in Wholesale Price Index (+) 0.88 14.52 8.33 0.57 42.86 12.76 4.4S23 Monthly Increase in Consumer Price Index (+) 0.90 12.90 8.33 0.65 40.00 9.90 5.4S24 Monthly Change in M2 Multiplier (+) 0.90 12.90 8.33 0.65 40.00 9.90 5.0S25 Deposit Money Banks' Foreign Liabilities to For. Assets (+) 0.88 14.52 9.72 0.67 39.13 9.03 2.0S26 Deviation of Reuters' Real Exchange Rate Index from its Base-Year Value (-) 0.25 32.26 22.22 0.69 38.46 8.36 5.4S27 Ratio of Deposit Money Banks' Domestic Credits to Total Assets (+) 0.74 33.87 23.61 0.70 38.18 0.00 5.8S28 Monthly Growth in Exports (-) 0.10 12.90 9.03 0.70 38.10 8.00 7.4S29 M2 to CB's Gross FX Reserves (+) 0.85 19.35 13.89 0.72 37.50 7.40 2.4S30 Monthly Change in ICRG's Political Risk Index for Turkey (-) 0.15 17.74 13.08 0.74 39.29 6.99 7.4S31 Monthly Growth in Central Bank's Domestic Assets (+) 0.76 25.81 19.44 0.75 36.36 6.27 9.4S32 WPI to CPI Ratio (+) 0.90 12.90 9.72 0.75 36.36 6.27 2.4S33 Monthly Change in Foreign Exchange Deposits to M2 Ratio (-) 0.75 24.19 22.22 0.92 31.91 1.82 7.6S34 Monthly Growth in Deposit Money Banks' Real Total Domestic Credits (+) 0.75 25.81 24.31 0.94 31.37 1.28 9.8S35 Deposit Money Banks' Domestic Credits to Output (+) 0.81 19.35 18.75 0.97 30.77 0.67 2.4S36 Consolidated Budget Balance to Output (-) 0.21 20.97 20.83 0.99 30.23 0.14 8.8S37 Imports to Output Ratio (-) 0.17 16.13 17.36 1.08 28.57 -1.53 3.6S38 Monthly Growth in M1 (+) 0.77 19.35 22.92 1.18 26.67 -3.43 7.8S39 Real Monthly Growth of Banking Sector Credits to Private Sector (+) 0.76 19.35 25.00 1.29 25.00 -5.10 9.2S40 Timing of Government Changes (+) 0.00 4.84 6.25 1.29 25.00 -5.10 3.4S41 Timing of General Elections (+) 0.00 1.61 2.08 1.29 25.00 -5.10 1.6S42 Real Monthly Growth in Deposit Money Banks' Net Past Due Loans (+) 0.79 14.52 21.53 1.48 22.50 -7.60 8.2S43 Monthly Growth in M2 (+) 0.89 6.45 9.72 1.51 22.22 -7.87 3.4S44 Terms of Trade (-) 0.24 16.13 25.69 1.59 21.28 -8.82 4.6S45 Annual Growth in Manufacturing Production Index (+) 0.23 12.90 24.31 1.88 18.60 -11.49 5.2S46 Annual Growth in Ratio of M2 to Central Bank's Gross Foreign Exchange Reserves (+) 0.80 4.84 22.92 4.74 8.33 -21.76 2.0

Conditional Probability (weighted index) (+) 0.50 83.87 22.22 0.26 61.90 31.81 11.4

Potential Early Warning Indicators of Currency Crises


S1 Exports to Imports RatioS2 Turkish Exporters' New Order Expectations (Up - Down)S3 Deviation of Reuters' Real Exchange Rate Index from its TrendS4 Deviation of SPO's Real Exchange Rate Index from its TrendS5 Deviation of JPM's Real Exchange Rate Index from its TrendS6 Real Interest Rate Differential (id-if)S7 Trade Balance to Output RatioS8 Annual Increase in Crude-Oil PricesS9 US 3-Month Treasury Bill RatesS10 Nominal Interest Rate Differential (id-if)S11 (Trade Balance + Short-Term Capital Inflow) / OutputS12 Monthly Increase in ISE 100 Index S13 Monthly Growth in Central Bank's Gross Foreign Exchange ReservesS14 CAB to Output RatioS15 Average Compound Auction Rates of the TreasuryS16 Crude-Oil Prices in USD/brS17 Deposit Money Banks' Net Foreign Liabilities to Total DepositsS18 Quarterly Change in Banking Sector Fragility IndexS19 Monthly Growth in ImportsS20 Short-Term Capital Inflows to OutputS21 Monthly Growth of Consolidated Budget Balance / OutputS22 Monthly Increase in Wholesale Price IndexS23 Monthly Increase in Consumer Price Index


NSR<0.5NSR<0.5

NSR>0.5NSR>0.5


S24 Monthly Change in M2 MultiplierS25 Deposit Money Banks' Foreign Liabilities to For. AssetsS26 Deviation of Reuters' Real Exchange Rate Index from its Base-Year ValueS27 Ratio of Deposit Money Banks' Domestic Credits to Total AssetsS28 Monthly Growth in ExportsS29 M2 to CB's Gross FX ReservesS30 Monthly Change in ICRG's Political Risk Index for TurkeyS31 Monthly Growth in Central Bank's Domestic AssetsS32 WPI to CPI RatioS33 Monthly Change in Foreign Exchange Deposits to M2 RatioS34 Monthly Growth in Deposit Money Banks' Real Total Domestic CreditsS35 Deposit Money Banks' Domestic Credits to OutputS36 Consolidated Budget Balance to OutputS37 Imports to Output RatioS38 Monthly Growth in M1S39 Real Monthly Growth of Banking Sector Credits to Private SectorS40 Timing of Government ChangesS41 Timing of General ElectionsS42 Real Monthly Growth in Deposit Money Banks' Net Past Due LoansS43 Monthly Growth in M2S44 Terms of TradeS45 Annual Growth in Manufacturing Production IndexS46 Annual Growth in Ratio of M2 to Central Bank's Gross Foreign Exchange Reserves


Political variables do not perform very well.Political variables do not perform very well.

NSR<1NSR<1

NSR>1NSR>1



Threshold (in

percentile)

Noise to Signal Ratio

(NSR)

Number of Months Prior to Crisis the First Good Signal

Occurs

Persistence of Signals per

Crisis Period (in months)

S1 Exports to Imports Ratio 0.10 0.05 8.6 3.8S2 Turkish Exporters' New Order Expectations (Up - Down) 0.10 0.14 4.2 2.4S3 Deviation of Reuters' Real Exchange Rate Index from its Trend 0.10 0.16 4.0 3.2S4 Deviation of SPO's Real Exchange Rate Index from its Trend 0.17 0.19 6.8 5.0S5 Deviation of JPM's Real Exchange Rate Index from its Trend 0.20 0.21 8.4 5.6S6 Real Interest Rate Differential (id-if) 0.17 0.24 5.6 4.6S7 Trade Balance to Output Ratio 0.10 0.26 5.0 2.6S8 Annual Increase in Crude-Oil Prices 0.90 0.30 5.6 2.6S9 US 3-Month Treasury Bill Rates 0.75 0.30 8.4 5.8S10 Nominal Interest Rate Differential (id-if) 0.14 0.31 7.2 3.6S11 (Trade Balance + Short-Term Capital Inflow) / Output 0.11 0.31 4.4 2.0S12 Monthly Increase in ISE 100 Index 0.11 0.34 3.8 2.0S13 Monthly Growth in Central Bank's Gross Foreign Exchange Reserves 0.10 0.37 3.2 1.2S14 CAB to Output Ratio 0.15 0.40 6.0 3.2S15 Average Compound Auction Rates of the Treasury 0.22 0.43 7.2 4.8S16 Crude-Oil Prices in USD/br 0.89 0.43 3.2 2.4S17 Deposit Money Banks' Net Foreign Liabilities to Total Deposits 0.90 0.48 2.0 1.8S18 Quarterly Change in Banking Sector Fragility Index 0.25 0.48 8.2 4.8S19 Monthly Growth in Imports 0.86 0.53 10.8 2.4S20 Short-Term Capital Inflows to Output 0.78 0.55 10.4 4.2S21 Monthly Growth of Consolidated Budget Balance / Output 0.11 0.56 6.4 2.0S22 Monthly Increase in Wholesale Price Index 0.88 0.57 4.4 1.6S23 Monthly Increase in Consumer Price Index 0.90 0.65 5.4 1.6S24 Monthly Change in M2 Multiplier 0.90 0.65 5.0 1.2S25 Deposit Money Banks' Foreign Liabilities to For. Assets 0.88 0.67 2.0 1.8

Potential Early Warning Indicators of Currency Crises


The results show that, in general, foreign-trade and

exchange-rate related indicators give the best results

in sending early warning signals prior to currency crises:

a falling ratio of export-revenues to import-payments below 56 percent (S1),

a sharp worsening in order-expectations of Turkish exporters (S2),

a significant (more than 6.8%) real appreciation of the Turkish lira against foreign currencies (S3, S4 and S5), and

a real interest rate differential more than –5.1 percent (S6)



Signals Approach:Signals Approach:FX Market Pressure Index and CCsFX Market Pressure Index and CCs

FX Market Pressure Index (P) before and after CCs in Turkey

-4

-2

0

2

4

6

8

-24-22-20-18-16-14-12-10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24

Pre-Crisis Window

before July 1988crisis

before Jan. 1991crisis

before Feb. 1994crisis

before Dec. 1995crisis


cri

sis

pre-crisis window


Exports to Imports Ratio (S1) before CCs in Turkey

0.35

0.45

0.55

0.65

0.75

0.85

0.95

1.05

-24-22-20-18-16-14-12-10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24

Pre-CrisisWindow






Threshold = 0.56

cri

sis

pre-crisis window

Signals Approach:Signals Approach:Best Three Individual Performers Best Three Individual Performers (1)(1)



Order Expectations of Exporters (S2) before CCs in Turkey

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35

-24-22-20-18-16-14-12-10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24

Pre-CrisisWindow






Threshold = -6.2

cri

sispre-crisis window


S2 that represents the order expectations of Turkish exporters is defined as the difference between the share of exporters who expect an increase in foreign orders for coming months and that of the exporters who expect a fall.

It is calculated from the Turkish Central Bank’s survey data on the amount of new orders received from the exports market (trend of the next 3 months, excluding seasonal variations).

The 10-percentile threshold for S2 corresponds a difference of –6.2, which means that the order falls exceeds the order increases.




Real Exchange Rate Misalignment (S3) before CCs in Turkey

-15

-10

-5

0

5

10

15

20

25

30

-24-22-20-18-16-14-12-10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24

Pre-CrisisWindow






Threshold = -6.8

cri

sis

pre-crisis window



Composite Leading Composite Leading Indicators and Estimation Indicators and Estimation

of Crisis Probabilitiesof Crisis Probabilities


We construct a weighted composite leading indicator (C) by using 15 of the best performing leading indicators, which are:

S1 Exports to Imports RatioS2 Turkish Exporters' New Order Expectations (Up - Down)S5 Deviation of JPM's Real Exchange Rate Index from its TrendS6 Real Interest Rate Differential (id-if)S7 Trade Balance to Output RatioS8 Annual Increase in Crude-Oil PricesS12 Monthly Increase in ISE 100 Index S13 Monthly Growth in Central Bank's Gross FX ReservesS18 Quarterly Change in Banking Sector Fragility IndexS20 Short-Term Capital Inflows to OutputS21 Monthly Growth of Consolidated Budget Balance / OutputS22 Monthly Increase in Wholesale Price IndexS23 Monthly Increase in Consumer Price IndexS24 Monthly Change in M2 MultiplierS33 Monthly Change in Foreign Exchange Deposits to M2 Ratio

Note: For weighting of Ss, the inverses of NSRs of individual indicators are used.

Signals Approach:Signals Approach:Construction of a Composite Leading Construction of a Composite Leading

IndicatorIndicator


Signals Approach:Signals Approach:A Composite Leading Indicator (C) for A Composite Leading Indicator (C) for

TurkeyTurkey

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1986

.04

1986

.10

1987

.04

1987

.10

1988

.04

1988

.10

1989

.04

1989

.10

1990

.04

1990

.10

1991

.04

1991

.10

1992

.04

1992

.10

1993

.04

1993

.10

1994

.04

1994

.10

1995

.04

1995

.10

1996

.04

1996

.10

1997

.04

1997

.10

1998

.04

1998

.10

1999

.04

1999

.10

2000

.04

2000

.10

2001

.04

2001

.10

2002

.04

2002

.10

2003

.04

2003

.10

2004

.04

window

1

window

2

window

3

window

4

window

5


Signals Approach:Signals Approach:Composite Leading Indicator and CCs in Composite Leading Indicator and CCs in

TurkeyTurkeyWeighted Composite Index (C) before CCs in Turkey

0.0

0.2

0.4

0.6

0.8

1.0

-24-22-20-18-16-14-12-10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24

Pre-Crisis Window






cri

sispre-crisis window


Signals Approach:Signals Approach:Probabilities of Currency Crisis EstimatedProbabilities of Currency Crisis Estimated(based on Weighted Composite Leading Indicator)(based on Weighted Composite Leading Indicator)

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

19

86

.04

19

86

.10

19

87

.04

19

87

.10

19

88

.04

19

88

.10

19

89

.04

19

89

.10

19

90

.04

19

90

.10

19

91

.04

19

91

.10

19

92

.04

19

92

.10

19

93

.04

19

93

.10

19

94

.04

19

94

.10

19

95

.04

19

95

.10

19

96

.04

19

96

.10

19

97

.04

19

97

.10

19

98

.04

19

98

.10

19

99

.04

19

99

.10

20

00

.04

20

00

.10

20

01

.04

20

01

.10

20

02

.04

20

02

.10

20

03

.04

20

03

.10

20

04

.04

window

1

window

2

window

3

window

4

window

5

To evaluate the overall performance of the model we used several statistical tests,such as quadratic probability score test, LPS, GBS, and unconditional probability indicators.


As it is almost always the case in economics, there are no easy solutions for difficult problems.

For the predictability of currency crises (CCs), this implies that it is almost impossible to explain and predict these events without considering the role of history and non-economic factors, such as cultural factors.

For governments, however, it is highly crucial to have an early warning mechanism that can be used for informative purposes, although building a reliable early warning system to detect possible CCs is a very challenging task.

Concluding RemarksConcluding Remarks (1)(1)Concluding RemarksConcluding Remarks (1)(1)


This study attempted to construct an EWS à la Kaminsky, Lizondo and Reinhart. It has a pioneering nature within the existing literature on Turkey, because it is probably the first, Turkey-specific, single country study which has a very broad sample period and a long list of potential leading indicators of CCs for Turkey.

The EWS built here show that, in general, foreign-trade and exchange-rate related indicators produce the best results in sending early warning signals prior to currency crises.

For Turkey, we need further empirical investigation to compare the results of the signals approach employed here with that of the achieved/achievable within the logit/probit framework and/or newly developed Markov-switching techniques.

Concluding RemarksConcluding Remarks (2)(2)Concluding RemarksConcluding Remarks (2)(2)


AppendixAppendix::Banking Sector Banking Sector

FragilityFragilityKibritçioğlu, A. (2003): “Monitoring Banking Sector Fragility”.

Arab Bank Review (Jordan), 5(2): 51-66.PDF: http://econwpa.wustl.edu:8089/eps/mac/papers/0312/0312011.pdf


Bank Runs

Credit Booms => increase in NPLs

Uncovered incr. in Foreign Liabilities

LiquidityRisk

CreditRisk

ExchangeRisk

Devaluations

Possible EventsPossible EventsMajor TypesMajor Types

of Risksof Risks

Fragility Increase

Decr. In Risk

Banking Crisis

Government Intervention?

Incr. in Risk

RiskRisk-Taking Behavior-Taking Behavior, , FragilityFragilityand Crises in Bankingand Crises in Banking


Valueof the

BSFIndex

Time

0

- 0.5

BSF Index

Phase 1 Phase

2

Phase 4 Phase

5

Phase

3

Banking Sector Banking Sector Fragility Index Fragility Index

and the Five and the Five Stages of Stages of FragilityFragility

Kibritcioglu (2003):“The BSF3 index is a

weighted average of real annual changes in foreign

liabilities, claims on private sector, and total

deposits.”


Changes in the BSF Index and the Five PhasesChanges in the BSF Index and the Five Phasesof a Hypothetical Banking Crisisof a Hypothetical Banking Crisis

Banks’

Behaviour

Direction of the Change in the

BSF Index

Banking Fragility

Probability of Approaching

Banking Crisis

Phase 1

excessively risk taking

increases significantly above zero

falls * (optimistic, or boom,

phase)

the probability starts to increase *

Phase 2

generally risk avoiding

suddenly begins to decrease

starts to increase

it increases furthermore (probably

panic arises)

Phase 3

risk avoiding falls below zero (but it’s still above –0.5)

increases significantly (medium fragility)

system is approaching the

borderline to crisis

Phase 4

risk avoiding falls below –0.5 continues to

increase (high fragility)

most probably, a crisis occurs in this

phase

Phase 5

gradually they start to take risk again

increases towards zero **

falls again (recovery period)

crisis is over if the BSF is very close or equal to zero again


Different Results about Timing of Different Results about Timing of Banking Crises in TurkeyBanking Crises in Turkey

Kibritçioğlu(2003)

Beginning of the Crisis

Peak of the Crisis Beginning of

the Distress

Date of Highest Fragility

Episode of High Fragility (if applicable)

July 1979 May 1980 Jan. 1979 - Nov. 1980 1982-1985 1982 1982 1982-1985 1982 Sep. 1982 Nov. 1983 medium fragility

Mar. 1987 Sep. 1988 Apr. 1988 - Oct. 1989 1991 1991 Jan. 1991 Mar. 1991 1991 Dec. 1990 Nov. 1991 Nov. 1991 - Mar. 1992

1994* 1994** 1994-1995 1994-1995 Nov. 1993 Oct. 1994 Apr. 1994 - Apr. 1995 Sep. 1997 July 1999 Mar. 1999 - Mar. 2000

2000-present Nov. 2000 Feb. 2002 June 2001 - Dec. 2002

Current Study (the BSF2, or BSF2*, index)Kaminsky and Reinhart

(1996 and 1999)Glick and Hutchison

(2000)

Bordo and Eichengreen

(2002)

Caprio and Klingebiel

(1996, 1999, 2002 and 2003)

Lindgren, Garcia and Saal (1996)

Hardy and Pazarbaşıoğlu

(1998)

Demirgüç-Kunt and

Detragiache (1997 and

1998)

Kibritçioğlu, A. (2003): “Monitoring Banking Sector Fragility”. Arab Bank Review (Jordan), 5(2): 51-66.PDF: http://econwpa.wustl.edu:8089/eps/mac/papers/0312/0312011.pdf

Documents

Kibritçioğlu, November 8, 2004, (1/79) An Analysis of Early Warning Signals of Currency Crises in Turkey, 1986-2004 Aykut Kibritçioğlu Associate Professor